How bad could it get? America’s ugly election

Coldish war, hottish market

Foreign holdings of domestic Chinese assets

Yuan trn

Source: Wind

1

2.5

2.0

1.5

1.0

0.5

0

20

19

18

17

16

15

2014

Equities

Bonds

Peace offerings

US-listed Chinese IPOs*

Source: Dealogic

*Primary listings only

†To August 31st

2

50

40

30

20

10

0

10

8

6

4

2

0

20†

19

18

17

16

2015

Value, $bn

Number

---

The Economist

September 5th 2020 

Finance & economics

63

1

I

n

2018, 

when

America’s long recovery

from the 2007-09 financial crisis pushed

the unemployment rate below 4%, the Fed-

eral Reserve had a simple message for

American workers: do not get used to it.

The central bank’s economic projections

revealed that its officials believed 4.5% to

be the lowest sustainable jobless rate, to

which America would need to return to

stop inflation surging upwards. If higher

interest rates and slower growth were

needed to achieve that, so be it. 

On August 27th Jerome Powell, the Fed

chairman, acknowledged what common

sense suggested two years before: that an

intentional increase in unemployment is

an odd thing to pursue after nearly 20 years

of depressed labour-market conditions.

Speaking at an annual central-banking

shindig, Mr Powell unveiled the conclu-

sions of a monetary-policy strategy review

begun in 2019. The coming changes to Fed

policymaking could initiate an important

global shift in central-bank practice.

The Fed’s old framework was forged by

the inflationary tumult of the 1970s. Post-

war economists understood there to be a

negative relationship between inflation

and unemployment—known as the Phil-

lips curve—such that policymakers could

push unemployment as low as they liked,

provided they were prepared to accept

more inflation. But soaring prices persuad-

ed many that this relationship did not hold

below some minimum sustainable level of

unemployment. Attempts to push jobless-

ness lower would yield higher inflation,

but at best only a temporary reduction in

unemployment. By the 1990s, most central

banks had resolved to target a low level of

inflation, generally around 2%. 

But since the embrace of inflation tar-

geting in the 1990s, the relationship be-

tween employment and inflation has

weakened. Soaring joblessness during the

Great Recession failed to produce the ex-

pected plunge in prices. Neither have low

levels of unemployment since then ended

an era of historically low inflation. Precise-

ly why the relationship between inflation

and joblessness changed is uncertain.

Some economists reckon central banks’

credibility in managing inflation anchored

the public’s expectations too well. Others

point to a decline in workers’ bargaining

power, which has eased the pressure on

firms to raise prices in order to cover the

cost of expensive pay packets. Still others

point to technological change and globali-

sation, which expand consumer options

and allow firms to respond to increased de-

mand without raising prices. Whatever the

cause, the flattening Phillips curve biased

monetary policy in an overly hawkish way,

eventually prompting the Fed rethink. 

The changes to its framework may seem

modest. Because the maximum sustain-

able level of employment cannot be mea-

sured, the Fed will give up worrying about

overshooting it and focus only on employ-

ment shortfalls. The 2% inflation target re-

mains a constraint, but a more flexible one

than before. It should be hit on average, Mr

Powell explained, meaning that periods of

below-target inflation can be offset by at

least some time with inflation above the

target as well.

But the conceptual change—abandon-

ing the notion of a minimum sustainable

unemployment rate—is significant. And

the practical effects could be large. Had the

Fed enjoyed more freedom in recent years,

it could have raised interest rates more

gradually, or not at all, enabling a faster and

WA S H I N GTO N ,   D C