The Powell begins to lead the Fed’s “normalization”

The Fed has a dual mandate to promote full employment while maintaining price stability and moderate long-term interest rates. As Jay Powell begins to lead the Fed’s “normalization” efforts to increase the Fed Funds Rate and decrease the Fed’s balance sheet following the Great Recession, he will need to assess several macroeconomic data points to help guide his decisions. While the Governor Brainard article describes financial asset valuations, U.S. dollar strength, lending standards, borrowing levels, commodity prices, and foreign economic activity as all critical information, the Fed should focus on unemployment, inflation, and GDP growth to decide on how much and how fast to raise interest rates.1 The Fed targets 2% inflation (i.

e. annual price level increase of personal consumption expenditures).2 If inflation gets above 2%, the Fed will probably raise interest rates higher/faster/more frequently. Additionally, the Fed considers full employment to be around 4.

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6% of the participating labor force (i.e. some frictional unemployment is healthy).2 The Fed’s employment goal is less precise than its 2% inflation target since a variety of factors affect NAIRU (e.g. demographic shifts, opportunity costs to having a job vs. welfare support programs, structural changes in the economy).

If the unemployment rate were to decrease significantly below 4.6%, the Fed will probably raise interest rates higher/faster/more frequently. Finally, the Fed will examine GDP growth rates to assess overall economic activity. If GDP growth rates increase significantly (i.

e. by ½ a percentage point or more), the Fed will probably raise interest rates higher/faster/more frequently. While the Fed is politically independent, Powell should not operate in a monetary policy vacuum. Powell must account for recent expansionary fiscal policies (e.g.

tax cuts and plans to increase infrastructure spending) when making decisions on how much and how quickly to raise the Fed Funds Rate. Sam Fleming’s article describes one motive for increasing interest rates is to prevent an “overheated economy.”3 Recent tax cuts and plans for increased government spending have been promoted by the President and Congress at a time when many believe the unemployment rate is already below the natural rate, (i.e. the vertical portion of the aggregate supply curve). Therefore, some in the Fed believe increased contractionary monetary policy is necessary (i.e.

raising interest rates higher/faster/more frequently). One silver lining for Powell is the decision and implementation lags are much shorter for his Fed’s monetary policies compared to the President and Congress’ fiscal policies. This gives Powell more time to wait and see how fiscal stimulus affects price levels, labor markets, and long-term interest rates before making monetary policy decisions.


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