The Corner

Economy & Business

Our Strong Economy Is An Indictment of the Fed

Jelena McWilliams, chairman of the Federal Deposit Insurance Corporation; and Randal K. Quarles, vice chairman of the Federal Reserve Board of Governors; testify before a Senate Banking, Housing and Urban Affairs Committee hearing on “Oversight of Financial Regulators” on Capitol Hill in Washington, U.S., December 5, 2019. (Erin Scott/Reuters)

The economy keeps adding jobs, with the unemployment rate dropping to 3.5 percent: a fifty-year low. This is excellent news — and news that should buoy the Trump campaign heading into next year.

But the continuing strength of the labor market also lets us cast a retrospective judgment about the Federal Reserve’s policies over the last few years: They have been too tight.

The central bank bases its policies in part of its estimate of the lowest unemployment rate the economy can sustain without accelerating inflation. For the last five years or so, it has thought that rate was higher than it has turned out to be — it thought, that is, that we were closer to the maximum sustainable employment rate than we were. On that theory, it spent much of 2014 and 2015 telegraphing that higher interest rates and a smaller Fed balance sheet were on the way, and subsequently it started to make good on those promises.

If the Fed had believed we could have 3.5 percent unemployment without excessive inflation, it would have held off on those steps — and we would have had lower unemployment, and higher wage growth, more rapidly than we did.

Some Fed policymakers have explicitly admitted the errors, and the Fed has implicitly done so by continually lowering its forecast of the long-term unemployment rate. But the errors ought to make the Fed reconsider whether a fallible forecast of sustainable employment rates ought to play as large a role in its policymaking as it does — and is another point in favor of adhering to a policy rule that does not require the Fed to know things it cannot know.

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