Jacquelyn Martin/AP Photo
Federal Reserve Chairman Jerome Powell attends a panel at the Federal Reserve Board Building, October 4, 2019, in Washington.
This story is part of the Prospect’s series on how the next president can make progress without new legislation. Read all of our Day One Agenda articles here.
Despite having three congressionally mandated goals—“maximum employment, stable prices, and moderate long-term interest rates”—in practice, the Federal Reserve has a single target. Since 2012, the Federal Reserve has aimed for 2 percent inflation. Unlike almost all its peers in the developed world, the Fed chose this target for itself. There was no legislation passed or executive order issued.
A future president could appoint individuals to the Federal Reserve who unilaterally change that target. In addition to the possibility that a more labor-friendly framework might better accommodate and even encourage broad-based wage gains, a framework that paid attention to both labor market and inflation outcomes would arguably be more consistent with the legislation that gave the Federal Reserve its current mandates.
The movement to implement inflation targets was inspired by the high inflation of the 1970s and ’80s. Even after inflation fell, central bankers stayed committed to preventing a zombie rush of price increases. “The ’70s” and “the Great Inflation” became synonymous with the disaster that needed to be prevented.
In the meantime, the world changed. Inflation shrank globally. In the developed world, inflation and interest rates are now universally low. Today, the New York Federal Reserve president says that low inflation is “the problem of this era.” This is a bit of a funny notion: Most people generally like lower prices. It’s the sort of statement that flows from an excessively narrow focus on the 2 percent inflation target. The Fed should think more broadly.
Specifically, the Fed should aim for better labor market outcomes. On almost every dimension, the American worker has had a tough go since the “Volcker shock” that finally slayed high inflation in 1982. Median wages are sluggish, labor share of income has declined, and unemployment has been high—even compared to the Fed’s conservative “natural rate of unemployment” estimate. Perhaps most importantly, the last three recessions have been followed by “jobless recoveries,” each worse than the one before.
In September 2009, the Fed staff outlined seven different scenarios for the future path of unemployment. All of the projections were too optimistic. It took almost a decade to return to 4.5 percent unemployment, the top range that Federal Reserve officials consider to be the long-run normal rate for the economy (that was also wrong; we’re at 3.5 percent today).
To their credit, Chair Jay Powell and Vice Chair Richard Clarida seem to recognize that more improvement is needed. Clarida often talks about labor’s low share of income and the fact that labor participation rates for prime-age Americans (those ages 25–54) are still below where they were in 2007. Powell goes even further. At his most recent congressional hearing, Representative Alexandria Ocasio-Cortez asked, “Do you think it’s possible that the Fed’s estimates of the lowest sustainable unemployment rate may have been too high?” Powell responded, “Absolutely.” He went on to say, “We don’t have any basis or any evidence for calling this a hot labor market … We haven’t seen wages moving up as sharply as they have in the past … To call something hot, you need to see some heat.”
But despite this rhetoric, the Powell Fed doesn’t seem poised to do anything new. The policymaking committee still estimates that unemployment is too low and that it will have to move up over the coming years. And officials seem poised to tweak the inflation target next year, but not fundamentally rethink its strategy in a world of low inflation and meager gains for workers.
This gives the next president a great opportunity. Powell’s term as chair ends in February 2022. Vice Chair Clarida’s entire term ends a month before then. And Vice Chair for Supervision Randal Quarles’s term in charge of bank regulatory policy at the Fed ends in October 2021. If a few members of the Fed’s Board of Governors retire early (as has been the case in recent years), the next president may be able to appoint the full slate of seven governors in his or her first term.
There are many important ways these nominees could change the Federal Reserve’s framework. They could set a baseline target for wages, growth, or labor force participation. Our preferred approach would commit the Federal Reserve to put a floor under the growth rate for gross labor income, which is the sum of everyone’s paychecks. If gross labor income grew under this floor (say 4.5 percent), the Fed would work to juice economic activity. If income was expected to grow at a robust pace above the floor, then the Fed could prioritize its inflation target.
Whatever the precise mechanics, the key point is that the Fed keep an eye toward labor market progress alongside containing high inflation, recognizing the deep and avoidable cost to workers when it has failed to do so. And the president has a role to play here, not just in appointing like-minded board members, but in encouraging a more labor-friendly approach.
In his memoir, former Fed Chair Ben Bernanke wrote that he consulted President Obama and congressional leadership about the possibility of announcing an inflation target. According to Bernanke, Obama “told me that the Fed should do what it believed necessary.” The next president should have a clearer vision for shaking up Fed orthodoxy. All the candidates are promising better outcomes for workers, but that job will be exceedingly difficult if the next Fed chair isn’t rowing in the same direction. We can have a Federal Reserve aiming for more jobs, higher wages, and a bigger slice of the pie for labor.
