Can the Fed help fix inequality?
Does the U.S. Federal Reserve have an obligation to combat inequality? Historically, the central bank itself has thought not, but that may be changing. As Bloomberg reports, Neel Kashkari, president of the Minneapolis Fed branch, is pushing a new project inside the Fed to analyze and understand inequality much more seriously.
"We had historically said: distributional outcomes, monetary policy has no role to play," Kashkari said in October. "That was kind of the standard view at the Fed, and I came in assuming that. I now think that's wrong."
At the end of the day, however, the question is not really whether the Fed should care about inequality, it's can the Fed do anything about it? Is inequality something the monetary policy toolkit is capable of addressing?
To at least some degree, the answer is yes.
Specifically, Kashkari is looking to develop a retinue of specialists on income and wealth distribution the central bank can regularly call on in deciding the course of monetary policy. And that project overlaps with another critique Kashkari's been making: that, despite how it may look, the United States is not at full employment. The closer the economy gets to full employment, and the longer it stays there, the more bargaining power everyday workers will have. Their wages will go up, while CEO compensation and corporate payouts to shareholders will have to go down to compensate. The portion of national income flowing to the working-class — and thus not flowing to the rich — will increase.
The implicit critique within Kashkari's project is that the Fed has not taken full employment seriously enough, or pushed aggressively enough to attain it. The official job Congress gave the Federal Reserve was to maintain both "maximum employment" and "stable prices." But the central bank also has enormous internal leeway in how it interprets those goals. And if you look back at the last few decades, the Fed's done an excellent job of keeping inflation low and stable, and a terrible job of maximizing full employment.
One solution here would be for the Fed to apply a much more stringent definition of full employment on itself. Progressive Democrats actually have a bill that would order the Fed to define maximum employment as median wages rising in tandem with overall economic productivity. (Something that hasn't happened since the 1970s.) It would also instruct the Fed to pay more attention to unemployment levels with different demographic and racial groups, rather than just national unemployment as a whole. All of those are great ideas, but it's also worth noting that these are all definitions the Federal Reserve is free to impose on itself if its officials felt like it.
Practically speaking, changing the Fed's definition of maximum employment would change how it adjusts interest rates: Keeping them lower longer, and being more willing to tolerate inflation in the name of creating more jobs and wage growth.
Kashkari's also not the only one who is thinking in these terms. While she didn't present it as part of an effort to combat inequality, Lael Brainard, a member of the Fed's board of governors, recently gave a speech suggesting the Fed deliberately aim for longer bouts of higher inflation, to make up for previous periods of time (like the last few years) when inflation consistently ran below target. Meanwhile, the Fed has already backed off its previous interest rate hikes, which suggests this kind of soul searching is going on throughout the institution.
The central bank, if it's serious, could also get more clever and go much further. The Fed's charter from Congress, for example, allows it to buy state and local debt with a maturity of six months or less. The Fed could explicitly state that it will use that power to buy up any short-term debt that state and local governments issue to plug holes in their budgets during recessions, or to finance the provision of basic public goods and services, and more.
But this sort of move would also require a good deal of institutional and political courage from Fed officials. The whole reason the Fed is limited to buying six-month debt maturities is to prevent it from buying longer-term debt and effectively financing state and local government fiscal policy. The traditional view that the Fed shouldn't concern itself with distributional questions flows from the norm that the Fed deals with monetary policy, while Congressional bodies deal with fiscal policy — which is to say, government spending, how much, and on whom.
And that point really gets to the limits of the Fed’s abilities. The impetus for Brainard's speech is that the Fed cut interest rates to zero after the 2008 crisis, and thus couldn't lower them any further, even though the economy still clearly needed more stimulus. The traditional assumption in economics has been that monetary policy could always adjust the economy back to full employment on its own. But what we've discovered in recent years is that fiscal austerity from Congress, plus monetary policy that's over-eager to prevent inflation, can so damage the economy that a reformed approach to monetary policy alone cannot fix the problem.
The point of keeping interest rates lower longer is to encourage more investment. But investors do not hand out money simply because interest rates are cheap. They hand it out because they see profitable opportunities in the economy, and that enough demand is rising to meet the money that investors can provide. If the demand is not there, they won't invest, no matter how low interest rates fall.
But creating that demand requires getting more money into everyday consumers' pockets, which is precisely the sort of thing that fiscal policy, not monetary policy, is supposed to concern itself with. Offering federal, state and local governments an open-ended commitment to finance their debt is about the closest the Fed can get without actual legal amendments to its charter that expand its powers. And offering that deal would be wildly controversial precisely because it would challenge the conceptual divide between monetary and fiscal policy. Not to mention, governments would have to be ideologically and politically willing to take advantage of the opportunity.
Until the day Congress chooses to get serious about addressing inequality themselves, or they provide the Fed with some equivalent of the fiscal spending powers Congress itself enjoys, there is only so much the central bank can do.
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