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The Fed’s goal is to get inflation at least close to 2% before it begins cutting rates.
While this is a formal goal backed by documented policy, it is also a source of growing frustration among liberals, which serves as another form of political pressure on Fed Chairman Jerome Powell as he tries to navigate a competitive election year. .
Some on the left want that number to be much higher. Some want the Fed to add a second goal focused on the labor market. And several Democratic lawmakers used a hearing with Mr. Powell last week to question the origins of the targets and why they have such importance within the central bank.
“It looks like it’s from Oakland, and it’s from the 1980s,” Rep. Brad Sherman said with some disbelief Wednesday when it was his turn to ask Powell a question.
The liberal advocate from California was right. The road to 2% began with a surprise comment in New Zealand in 1988.
The Fed publicly adopted the standard 24 years later in 2012, but in the process drew displeasure from those on the left of the political spectrum, largely because it lacked parallel goals for the labor market.
Sen. Sherrod Brown, chairman of the Senate Banking Committee, emphasized this dynamic Thursday by suggesting that Powell move quickly to lower interest rates “to prevent workers from losing their jobs,” saying, “This town is “They seem to have forgotten that maximum employment is part of that,” he added. It’s part of the Fed’s dual mission. ”
Although the Fed’s dual mandate requires it to aim for both price stability and maximum employment, it does not set numerical labor targets.
Inflation targeting is key to how interest rate cuts are decided. Mr. Powell and other Fed officials have made clear that the Fed won’t begin lowering its benchmark interest rate from its 22-year high until it is confident that inflation will fall “sustainably” to 2%.
And last week, Chairman Jerome Powell strongly suggested that the 2% inflation target would not be achieved. He mentioned the matter seven times during his five-minute opening remarks to lawmakers on Wednesday and Thursday.
He also acknowledged the kiwi’s origins in response to a question from Mr Sherman, but added: “2% is a global standard and it’s a fairly durable standard.” He reinforced his belief that it would be OK for the U.S. to reach the 2% level in the coming months.
“People talk about this all the time,” said Preston Mui of a labor market-focused group called Jobs America. Raising the target further to 3% “is probably not a political consideration for the Fed at this point.”
But Mui added that nevertheless, talking about this figure “has been a lot of headache for Mr. Powell over the past couple of years.”
How did the Fed get here?
The Fed’s path to its 2% inflation target was a winding path that began with a now-infamous interview in central banking circles.
Don Brash, the Reserve Bank of New Zealand governor, made off-the-cuff comments in 1988 that he wanted to keep inflation between 0 and 1%. This started a policy-making process that led his country to formally adopt his 2% target shortly thereafter.
Other central banks followed suit, a move criticized in some quarters as placing too much emphasis on inflation.
Perhaps the most colorful criticism came from British economist Mervyn King, who served as Governor of the Bank of England. In 1997, he said he feared that an overemphasis on price targeting could send central bankers into an “inflation frenzy.”
The Federal Reserve, then under President Alan Greenspan, resisted publicly embracing the idea, but it was discussed throughout the 1990s and early 2000s.
“When you read the FOMC record on inflation targeting, that’s a concern,” Federal Reserve historian Sarah Binder said of political considerations in a recent interview.
There was resistance to implementing the system during the 2008 recession when Ben Bernanke was in charge. Binder said there was concern among Fed directors that they “had to worry about a backlash from Democrats.”
But by 2012, with the recession in the rearview mirror and Bernanke entering his second term, the Fed reversed course and officially adopted a 2% target.
Bernanke argued in his memoir that the 2% target would increase confidence among businesses and consumers, giving banks more flexibility to meet both sides of their dual responsibilities.
This is an argument that is still used today, with a commentator on the Fed’s website saying that a 2% target is “most consistent with the Fed’s mandate of maximum employment and price stability.”
However, many on the left did not fully agree. In his memoirs, Chairman Bernanke said that the main liberal spokesperson at the time, Massachusetts Representative Barney Frank, brought up the lack of parallel labor market goals, saying that even if he was aligned with the policy, he was “completely comfortable with it.” It wasn’t,” he admitted. end.
That’s a criticism that’s been going on for years.
“I think it should be higher than that,” Congresswoman Maxine Waters said in an interview with Yahoo Finance’s Jennifer Schoenberger last week, saying raising it would help working families. Stated.
Rakeen Mahboud, chief economist at the left-leaning Groundwork Collaborative, further elaborated on the goal, saying it “codifies the fact that inflation is more important to the Fed than unemployment.” “There is,” he said.
The ongoing criticism is further contextualized by the Fed’s 2020 move to adopt a flexible average inflation targeting framework. In fact, this change made the 2% target less stringent by allowing the Fed to look at 2% as an average and allow for periods of slightly higher inflation.
Republicans appear to be trending back to the tougher pre-2020 goals, with some Republicans keen to remove jobs from the Fed’s dual mandate altogether.
Chairman Powell said last week that the policy would be reviewed from later this year until the end of 2025.
Why can’t it change so easily?
The 2% target could become a bigger issue in the coming months, with many Democrats continuing to push for rate cuts despite falling short of expectations through the first few months of 2024. Some in the financial world are even predicting zero interest rate cuts for the entire year.
“Interest rates are too high,” Massachusetts Representative Ayanna Pressley told Powell.
Another problem for the left is that simply adding a corollary target focused on the unemployment rate, which rose to 3.9% in February’s jobs report, is not as easy as it seems.
Mui, a senior economist at Employ America, said his group looks at the prime-age employment rate (the number of young workers relative to the total population) or more nuanced metrics such as wage growth, job turnover, and overall labor force participation. He said he is focusing on.
“I think there is a real risk if there was a hard commitment to defining an unemployment target.” [in some scenarios] In fact, not enough attention is being paid to that aspect of their mission,” he says.
Ben Werschkul is Yahoo Finance’s Washington correspondent.
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