Powell’s address at the annual conference traditionally held in Jackson Hole, Wyo., on Thursday broke from this orthodoxy when he said that “a robust job market can be sustained without causing an outbreak of inflation.” The Fed chair added that the bank would focus on boosting wages and employment and would keep the interest rate at zero for years to come even if inflation exceeds the once unacceptable threshold of 2 percent. The Fed, like all central banks, long ago established what it considered acceptable and unacceptable rates of inflation; it is and always has been free to change those targets, redefine them or discard them, but considered it heresy to deviate from orthodox parameters. The belief that nothing was more destructive than rampant inflation shaped every central bank decision and disposed the bank to raise interest rates at the slightest hint that the economy was growing too quickly and getting too hot.
More than Congress or the White House, the Fed has staved off financial collapse during the pandemic and the lockdowns. Its guarantees to buy everything from municipal bonds to stocks and to lend hundreds of billions of dollars to midsize companies halted the spiraling panic in markets in early April. Its assurances alone brought calm, and it has not even had to do much of what it was prepared to do. It has also lent liberally to foreign central banks, which kept the global financial system stable, buoyed equity markets and pacified bond markets.
But the Fed’s actions have not been met by a commensurate degree of urgency from Congress after it authorized nearly $3 trillion in unemployment benefits, small-business loans and direct checks in April. As a result, the stability of the financial system strikes many as yet another instance of wealthy people and wealthy companies getting bailed out while the rest suffer. But there is little more that the Fed alone could have done; the Fed must follow its mandate, and keeping the financial system afloat is certainly better than having it collapse. The failure of Congress does not diminish the Fed’s relative success.
Now, the Fed is going even further, and showing a willingness to recognize that the orthodoxies of the 20th century should not determine policy for the 21st century.
There is a growing awareness and acceptance — among policymakers, market makers, economists and bankers — that inflation has not accelerated even in the face of years of low interest rates and low unemployment. This contradicts traditional models that gained widespread acceptance in the last part of the 20th century that low unemployment would lead workers to demand higher wages, which would in turn push up prices. Most economists, and especially those working for the Fed, also believed more money in circulation tends to trigger inflation. But for the past decade, central banks including the Fed have kept interest rates low; there has been easy money easily circulating, and there have been tighter and tighter labor markets (at least until the pandemic). And yet wages have risen only marginally, and inflation in the United States, in Europe, and even in economies such as China and India has barely topped 2 percent a year in the developed world and well below its late 20th-century range in the developing world.
Still, many economists believed we were living through an anomalous period and argued that was because of central bank policy after the Great Recession; others contended that there was inflation but that instead of showing up in the price of consumer goods, it was showing in assets such as real estate, fine art and above all in stocks. And most economists in the financial sector and in government held to the view that even as inflation was staying low longer than expected, it was only a matter of time before it gathered steam — except that it never did.
But after a decade when by every measure inflation should have increased but did not, the Fed and many others are finally willing to contemplate that something fundamental has changed permanently.
It is unclear why inflation is disappearing. Compelling theories range from the slowing population growth in much of the world to the deflationary effects of new information technologies that are paid for not by money but by user data. There’s also the highly efficient supply chains that have evolved with very little slack that have allowed companies not to build up inventories. That has meant leaner operations and lower costs, and it also has created the near-fatal shortage in the global supply of equipment and medicine in a time of pandemic duress.
While we don’t know why inflation has seemingly evaporated, the Fed now recognizes that too little inflation can be its own economic head wind in a world where wages have not kept pace even before the pandemic. None of this, of course, means that inflation will never again be a threat, but it does connote a welcome willingness to confront the world now and going forward as it is and not as the models say it should be. And this new shift allows the bank to be nimbler and more creative, not words usually associated with staid bankers, but which certainly now applies. All of this is cause for some quiet celebration, and also a stark reminder of how much more Congress and the White House could be doing to address the extraordinary economic challenges caused by the pandemic. It is welcome that the Fed is doing what it can, but it can’t do it alone.