(Bloomberg) -- Transcripts of the Federal Reserve’s 2015 policy meetings show that then-Fed Chair Janet Yellen acknowledged the Fed should sacrifice potential job gains in order to cut off the possibility of higher inflation.
Yellen, who left the Fed in 2018, has been chosen by President-elect Joe Biden to lead the Treasury Department and hold one of the most powerful economic policy positions in his administration, pending her confirmation by the U.S. Senate.
Her comments, as policy makers debated their first increase in interest rates after holding them near zero for seven years, highlight an argument over the relationship between inflation and unemployment that -- with hindsight -- has led some to criticize Yellen as having been too hasty to lift off.
The discussion shows how she and some colleagues overestimated the potential for accelerating inflation and underestimated the room still left in the economy to generate jobs.
How the argument ends can matter for economic equality -– a key priority of the Biden team. In this case it led the Fed to raise rates at a time when unemployment for Black Americans was much higher than the national rate, even though inflation was mute and -- as it turned out -- would remain so.
In the years that followed 2015, price gains continued to mostly undershoot the Fed’s 2% target, even as overall unemployment fell to 3.5% in 2019, a half-century low.
“We would want to check the pace of employment growth somewhat to reduce the risk of overheating that could eventually force us to tighten abruptly,” Yellen said during the December 2015 meeting, according to the documents the Fed released on Friday with the customary five-year lag for meeting transcripts.
“If the labor market were to continue to improve markedly as we move through 2016, then further moderate increases in the federal funds rate would probably be warranted, even if core inflation was still showing no signs of picking up,” she said then.
Inflation Trigger
If inflation remained quiescent, Yellen contemplated the idea that officials might have to recalculate their estimates of the level at which unemployment would trigger inflation, but ultimately pushed that idea aside.
“Although we might consider lowering our estimates of the natural rate of unemployment a bit in response to such developments,” she said, “it would also be prudent to view them as a sign that the underlying strength of the economy was in fact increasing, and that inflation would move up as labor and product markets tighten.”
Officials ended that meeting by agreeing to raise interest rates by a quarter percentage point, citing their expectation that inflation would rise gradually to their 2% target. They also signaled four additional increases were coming in 2016.
Hawkish Move
That move and Yellen’s comments now appear overly hawkish. Unemployment was still 5.1%, and inflation never emerged as a threat. The comments may prove particularly concerning to progressive Democrats, because the interest-rate increase came when unemployment among Black Americans stood at 9.4%.
No policy makers made reference to Black or minority unemployment during the December 2015 meeting. Fed officials regularly point to those measures now, and last year redefined how they interpret their target of “maximum employment,” saying they consider it a “broad-based and inclusive goal,” a nod to minority employment gaps.
Some in Biden’s economic team have said they want the Fed to focus even more on racial inequality in the economy. Democrats in Congress have introduced legislation to add that goal to the Fed’s existing mandate for price stability and maximum employment.
A Biden transition spokesperson declined to comment.
In her own remarks when Biden introduced her as his pick for Treasury, Yellen stressed the need to address inequality and “racial disparities in pay, job opportunities, housing, food security and small business lending that deny wealth building to communities of color.”
Shouldn’t Overcriticize
Roberto Perli, a former Fed economist, said that it’s fair to view, with hindsight, the 2015 liftoff as a mistake, but said Yellen shouldn’t be too criticized too harshly for at least two reasons.
“You don’t know what’s going to happen and you have to manage risk,” including the risk of higher inflation, he said.
Additionally, moving rates up by a quarter point came nowhere near bringing the federal funds rate to its neutral level.
“In an ideal word they probably shouldn’t have lifted off, but even after this, policy was still accommodative,” said Perli, now a partner at Cornerstone Macro LLC in Washington. “You never heard Janet Yellen say we needed to make policy restrictive.”
As the following year unfolded, the Fed, in fact, didn’t follow through on all the projected 2016 hikes. Largely because of turmoil in global financial markets, the Fed waited until December 2016 to raise again.
Under the current Fed chair, Jerome Powell, the central bank has gradually embraced a very different posture, largely abandoning the view that low unemployment necessarily leads to higher inflation.
Shift Foreshadowed
Intriguingly, Yellen foreshadowed the possibility of that shift in strategy in her December 2015 remarks.
“If inflation were to remain persistently subdued beyond next year despite further improvements in the labor market and no special transitory factors were in play, then, in my view, a more radical rethinking of the economy’s productive potential would surely be in order,” she said.
The transcripts show Lael Brainard, who was also considered by Biden for the post of Treasury secretary, was far more cautious than Yellen in her assessment of the economy and the need for rate hikes. She raised concerns about the international economic outlook and was more pessimistic over inflation.
“I’m uneasy about the inflation leg of our mandate, and it would be difficult for me to point to any developments in the inter-meeting period that have raised my confidence that core inflation will move to our 2% target in the next two to three years,” Brainard said in December 2015. In the end, she voted for the rate increase.
Powell, Tarullo
The idea that a falling unemployment rate for some segments of the population pointed to higher inflation down the road was also met with resistance by then governors Powell and Daniel Tarullo in the December 2015 meeting.
Powell argued that labor force participation could move up, in effect adding supply to the labor market. Nevertheless, Powell penciled in a rate hike in his forecast submitted that month and voted for the increase.
Tarullo was harsher, saying he didn’t have “reasonable confidence” that inflation was on a path to 2%. “I don’t think it is appropriate policy to raise rates today,” he said.
He also scolded unidentified members of the committee for pre-committing officials to raise rates.
“It seems the best reason to act lies not in the economics we face at today’s meeting, but in the fact that many on the committee and, more recently, a particularly influential member thereof, have intimated that we’re going to do so,” he said.
He said he would go along with the decision to raise rates to protect institutional credibility.
(Updates with economist’s comments from 15th paragraph)