A False Choice
Biden’s top labor economist suggests a trade-off between inflation and employment.
Count President Biden’s top labor economist, Janelle Jones, as among the few who thinks that the Federal Reserve should keep its foot on the gas. At 6.2 percent, inflation is up to its highest rate in decades. Yet the Fed has not only set rates to near zero but is also still buying long-dated securities—quantitative easing—a step called for only when the economy is in an emergency. The Fed is winding down its asset purchases and might raise rates next year, but despite high inflation and many unfilled jobs, Jones is concerned that doing so will hurt the labor market.
The trade-off between inflation and employment, however, is a false one. Economists in the 1960s believed that if the central bank tolerated some inflation, it would boost employment. In the 1970s, they realized that this wasn’t always true. If markets believe that inflation will rise and the Fed won’t do anything about it, inflation will keep rising—but employment doesn’t have to. In fact, such a dovish approach can hurt the economy by creating uncertainty and diminishing the purchasing power of households. Mismanagement can yield both unemployment and inflation.
The dirty secret in monetary policy is that it does not exert perfect control over either inflation or employment. To this day, the exact mechanism by which rates affect employment is not fully understood—and that’s even truer with the new tools that central banks use. But one thing is certain: a commitment to lower inflation is fundamental to a central bank’s credibility. Without that commitment, it can’t control inflation or influence unemployment much.
Current policy still has its foot on the gas, as Jones likes it. Many things could change in a year—and many of them could justify keeping rates at zero.
For now, though, the Fed should act. To preserve its credibility, it should end quantitative easing and use the program only sparingly in the future. The Fed also may need to speed up its planned rate increases if inflation remains high. Right now, a small rate increase—say, 25 basis points—would send a strong signal to markets. If inflation goes on for too long, the Fed may need to undertake large rate increases to bring it into line, which would do far more damage to the economy and the labor market.
Things are not as simple as Jones argues. History is replete with examples of central bankers deciding the economy can tolerate more inflation because employment is more important. When they make this choice, the economy usually ends up with the worst of both.
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