Federal Reserve Chairman Powell Resets the Debate on Monetary Policy

July 25, 2019

On July 9 and 10, Federal Reserve Chair Jerome Powell testified before Congress regarding the Fed’s conduct of monetary policy. Both his prepared testimony and his responses to legislators’ pointed questioning marked a dramatic departure from the consensus that has long guided macroeconomic policy in the United States. When historians write the story of American economic policy in the early 21st century, they may highlight Powell’s 2019 testimony as a key turning point.

In this rapid-response issue brief, I highlight the parts of Powell’s testimony that marked a clear break with the conventional wisdom on macroeconomic policy. For a broader discussion of monetary policy and the role of the Fed, see this 2017 report, written by me and Mike Konczal.

In his testimony, Powell made six claims that sharply contrast with the orthodox view.

  1. The US economy is not operating at potential. While many interpret an unemployment rate below 4 percent as a clear sign that the economy has reached or passed full employment, Powell rejected this view. He argued that in the absence of faster wage growth, “we don’t have any basis for calling this a hot labor market.”
  2. Low unemployment does not necessarily lead to higher inflation. For decades, macroeconomic policy has been guided by the idea of the “Phillips curve,” which says that when unemployment gets lower, inflation will pick up. But during questioning by Rep. Alexandria Ocasio-Cortez (D-NY), Powell admitted that the Fed had been “absolutely” wrong to think that low unemployment would lead to higher inflation, and that the relationship between the two variables is at best “a very faint heartbeat,” if it has not disappeared altogether.
  3. The central bank cannot stabilize demand by itself. In textbook macroeconomics, all that is needed to avoid deep recessions is for the central bank to set the interest rate at the right level. But under question from Rep. Rashida Tlaib (D-MI), Powell said that the Fed could not be counted on to maintain full employment on its own. If there is another severe recession, he said, the Fed would need “support from fiscal policy” to respond to it.
  4. High government debt is not as dangerous as people think. Powell did not entirely dismiss concerns over government debt, but he suggested that they have been greatly exaggerated. Today’s combination of relatively high government debt and ultra-low interest rates would, he suggested, be surprising to “my predecessors who predicted that more debt would lead to higher interest rates… With the debt we have, we still borrow at very low interest rates.”
  5. Monetary policy affects the distribution of income. Under previous chairs, Fed officials have repeatedly said that while rising inequality might be a problem, it wasn’t something the Fed could do anything about. Powell, however, highlighted rising inequality as something the Fed should do a better job addressing. And he specifically linked stagnant wages, especially at the lower end of the distribution, over the past two decades to weak labor markets, as opposed to the conventional culprits of technology and trade.
  6. The size of the labor force depends on the state of the labor market. On several occasions, Powell rejected the idea that businesses are unable to find enough workers. Despite low unemployment, he argued, there is no labor scarcity, because relatively strong labor market conditions bring new people into the labor force. This is a departure of the orthodox view that the size of the laborforce depends on demography and other structural factors, and it suggests that monetary policy—and demand conditions in general—can affect long-term economic growth and not just short-term fluctuations.

To an outsider, these claims may not seem so radical. However, Powell’s statements are a dramatic departure from the conventional wisdom that has guided macroeconomic policy in the US since the 1980s—and they have far-reaching implications. If Powell’s claims are taken seriously, they suggest that the idea of an independent, apolitical Fed is not sustainable, and that monetary policy needs to be a subject of democratic debate.