Protesters rallied in Washington, New York City and Philadelphia yesterday against an imminent government action that would damage the financial prospects of ordinary workers. And no, it had nothing to do with Donald Trump.
The Center for Popular Democracy’s Fed Up campaign wants the Federal Reserve to break with expectations and hold interest rates steady rather than hiking them this week. They believe minority communities have yet to recover from the ravages of the financial crisis, and are still experiencing high unemployment and stagnant wages.
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Fed Up and others pushing for the Fed to hold steady have accumulated significant new intellectual firepower to prove their point. A group of 22 economists and former central bankers have coalesced around a key idea: The impetus for the Fed’s rate hikes, to stabilize prices, is factually wrong. The 2 percent inflation target, which the Fed has undershot for years, is too low and should be abandoned, according to this faction.
The agitators for this change include Jason Furman, formerly President Obama’s chair of the Council of Economic Advisers; Jared Bernstein, former chief economist for Vice President Biden; Nobel laureate Joseph Stiglitz; and Narayana Kocherlakota, former president of the Minneapolis Federal Reserve. While on the political left, it’s a pretty mainstream group. But their call to abandon the inflation target is a radical departure from the paint-by-numbers monetary policy we’ve been sleepwalking through for the last year.
To be clear, when the Fed raises interest rates, it’s deliberately trying to keep the economy from overheating and inflation from rising. The Fed’s dual mandate is to maintain a balance between maximum employment and price stability. Interest rate hikes act as a wet blanket to smother the economy, reducing the type of investment that creates jobs. This is supposed to be a trade-off for stable prices.
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Only prices aren’t spiraling out of control. During the Great Recession, the Fed cut interest rates to practically zero and kept them there for seven years. Every so often some analyst would scream that runaway inflation was right around the corner. But inflation consistently undershot the Fed’s 2 percent target. By one measure, we hit 2 percent this February for the first time in five years, only to fall back down. Analysts have revised inflation forecasts down in recent months, aligning with a trend present since the beginning of the Great Recession.
Obviously, if there’s not enough momentum in the economy to even get inflation to the 2 percent level, the Fed has no business raising rates and throwing people out of work. Fed officials are overreacting to fear of a future threat in a way that will harm some of the most vulnerable members of society. “Every time that you cut jobs – you are hurting real people,” said One Pennsylvania’s Tim Wilson in yesterday’s protest in Philadelphia.
Setting the inflation rate at 2 percent is not only an arbitrary figure, it creates expectations in the economy. Raising the target would drive expectations upward. And as the group of economists explained in a letter to the Fed last week, the artificially low inflation target leaves the Fed less room to stimulate the economy if it slows. “A higher inflation rate means you could support more business investment, more housing investment, and more demand overall,” said Jason Furman on a press call last Friday. If Congress had its act together, it could supply fiscal stimulus, but we’re in an age of austerity. Therefore, the Fed needs the maximum firepower available.
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Fed board members, including Vice Chair Stan Fischer, have mused about setting a higher inflation target. After all, the Fed can only lower interest rates to zero. A higher inflation target means that rate drop has a greater impact. If we expect a more frequent zero interest-rate environment — and we do — a higher target serves as the best path to shorter recessions and faster recoveries. It can even act as an automatic stabilizer to avert economic downturns in the first place.
It also would keep the Fed in step with a changing economy. Canada reassesses its inflation target every five years, and does it in public, rather than the Fed’s normal practice of deliberating behind closed doors. This would not only make the central bank keep up with the times, it would add credibility to its decisions.
Now, ordinary people might hear “we need more inflation” and think the prices for everything they buy would rise unsustainably. But the Economic Policy Institute’s Josh Bivens explains that inflation typically goes hand in hand with wage growth, rather than eroding living standards. Plus, Social Security benefits are indexed to inflation, so a boost wouldn’t affect them much. Inflation is also good for borrowers; it has the effect of lowering real interest rates, reducing debtors’ effective obligations. “When we run a tighter economy that’s associated with a higher inflation rate, ordinary individuals are unambiguously better off,” said Joseph Stiglitz on the press call.
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By contrast, hiking interest rates when inflation is not present really does hurt ordinary people. An analysis by WalletHub finds that consumers will pay $1.5 billion more in finance charges on their credit cards for every quarter-point rise in interest rates. With three prior rate hikes since late 2015, that cost will total $6 billion a year if the Fed hikes again this week. Home and auto loan rates will also likely rise. And then there’s the Fed Up Campaign’s main point, that raising interest rates will harm job growth. Meanwhile, higher interest rates benefit savers who have their money parked in interest-bearing vehicles, and these are overwhelmingly wealthier people. There’s no question that higher interest rates redistribute wealth upward and exacerbate inequality.
If the economy were truly overheating and suffering from inflation spikes, maybe that would be tolerable. But if we’re showing no such signs, raising rates is akin to a suicide pact. Lack of inflation clearly indicates that we are not at full employment. Even wage growth has slowed of late. So why be so quick to harm workers?
As the Fed committee announces its interest rate decision on Wednesday, it shouldn’t ignore the protesters assembled in the streets, as sure as it shouldn’t ignore the failure to meet the targets it set. In fact, there’s substantial evidence that the Fed has targeted the wrong numbers. With Congress and the president, shall we say, less than focused on what would really support the economy, the Federal Reserve becomes much more important. Its policymakers should take that responsibility more seriously and gauge how they affect everyone, not just their friends in high places.
