Does everyone know what LA FED is? It is the Central Bank of the United States. — the official name is the Federal Reserve System. (The “system†consists of twelve regional federal reserve banks which function as a unit in terms of national policies but which are responsible for implementing the rules and regulations of the FED within their local districts.). Created in 1913, the FED had become by the 1980s the most powerful element of what economists call AGGREGATE DEMAND MANAGEMENT. This term describes the actions of government entities to slow inflation or revive the economy when it is in recession.
Throughout the Principles of Economics textbooks, there are sections describing the appropriate role for government in a mixed economy like the United States. The most fundamental role is to enforce contracts and protect individual rights — including the property rights of these individuals. An economy organized by the use of markets (unrestrained interactions between buyers and sellers) could not be maintained if contracts were inapplicable. Imagine what it would be like to make deals only with people you could physically dominate to force them to stick to the terms of the deal. That is why all market economies have police and courts.
Other roles of government include maintaining competition (which is why there are antitrust laws), providing social goods and services like the military, public education, firefighters, and income redistribution (as in our social security system, public welfare, etc.).
A more complicated role is to change what the market system would do without government intervention to subsidize some activities and restrict others. The reason for this is that often the signals sent by the markets — the prices charged for goods or services — do not accurately reflect the benefits and / or costs to society. When I buy gasoline, I don’t pay for the damage caused by the exhaust coming out of the tailpipe which can make people sick and ultimately raise the temperature of the earth. Likewise, when I take an Amtrak train between New York and Washington, DC, the profit to society as a whole is much greater than my profit, as evidenced by the price I’m willing to pay. Any savings from having either one less car on the road or fewer people traveling by plane between the two cities are not counted in the price of the train ticket. This is why gasoline is taxed and why Amtrak is subsidized.
This brings us to aggregate demand management. This is the most recent addition to the economic responsibilities of the national government. Before the 1930s, no reputable economist would have argued that the onus was on government to stimulate total demand for goods and services by intervening in market activities. When the economy fell into periodic crises (called depressions back then — we now call them recessions), the point was simply to wait until the end, to let prices and wages fall until the economy corrects itself. Even though the periods of depression were long (as happened, say, in the 1870s in the United States), they eventually self-corrected – at least that was conventional wisdom within the economics profession. .
In the midst of the Great Depression of the 1930s, John Maynard Keynes exploded this conventional wisdom with his book The General Theory of Employment, Interest and Money. He argued that there was no self-correction mechanism and therefore the government had to step in whenever total (aggregate) demand was low and unemployment increased. In the United States, this commitment was made with the passage of the Employment Act of 1946.
[There is a very interesting book called Congress Makes a Law, The Story Behind the Employment Act of 1946, by Stephen Kemp Bailey (NY: Columbia University Press, 1950) which details how a law originally proposed as the Full Employment Act of 1945 was significantly watered down so that when it was finally passed it mandated that Congress take action to provide for “high employment†with “stable prices†(without defining those terms). The law also required that all actions had to be consistent with the free enterprise system.]
In 1978, with the passage of the Full Employment and Balanced Growth Act, the objectives were clarified. The federal government (through the budget process based on proposals from the president and adopted by Congress) and the FED have been instructed by Congress to pursue a “DUAL TERMâ€. Specifically, there was a target of 4% unemployment (which turned into “maximum employmentâ€) and stable prices.
[Pursuant to that act, the FED must report to Congress twice a year on actions it has taken to achieve the goals of that law.  Reports are available at https://www.federalreserve.gov/monetarypolicy/mpr_default.htm ]
In the years following the adoption of the Full Employment and Balanced Growth Act, the Fed set a target of keeping inflation at around 2% (on average). Despite the fact that the economy rarely hits its numerical target, the Fed still aims to achieve an unemployment rate as close as possible to the “magic number” of four percent.
