Progressives widely praised Federal Reserve Chair Jerome Powell last year for a historic shift in policy when he pledged to keep interest rates near zero until the economic recovery was felt by most Americans.
Now, surging inflation could place that promise in jeopardy before it has barely taken hold.
Price spikes are reaching 30-year highs, and if they don’t ease, the Fed might start to pull back its support for the labor market before the economy reaches a point where anyone who wants a job can get one.
Powell, newly nominated by President Joe Biden for a second term, would disappoint many progressives and Fed watchers if he chooses to curb the central bank’s efforts to boost the economy. But pressure will also grow more intense for the Fed to raise interest rates if price increases continue.
“The big challenges facing the Fed chair are: figuring out the nature of this inflation and this moment in the economy — and then carrying out a plan in the face of a lot of yelling,” said Austan Goolsbee, a University of Chicago professor who was a top economic adviser to President Barack Obama.
In the last week, some prominent, moderate Democrats have called on the Fed to speed up its efforts to scale back its vast bond-buying program, which is intended to keep borrowing costs down, and consider raising rates faster than it’s planning to.
“The central bank should express a more realistic understanding of inflation and firm up monetary policy by tapering its asset purchases more quickly,” Jason Furman, a Harvard professor who chaired Obama’s Council of Economic Advisers, wrote in The Wall Street Journal. “They have a dual mandate. They have to take inflation into account even if the economy isn’t yet at maximum employment.”
Steven Rattner, also a former Obama official, wrote that, for the Fed, “addressing inflation will mean raising interest rates, perhaps sooner than it thinks necessary.”
But a senior White House official underscored the importance of the Fed’s commitment to getting the economy to full employment, saying that stance played a significant role in Biden’s decision to renominate Powell, though the administration stresses the central bank’s political independence.
“A year ago, forecasters were saying that it would take us another two years to get to an unemployment rate of 4.6 percent,” the official said. “Here we are, and it is because of the combined power of fiscal and monetary policy.”
The Fed’s willingness to be patient in the face of aggressive price increases is a tangible shift from how the central bank typically reacted in previous decades. Policymakers often jacked up interest rates at the first sign of accelerating inflation, with price stability trumping full employment as a central bank goal. That policy hit lower-income Americans the hardest.
Powell’s actions on this front are part of what led him — a Republican and former private equity investor — to secure the backing of some prominent progressives such as former Labor Secretary Robert Reich and Rep. Pramila Jayapal (D-Wash.), who heads the Congressional Progressive Caucus.
Yet the situation the Fed finds itself in is different from the one it was expecting when it adopted the new policy in August 2020 of pursuing “broad and inclusive employment.” As part of that policy, the central bank said it would actually seek slightly higher inflation in pursuit of so-called maximum employment, a move enthusiastically greeted by activists who had long pushed the Fed to heed the needs of lower-income people.
The inflation plaguing the economy today has stemmed more from supply chain bottlenecks than the kind of healthy labor market dynamics — where employers bid up wages because so many people are already employed — that the Fed was envisioning.
Wages are rising, but millions of people who had jobs before the pandemic are out of work, with some held back by a lack of child care or fear of returning to public-facing occupations while the pandemic still rages. The question now is how many of them will return before the Fed feels like it has to raise rates in response to inflation.
“Because inflation has become the main worry, they’re less willing to test the limits of maximum employment,” said Derek Tang, an economist at Monetary Policy Analytics.
That has some progressive groups on edge. The Fed Up Campaign, a coalition of labor and community groups that has been critical of the central bank’s past attempts to preempt inflation, urged the Fed to not lose sight of its employment goals.
“Working people need the Fed to continue pro-employment, pro-wage growth, pro-racial justice macroeconomic policies for as long as economic conditions allow,” the group said in a statement after Powell’s renomination was announced. “Fed mistakes gave us a ‘jobless recovery‘ after the last recession, and that can’t happen this time.”
The Fed could get lucky next year if employment growth continues at the current rapid clip — more than 1.3 million net jobs have been added to the economy over the past three months. That means the country could reach something resembling maximum employment sometime in the second half of next year, when the market is expecting rate hikes to begin anyway.
“The Fed could potentially have a Goldilocks moment in the first half of next year where you still have reasonably strong growth, elevated inflation, but having achieved full employment, so it creates the right conditions to raise rates,” said Dana Peterson, chief economist at the Conference Board, a business research firm that publishes economic indicators.
She added that if Democrats’ $1.7 trillion social spending bill passes, it would provide an additional boost to both growth and inflation, giving the central bank even more room to make borrowing costs more expensive without hurting the broader economy.
But the final stretch toward reaching a labor market that is plentiful for all workers could prove much more difficult than the growth so far. Adam Ozimek, chief economist at freelancing platform Upwork, said many businesses are still getting back to their pre-pandemic employment levels.
“That’s easy growth,” he said, adding that the economy needs to add more new businesses. “What comes next is harder.”
The Fed will also have to determine what “maximum employment” actually looks like, a goal that it hasn’t defined. The central bank’s economic models have historically identified it as when job growth leads to accelerated inflation, but those signals are harder to parse when supply problems are also feeding price increases.
Fed officials have also noted that, before the pandemic hit, unemployment reached as low as 3.5 percent without triggering a significant uptick in inflation.
“My sense of what people have considered [maximum employment] to be is getting back to pre-pandemic levels of employment,” said Nick Bunker, economic research director for North America at the Indeed Hiring Lab. He added that the economy could reach that milestone next summer or fall. “But is getting back to pre-pandemic baseline necessarily the same as getting back to maximum employment? I’m skeptical of that.”
If the Fed is too impatient about raising rates to combat inflation without letting the labor market reach its full potential, it could set a bad precedent, he said.
“It could make the dedication to the employment side of the mandate seem less than it was in August 2020 when they wrote down this framework,” Bunker said.