The Fed is being ruled by doves as Biden looks to avoid repeating past mistakes

Any attempt to keep unemployment below its “natural rate” — usually referred to these days as the NAIRU – the non-accelerating inflation rate of unemployment- to avoid the implication that unemployment is somehow good — would, he asserted, lead to ever-accelerating inflation, and it would take a period of high unemployment to get inflation back down.

The experience of the 1970s and ’80s seemed to confirm this analysis. Low unemployment seemed to be associated with ever-rising inflation, and getting inflation back down did indeed seem to require high unemployment.

If you accepted this “accelerationist” hypothesis, the Fed’s job wasn’t to keep unemployment low, because it couldn’t do that. It was, instead, merely to provide stability in both prices and employment.

But here’s the thing: Since at least the mid-1990s, the data haven’t looked anything like that.

Notably, unemployment dipped below 4 per cent both at the end of the 1990s and at the end of the 2010s, in each case without provoking accelerating inflation, while even very high unemployment after 2008 failed to produce the deflationary spiral that Friedman-type analysis would have predicted.

And if low unemployment doesn’t lead to accelerating inflation, it seems all too likely that we have consistently been running the economy too cold, sacrificing jobs and output unnecessarily. While the Fed hasn’t explicitly admitted this, it’s clearly a regret that weighs on its policy now.

There’s also another consideration that has made the Fed more dovish: fear that the effects of tight money may prove very hard to reverse.

Back in 1935, Mariner Eccles, another Fed chairman, argued that the Fed could do little to reverse deflation because you can’t push on a string. This made sense at the time. The Fed had very little ability to cut interest rates, because they were already near zero. But for a long time economists assumed that those Depression-era conditions would never come back, that the Fed could always engineer an economic recovery when it wanted to.

As it turns out, however, interest rates can indeed hit the “zero lower bound” in the 21st century; in fact, that has been the norm since 2007.

This in turn means that while everyone is talking about inflation risks right now, the Fed is also concerned about the risks of overreacting to inflation. If it raises interest rates and that pushes the economy into a recession, it might not be able to cut rates enough to get us out again.

So if you ask why monetary doves rule the Fed roost, it’s not just a matter of personalities — or ideology. The past couple of decades have highlighted the downsides of hawkishness, and the Fed doesn’t want to repeat what it now, quietly, views as past mistakes.

This article originally appeared in The New York Times.

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