Fed Chair Powell Makes the Case for Stimulus
February 25, 2021
By J.W. Mason
In congressional testimony this week, Federal Reserve Chair Jerome Powell aggressively challenged macroeconomic conventional wisdom in ways that strengthen the case for a major rescue package like the one making its way through Congress.
Powell made three key arguments:
- First, the public debt should not be a factor in determining the scale of stimulus and relief spending today.
- Second, rising inequality is a macroeconomic problem.
- And third, the official unemployment rate does not reflect the full amount of unused capacity in the economy.
Historically, the Fed has had a well-deserved reputation for throwing cold water on any program for increased public spending. Fed Chair Alan Greenspan, for instance, famously warned President Bill Clinton that if Clinton followed through with his proposed public investment program, he’d be punished with higher interest rates; instead, Greenspan told Clinton he’d better pursue deficit reduction.
But under now–Treasury Secretary Janet Yellen’s leadership, from 2014 to 2018, the Fed began to move away from its traditional single-minded focus on inflation control and its support for austerity—a shift that has accelerated under Powell.
A lifelong Republican and professional banker appointed by Donald Trump is not the background you’d expect for someone turning the Fed into an advocate of more public spending and less worry about debt or inflation. But that’s exactly what’s happened, as his congressional testimony this week confirmed.
Let’s examine each of his major arguments in turn.
Now is not the time to worry about federal debt.
Powell resisted several senators’ attempts to get him to express concerns about the public debt. After gently explaining to Sen. John Neely Kennedy (R-LA) the difference between the debt and the deficit, Powell said:
I think that we will need to get back on a sustainable fiscal path, and the way that has worked when it’s successful is you just get the economy growing faster than the debt. I think that we’re going to need to do that, and that’s going to need to happen, but it doesn’t need to happen now. Now is the wrong time to be doing that.
Powell made two critical points here.
First, economic sustainability is not about the level of debt per se, but about the growth of the debt relative to GDP. Faster growth is just as much a route to fiscal sustainability as is lower spending. In fact, in most historical periods where the debt-GDP ratio has come down, it’s because the country grew out of the debt rather than paying it off.
Second, whatever we think may happen to the federal debt down the road, now—amid a pandemic and economic crisis—is not the time to worry about it.
It’s worth noting that Powell’s language is even stronger than it was before the pandemic. While he’s always rejected the idea that the federal debt posed any immediate danger, he used to allow that there might be some costs to a higher debt ratio. This time, he didn’t offer fiscal hawks even that lifeline.
Faster growth contributes to income equality, and vice versa.
Powell’s testimony is the latest reminder of how much the inequality conversation has shifted. Not so long ago, the dominant economic view was that income distribution was not something that either monetary policy or fiscal stimulus could do anything about. Nor was it a source of other macroeconomic problems; we might prefer to live in a more equal world, most economists thought, but that had to be traded off against the costs of redistribution.
In his testimony this week, Powell offered far-reaching criticism of the old orthodoxy that inequality is outside the scope of macroeconomics.
First, he rejected, as he has previously, the idea that income simply reflects people’s innate capabilities. In a weak labor market, where unemployment is high, the same worker doing the same job receives a lower wage than they would in a strong labor market, where businesses have to scramble to fill every job opening. This is true not only because workers’ bargaining position is stronger when there are fewer people looking for work, but because businesses only make a serious effort at training when labor is scarce. As Powell testified, “when unemployment was routinely below 4 percent, as low as 3.5 percent . . . we saw lots of virtuous effects in the labor market . . . One of them was, you saw employers investing more in training.”
He also rejected the notion that the goals of equality and growth necessarily conflict. In many cases, efforts to reduce inequality may also contribute to growth. Sen. Elizabeth Warren (D-MA) put the question to him directly:
You’ve talked a lot about how inequality undermines opportunity and mobility, and you’ve described it as something that holds our economy back. So I take it from these comments that you believe that inequality weighs our economy down and stunts economic growth. Is that a fair statement?
Powell’s reply: “Yes, it is.”
Full employment means more than a return to the pre-pandemic economy.
Third, and perhaps most important for current debates, Powell was clear that the US is very far from “overheating,” that is, from meaningful supply constraints that could trigger inflation.
The Fed’s legal mandate includes maximum employment and price stability. The Fed has never formalized the former goal into an exact target. But historically, it has most often used the official unemployment rate as its preferred indicator of how close the US economy is to full employment.
So it’s notable that in this week’s testimony—as in a number of earlier remarks—Powell decisively rejected the idea that the official unemployment rate is a guide to the state of the labor market. “When we say maximum employment,” he said, “we don’t just mean the unemployment rate. We mean employment rate as a percentage of the population, which takes high levels of participation. We look at wages.”
As he points out, the question of who can or who wants to engage in paid work depends on how hard employers are looking. “When unemployment was low over the last few years, labor force participation moved up despite lots of predictions that it wouldn’t . . . Employers were going to prisons, getting to know people before they came out, and giving them jobs as they came out.”
It’s a big deal that Powell seemed to agree with progressive economists, including those at Roosevelt, who have long argued the employment-population ratio is a better guide to the state of the labor market than the headline unemployment rate.
It’s especially important because prior to the pandemic, the official unemployment rate was back at the level of the late 1990s—the last truly strong labor market in US history—while the prime-age employment-population ratio was still 1.5 points short of it. If the true amount of labor-market slack at the end of 2019 was much larger than the official measures suggest, that implies that we are much farther from full employment than people think, and that the need for public spending to raise demand is much greater.
Powell discussed these issues in more detail in a speech earlier this month, arguing that the recovery in labor force participation rates in the few years before the pandemic effectively refuted claims that the earlier decline in US labor force participation was due to technology, demographics, or other structural factors, and not just weak demand.
Furthermore, despite the low headline unemployment rate in 2019, there was only modest—though welcome—acceleration in wage growth, and no upward pressure on inflation. The US economy was not experiencing full employment in any meaningful sense immediately before the pandemic. So people who use pre-pandemic employment levels as the benchmark for how much stimulus is needed now are aiming much too low. They are not only giving up on the possibilities of faster growth; they are ignoring the potential for tight labor markets that would reduce income inequality and the racial wage gap.
Powell did not spell this argument out as fully in this week’s hearings as he has in the past, but everything he said was consistent with it. In probably his most direct answer on the topic, he said, “We think there is significant ground that needs to be covered before we get to full employment.”
Along the same lines, Powell stressed that inflation should not be a concern for public spending today: “. . . that is not a problem for this time, as near as I can figure. And if it does turn out to be, we have the tools that we need.”
If you support a federal relief bill on the scale of the American Rescue Plan or larger, you should be encouraged to find that the Fed chair is on your side. If you’re a deficit hawk looking for an authority figure to validate your fears, I’m afraid you will have to look elsewhere.