One word can move a mountain. Last week US Federal Reserve chair Jay Powell announced that the Fed’s updated policy strategy will no longer worry about “deviations” but only “shortfalls” from full employment so long as inflationary pressures are absent.
In other words, it will not tighten monetary policy to prevent “overheating” just because more Americans get jobs than economists thought was possible.
This is excellent news, and a great credit to Mr Powell and his colleagues. They have listened with empathy to those on the margins of the labour market, who are the last to benefit from economic expansions and the first to suffer from slowdowns. They have believed their eyes more than models predicting tight labour markets must push inflation up. In practical terms, it signals a big dovish shift by the Fed. American workers and investors all have reason to thank Mr Powell.
But let us temper the acclaim: the Fed is merely catching up with its own legal duties. The Federal Reserve Act mandates the US central bank “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. The instructions never called for preventing employment from going too high (or unemployment too low) in its own right. Yet that is how the Fed, with the approval of most economists, behaved for too long, reining in recoveries long before any inflation was ignited.
Europeans should pay close attention. For the European Central Bank has also treated its own legal mandate far too narrowly. There is a widespread misperception that the ECB is treaty-bound to the single duty of ensuring price stability. The central bank shares the blame for allowing this error to proliferate, sometimes seeming to believe it itself.
In fact, EU treaties mandate not one but two objectives for the ECB. The first is price stability. But beyond this, the ECB has a legal obligation to “support the [EU’s] general economic policies” and contribute to the objectives “laid down in Article 3 of the Treaty on European Union”. Article 3 calls for full employment, improvements to “the quality of the environment”, economic and social cohesion and social justice and protection, among other goals.
True, price stability is the primary mandate. But the popular idea that the ECB is charged with monetary policy only and must stay away from economic policy has no foundation in the treaties. On the contrary, the ECB is obliged to promote specific policies, namely those of the EU as a whole, so long as that does not conflict with its pursuit of price stability. This neglected fact has a number of far-reaching implications.
One is that when the German Constitutional Court ruled against the ECB’s bond-buying programme in May, it got things exactly wrong. While the judges argued the ECB must consider the economic policy consequences of its monetary decisions, they posited their own such policy priorities, largely reflecting the interest of savers, and ignored the very different economic policy goals explicit in the treaties.
Another is that the ECB is not only allowed to incorporate climate change considerations into its monetary policy framework, as its president Christine Lagarde clearly favours, but it is legally required to do so. After all, the environment is a treaty objective, and the European Green Deal is a flagship economic policy of the EU.
A third is that the ECB erred badly a decade ago in its participation in the “troika” of creditors in the fiscal rescue programmes for countries hit by the eurozone sovereign debt crisis. On many occasions the central bank pushed for fiscal and structural policy changes that ostensibly favoured debt sustainability (in fact they were often counterproductive) over such treaty-mandated goals as social protection, cohesion and full employment.
But most importantly, taking its full legal obligation seriously means the same for the ECB as for the Fed. While the ECB must strictly prioritise inflation, unlike its American counterpart’s more balanced dual mandate, it has no more right than the Fed does to rein in “excessive” growth if inflation remains under control. And yet the ECB’s own explanation of its second mandate still says it should avoid fluctuations — not just shortfalls — in output and employment.
In practice, the ECB has been taking much better care of its employment mandate in recent years. Some of its policymakers are becoming more outspoken about its legal obligations beyond inflation. But old ideas die hard. The ECB would do well to follow the Fed’s lead, even if it comes down to a single word.