The U.S. Federal Reserve's two main goals are to promote maximum employment and keep inflation close to 2%. But it also acts as if it has another, unspoken mandate: Don't do anything too radical in pursuit of those goals. This allegiance to what's considered "normal" harms a lot of people, black Americans in particular.
Consider what happened in November 2010, when the economy was just starting to recover from a deep recession. Many Fed officials expected the unemployment rate to remain above 7 percent, and inflation below 1.5 percent, for the next few years — a situation that clearly called for more stimulus, assuming that the central bank was willing to do "whatever it takes" to achieve its macroeconomic objectives.
Yet the Fed chose not to signal a longer period of low short-term interest rates or increase bond purchases aimed at bringing down long-term interest rates. Policy makers saw such steps as being too unusual relative to "normal" monetary policy.
This is just one example of a broader pattern of behavior. The Fed’s preference for normality is baked into most empirical economic models of U.S. monetary policy, such as the famous Taylor rule (named after Professor John Taylor of Stanford University).
These kinds of rules are based on the premise that the Fed is constrained in how far below normal it will lower interest rates in response to low levels of inflation and economic activity. Hence, it should come as no surprise that if the Fed follows such a rule, it could well end up with many years of inadequate employment and below-target inflation.
Who gains from the Fed’s unspoken mandate? Well, it's good for banks and other investors in long-term bonds, because it dampens interest-rate changes that would otherwise make the prices of those bonds highly volatile.
But most Americans lose from the unspoken mandate, because they experience more volatility in employment and prices than they otherwise would. Blacks are among the hardest hit, because their unemployment rate tends to increase a lot more than those of other groups during recessions.
I’m often asked how the Fed can use the rather blunt tool of monetary policy to mitigate racial inequities. One simple answer: Stop putting so much weight on the unspoken mandate of “normal” monetary policy. This would help all Americans, and — assuming historical patterns hold true — particularly black Americans.
This week, the Fed will probably increase its short-term interest-rate target by another quarter percentage point and announce plans to shrink its bond holdings. Officials will portray the moves as necessary to "normalize" monetary policy, providing further evidence that the unspoken mandate is a key shaper of Fed policy, and that all Americans — especially black Americans — remain needlessly exposed to excessive economic risk.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
Some defend the Fed’s lack of aggressiveness in responding to low employment and inflation by pointing out these variables are measured with error. However, the correct response to any such measurement error is to formulate the best possible estimates of the relevant variables, and then respond aggressively to those estimates. See for example Boehm and House (2014).