ECONOMICS Bloomberg Businessweek October 12, 2020
29To avoid the vortex of outright deflation—falling
prices—the European Central Bank cut its key
short-term interest rate below zero in 2014. The
Bank of Japan followed in 2016. Powell’s Fed has
resisted going subzero, but it’s ahead of its peers
in one respect: It’s the first to embrace overshoot-
ing its inflation target to compensate for periods
of undershooting.
Economist Paul Krugman wrote in 1998 that
to stir growth when interest rates are near zero,
the central bank must “credibly promise to be
irresponsible—to make a persuasive case that it
will permit inflation to occur, thereby produc-
ing the negative real interest rates the economy
needs.” “Irresponsible” is not a word one would
apply to Powell and his sober peers on the rate-
setting Federal Open Market Committee. He’s
aware of the perception problem: “This is all
about credibility. We understand perfectly that we
have to earn credibility,” he told reporters after
the meeting of the FOMC on Sept. 16.
A reputation for probity at the Fed that’s so
good it’s bad isn’t the only thing keeping inflation
undesirably low. The pandemic, by suppressing
demand for goods and services, has knocked down
the measure of inflation that the Fed watches—the
year-over-year change in the price index for per-
sonal consumption expenditures—to just 1.4% in
August. Meanwhile, the economic recovery is fal-
tering because coronavirus relief programs have
expired. In a speech on Oct. 6, Powell warned of
“tragic consequences” for racial and wealth dis-
parities if relief isn’t extended. But hours later,
President Trump cut off negotiations with congres-
sional Democrats until after the election.
Even before Covid-19 struck, U.S. economic
growth depended on ultralow interest rates, big
federal budget deficits, and an unsustainable rate
of business borrowing. (And while growth helped
the poor by creating jobs, it helped the rich even
more by swelling their portfolios.) In September
the Congressional Budget Office projected that the
U.S. economy would grow only 1.6% annually for
the next 30 years, well below the 2.5% rate of the
past 30. Harvard economist Lawrence Summers,
who was President Clinton’s Treasury secretary
and headed President Obama’s National Economic
Council, argues that cutting interest rates alone can’t
cure what he calls secular stagnation, so Congress
needs to do more deficit spending, encourage invest-
ment, and discourage saving. “I sort of suspect that
we’re past peak central banking,” he said in May in
a Princeton webinar.
The Fed’s new inflation policy is in part an
admission that the old rules no longer apply.
Policymakers used to assert with confidence that
an unemployment rate below 6% would lead to
high inflation. Yet even when unemployment hit a
low of 3.5% in February, inflation remained below
the 2% target. Neel Kashkari, the dovish president
of the Federal Reserve Bank of Minneapolis, has
disparaged theories tying low unemployment to
inflation as “ghost stories.”
The policy unveiled by Powell at the end of
August removes the long-standing promise to react
to very low unemployment. From now on the Fed
will react only to high unemployment. And instead
of focusing on a single number—the national unem-
ployment rate—it’s promising to consider low- and
moderate-income Americans, some of whom need
unemployment to be very low before employers
will consider hiring them.
These are unusually dovish policies for the
world’s most powerful central bank. If inflation
has been running “persistently” below 2%, the
Fed “will likely aim to achieve inflation moderately
above 2 percent for some time,” the new policy
says. The FOMC got more specific at its Sept. 15-16
meeting, saying it won’t raise rates until inflation
has reached 2% and is “on track” to moderately
exceed it for some time. With these changes, U.S.
monetary policy “is as easy as it’s ever been in
modern times, or even in nonmodern times,” says
Padhraic Garvey, head of research for the Americas
at ING Bank NV.
But will it work? David Wilcox, a former Fed
official who’s a senior nonresident fellow at the
Peterson Institute for International Economics,
calls it “a very substantial step forward.” Allison
Boxer and Joachim Fels, both of Pimco, a big bond
investor, are skeptical. “We wonder if the Fed lead-
ership is using surprises and emphatic language to
try to compensate” for an FOMC “that may not be
fully on board with a more significant regime shift,”
they wrote in a note to clients.
Investors would have been more impressed
if the Fed had supplemented its promises with
actions, such as an increase in purchases of
medium- and long-term Treasury securities to stim-
ulate economic growth, says Aneta Markowska,
chief financial economist at Jefferies & Co. “They
didn’t seem to see the urgency. They think what
they’re buying now is a lot. And it is a lot. But they
could have done a little bit more,” she says. “I feel
it was a wasted opportunity.”
For the Fed, promises are easy to make but
could be hard to keep. When it comes time to let
inflation run above 2%, there are likely to be shrieks
of pain from the bond market and people living on
fixed incomes. Willfully allowing inflation to go○ Clarida○ Kaplan○ Kashkari○ Powell