Lael Brainard on monetary policy and employment
The new framework calls for monetary policy to seek to eliminate shortfalls of employment from its maximum level, in contrast to the previous approach that called for policy to minimize deviations when employment is too high as well as too low. The new framework also defines the maximum level of employment as a broad-based and inclusive goal assessed through a wide range of indicators.
Some pundits regard this as a significant change, perhaps indicating that the Fed will stop being so mean to workers looking for jobs. While I don’t oppose the change, I don’t see much difference from previous policy.
This is a really complicated issue with lots of moving parts and lots of subtle distinctions. So here are some of the tools I will work with:
- The Plucking model. The business cycle is mostly (not entirely) shortfalls from full employment, not symmetrical deviations around a natural rate of unemployment.
- The Natural Rate Hypothesis predicts that (for positive inflation rates) employment does not depend on the average rate of inflation. In the long run, workers adjust to changes in the expected rate of inflation, and hence money is roughly super-neutral in the long run.
- The Fed erred in raising rates 9 times during 2015-18, as it relied too heavily on highly flawed Phillips Curve models of the economy. As a result, inflation has averaged less than 2% over the past decade.
- The Fed recently switched to average inflation targeting (AIT), which will cause inflation to average roughly 2% in the years ahead.
- Under AIT, there is no such thing as hawks and doves.
If you combine the first two points, then the implication is that a Fed policy that minimizes shortfalls in employment is basically the same as a Fed policy that minimizes deviations in employment. After all, the only long run equilibrium in the labor market is full employment, according to the natural rate hypothesis.
[Note: A permanent and unchanging 40% unemployment rate caused by a $35/hour minimum wage is “full employment” as defined by macroeconomists]
The existence of a 2% AIT means we’ve moved beyond hawks and doves; all future disputes will be about fluctuations in inflation and employment, not the average rate of inflation.
That doesn’t mean there is nothing new at the Fed:
For nearly four decades, monetary policy was guided by a strong presumption that accommodation should be reduced preemptively when the unemployment rate nears its normal rate in anticipation that high inflation would otherwise soon follow. But changes in economic relationships over the past decade have led trend inflation to run persistently somewhat below target and inflation to be relatively insensitive to resource utilization. With these changes, our new monetary policy framework recognizes that removing accommodation preemptively as headline unemployment reaches low levels in anticipation of inflationary pressures that may not materialize may result in an unwarranted loss of opportunity for many Americans. It may curtail progress for racial and ethnic groups that have faced systemic challenges in the labor force, which is particularly salient in light of recent research indicating that additional labor market tightening is especially beneficial for these groups when it occurs in already tight labor markets, compared with earlier in the labor market cycle.33 Instead, the shortfalls approach means that the labor market will be able to continue to improve absent high inflationary pressures or an unmooring of inflation expectations to the upside.
The phrase “changes in economic relationships” is a polite way of saying the Fed screwed up in 2015-18 and tightened too soon because they relied on flawed Phillips Curve “economic relationships”. They learned a lesson and promise not to do so again. But despite all the woke window dressing about jobs for minorities, this isn’t really about jobs at all, it’s about achieving their target. The mistake made during 2015-18 was a mistake whether you focus on employment shortfalls or employment deviations.
So what does the Fed’s dual mandate mean today? Roughly this:
We promise to deliver 2% PCE inflation on average, and allow modest fluctuations around that average only to the extent that those fluctuations reduce employment shortfalls. As a practical matter, reducing employment shortfalls means keeping employment close to the natural rate, which implies also reducing employment deviations.
AIT really is new—and an improvement. The increased awareness of the unreliability of Phillips Curve models really is new—and an improvement.
The talk about employment is just a bunch of pretty words. Not that there’s anything wrong with pretty words, if they help to provide political cover for AIT and moving on from Phillips Curve models.