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Fed adopts policy that could help low-income Americans

Aug 28, 2020

Commentary: The Fed has adopted changes to policy which might seem small, but in fact have important implications for New Mexicans.

The Fed announced that it will no longer preemptively increase interest rates when unemployment falls but will keep rates low until inflation picks up. Second, the Fed announced that the 2% inflation rate target is no longer a cap; instead, the Fed will seek to achieve an average 2% inflation rate. This means that inflation can climb above 2% for substantial period of time before the Fed takes action.

Together, these two announcements mean that interest rates are likely to remain lower going forward than otherwise would have been expected. And it means that inflation rates will also be higher, perhaps double the average of 1.4% we have experienced the last five years.

Economists have long assumed a trade-off between inflation and unemployment, a relationship referred to as the Phillips Curve after A. W. Phillips who first identified it. The idea is simple. Lower unemployment makes it harder for businesses to find workers, so wages are bid up. The higher wages are passed on to consumers as higher prices causing inflation.

The Fed uses the Phillips curve to help control inflation in that low unemployment has been interpreted as a signal of future inflation, so has triggered rate hikes to short circuit that inflation. But the implication of this policy is that unemployment is deliberately kept high to keep wages in check.

The problem with this Fed’s policy is that it has contributed to racial inequality. Unemployment rates among blacks and Hispanics is higher than among whites. During the second quarter that ended June 30, for example, the black unemployment rate was 16.1%, for Hispanics 16.7%. Among white workers, the unemployment rate was 12.0%. While these rates are elevated due to COVID, they make clear a persistent pattern of high unemployment among minorities.

Under the old policy, as the overall unemployment fell toward, say, 5%--implying a rate among blacks and Hispanics of near 10% and among whites of 3%--the old Fed policy would be to put the breaks on, to shift the policy focus from unemployment to inflation. Continuing high unemployment among minorities was not a priority.

The irony of this is that inflation is primarily a rich person’s problem. Inflation erodes the value of savings. Poor people don’t have savings. This exacerbate the income inequality that has become a corrosive factor in our modern U.S. society.

If you want to lift people out of poverty, the best way to do this is to give them a job. If you want to protect wealth, fight inflation. The old Fed policy favored the wealth over the poor and minorities. The new policy flips that, focusing on jobs, not inflation.

The effect of the Fed’s new policy will be slow and long-term but the outcome, over decades, should be less poverty and to help lift people into the middle class. This will help minorities. Here in New Mexico, a low-income state that is minority majority, the impact should be positive.

Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. He has taught money & banking for 35 years. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.