Good Politics Versus Good Policy: The Fed’s New Average Inflation “Target”

At the Federal Reserve’s annual Jackson Hole symposium last week, Chairman Jerome Powell announced the results of the Fed’s monetary policy framework review. As expected, that review has resulted in the Fed adopting an average inflation target.

Sort of.

The twist is that they are going to target average inflation in a “flexible” way. What does that mean? In Powell’s own words:

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

Talk about leaving yourself wiggle-room! There’s no credible commitment here.

In theory, making up for past misses is a good thing, but the flexible nature of this new policy makes it very difficult to know exactly what the Fed will do as economic conditions unfold. All that we really know is that the Fed will now try to make up for previous misses by shooting for higher (lower) inflation after inflation comes in below (above) target – when it’s convenient.

It is also rather disappointing because, after basically a decade of being unable to hit its inflation target, the Fed has essentially broadened its definition in a way that ensures it can’t miss. Even more disappointing is that the review they conducted really doesn’t seem to have been a scientific review of monetary policy as much as it was a political exercise.

The Fed’s new view of the employment portion of their mandate provides a clue:

… our revised statement emphasizes that maximum employment is a broad-based and inclusive goal. This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities. In addition, our revised statement says that our policy decision will be informed by our “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level” as in our previous statement.

To borrow some of Powell’s language, this statement could be viewed as an admission that inflation targeting fails to adequately account for employment problems among disadvantaged groups of Americans, and that employment is now the more important part of the Fed’s mandate. But, Powell also said the following:

The change to “shortfalls” clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals. Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimize that shortfall by using our tools to support economic growth and job creation. [Emphasis added.]

So, maybe things aren’t so different now?

Regardless, there is an undeniable nod here to those who want the Fed to do more than focus on just aggregate unemployment. Politico’s Victoria Guida links Powell’s statement directly to appeasing those who believe that “the central bank should help disadvantaged Americans,” and it seems like she’s on the mark. (Though I’d argue that the Fed is apolitical in name only, and I’m not the only one.)

Viewed through the lens that Guida uses, the new policy statement is a politically savvy move. It won’t satisfy the staunchest critics, but that’s irrelevant. The apparent policy shift lets the Fed appease any member of Congress even close to being on the fence about imposing a new racial inequality mandate on the central bank.

Powell clearly wants nothing to do with that sort of mandate, but he can’t ignore Congress. The fact that Congress can – and regularly does – ignore common sense when it enacts requirements on federal agencies only heightens the danger that harmful legislation will be passed.

It makes no sense, for instance, to pass a law that requires federal regulators to ensure financial stability knowing that the term cannot be objectively defined. And it defies common sense to hold lenders legally accountable for failing to accurately assess borrowers’ ability to repay a loan when there is no single metric (or set of metrics) that can measure such an outcome (see page 43).

But that’s exactly the sort of legislation that Congress passes because it provides them political cover while relieving them of actually having to fix something. Sen. Elizabeth Warren’s (D-Mass.) Federal Reserve Racial and Economic Equity Act does a great job of carrying on this tradition.

Warren’s bill would require the Fed, when conducting everything from monetary policy to regulatory policy, to “exercise all duties and functions in a manner that fosters the elimination of disparities across racial and ethnic groups with respect to employment, income, wealth, and access to affordable credit.”

The bill does not include a single word on how to define these disparities, much less how any policy is supposed to achieve these goals in the context of the Fed’s other mandates. But it would require the Fed to report to Congress on these disparities and to explain what they are doing to eliminate them. In other words, it would provide the perfect opportunity for Congress to act like they have done something to eliminate economic inequality among racial groups while having actually done nothing beneficial.

It would be refreshing if the Fed’s leadership stood up to this effort and refused to play identity politics. Doing so does not require a denial of America’s past mistakes, it only demands acknowledging that this sort of ill-defined mandate is unlikely to fix anything that those mistakes might have caused.

It would be very easy, for example, for the Fed to enumerate existing economic disparities in the U.S., while also explaining that monetary policy provides no cure.

It is true, for instance, that 42 percent of black males age 14 to 16 live in homes in the lowest income quintile, whereas only 12 percent of white males age 14 to 16 live in such homes. It is also true that of those black males born into the lowest quintile, 54 percent end up in the same quintile, based on individual income, when they are between the ages of 28 and 35.

Of course, the Fed would also have to point out that black women have individual earnings mobility close to that of white women – 29 percent of white women born into the lowest quintile remain in the same group when they are between 28 and 35, whereas the rate is 34 percent for black women. (The situation is bleaker for black women when family income metrics are used.)

It’s also true that poverty rates are higher for Native Americans than blacks, higher for Vietnamese Americans than Filipino Americans, and higher for Dominicans than Cubans.

So, should the Fed maintain expansionary monetary policy until the black-white gap for males is closed, even if doing so harms black women (and everyone else)? Should they expand their purchases of bonds until the poverty rate among all different “Hispanic” groups equalizes, or until Native Americans have the lowest poverty rates of any group?

Perhaps supporters of Warren’s bill have something different than monetary (or regulatory) policy in mind, such as providing banks with more funds to lend to young black males or Native Americans? If that’s the sort of thing Congress has in mind, they should say so.

Hopefully enough members of Congress see how dangerous it is to drag the Fed further into this game of identity politics. That effort runs counter to the idea that people judge each other based on the content of their character rather than by the color of their skin, and it fosters the demonstrably false idea that the American mainstream is only attainable for white people.

It also reinforces the false notion that the economy is a zero sum game where some groups are winning at the expense of others, and it perpetuates a culture of victimhood that helps turn the well-connected into millionaires. It moves us farther away from a free enterprise system and closer to the centrally planned economies that trap people in poverty and subjugate them to an elitist ruling class.

As my colleague Mike Gonzales has explained:

In response to the activists’ demands [during the 1960s and 1970s], the policy makers of the past blessed the federal bureaucracy’s creation of racial and ethnic categories and the related use of racial preferences for university admissions, employment and government contracting. The formalizing of groups, the addition of incentives to adhere to them, and the culture of victimhood that the whole scheme instilled, betrayed the colorblind promise of the civil-rights movement. The Civil Rights Act of 1964 was intended to cure problems like segregation. Instead, by creating an incentive system based on grievances, the architects of identity politics all but ensured victimhood would never end.

Rather than continue down this path – one that has clearly failed millions of Americans – Congress can implement countless policies to expand economic freedom and help Americans improve their lives. A great place to start would be to reverse decades of harmful housing policies that unnecessarily saddle lower income folks with higher home prices and debt, trap people in poverty, and offer few incentives for upward mobility.

Instead, some of the leading progressives want to expand the existing government-dominated housing system and to close “the racial wealth gap” by providing subsidies to prospective home buyers in areas that were formerly red-lined. (This term refers to the federally-initiated policy of “outlining areas with sizable Black populations in red ink on maps as a warning to mortgage lenders, effectively isolating Black people in areas that would suffer lower levels of investment than their white counterparts.”)

But a major problem with this approach, as a Brookings study shows, is that most of the people who now live in these formerly segregated areas are not black – they are white and Latino. The study shows that “Black residents in redlined areas account for just 8% of all non-Latino or Hispanic Black Americans.”

This case is the perfect example of politicians being more concerned with playing identity politics than actually solving economic problems. It is also directly comparable to what they are doing to the Fed. Hopefully, there are still enough reasonable members of Congress to reverse course before it’s too late.