The Federal Reserve is pulling out all the stops to make it easier for you to find a job
- The Federal Reserve's strategic review on August 27 was historic, prompting some experts to suggest the nation is shifting toward 'fiscal policy' dominance after 30 years of stabilizing the economy by 'monetary policy.'
- It's a big deal. Since 1977, congress has given the Fed a 'dual mandate' to 'promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.' That last part is what's changing.
- Fed Chairman Jerome Powell, in shifting from the Fed's historic focus on interest rate adjustment to manage inflation, emphasized the decision is about increasing employment.
- Powell said the Fed will adopt 'flexible average inflation targeting,' which allows inflation rates above and below 2%, the level the Fed has tried to stay under for decades.
- Allowing inflation above 2% would help with job creation, economists say, meaning the central bank is switching things up in a big way to bring unemployment down.
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Investment firm Morgan Stanley has been predicting since April that, for the first time in 30 years, the US may shift from monetary policy dominance to fiscal policy dominance.
If you're not an economist or a financial expert, you probably don't know what that means, but it is actually crucial to the health of the US economy, and how high — or low — unemployment can get.
On August 27, the nation's central bank, the Federal Reserve System (or "The Fed") amended the Statement on Longer-Run Goals and Monetary Policy Strategy. The Fed has reviewed the statement every year since originally publishing it in 2012 to more transparently communicate its outlook on monetary policy.
In 2018, Fed Chairman Jerome Powell took office during the one of the country's longest economic expansions ever. During his first year as chair, he increased interest rates four times to combat inflation as the economy expanded. His policies have emphasized a strong labor market, a change from many previous Fed chairs who focused on interest rates as a tool to manage inflation, but largely a continuation from the tenure of Janet Yellen, who was appointed Fed chair under President Barack Obama.
According to commentary from Scott Brown, chief economist at financial services firm Raymond James, "this isn't a change from how the central bank views things. The Fed has simply formalized it, providing a clearer break from past views."
So what are monetary policy and fiscal policy? How has the Fed broken from its past views? And why does it matter for your career?
What is monetary policy?
According to the Fed, "monetary policy refers to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth." The Fed is nonpartisan, ideally operating outside the realm of politics.
, congress has given the Fed a "dual mandate" to "promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates." That last part could be what's changing.
The Fed has a few goals it's trying to meet, as set by congress in 1977: promoting maximum employment and price stability, often referred to as the "dual mandate." It attempts to achieve these goals by managing the level of interest rates, the reserves required by banks (how much a bank has to keep on hand without lending out), and influencing the cost of credit available in the economy.
A group within the Fed, the Federal Open Market Committee ("FOMC") is in charge of putting policies in place that will achieve this "dual mandate." These policies together make up the country's monetary policy. Monetary policy can be expansionary or contractionary, meaning the policies can be intended to spur economic activity in a downturn or protect the economy from high inflation in times of high economic growth.
In 2008, the Great Recession necessitated a reduction in interest rates. The Fed reduced interest rates from 5.25% in June 2007 to 0% by December 2008, an expansionary policy meant to encourage spending and spur economic activity. Similarly, when Powell increased interest rates in 2018, it was a contractionary move meant to combat high levels of inflation.
What is fiscal policy?
Fiscal policy is determined by congress and the current administration. Fiscal policy encompasses all spending and tax policies meant to impact economy activity.
Like monetary policies, fiscal policy can be expansionary or contractionary. The recent CARES Act, in which Congress increased spending in order to stimulate the economy during a recession, is an example of an expansionary fiscal policy. Contractionary fiscal policies are politically unpopular (few want a congressperson who supports slowing economic growth), so they are rarely used.
Why would a shift from monetary policy to fiscal policy be a big deal?
The biggest change in the FOMC's August 27 statement was a switch to an inflation policy approach called flexible average inflation targeting ("FAIT"). The Fed believes that an inflation rate of 2% "fosters price stability, moderate long-term interest rates and enhances the Committee's ability to promote maximum employment in the face of significant economic disturbances."
With FAIT, policymakers will continue to target an inflation rate of 2%, but will allow for times when the inflation rate may be higher or lower than 2%, so that the inflation rate averages out to the target. Brown notes that this average will be approached "not in a mechanical or mathematical way," but instead with judgment from policy makers.
In simple terms, this is because the Fed has decided on "lower neutral longer-run interest rates," meaning the Fed has concluded that in the long run, the neutral interest rate that would provide for a stable economy will be lower than in the past. As interest rates being that low can lead to inflation, the Fed would have less room to cut rates by conventional means, weakening a standard tool of monetary policy. But it means the Fed is pulling out the stops to push for more jobs.
According to Morgan Stanley, the US have been led primarily by monetary policy since the '90s due to "Congress's inability, or unwillingness, to borrow more money." In simpler terms, this means that economic health has been more determined by changing interest rates and changing money supply than it has through congress' spending and taxes, so in the absence of congress rediscovering that power, the Fed shifting its stance could create a much healthier economy.
In a research note published after Powell's remarks, Mike Wilson, Morgan Stanley's chief US Equity strategist and chief investment officer, suggested that the Fed's recent adoption of FAIT and the pressure on congress to fund another stimulus bill may indicate a shift toward fiscal policy dominance.
Fiscal policy dominance would likely mean higher spending for the US, leading to a larger fiscal deficit in the long run. The initial CARES Act spent more than $2 trillion to stimulate an economy stunted by the coronavirus, adding to the deficit, which grew to nearly $1 trillion in 2019.
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