The “Phillips curve”, an observed relation between the rate of inflation and the unemployment rate (that the rate of inflation and the unemployment rate are inversely correlated) was taught as Holy Writ when I took economics classes way back when. A little bit later Milton Friedman and Edmund Phelps demonstrated that the inverse relationship only held true in the short term while in the long term inflation has no relationship with unemployment. Nonetheless an inverse relationship between inflation and unemployment has remained a motivator for central banks including the U. S. Federal Reserve.
The editors of the Wall Street Journal observe that one of the outcomes of the virtual Jackson Hole conference was that the Fed has effectively abandoned the Phillips curve as a decision-making tool:
Starting in the 1980s, the U.S. economy achieved unprecedented low unemployment without an uptick in consumer prices as orthodox theory had predicted. Instead, as Mr. Powell noted in announcing the new strategy, business cycles now seem more likely to end in financial panics than in inflationary spikes that trigger interest-rate increases.
One happy result is that the Fed is all but abandoning the discredited Phillips Curve, the theory that policy makers must trade off between employment and inflation. The Fed previously tried to head off inflation by raising rates whenever it thought the unemployment rate was falling too far—whatever that meant—but now the Fed will wait for inflation to appear before acting.
but they look at some of the other announcements with foreboding:
Abandoning the Phillips Curve is a win for the economy, but it comes at a substantial cost in this review as the Fed also is overhauling its inflation target. Since the Fed adopted inflation targeting in the late 1990s and early 2000s (and formalized a 2% target in 2012), policy makers have viewed the target as a ceiling.
No longer. The Fed now will aim to achieve “average†inflation of 2%, meaning it will tolerate periods of faster price rises to compensate for periods when inflation falls short. Mr. Powell believes such a symmetrical target is necessary to “anchor†inflation expectations.
This is a political minefield because the definition of the inflation time period will always be open for debate. Mr. Powell and future Fed chairs will face pressure to maintain low rates to compensate for some protracted period of low inflation, or because a Senator or Twitter-happy President “believes†inflation will fall below target in the near future.
bringing to mind Lord Keynes’s wisecrack about the long run. They muse:
Well, what if there’s nothing natural about falling growth because the Fed’s policies are causing it? Research suggests sustained low rates can dent an economy’s growth potential by steering investment to unproductive uses, sustaining zombie companies, rewarding corporate financial engineering instead of capital expenditure, and contributing to asset booms and busts. It’s a shame the Fed has decided to double down on its low-rate, quantitative-easing bets before such a self-examination.
It was the head of Singapore’s monetary authority who best summed up the biggest fear gripping the virtual Jackson Hole conference this year.
“We are not going back to the same world,†Tharman Shanmugaratnam warned.
“We’ve got to avoid a prolonged period of high levels of unemployment, and it’s a very real prospect. It is not at all assured that we will get a return of tight labour markets even with traditional macroeconomic policy being properly applied.â€
The notion that central bankers need to face the reality of permanent upheaval and long-term economic damage by deploying new tools and dovish policies was the main theme of the Federal Reserve’s flagship annual event.
Notionally, its empowering statute imposes on the Federal Reserve a “dual mandate”: maximizing employment and stabilizing prices. IMO those were both abandoned decades ago in favor of a different dual mandate. Like any other bureaucracy the Fed’s greatest imperative is to ensure its own continued survival. To that end it has all but abandoned its obligations in supervising and regulating banks. The consequences of that were clear during the financial crisis of 2007-2008 and, sadly, since.
The other objective, of course, is to ensure that they have cozy berths waiting for them when they leave the Fed’s peculiar public-private environment for the nominally private sector. They’ll be fine as long as stock prices rise amiright or amiright?
The Fed went from managing banks to trying to manage the economy. A financial institution simply doesn’t have the (legal) tools to do that. But they try anyway, because it’s only other people’s money that’s at risk.
When fixed interest rates are set below actual market rates, money will flow to instruments that at a minimum beat the fixed interest rates. And it’s far quicker and easier to move money between financial assets than to or from fixed assets (manufacturing, land, tangible goods, etc.). Thus the increasing financialization of the economy. IMO OMB has been trying to reverse that trend (the trade war with China is a part of it), but when the whole economic bureaucracy is against it, it’s hard to do.
In a globalized economy no one country’s central bank has the tools to do that period. The Fed’s ability to “run the economy” is an idea that became obsolete in the 1980s.