The Washington PostDemocracy Dies in Darkness

American elites have completely failed to understand what the Fed should be doing right now

Federal Reserve Board Chair Janet Yellen fights the good fight for fuller employment, but she needs backup. (Shawn Thew/EPA)

Here are a few questions I’d like you to consider, and you don’t need to be an economist to give a valid responses. In fact, it’s better if you’re not.

Which do you think is a bigger problem facing the U.S. economy right now: a) inflation, or b) unemployment? Do you think wages are growing: a) too quickly, or b) too slowly? Which is the bigger threat to the economy: a) that it overheats, or b) is undercooked?

I’m going to make the bold assumption that most of you answered “b” on all of the above. And in a moment, I’ll provide the data to confirm your gut. What’s unsettling, and in need of explanation, is why so many influential voices, from the punditry to the markets, answer “a.”

The answer, I believe, is that America lacks a substantial political movement in support of progressive macroeconomics. The debates over full employment and Federal Reserve policy are generally dominated by the interests of the minority who worry more about inflation and asset values than those who worry about jobs and paychecks.

Right now, for example, the risks facing the Fed are asymmetric the following sense: There’s a greater chance that the Fed’s actions would hamper growth in an already weak economy than there is that its inaction would set off an inflationary spiral. Yet, the outside pressure on the Fed is asymmetric in the other direction: There’s more pressure on it to tighten than to sit tight for a “considerable time.”

Obviously, important voices, most notably that of Paul Krugman, are often raised in support of the need to worry a lot more about growth, jobs and wages, than inflation and overheating. Yet the stance of the Yellen Fed — data driven, correctly focused on the actual slack problem vs. the phantom inflation problem — is defensive, constantly reassuring the hawks not to worry, they’ll tighten soon enough.

Historical data, current conditions, and future expectations all point towards the need for continued support from monetary policy:

  • Core inflation by the Fed’s preferred measure (core personal consumption expenditures) has been at or below 1.5 percent since January 2013.
  • Average nominal wage growth has been stuck at 2 percent, with very few signs of acceleration even as the job market tightens.
  • The current gap between actual and potential gross domestic product (what GDP would be absent all this slack) amounts to more than $700 billion, about $2,400 per capita.
  • Since the 2007 economic peak, the share of national income going to workers’ compensation is down about three percentage points. This is important — and hardly ever raised in this debate — because it means if the job market tightened up and workers got a bit more bargaining power, non-inflationary wage gains could be financed by a rebalancing of the profit and wage shares of national income. (And here we also see why vested interests would prefer this not be discussed.)
  • Historically speaking, real wages of middle- and low-wage workers, especially men, have been flat for decades, and as I pointed out earlier this week when the 2013 Census data were released, the real median household income is $5,000 lower now than in the late 1990s.
  • Looking forward, inflationary expectations are solidly within the Fed’s 2 percent target range.
  • Although Fed critics worry about asset bubbles, and no question investors are “reaching for yield” given very low interest rates, Fed Chair Janet Yellen is correct when she asserts that asset prices, including stock and real estate valuations, are within historic ranges.

Putting it all together — the persistent slack, the terrible record on middle-class incomes, and yet the outside pressure on the Fed to fight inflation nevertheless — I see a system that’s institutionally biased against full employment. Although this bias is finally being challenged by activists who showed up at the big Fed meeting in Jackson Hole, Wyo., an extremely welcome development, it’s fair to say that such counter-pressures are in their infancy.

How can this dynamic change? How can we bring real balance to the pressures on the Fed to fight just as hard for full employment as for price stability?

First, the broader public must understand the costs of slack. That’s the point of the recent book by Dean Baker and myself, wherein we document the critical importance of full employment to middle- and low-wage workers, to the fiscal budget, and even to income inequality and opportunity.

Second, it must be understood that full employment is a “policy variable.” Here, the minimum-wage debate provides an excellent example of what I mean. Most models of capitalist economies do not consider wages something to be set by policy; they are to be set by “markets.” But, although the issue is still hotly debated, it is widely accepted that for the lowest-wage workers, wages should not be allowed to fall below a floor called the minimum wage, and that floor should be regularly raised.

We need to develop that same expectation regarding full employment.

Finally, we need more help from the economic academic community. One reason the minimum wage debate has evolved as it has is that top academic economists examined the empirical evidence behind the market assumptions and found them wanting. Their careful work, followed up by years of complementary analysis, reshaped the debate.

That needs to happen on these issues of full employment, wages, incomes, inequality and inflation. Many economists actually recognize, for example, that the historical negative correlation between slack and inflation is much diminished. And yet the asymmetric pressures to prematurely tighten persist.

By recognizing and promulgating the costs of slack, the fact that something can be done about them, and the empirical research behind those assertions, we might be able to turn this around.