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One Year Later, Fed Formally Adopts Alexandria Ocasio-Cortez Approach To Employment

“I’ve been seeing lately that economists are increasingly worried that the idea of [the] Phillips curve that links unemployment and inflation is no longer describing what is happening in today’s economy, what are your thoughts on that?”, Alexandria Ocasio-Cortez asked Jerome Powell, during a hearing on July 10, 2019.

She already knew the answer.

“The connection between slack in the economy – the level of unemployment and inflation – was very strong if you go back 50 years and it’s gotten weaker and weaker and weaker to the point where it’s a faint heartbeat”, Powell responded. He pressed his thumb and forefinger together and held his hand to his ear for emphasis.

The Fed chair proceeded to admit that, by all appearances, the economy “can sustain much lower levels of unemployment than we thought without triggering troubling levels of inflation”.

“Mmm, hmmm”, Ocasio-Cortez responded, before prodding Powell further:

Do you think that that could have implications in terms of policymaking – that’s there’s perhaps room for increased tolerance in terms of policies that have historically been thought to drive inflation? One of the arguments about policies that directly target middle class Americans is that they could drive inflation. Do you think that that decoupling is something we should consider in modern policy making considerations?

Powell responded cordially and emphasized that inflation is subdued across the globe.

The exchange was polite, but the implication was clear. The use of the word “modern” was probably not an accident. Ocasio-Cortez was advocating for Modern Monetary Theory or, at the least, she was intent on letting the Fed know that Progressives are well aware that the flattening of the Phillips curve can be utilized to argue for funding expensive agenda items with MMT-esque partnerships between monetary and fiscal policy.

Fast forward a year and MMT has arrived. The pandemic forced the issue. The nexus between monetary accommodation and fiscal policy is now clear even to casual observers. And policymakers have mostly abandoned the pretense that central banks aren’t engaged in arm’s length monetization, even as belabored attempts to dodge accusations of overt government financing persist.

Of course, this is necessary and desirable. Advanced economies which issue their own currencies needn’t concern themselves with deficits during acute crises.

Central banks can and should accommodate government spending in exigent circumstances like those which accompanied the pandemic.

I’ve variously argued that it wouldn’t be a terrible idea to cut primary dealers out of the equation. Let’s face it, inserting banks as middlemen serves no purpose other than helping maintain the charade that central banks aren’t engaged in debt monetization. Their presence in the equation serves as an impediment to the transmission of monetary policy to the real economy. The figure below suggests as much.

The limits to what can be achieved via direct, overt debt monetization by central banks in advanced, currency-issuing economies are defined by inflation, not arbitrary “thresholds” for deficit spending, and not some imaginary ceiling on the national “debt”, which is itself a misnomer (one cannot properly “owe” a sum denominated in a currency one prints).

On Thursday, Jerome Powell outlined the Fed’s new approach to inflation and, relatedly, employment. In essence, the argument Ocasio-Cortez made 13 months ago is now enshrined in Fed policy.

“The muted responsiveness of inflation to labor market tightness, which we refer to as the flattening of the Phillips curve, also contributed to low inflation outcomes”, Powell said, in his Thursday remarks. He added the following about a change to the wording around the Fed’s approach to fostering maximum employment:

In earlier decades when the Phillips curve was steeper, inflation tended to rise noticeably in response to a strengthening labor market. It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation. The change to “shortfalls” clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals. Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimize that shortfall by using our tools to support economic growth and job creation.

Bloomberg’s Cameron Crise wrote that with “the employment mandate [having] shifted to address shortfalls from full employment, not deviations… the notion of going ‘beyond full employment’ now appears meaningless for policy”.

Indeed it does.

The excerpt above from Powell marks the formal adoption of what is, at heart, a common sense approach to the Fed’s employment mandate. If there is no discernible link between job creation beyond some imagined threshold for “full employment” and an undesirable, unhealthy rise in inflation, then efforts to deliberately curtail the pace of job creation can only be explained by incompetence, cruelty, or an obstinate refusal to abandon economic orthodoxy in the face of real world outcomes.

