On Wednesday, the Federal Reserve announced a target of 6.5 percent unemployment, marking a long-overdue change in policy: for the first time, it was outlining jobs as a specific objective. This development took quite some time. The 1978 Humphrey-Hawkins Act explicitly called for the Fed’s goals to be low inflation and low unemployment, yet the Fed didn’t even mention unemployment in its statements until 2010. Wonder why we have a jobs emergency in America? That’s a big part of the reason.
For more than thirty years, beginning with chairman Paul Volcker and extending through the long, now-tarnished reign of Alan Greenspan and the first few years of Ben Bernanke, the Fed has neglected employment. In fact, Fed chiefs tended to see a relatively high unemployment rate as critical to their objective of controlling inflation. If the rate stayed high while they pursued their inflation targets — usually about 2 percent a year — so be it. Until the late 1990s, the result was unnecessarily high interest rates, and therefore slow rates of growth.
The Fed didn’t put it that way, of course. It claimed that if the unemployment rate wasn’t above a certain level, inflation would inexorably rise. One consequence of the artificially high rate was the suppression of wage hikes. Wage increases were widely thought to be a main driver of inflation, and an impediment to economic growth because they would undermine profits—never mind that wages rose handsomely and consistently through twenty-five years of heavy investment and rapid growth after World War II.
The new 6.5 percent target sends a message to the markets that interest rates will stay low until many more jobs have been created. Prior to this, the Fed pegged its low-rate quantitative-easing policies to specific time limits. Two problems remain, however.
First, the target isn’t low enough — the unemployment rate will fall significantly farther before it creates inflation. An unemployment rate of 5.5 percent would cause the federal deficit to fall sharply due to economic growth alone.
Second, the Fed may not stick to its guns. Keeping inflation in check is widely thought to be one of the Fed’s great achievements; to get the economy back on track, it will have to stand up to constant external and internal pressure to increase interest rates.
Inflation scares are the great refuge of conservatives, and of creditors who don’t want their loans to lose value. But these scares aren’t based on empirical studies or even decent theory. The low unemployment rate of the 1990s — below 4 percent — did not generate inflation, for example.
The Fed’s move doesn’t relieve the federal government of the need for additional stimulus funds, nor of the need to make targeted public investments in infrastructure and other areas. But if it follows through, it will represent a historic shift — one that bodes well for the economy in the months ahead.