The EconomistSeptember 5th 2020 Finance & economics 631I
n2018, whenAmerica’s long recovery
from the 2007-09 financial crisis pushed
the unemployment rate below 4%, the Fed-
eral Reserve had a simple message for
American workers: do not get used to it.
The central bank’s economic projections
revealed that its officials believed 4.5% to
be the lowest sustainable jobless rate, to
which America would need to return to
stop inflation surging upwards. If higher
interest rates and slower growth were
needed to achieve that, so be it.
On August 27th Jerome Powell, the Fed
chairman, acknowledged what common
sense suggested two years before: that an
intentional increase in unemployment is
an odd thing to pursue after nearly 20 years
of depressed labour-market conditions.
Speaking at an annual central-banking
shindig, Mr Powell unveiled the conclu-
sions of a monetary-policy strategy review
begun in 2019. The coming changes to Fed
policymaking could initiate an important
global shift in central-bank practice.
The Fed’s old framework was forged by
the inflationary tumult of the 1970s. Post-
war economists understood there to be a
negative relationship between inflation
and unemployment—known as the Phil-
lips curve—such that policymakers could
push unemployment as low as they liked,
provided they were prepared to accept
more inflation. But soaring prices persuad-
ed many that this relationship did not hold
below some minimum sustainable level of
unemployment. Attempts to push jobless-
ness lower would yield higher inflation,
but at best only a temporary reduction in
unemployment. By the 1990s, most central
banks had resolved to target a low level of
inflation, generally around 2%.
But since the embrace of inflation tar-
geting in the 1990s, the relationship be-
tween employment and inflation has
weakened. Soaring joblessness during the
Great Recession failed to produce the ex-
pected plunge in prices. Neither have low
levels of unemployment since then ended
an era of historically low inflation. Precise-
ly why the relationship between inflation
and joblessness changed is uncertain.
Some economists reckon central banks’
credibility in managing inflation anchored
the public’s expectations too well. Others
point to a decline in workers’ bargaining
power, which has eased the pressure on
firms to raise prices in order to cover the
cost of expensive pay packets. Still otherspoint to technological change and globali-
sation, which expand consumer options
and allow firms to respond to increased de-
mand without raising prices. Whatever the
cause, the flattening Phillips curve biased
monetary policy in an overly hawkish way,
eventually prompting the Fed rethink.
The changes to its framework may seem
modest. Because the maximum sustain-
able level of employment cannot be mea-
sured, the Fed will give up worrying about
overshooting it and focus only on employ-
ment shortfalls. The 2% inflation target re-mains a constraint, but a more flexible one
than before. It should be hit on average, Mr
Powell explained, meaning that periods of
below-target inflation can be offset by at
least some time with inflation above the
target as well.
But the conceptual change—abandon-
ing the notion of a minimum sustainable
unemployment rate—is significant. And
the practical effects could be large. Had the
Fed enjoyed more freedom in recent years,
it could have raised interest rates more
gradually, or not at all, enabling a faster andWASHINGTON, DC
The Fed’s move to emphasise full
employment could start a global trendThe Federal ReserveNew job
description
C
entral bankerswholeaveoffice
often write memoirs. Few are as
damning of the financial system they
once served as Urjit Patel, the governor of
the Reserve Bank of India (rbi) in 2016-18,
and Viral Acharya, its deputy governor in
2017-19, who is now an academic at nyu
Stern School of Business. In separate
books, they tell stories of rampant gov-
ernment meddling in the banking sys-
tem. Both stood down before their terms
ended. Their books suggest why.
Mr Patel does not directly address his
departure. But he appears to have
reached breaking point when the govern-
ment of Narendra Modi tried to dilute
new bankruptcy rules that it had once
championed to tackle the problem of
zombie corporations.
In a chapter titled “The Empire Strikes
Back”, he relates how the government
lobbied the rbito extend repayment
times for companies with 2trn rupees
($27bn) in aggregate exposure. “Instead
of buttressing and future-proofing the
gains thus far”, he writes, the atmosphere
became one of going “easy on the pedal”.
Mr Patel describes how Indian savers,
to whom he dedicates his book, see their
funds used by government-controlled
banks and other financial institutions
for “vague (and extraneous) objectives”,
such as supporting politically connected
states and companies and, sometimes,
the stockmarket. The distortions un-
dermine banks’ incentives to apply the
scrutiny needed to properly allocate
credit. Price signals become confused;
interest rates for viable private compa-
nies must remain high to offset the ones
that don’t pay.
Mr Acharya documents other forms of
interference. These include constant
pressure to provide stimulus, raids on
the central bank’s reserves to cover bud-
get deficits, and even threats to invoke along-buriedclauseintherbi’s enabling
legislation,allowingthegovernmentto
givedirectionstothecentralbankwhen
it wasin“thepublicinterest”.Suggesting
sympathyforMrPatel,hesaystheex-
governor’sbattletodefendfinancial
stabilitymadehisjobuntenable.
MrAcharyagrimlyconcludesthata
“silentcrisis”hasbeenunfoldingin
India’sbankingsystem,withborrowers
preventedfromdefaultingonlybecause
thegovernmentispresumedtoprop
everythingup.Thatworksuntilthe
government’s“solvencyisitselfconsid-
eredtobeonthebrink”.Withtheecon-
omyshrinkingby24%intheApril-June
quarter,comparedwiththesameperiod
in2019,andpublicfinancesunderpres-
sure,thestrainsareonlylikelytoget
worse.Butatleastwiththesetwobrave
booksthesilencehasbeenbroken.Silent no more
Indian financeTwo aggrieved central bankers spill the beansEndangered species..............................................................
Urjit Patel, Overdraft, Saving the Indian Saver. Viral
Acharya, Quest for Restoring Financial Stability