(Bloomberg Businessweek) -- In 1994 three unemployed residents of Tucson sued then-President Bill Clinton, seeking to enforce elements of a law Congress had passed 16 years earlier. The 1978 Humphrey-Hawkins Full Employment and Balanced Growth Act established a 4% target for the US jobless rate and directed the White House to work in concert with the US Federal Reserve to achieve it. Unemployment was 6% at the time the plaintiffs, who included a Vietnam veteran and two homeless men, filed their suit. But a provision in the original bill allowing job seekers to sue if they couldn't find work was left out of the final legislation, which is why the judge presiding over the case threw it out.
Almost three decades later the US job market is about the tightest it's been in recent memory, with vacancies near an all-time high and unemployment at 3.5%—half a point below the threshold prescribed in the Humphrey-Hawkins Act. Yet the division of labor the law envisages is coming under scrutiny at a time when inflation is running at its highest level since the early 1980s and the Biden administration is looking to the Fed to rein it in, even at the cost of putting Americans out of work.
“The Fed has a primary responsibility to control inflation,” President Joe Biden wrote in a newspaper editorial published in May, adding that “past presidents have sought to influence its decisions inappropriately during periods of elevated inflation. I won't do this.”
The Fed is rare among central banks for having an employment mandate alongside the more traditional price stability mandate. The former is a byproduct of the civil rights movement, which throughout the 1960s and '70s fought for legislation ensuring adequate employment opportunities for all. The two objectives are widely seen as complementary: The conventional wisdom is that low and stable inflation allows businesses to focus on investment and hiring.
But the Fed's balancing act becomes more difficult during bouts of high inflation. At those times, the tendency among policymakers has been to conflate the two mandates in a way that obscures the often painful trade-offs.
In February 1981, when inflation was 11.4% and unemployment 7.4%, then-Fed Chair Paul Volcker told the Senate Committee on Banking, Housing and Urban Affairs he was “wholly convinced” that, given that the 4% unemployment target couldn't be reached in the short run, “the kinds of policies we are following offer the best prospect of returning the economy in time to a course where we can combine as full employment as we can get with price stability.”
By the end of the following year, unemployment had risen to almost 11%, the highest since the Great Depression. It didn't return to 6%, where it stood when Volcker took office in August 1979, until he stepped down in August 1987.
Today, Fed Chair Jerome Powell has a strikingly similar message. At a Sept. 21 press conference, he told reporters that “restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run.”
Powell's remarks came minutes after the central bank published updated quarterly projections showing Fed officials expected it would be necessary to engineer an increase in the unemployment rate, to 4.4% by the end of 2023, to bring inflation down to its 2% target. It marked the first time since the Fed began publishing the projections in 2012 that officials signaled an increase above the “longer-run level” they see as consistent with stable prices, which they currently estimate is 4%—coincidentally what's specified in the Humphrey-Hawkins Act.
“If you go to the Fed's statement on longer-run goals, they say that these two goals are typically not in conflict,” says Narayana Kocherlakota, a University of Rochester economics professor who was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015. “Once you have the kind of supply-side shocks that we are experiencing right now, that introduces the conflict. And I think that the Fed—if it's going to stick to 2%—is going to have to endure temporarily high unemployment.”
Powell, as well as almost everyone else on the central bank's rate-setting Federal Open Market Committee, argues the labor market is currently too strong and wage growth too high for inflation to return to the low levels that prevailed before the pandemic. That's despite an acknowledgement on their part that a lot of the high inflation the US is experiencing today can be accounted for by supply-side factors resulting from Covid-19 and the war in Ukraine.
It's a stark about-face from the way Fed officials talked about the labor market just before the pandemic. Unemployment then was also at historical lows, and the focus was on bringing more people from disadvantaged groups into the workforce.
In August 2020, the Fed unveiled a monetary policy framework that redefined maximum employment as a “broad-based and inclusive” goal. The move is now widely seen as having played a role in policymakers' decision to delay interest-rate increases until this year, even though inflationary pressures had bubbled throughout most of 2021.
Since May, the Fed has unleashed a series of unusually large rate hikes, and Powell has pledged the central bank won't let up until inflation has been decisively conquered. In August he warned the aggressive campaign of monetary tightening would “bring some pain for businesses and households.” Investors have penciled in an additional 75-basis-point increase at this week's FOMC's meeting, which ends on Wednesday.
Critics such as Gertrude Schaffner Goldberg—who chairs the National Jobs for All Network, a full-employment advocacy group whose founding members include some who were involved with the original Humphrey-Hawkins legislation—say the Fed's approach to cooling inflation by icing demand for workers is misguided, and so is Biden's support for it.
“This is not the only way to control inflation, and it certainly isn't the way to control a supply-side inflation,” Goldberg says. “Raising interest rates puts the burden of fighting inflation on working people who aren't really responsible for it.”
In fact, the Humphrey-Hawkins Act spells out a range of solutions to inflation that don't involve tight monetary policy, such as the establishment of government stockpiles of essential commodities, inducements to collective bargaining and greater enforcement of antitrust laws to increase competition. It also states that policies for reducing inflation should be designed so as not to impede achievement of the employment goal.
Democrats are pursuing some of these alternatives. The White House has released oil from the Strategic Petroleum Reserve in a bid to bring down gasoline prices. And the president's allies in Congress have passed legislation to ease shortages of vital inputs such as microprocessors and minerals used in the production of electric batteries by offering investment incentives to expand production stateside. It may be years, however, before some of those policies influence the trajectory of prices.
Meanwhile, with the Nov. 8 midterm elections looming, Powell is starting to get pushback from Democratic lawmakers worried that the Fed's rapid-fire rate hikes will push the economy into a recession. Sherrod Brown, the US senator from Ohio who plays a key role overseeing the Federal Reserve as head of the banking committee, sent Powell a letter on Oct. 25 asking him to stay focused on employment as the central bank fights inflation. Colorado Senator John Hickenlooper penned a similar letter on Oct. 27, urging the Fed to pause.
For its part, the Fed's willingness to put a number on the labor market damage it foresees as a necessary element of the inflation fight—down to the tenth of a percentage point on the unemployment rate—marks the latest chapter in an extraordinary evolution in central bank transparency that began in 2012, when it first started publishing the projection and the Fed chair began conducting press conferences after policy meetings.
Dartmouth College economist Andrew Levin, who helped design the projections as a special adviser to then-Fed Chair Ben Bernanke, says it's time to overhaul them. Levin says today's inflation isn't rooted in a strong labor market, citing falling real wages as one piece of evidence. But he also argues the Fed has little choice but to keep tightening, given how far inflation is above its 2% target.
In other words, the Fed's employment and inflation mandates are in conflict, and the projections as currently designed—as well as the central bank's messaging around them—don't give a sense of how monetary policy will seek to balance them under a range of possible scenarios as the inflation fight continues.
“They need to communicate clearly to the public what may be needed to restore price stability. What are the trade-offs that's going to create?” Levin says. “And they need to have that conversation with the public and with Congress, with the financial markets, to explain how they're handling the trade-off.”
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