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Federal Reserve: we have to hold the Fed accountable for bad predictions

As of April 2019, only 3.6 percent of adults in the US labor force were unemployed, as defined by the Bureau of Labor Statistics. It’s the lowest rate America has experienced since 1969.

An unemployment rate that low is supposed to augur disaster, if you listened to many macroeconomists — and indeed, many Federal Reserve officials responsible for managing employment in the US — over the past few years.

Mainstream macroeconomics uses a concept called the non-accelerating inflation rate of unemployment, or NAIRU. NAIRU, a term introduced by Milton Friedman in 1968, is supposed to represent the minimum level of unemployment that an economy can achieve without setting off a dangerous inflation spiral, in which prices increase, wages rise to keep up, prices rise to cover the wages, and on and on.

The “accelerating” part is important here. Friedman thought that in the long run, there’s no trade-off between unemployment and inflation, which is why “stagflation” in which both are high, as the US would later experience in the 1970s, is possible. But a trade-off arises if inflation keeps rising, even from a low base. “There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off,” he summarized.

As Mike Konczal explained at Vox last year, one way to think about this idea is that there’s a level of economic growth that can be supported by the real resources (workers, factories, land, etc.) in the economy. If unemployment gets very low because growth is outstripping that level, then you have more money chasing fewer resources. Prices rise and you get troubling levels of inflation. That’s the theory, anyway.

The Fed estimated that during the recovery, from around 2009 to 2015, NAIRU was somewhere between 5 and 6 percent. In 2012 and 2013, 5.6 percent was the main prediction.

We’re now 2 full percentage points below that. Some 3.2 million more people in the civilian labor force are employed than the Fed’s prediction suggested is wise. That suggests we should be seeing really dangerous levels of inflation right now.

Except … that hasn’t happened. We’re at a historic low point in terms of unemployment, yet inflation remains low too and shows little sign of rising. According to the Fed’s preferred measurement, inflation is at only 1.6 percent, below the Fed’s target of 2 percent.

Moving beyond NAIRU

The Fed has been revising down its NAIRU estimate, even if it has yet to fully abandon NAIRU. That’s a good reason to think we should change monetary policy, scrap the obsession with inflation, and adopt a new rule that encourages the Fed to keep unemployment as low as possible.

And we need to hold policymakers to account when their existing policies have failed — or have been based on provably false premises.

Skanda Amarnath, a monetary policy analyst who goes by @IrvingSwisher on Twitter and is a must-follow for anyone interested in these topics, put together a nice roundup of Fed policymakers saying that we had achieved full employment years ago — or, put another way, millions of jobs ago.


Various wrong pronouncements of full employment by Fed policymakers

Fed policymakers were very eager to proclaim we were at full employment when we very much were not!
Skanda Amarath

Here’s John Williams, then-president of the San Francisco Fed, in November 2015:

With the unemployment rate now at 5 percent, we’ve reached my estimate of full employment based on that measure.

If unemployment were still at 5 percent, instead of falling to 3.6, some 2.3 million fewer people would have jobs right now. Hardly full employment, as it turns out!

Or here’s Jay Powell, the current Fed chair, in November 2016:

Today, we are reasonably close to achieving full employment and our 2 percent inflation objective.

We were not. Unemployment was 4.7 percent. We were still some 1.8 million jobs away from our current point.

Eric Rosengren, president of the Boston Fed, said the same basic thing a month earlier:

The unemployment rate is currently at 5%. I think that we can come down a little bit more from where we are, so my own estimate of full employment is 4.7. But my own view is that, at 4.7%, the economy would be running a little bit hot.

If we were “running a little bit hot” at 4.7 percent unemployment, we should certainly expect inflation now that unemployment is down to 3.6 percent. Didn’t happen!

The list just keeps going. Here’s Charles Evans, president of the Chicago Fed, in May 2017, when unemployment was 4.4 percent:

Today, we have essentially returned to full employment in the U.S.

Nope! We had further still to go.

Here’s Patrick Harker, president of the Philadelphia Fed, in May 2016, when unemployment was 4.8 percent:

Regarding the employment side of our mandate, I believe we have, for the most part, attained our goal already and that the labor market is basically functioning at full employment.

Spoiler: The labor market was not basically functioning at full employment.

Indeed, even with unemployment at 3.6 percent, it’s hard to say we’re really at full employment in a policy-relevant sense until we stop creating jobs, people stop joining the labor force, and inflation starts rising.

None of that has happened. We are not at full employment.

The Fed’s eagerness to prematurely declare mission accomplished has real-world consequences. The Fed’s governing body has, for the past few years, been gradually raising interest rates, from a low of 0.25 to 2.5 percent. That hasn’t killed the economic recovery — unemployment continued to fall — but it’s certainly slowed down the recovery. Indeed, that’s the whole point: to slow the economy in the interest of preventing inflation.

That means the Fed has deliberately chosen to keep hundreds of thousands, if not millions, of people from finding work that they could have found with looser policy, in the name of preventing inflation.

As Amarnath argues, the Fed should be erring on the side of letting jobs proliferate, letting people enter the labor force, letting wages rise. It’s erred too often on the side of fighting phantom inflation that never arose, and workers have paid the price. It’s time for that calculus to change.


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