Since January, when the Fed began changing course, the Standard & Poor’s 500 index has risen more than 600 points, or 25 percent. The unemployment rate, meanwhile, has fallen from 4 percent to 3.5 percent.
As Fed leaders completed two days of meetings on Wednesday for the final time this year, the pressure is largely off. The stock market is back at record highs. Unemployment is at a 50-year low, inflation remains tame, and the economy continues to grow at a healthy pace around 2 percent with little chance of a recession. While President Trump’s trade war continues to inflict harm, the Fed’s actions are widely credited with offsetting most of it, at least for the United States.
The Fed, under Chair Jerome H. Powell’s leadership, made two big admissions this year that laid the foundation for what many have dubbed “Powell’s pivot” — or “pirouette” — on policy.
The first was acknowledging that the economy wasn’t in danger of overheating in the short term. The second was acknowledging that unemployment could go even lower than the Fed thought without any negative side effects, a major revision to how it thinks about the economy’s long-run potential.
“The data is just screaming at them: We can sustain this low unemployment rate for a considerable amount of time without creating inflationary pressures,” said Tim Duy, an economics professor at the University of Oregon and author of the “Fed Watch” blog.
The Fed spent most of last year concerned that Trump’s tax cuts would spur a hot economy and rising inflation. Fed leaders anticipated they would need to raise interest rates twice in 2019 to tap the brakes on the economy. None of that came to pass.
By Jan. 4, Powell had a different message, effectively admitting the December 2018 rate hike was a miscalculation. The Fed, he said, would “patient" on rate hikes because there was little sign of an inflationary spike. By March, the Fed announced a plan to stop selling off the assets it purchased in the aftermath of the Great Recession, another sign the Fed was taking its foot off the brakes.
In July, the Fed made its first rate cut in more than a decade, as it became more likely that the economy needed stimulus, not restraint.
In the run up to the July rate cut, Powell appeared before Congress and indicated Fed leaders had been wrong about their projections for the economy. Unemployment could go a lot lower than Fed leaders had previously predicted.
“We really have learned that the economy can sustain much lower unemployment than we originally thought without troubling levels of inflation,” Powell said in response to questions from Rep. Alexandria Ocasio-Cortez (D-NY).
As far back as May 2016, Fed leaders such as John Williams — now the head of the New York Fed — said the economy was “basically at full employment,” meaning he did not think a lot more people would get hired. At the time about 144 million people had jobs, and the unemployment rate was 5 percent. Today, over 152 million Americans are working, and the unemployment rate is 3.5 percent.
“The Fed is eating humble pie,” said Diane Swonk, chief economist at Grant Thornton.
Until about five years ago, the Fed thought the U.S. unemployment rate wouldn’t get much below 5 percent. As the labor market has shown continued strength with month after month of job gains, the Fed has had to repeatedly revise its long-run forecast. As of September, the Fed was still saying 4.2 percent was roughly the full employment mark.
On Wednesday, the Fed lowered that forecast again to 4.1 percent. Economists credit Powell, who has a legal background not a PhD in economics, for being willing to discard economic models of the past that no longer seem to hold.
“I would look at today’s level of unemployment as well within the range of potential estimates — of plausible estimates — of what the natural rate of unemployment is,” Powell told Congress in July.
Trump has repeatedly blasted the Fed for setting interest rates too high last year, and White House officials have openly cheered the Fed’s pivot. Larry Kudlow, the president’s top economic adviser, has long said the economy wasn’t experiencing any signs of inflation and the Fed should take it easy.
Some Fed officials have openly said they think the central bank hurt the economy by taking interest rates from barely above zero in 2015 to nearly 2.5 percent by December 2018.
“I’m concerned that we’ve needlessly raised interest rates over the past three years and put the economy into a more dangerous position that makes it more vulnerable to shocks that could hit us,” said Minneapolis Fed President Neel Kashkari in a September interview.
Fed governor Lael Brainard put it this way in a speech last month when she expressed some regret about raising interest rates too soon in 2015 and 2016: “A better alternative would have been to delay liftoff until we had achieved our targets," she said, referring to inflation returning to at least 2 percent (which has yet to happen) before raising rates.
Many economists point out that Trump also carries some of the blame for the economic slowdown this year as his tariffs and unpredictability caused business investment to slump.
“Part of the reason the Fed had to cut this year was because the trade wars were taking a bigger bite out of growth,” said Swonk. “We can thank the Fed.”
Fears of a recession have faded, largely because of the Fed’s three interest rate cuts in the latter half of the year which helped to counterbalance the harm from Trump’s trade war. Even the bond market, which briefly flashed a warning sign in August when the yield curve inverted, is now back to its normal.
Trump has called Fed leaders “boneheads” and Powell an “enemy.” Those broadsides have not gone over well with many on investors, economists and business leaders who think Trump is undermining the Fed’s independence. But the Fed has ignored personal slights and focused instead on what Fed leaders see as valid criticism.
“The best thing you can do when you realize you made a mistake is put it behind you,” said Andrew Levin, an economics professor at Dartmouth College who spent two decades as a Fed economist. “Powell was willing to make a U-turn and lead the committee despite some dissents this year and in an atmosphere where he was being constantly publicly criticized.”
The Fed now faces a test in 2020 to keep the economy healthy and decide how important it is to get inflation back to the Fed’s 2 percent goal after years of undershooting it.