Following Powell’s remarks and the unveil of the Fed’s new framework Thursday, Stephanie Kelton offered a one-sentence take: “So now we sit back and wait to see if Congress delivers”.

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10 comments on “One Year Later, Fed Formally Adopts Alexandria Ocasio-Cortez Approach To Employment

  1. Alex says:

    The demise of unions, the rise of technology & globalism in trade has rendered the Phillips meaningless. It sure took a long time for the Fed to recognize this.

  2. Sheldan says:

    “I’ve variously argued that it wouldn’t be a terrible idea to cut primary dealers out of the equation. Let’s face it, inserting banks as middlemen serves no purpose other than helping maintain the charade that central banks aren’t engaged in debt monetization. Their presence in the equation serves as an impediment to the transmission of monetary policy to the real economy.”

    H – you’ve mentioned this theme several times, but I’m having trouble understanding how cutting out middlemen would transmit monetary policy to the real economy. I’m not arguing to keep the middlemen in place; I could care less if they stay or go. I just don’t get how the mechanism you suggest would help.

    Thanks in advance for explaining.

  3. runamok says:

    It’s up the Congress now to get funds into the real economy. As the above reader suggests, it’s a charade that they are in the middle. As long as they continue to say it’s a “loan,” no one will panic. As soon as they say, it’s “not a loan,” watch out. I’m in the Lacy Hunt school on this. I still think they are not close to saying “it’s not a loan,” while the pressue continues to mount for outright debt monetization.

    I have watched the RNC each night this week so far. No whispers even of, what’s the right word, “help,” for the economy. It’s all been about power and optics. Last night, the impending hurricanes in the Gulf didn’t raise evern a “we will be there for you” empty sloganeering, as best I was able to watch and listen.

    I don’t see how the money is going to get into the economy, barring Senate and White House loses for Republicans. Meanwhile, we sink into an economic depression. This whole thing sucks and didn’t have to be this way.

  4. m.rossi.103 says:

    If we’re going to cut out the middlemen of banks (which i support) in the issuance of notes why even bother with bonds at all?

    Why not simply fire up the printing presses instead of selling IOU’s to the central bank for digitally created coin?

    • exactly. the US does not have to issue debt at all. the decision to issue interest-bearing USDs (which is all bills and bonds are) is entirely discretionary.

      • m.rossi.103 says:

        I understand that it’s discretionary. I’m implying that the “bug” of the widening wealth gap associated with fed backstops is actually a feature.

        We accept the societal cost of a widening wealth gap with every fresh downturn while the fed pretends it has no choice (even denying the connection between its actions and said problem.)

        All the while their emergency powers expand into new territory once thought the realm of fantasy.

  5. Major Fomo says:

    The glorious vision of AOC would be a dystopia for me. That said, I very much appreciate the MMT crowd because they seem to be some of the only people these days who have an accurate understanding of reality! Even if their solution takes the opposite path from what seems best to me, we won’t get anywhere if no one can correctly diagnose the problem to begin with.

  6. slouted says:

    What are people’s thoughts on Congress getting this one right. Seems like they’re pretty deadlocked…

    • DownstreamV says:

      As H explains..”efforts to deliberately curtail the pace of job creation can only be explained by incompetence, cruelty, or an obstinate refusal to abandon economic orthodoxy in the face of real world outcomes “.

      Punk, do you feel lucky ?

  7. Vlad is Mad says:

    First, its not just AOC, but Trump finally has the low rate central banker he wants. He must be thrilled. It is nice to see that Trump owns Powell. Next, the Phillips curve is indeed a weak relationship to core PCE, but it is not completely dead. It meshes well with OER and Atlanta wage tracker. So this is going a bit to far to say its dead. And the reason it has failed in some eyes is down to goods prices and health care prices. On the first issue those good prices were constrained by globalization and impact that is now in reverse.

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