In the first 18 years of the new millennium, the U.S. economy has fared much worse than it could have. If the Federal Reserve wants to improve that performance, it should consider changing the way it manages growth and inflation.
Here are some markers:
- Employment among people in their prime working years (ages 25 to 54) has yet to recover to where it was before the recession of 2007 to 2009, and remains well below its 2000 level;
- The share of total income received by workers — as opposed to that received by business owners — declined by more than 10 percent from early 2000 to early 2017;
- Adjusted for inflation, median income for men barely exceeds its 2007 level, and remains below its 2000 level (women have seen very modest income growth since 2000);
- The median net worth of American households has yet to recover from the last recession and, after adjusting for inflation, remains below the levels of the late 1990s.
The Fed’s monetary policy has contributed to this poor performance. Statutorily, the central bank is charged with promoting price stability and maximum employment. It has defined the former goal as 2 percent annual inflation. It is less precise about the second goal, but many view it as keeping the economy’s inflation-adjusted output close to its potential.
Since 2000, the Fed has largely failed to achieve those objectives. In most years, core inflation –- which excludes volatile food and energy prices — has been well below 2 percent, and real growth in gross domestic product has fallen far short of potential.
Here’s a chart showing how inflation has missed the Fed’s target (using the central bank’s preferred measure of inflation, the core price index for personal consumption expenditures):
And here’s a chart showing how far growth has been from its potential (as estimated by the Congressional Budget Office):
With these inflation and growth outcomes, it’s no surprise that employment remains subdued compared to 2000 levels. Or that workers have lost bargaining power, and so lost income and wealth.
This picture suggests that the Fed should change its attitude toward its mandates: It needs to stop treating its objectives as ceilings, as opposed to targets. This would mean allowing inflation to rise above the central bank’s longer-term goal of 2 percent, and occasionally allowing growth to exceed potential.
Now would be a good time for such an attitude adjustment. At the end of last year, Congress passed a tax bill that seems likely, in and of itself, to push upward on both inflation and potential output. Will the Fed choke off this fiscal stimulus by increasing interest rates? Or will it leave rates unchanged, allowing the stimulus to pass through? Americans who have suffered through this millennius horribilis must hope that the Fed takes the latter course.