As the Federal Reserve kept interest rates low after the recession and bought bonds, critics in Congress, Wall Street and within its own ranks accused it of courting inflation, debasing the dollar, enabling fiscal profligacy and distorting markets.
Today, with a record expansion and unemployment at a 50-year low, some critics are making the opposite case: The Fed has tightened too much, and growth is lower and unemployment higher than they should be.
President Trump is the loudest, but economic commentators from across the spectrum and even some current and former Fed officials have made that case.
“Any neutral observer has to conclude that the last recession and ‘recovery’ were significant failures” for the central bank, Narayana Kocherlakota, former president of the Minneapolis Fed, said this week. Last month, Fed governor Lael Brainard said the central bank moved too soon when it started raising rates in late 2015.
The best evidence for their case is that in December 2015, central bank officials thought the natural unemployment rate—the lowest sustainable without fueling inflation—was 4.9%. Now the unemployment rate is 3.5%, yet inflation continues to run below the Fed’s 2% target.
Had the Fed realized that, critics say, it would have raised rates more slowly or not at all, and employment and inflation today would have been higher. In August 2018, Adam Ozimek, then an economist at Moody’s Analytics, estimated that gross domestic product would have been 0.4% to 0.8% higher and employment 530,000 to one million higher.
Whether this is a failure by the Fed isn’t straightforward. Central bankers act on what they know about the economy in real time, and that knowledge is suffused with uncertainty. Central bankers know they will be wrong about the future—but not in which direction—so they act in a way to minimize the cost of errors.
From 2009 through 2015, the Fed ignored those who wanted a faster return to “normal” interest rates and chose to err on the side of keeping rates low longer than needed, and risk an inflation rebound.
Once it began to raise rates, it did so more slowly than the Fed had ever tightened before. Its aim was to get rates to neutral—a level, then pegged at 3.5%, that neither stimulates nor holds back growth—but to go so gradually that growth would retain enough momentum to keep pushing unemployment down and inflation up. As the Fed raised rates from 2015 to 2018, it thought they were still below neutral and thus nudging unemployment down and inflation up.
But new data kept forcing the Fed to lower its view of the natural unemployment rate and the neutral interest rate, and adjust plans accordingly. Both interest rates and unemployment are lower today than either it or the private sector projected in 2015.
Asked Wednesday if the Fed had tightened too fast, Fed Chairman Jerome Powell said it wasn’t trying to “slow the economy down, we were really just trying to get [interest rates] near neutral.” He noted that last December, when rates reached between 2.25% and 2.5%, that was “still meaningfully below” what most Fed officials considered neutral.
But new information has painted a different picture: Neutral, Mr. Powell has previously said, is probably lower than he thought, and this year global growth stumbled and trade risks flared. Those factors prompted the Fed to cut rates three times to between 1.5% and 1.75%. If the Fed made an error, it was one from which it has recovered with little obvious damage: The job market has steadily strengthened, and recession risks have faded.
Had the Fed listened to its more dovish critics, the job market might be even stronger yet. But some doves weren’t always so dovish.
When Mr. Kocherlakota first joined the Fed in 2009, he opposed many of the Fed’s easing measures out of fear of inflation, before having a change of heart in 2012. Just last fall Ms. Brainard was recommending that rates should top 3%. By contrast, Mr. Ozimek has consistently argued that the state of the labor market didn’t support the Fed’s pace of tightening. The chief economist at Moody’s Analytics, Mark Zandi, disagreed with him at the time and still does. (Mr. Ozimek is now chief economist at Upwork, which connects freelancers with employers.)
As for Mr. Trump, he has sought to put on the Fed two advocates of lower rates who were calling for higher rates when Barack Obama was president.
Had the Fed listened to them at the time, the consequences would have been far more serious than anything that has happened in the past year.
Write to Greg Ip at greg.ip@wsj.com
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