Inflation or unemployment?

Do you care more about higher prices at the grocery store or a steady job? Of course your answer will depend on your circumstances, but for the Federal Reserve it’s a tradeoff that rests at the heart of a policy dilemma it faces constantly.

As the Fed debates how to serve its dual mandate of keeping prices stable and reaching full employment, officials are often faced with deciding whether to act against inflation by raising interest rates or allowing rates to remain lower to foster new job growth. As of late, it’s sided with the latter policy, which is why interest rates have been at or near historic lows for years.

Now the Fed is officially shifting its approach to lean a little more toward keeping interest rates low even once the economy starts to grow again.

Or as Fed Chairman Jerome Powell put it last week, the Fed’s policy framework “must adapt to meet the new challenges that arise.” That adaptation is to shift from setting a constant inflation target of about 2% to keeping inflation at an average of 2%. The subtle shift in emphasis indicates the Fed may be more willing to tolerate a little higher inflation for a short period of time than it previously would.

In thinking through the underlying logic of where the Fed is now headed, we couldn’t help but remember an argument Robert Kaplan, the president of the Dallas Federal Reserve Bank, made to us last year when the economy was strong and very different than it is now. At the time, he noted that the possible gains of allowing the employment market to run “a little hotter” could be that some Americans in at-risk groups make permanent employment gains they otherwise would miss out on.

Our thought now is that as we are still in the midst of a pandemic-driven recession, it makes sense for the Fed to rethink economic models that might otherwise compel it to raise interest rates. Tightening the money supply when the country is at the front end of a recession increases the chances of a deeper, more painful downtown. But our concern about runaway inflation is never far from our minds. Inflation can prove to be devastating to middle-class Americans who can’t really afford rising prices, and once inflation gets out of hand it’s very hard to get it back under control.

So our thought is this: We’re encouraged to see what the Fed is doing in the short run given that we’re in a recession, but we’d caution against letting inflation fall too far out of view. Americans need jobs, but they need to be able to afford the necessities of life as well. If that’s a hard balance for the Fed to strike, it’s even harder for working families to do so.

The Dallas Morning News