Many people think of the Federal Reserve Board as an obscure and esoteric institution that only those concerned about finance need concern themselves with. Nothing could be further from the truth.
The Fed’s ability to set interest rate policy directly affects the rate of growth in the economy and therefore the rate of job creation. This in turn affects the tightness of the labor market, which determines the extent to which workers have the bargaining power to achieve wage gains.
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The basic story is that when the Fed raises its short-term interest rate it puts upward pressure on interest rates throughout the economy. It means higher interest rates on mortgages and car loans, on student loan and credit card debt. It also means that companies have to pay more money to borrow as do state and local governments. The result of higher interest rates in these and other areas is less borrowing and therefore less demand in the economy. This translates into less growth and fewer jobs.
There has been a major debate in recent years both at the Fed and among economists more generally on how low the unemployment rate could go. Just a few years ago, it was widely believed that if the unemployment rate fell much below 5.5 percent inflation would begin to spiral upward. Proponents of this view wanted the Fed to start aggressively raising interest rates to make sure the unemployment rate did not get too low.
In December of 2015 the Fed did start raising interest rates from the zero level set in the Great Recession, but it has been relatively cautious in its rate hikes thus far. While some of us would still argue that it raised rates more than was warranted by the economic situation, the current 1.25 percent level for the short-term rate directly under its control is still low by any historic standard.
As a result, the unemployment rate has fallen to 4.3 percent and millions more are working than if the Fed had followed the route advocated by the inflation hawks. And the beneficiaries of this drop in the unemployment rate have been overwhelmingly the most disadvantaged groups in society.
Comparing August of 2017 to August of 2015 the employment rate (the percentage of the adult population that is employed) for whites has risen by just 0.5 percentage points. The employment rate for Latinos rose by 1.4 percentage points, while the employment rate for African Americans rose by 1.7 percentage points. There is a similar story if we look at employment by education level, with the strongest gains by those with the least education.
This pattern also shows up in the wage growth data. While those towards the top end of the wage distribution saw respectable wage gains throughout the recovery, those at the middle and bottom had largely stagnant real wages. This has reversed in the last few years as the labor market has tightened. Workers at the middle and bottom of the wage distribution are now seeing more rapid wage growth than those closer to the top.
This story should be very important to anyone concerned about the plight of low and moderate income people. There would be big fights in Congress if someone proposed raising or lowering food stamp benefits by $10 billion, but Fed policy could easily redirect ten times as much money to low and moderate income households through increased employment and higher wages, with no one paying attention.
It is important that people start paying attention now. There are currently four opening on the Fed’s seven-person board of governors. This seven person board, along with the 12 presidents of the district Fed banks, determines the Fed’s monetary policy. Donald Trump will have the ability to fill these vacancies. (He already has already made one nomination for a vacant governor slot.)
In addition, Janet Yellen’s term as Fed chair expires in February of next year. Trump will also have the opportunity to replace Yellen. While the Fed chair only has one vote, they have enormous influence over Fed policy. The rest of the group tends to defer to the Fed chair, especially when it is someone like Yellen who has established her expertise on monetary policy over several decades at the Fed and in other policy positions.
There is actually a possibility that Trump will reappoint Yellen as Fed chair in spite of her being a Democrat. There has been a tradition of presidents reappointing Fed chairs from the opposite party, so there would be plenty of precedent for this. Trump may also be looking for a way to be conciliatory to Democrats and earn himself some good press.
In addition, Yellen is likely to be good for the economy. She will try to maintain the economy on a path of stable growth and ideally falling unemployment. Most of the likely Republican picks are among the inflation hawks who have been arguing for higher interest rates for years. Trump would certainly like to be able to run for re-election with a strong economy under his belt.
The idea of doing anything that might help Trump stay in office is undoubtedly repulsive to many progressives. But it doesn’t make sense to hope that the economy will tank to undermine his election prospects. The people who would pay the price for another recession are overwhelmingly the least advantaged in society.
There is a long list of reasons that Trump should not get another term in office, and the list will surely lengthen in the next three years. This should be the basis for unseating him, not the sabotage of the economy. We should all hope that Janet Yellen gets another term as Fed chair.