Last year at this time we were in the depths of a global crisis. A mysterious disease was sweeping the world and governments shut down economies in an attempt to stop the spread. Rightly or wrongly, these closures have ended our lives and our livelihoods. The unemployment rate in the United States reached nearly 15%and measures of “underemployment” reaches up to 23 percent. Total wages and salaries fell 6.5% in a single quarter.
The Federal Reserve has taken extraordinary measures to cushion the fallout. Today, the Fed is tolerating higher inflation to accelerate the recovery. But the time for this temporary overshoot is coming to an end.
Many libertarians are uncomfortable with the Fed’s very existence. I appreciate their passion for sound money and human freedom. But the Fed exists and it can adopt better or worse policies. To increase money and credit growth during a recession, the Fed lowers interest rates. To slow their growth in order to stop inflation, the Fed raises interest rates. At best, the Fed ensures that money and credit can grow evenly, thereby promoting stable prices and maximum employment.
The deterioration of our country’s long-term growth has brought interest rates close to zero, even in normal times. To give themselves room to lower interest rates during recessions, Fed policymakers choose to target an average annual inflation of 2%, not zero. They hope that low and stable inflation will cause little harm as long as households anticipate it. When the Fed does not reach this objective, it exceeds it to bring the average back to 2%. Otherwise, interest rates would fall closer to zero.
The inflation we are seeing today puts us back on the path to price stability by offsetting the deflation and disinflation of the past 10 years. It is painful for the families. It’s like medicine: bitter, temporary and, if prescribed correctly, necessary. Every worker should require a cost of living adjustment. Inflation means your wages should also increase. Frankly, not all of us will get it. It is a sacrifice we did not choose.
The question is, which is worse: a small decrease in your inflation-adjusted salary, or longer, deeper layoffs during recessions? The Fed is betting that a little inflation today will save jobs tomorrow.
This solution is not perfect. We must demand better. More importantly, we need to jump-start the economy – long-term real growth, not just a rebound from 2020. Higher long-term growth would push interest rates from zero, allowing the Fed to aim true price stability without becoming powerless in recessions.
The key ingredient to long-term growth is higher productivity. But the Fed is powerless to raise productivity except indirectly through the benefits of a long-running economic expansion. As Fed officials often point out, growth-promoting policies are entirely the responsibility of Congress. But until growth picks up, we could be stuck with an average annual inflation of 2%.
Fed Chairman Jerome Powell (who is to renew soon) and other monetary policy makers know that inflation has now averaged 2% over the past five years. They have completed the retrospective part of their recovery strategy. Now is the time to look forward. With an unemployment rate below 6% and over $4 trillion in additional spending On the horizon, isn’t it time to reduce monetary policy easing from the maximum? As in the years following the global financial crisis, they should allow the labor market to fully tighten, but recognize that a return to 3.5% unemployment could be a slow and steady climb.
The patience of everyone else as we emerge from the depths of the crisis deserves to be rewarded.