As widely expected by about the entire world, yesterday, the Federal Open Market Committee (FOMC) cut the Fed Funds Rate by 0.25%.
In their statement, which can be found here, they essentially acknowledged that the dual mandate, (1) maintain price stability, which they define as 2% inflation and (2) achieve maximum employment, is at odds.
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Uncertainty about the economic outlook remains elevated. The Committee is attentive to the risks to both sides of its dual mandate and judges that downside risks to employment have risen.”
So, inflation remains above 2%, which is their stated long-term target, while the labor market is weakening. They feel the need to address labor weakness at this time.
When the dual mandate is at odds the Fed must pick whether they want to target inflation or employment knowing if they move to support one they could negatively impact the other.
At this time, the Fed believes inflation is at a reasonable level so they’re taking action to support employment, which could potentially impact the aggregate price level (inflation) down the road, which they acknowledge. They also say they will continue to monitor the data and act accordingly.
The problem as I see it is that the Fed actually has very little control over the labor market and employment. They have far greater control and influence over the aggregate price level / inflation because inflation is directly tied to quantity of money, of which the Fed has both direct and indirect control, relative to the supply of goods.
Here are two charts showing two major periods of Fed rate cut cycles along with the unemployment rate.
09/30/2000 – 09/30/2003
06/30/2007 – 12/31/2009
In both cases, job losses increased dramatically even as the Fed was cutting aggressively.
Some may say, well there’s a lag in the effect or maybe the job losses would have been much worse. Possibly. But it’s more likely that when recession takes hold it will continue until the excesses and the malinvestments of the “boom” part of the cycle have been liquidated regardless of the what the Fed is doing. Only then does the economy find a new bottom and can begin rebuilding from that new, much more solid foundation.
One risk of the Fed focusing on employment, which they have very little control over, at the cost of higher inflation, is stagflation where unemployment continues to tick up while cost of living is also simultaneously increasing. In that scenario many households lose income while also suffering from higher expenses… so they get hit on both ends. The Fed will need to tread carefully.
Past results and relationships are no guarantee of future results or that relationships will always hold.
