Criticism of Fed interest rate hikes sometimes turns into demagogy, as did former President Donald Trump’s attacks on Powell when the Fed raised rates. But the progressives’ question deserves an answer: how can a tightening of monetary policy be morally justified even if it is expected to have a negative effect on employment?
What makes the question difficult is that the costs of inflation, while significant, are diffuse, while the costs associated with unemployment are highly concentrated. The costs of being unemployed are personal and often severe. They can include broken families, compromised mental health, and diminished long-term prospects.
At the same time, the human toll of unemployment cannot be the sales pitch Warren and like-minded observers want it to be. If so, it would mean that a stricter policy is never warranted. It can’t be true.
Some progressives also take a simplistic view of the relationship between unemployment and inflation. During the current period of high inflation, House Speaker Nancy Pelosi has repeatedly said that she was told in the 1980s, when she first came to Congress, that inflation rises every time unemployment was falling.
He may have been told that; it reflected the conventional wisdom of an earlier era. The early 1980s saw a severe recession caused largely by an effort to control inflation. But his assertion that inflation rises as unemployment falls has been proven wrong in his own career. Unemployment fell from 1992 to 1998, then from 2011 to 2020, without an increase in inflation.
In the long term, tolerating high inflation does not appear to increase employment, and low inflation does not threaten it. Keeping inflation low is therefore a reasonable long-term objective. The question today is: what should the central bank do when a regime of low inflation was conquered at great expense – that recession of the early 1980s – but is now threatening to end?
One option, driven by Warren’s rhetoric, would be to accept the current level of inflation on the grounds that lowering it would weaken the labor market. But accepting current inflation may in practice mean accepting higher inflation. Market expectations for inflation over the next five to ten years are currently only slightly above the Fed’s 2% annual target.
Throw in the towel, and those expectations might rise — and become self-fulfilling. The Fed would then be faced with a worse version of its current choice: either accept inflation drifting even higher, or suppress it at the cost of unemployment. Letting inflation drift higher, giving up the fight because of the risk of rising unemployment, and then being forced to act is more or less how the United States experienced this severe recession in the early years. 1980.
The remaining options relate to degrees of tightness: a lot or a little, fast or slow. The fact that expectations are under control suggests that it might still be possible to restore low inflation without a sharp rise in unemployment. This is an argument for going fast. The same goes for the fact that the unemployment rate is still relatively low. Judging by their projections, Fed policymakers think they can get inflation under control as unemployment peaks at 4.4%, lower than it was in any month of the Reagan or Obama presidencies.
The Fed could see its resolve tested if inflation starts to subside. There may be a temptation to stop tightening when inflation drops to 3%, rather than inflict the additional pain needed to get back to the 2% target. If inflation is relatively predictable and stable, an average of 3% might not impose much higher costs than an average of 2%. But the Fed would not make this choice in a vacuum. She then gives up her initial objective under duress, which can only discredit her future commitments.
Recent statements by Powell acknowledged the cost of restoring price stability, but noted that without it, “the economy doesn’t work for anyone.” The alternative to taking the necessary action now, he explained, is to risk higher inflation and then a deeper recession. The critics are wrong: he should continue to tighten monetary policy, and in good conscience.
More from Bloomberg Opinion:
• The Fed should be prepared to cause a recession: publishers
• The best scenario for fighting inflation is dead: Jonathan Levin
• Jerome Powell to Rest of the World: Drop Dead: Marcus Ashworth
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Ramesh Ponnuru is a Bloomberg Opinion columnist. He is the editor of National Review and a Fellow of the American Enterprise Institute.
More stories like this are available at bloomberg.com/opinion