The Federal Reserve decided on Wednesday that Americans’ wages will grow too fast next year and voted to slow them down by raising interest rates. While the economy has certainly recovered from the dark days of January 2009 — when the economy was losing about 800,000 jobs per month — employment of prime-age workers is still well below its pre-recession level, wage growth has been anemic, and inflation practically non-existent.
Still, the Fed’s potentially misguided assessment is nothing compared to the disaster it would create if it took the monetary policy advice of leading Republicans.
Republican presidential candidates and congressional leaders have harshly criticized the Fed for keeping interest rates too low and focusing too much on employment. Republican presidential candidate Donald Trump, for example, has said, “They are not raising [rates] because Obama has asked them not to raise them… He wants to get out of office, because we’re in a bubble, and when those rates are raised, a lot of bad things are going to happen.” Sen. Marco Rubio (R-FL) has supported reducing the Fed’s independence and requiring it to ignore employment when making its decisions.
And none have gone farther than Sen. Ted Cruz (R-TX), who recently argued that “the Fed should get out of the business of trying to juice our economy, and simply be focused on sound money and monetary stability, ideally tied to gold.” A return to the gold standard would be a return to the monetary policy that brought the Great Depression.
Republicans have recently attacked the Federal Reserve and pushed for changes that could seriously hamper the economy.
Ignoring or Not Believing Markets’ Inflation Predictions
In 2010, the Fed began purchasing government debt in an effort to spark employment and wage growth by reducing borrowing consumers’ and businesses’ borrowing costs. These first two rounds of these purchases — known as quantitative easing or QE — raised GDP
by almost 3 percent and added 2 million private-sector jobs that otherwise would not have existed. Nevertheless, leading Republicans have harshly criticized QE, arguing that it would stoke higher inflation in the future.
Current House Speaker Paul Ryan warned that “the inflation dynamic can be quick to materialize and painful to eradicate once it takes hold… There is nothing more insidious that a country can do to its citizens than debase its currency.” Presidential candidate Jeb Bush has also predicted that the Fed’s asset purchases “will be monetized in a way that either creates high inflation or a crisis of some kind.” Rep. Jeb Hensarling (R-TX), the House Financial Services Committee Chair, warned, “We know that this unprecedented balance sheet is going to have to be unwound at some time. And so you’re kind of on a tightrope here. On the one side, it’s significant inflation. On the other side, you could throw us back into recession.”
But markets have not shared Ryan, Bush, and Hensarling’s concerns about inflation. Instead, inflation has been well below 2 percent — the Fed’s target rate — and markets have predicted that inflation over the next five to ten years would fall well below 2.5 percent or even 2 percent.
Worrying about The Incomes of the Top 1% instead of Wages for The Middle Class
Another frequent criticism of low interest rates is that they reduce savers’ income.
Sen. Rand Paul (R-KY) has argued, “By artificially keeping interest rates below the market rate, average ordinary citizens have a tough time earning interest.” Cruz has complained that “Americans are living with near-zero interest rates on their savings.” When Fed Chair Janet Yellen testified in Congress in February, Sen. Patrick Toomey (R-PA) and Reps. Frank Lucas (R-OK), Steve Stivers (R-OH), and Mick Mulvaney (R-SC) all blamed low interest rates for reducing the incomes of savers and increasing inequality.
But it is wealthy households who rely on income gained through interest — not middle-class households. In 2007, when the interest rates were as high as 5 percent, interest and dividends accounted for less than 1 percent of income for households in the middle, compared to 8 percent of income for households in the top 10 percent of income. Just 400 taxpayers received more than 5 percent of all the interest income declared in the country’s 2012 tax returns.
Growing Attempts to Rein in the Fed for Caring about Employment
Republicans have paired their rhetoric with legislative efforts to rein the Fed in. One effort has been to force the Fed to no longer focus on fighting unemployment and only to focus on inflation. Two bills have been introduced in the Senate that would do just that. Rubio is a cosponsor of one of them, while Sen. Bob Corker (R-TN) — a leading member of the Senate Banking Committee — coauthored another with Sen. David Vitter (R-LA).
Both bills would make the Fed act more like the European Central Bank, or ECB, which only has an inflation target. The ECB did not bring interest rates to zero or begin quantitative easing until 2014 — when inflation actually fell below 1 percent — and even hiked interest rates in 2011. But Eurozone GDP grew 3 percent between the end of the Great Recession in the second quarter of 2009 and third quarter of 2013, while U.S. GDP grew 10 percent during that time period.
Ryan and Hensarling have also supported a bill that would force the Fed to adopt a rule for setting interest rates, eliminating its independent discretion. The problem with such a rule — as pointed out by Fed Chair Janet Yellen — is that a single mathematical formula cannot come up with the best policy under every scenario. Research by the Fed shows that “the current unemployment rate would still be above 6 percent and inflation would now be running somewhat below zero” if the Fed had adopted the reference rule in the bill Ryan and Hensarling support.