Economic research shows that monetary policy works best when conducted by an independent central bank. After Fed chairs in the 1960s and 70s caved to pressure from American presidents, those who followed sought, at least to some degree, to reestablish the Fed’s independence. Until now, that is.
Since 2019, the Fed has politicised its activities in virtually every way: through its monetary policy goals, the use of its enhanced balance sheet, its regulatory actions and its emergency lending activities. Each of these changes has pushed the Fed further from being an effective and independent central bank toward becoming a purely political institution, which prevents it from choosing the best policies for Americans and the US economy.
Monetary policy: ‘Inclusive’ employment and (flexible) average inflation targeting
Fed officials, including current Chair Jerome Powell, have acknowledged that monetary policy is a broad tool that cannot be used to address the problems of racial and income inequality. Despite this admission, however, the Fed has injected the issue of inequality into its monetary policy goals.
In August of 2020, the Fed rewrote its statement of goals and strategy to emphasize employment ahead of inflation. The new language described the maximum employment goal as “a broad-based and inclusive goal that is not directly measurable”. Chair Powell cited racial differences in unemployment rates as a motivation for the change. This shifted the Fed’s goal from focusing on the best outcome for most Americans to a purely discretionary target, which the Fed admits is impossible to measure.
At the same time, the new objectives stated that the Fed would target a rate of 2% inflation averaged over time, giving Fed officials greater ability to deviate from the prescribed rate of 2% annual inflation. Moreover, Fed officials have since revealed that they only intend to seek an average 2% when it has previously been below target. When inflation is above target, in contrast, the Fed will allow it to remain so and will not bring it down enough to return to the previous price-level trend.
