Fed’s Inflation Target Faces Heat from LiberalsSeeking Economic Reform

Jay Powell is staying hyper-focused on a numeric goal that originated 36 years ago in New Zealand — despite pushback from Democrats.

The Federal Reserve’s goal is to get the inflation rate at least near 2% before it begins cutting interest rates.

That’s a formal target backed by written policy, but it’s also the source of growing liberal discontent serving as another form of political pressure on Fed Chair Jerome Powell as he tries to navigate a white-hot election year.

Some on the left want that number to be higher. Some would prefer the Fed add a second target focused on the labor market. And several Democrats used public hearings this past week with Powell to question the target’s origins and why it has so much importance inside the central bank.

“It seems to come from Auckland and from the 1980s,” a somewhat disbelieving Rep. Brad Sherman said on Wednesday when it was his turn to question Powell.

The liberal stalwart from California was right. The path to 2% began with an off-the-cuff comment in New Zealand in 1988.

The Fed publicly adopted the standard 24 years later, in 2012, in a process that was met with discomfort from the left side of the political spectrum largely because of the lack of a parallel labor market target.

Senator Sherrod Brown, chairman of the Senate Banking Committee, underlined this dynamic on Thursday when he suggested Powell move quickly to cut rates “to prevent workers from losing their jobs” and added that “this town too often seems to forget that maximum employment is part of the Fed’s dual mandate.”

The Fed doesn’t have a numeric labor target even though its dual mandate requires it to aim for both stable prices and maximum employment.

Its inflation target is key because of how rate cuts are decided. Powell and other Fed officials have made it clear they won’t start lowering the benchmark rate from its 22-year high until they are confident inflation is moving down “sustainably” to 2%.

And Powell strongly signaled last week that the 2% inflation target isn’t going anywhere. He mentioned it seven different times within the span of his five-minute-long opening remarks before lawmakers on both Wednesday and Thursday.

He also acknowledged its Kiwi origins in response to Sherman’s questioning but added that “2% has become the global standard — it’s a pretty durable standard.” He reinforced his belief that it wouldn’t be a problem for the US to achieve the 2% level in the months ahead.

“People are always talking about this,” said Preston Mui, who is with a labor market-focused group called Employ America. Changing the target by moving it even higher to 3% “is probably not something that’s politically in the cards for the Fed at all right now.”

But talking about the number has nonetheless “caused a lot of headaches for Powell over the last two to three years,” Mui added.

How the Fed got here

The path to the Fed’s 2% inflation target was a winding one that began with an interview that is now infamous in central banking circles.

Don Brash, who was governor of New Zealand’s Reserve Bank, offered an off-the-cuff comment in 1988 that he wanted an inflation rate between 0% and 1%. That set off a policy-making process and led his nation to adopt a formal 2% target soon thereafter.

Other central banks followed and the moves were criticized from some quarters as being too inflation-focused.

Perhaps the most colorful takedown came from Mervyn King, a British economist who served as governor of the Bank of England. He said in 1997 that he worried a hyper-focus on price targets would lead to central bankers becoming “inflation nutters.”

The Federal Reserve, under Alan Greenspan at the time, was resistant to a public embrace of the idea but debated it throughout the 1990s and early 2000s.

“If you read FOMC transcripts around inflation targeting, it’s a concern,” said Federal Reserve historian Sarah Binder of political considerations in a recent interview.

There was resistance to implementing it during a 2008 downturn, with Ben Bernanke in charge. There was concern among Fed governors that “we’ve got to be worried about pushback from Democrats,” Binder said.

But by 2012, with a recession in the rearview mirror and Bernanke in his second term as chair, the Fed pivoted, and a 2% target was publicly adopted.

Bernanke argued in his memoir that a 2% target increases business and consumer confidence and therefore gives the bank more flexibility to address both sides of its dual mandate.

It’s an argument that is still used today, with an explainer on the Fed’s website saying the 2% target “is most consistent with the Federal Reserve’s mandate for maximum employment and price stability.”

But many on the left were never fully on board. Bernanke acknowledged in his memoir that a main liberal voice of that era — Rep. Barney Frank of Massachusetts — brought up the lack of parallel labor market target and “wasn’t completely comfortable” with the policy even if he went along with it in the end.

It’s a critique that has persisted for years.

“I think it should be higher than that,” Rep. Maxine Waters said of the 2% target in an interview with Yahoo Finance’s Jennifer Schonberger last week, saying an increase would help support working families.

Rakeen Mabud, the chief economist at the left-leaning group Groundwork Collaborative, put a finer point on it, saying the target “codifies the fact that inflation is just more important to the Fed than unemployment is.”

The ongoing critique is further contextualized by a 2020 move at the Fed to adopt a flexible average inflation targeting framework. In effect, the change made 2% into a less rigid target by allowing the Fed to look at 2% as an average and allowing inflation to run slightly hotter for stretches.

Republicans appear inclined to return to the harder pre-2020 target, with some quarters of the GOP eager to remove employment from the Fed’s dual mandate entirely.

The policy will be under review, Powell said last week, beginning later this year and through the end of 2025.

Why it won’t be so easy to change

The 2% target could grow as an issue in the months ahead, with many Democrats continuing to call for rate cuts even as forecasts have dropped throughout the early months of 2024. Some in the financial world are even predicting zero cuts all year.

“Interest rates are too damn high,” Congresswoman Ayanna Pressley of Massachusetts told Powell.

Another issue for the left is that simply adding a corollary target focused on the unemployment rate — which ticked up to 3.9% in the February jobs report — is not necessarily as easy as it might sound.

Mui, the senior economist at Employ America, said his group is focused on more nuanced measures like the prime age employment rate — the number of younger people working against their overall population — or wage growth or quit rates or overall labor force participation.

“I think if there was this rigid commitment to defining an unemployment target, there’s actually a risk [in some scenarios] that it actually doesn’t pay enough attention to that side of their mandate,” he said.