[This “magic number†was defined by the Council of Economic Advisers in 1961 as the “full employment†level of unemployment. Since there are always people just entering the labor force or between jobs, any unemployment rate lower than that was deemed “too low†and liable to produce an acceleration of inflation. Over the years, by the way, that “minimum†was thought to be drifting higher. Some economists argued, especially in the 1980s that the appropriate target for unemployment was closer to six percent.  Currently, the target is back at four percent, which the economy had achieved before the current pandemic-induced recession.]
Unfortunately, for various reasons, the Fed has mostly failed to achieve an unemployment rate as low as four percent. According to annual data, it has only been THREE YEARS since 1978, when that rate was four percent or less.
[The Federal Reserve Bank of St. Louis has a marvelous collection of economic statistics that can be accessed just by googling FRED.  The specific graph of annual unemployment rates going back to 1948 (seasonally adjusted) is available at https://fred.stlouisfed.org/series/UNRATE#0.]
Despite the failure to meet this target, whenever unemployment has risen during recessions, the Fed has jumped at the task of responding by trying to stimulate the economy. Their main tool is to reduce the federal funds rate, which is the rate that banks charge each other for short-term loans (sometimes as short as day-to-day). The FED sets a target, announces that target, and then takes action to meet that target. (The FED committee that does this is the Federal Open Market Committee [the FOMC].)
Starting in 2008, the Great Financial Crisis produced the Great Recession —- unemployment peaked at 10% in October 2009 —. The Fed has made extraordinary efforts, including pushing the federal funds rate close to zero and holding it until December 2015.
With the onset of the pandemic in early 2020, the Fed again lowered the fed funds rate to near zero (in March). It has been there ever since and in recent speeches the Fed chairman has made it clear that until they see signs that the economy has fully recovered, they will not increase this rate.
[For a report on the most recent meeting of the FOMC, see Alex Cook and Lauren Perez, April 2021 Fed Meeting – Fed Maintains Rates Amid Speculation About Future Inflation Concerns, available at https://www.magnifymoney.com/blog/news/fed-meeting/.]
I consider the recent attention of the FED to the unemployment part of its dual mandate to be very welcome. When Howard and Paul Sherman and I wrote our textbook on macroeconomics, we complained that the Fed had mostly focused on fighting inflation — dodging half of its “dual tenure†— half promoting inflation. maximum employment.
[For our discussion of Monetary Policy and the FED, see Sherman, Howard, Michael Meeropol and Paul D. Sherman, Principles of Macroeconomics, Activist vs. Austerity Policies, 2nd Edn. (NY and London: Routledge, 2019): chs. 22 and 23.]
But recent increased government activity to promote “maximum employment” has produced the inevitable backlash.
(This response from political and business leaders and too many economists was foreshadowed by Polish economist Michal Kalecki. In 1943 he wrote an article “The Political Aspects of Full Employment” in the Political Quarterly, available at https://delong.typepad.com/kalecki43.pdf in which he warned that if the government made the unemployment rate “too low”, strong political pressure would be exerted to force the government to “reverse”. Kalecki’s reasoning was based on the Marxist view that business owners make their profits by extracting “surplus value†from their workers. One of the ways to do this is to keep wages low. However, with low unemployment, workers have more bargaining power and therefore wages tend to rise. Kalecki’s conclusion is that whenever the government takes action to reduce unemployment, business leaders are sure to use all of their political influence to force the government to back down. In the modern age, this manifests itself in the demonization of federal budget deficits.)
Sure enough, in recent weeks there have been rumors that the economy is in danger of “overheating” because of all this federal government spending — extra unemployment benefits, various other elements of the US bailout – – and because of all government spending in the recently proposed budget and the Jobs Bill and the Families Bill. Rekindling the demonization of federal budget deficits is an important example of the zombie economy that I pointed out in my last comment.
The good news is that in recent statements, Treasury Secretary Yellen and Fed Chairman Powell have argued that there is virtually no danger of sustained inflation due to large increases in federal spending. In fact, Powell has made it clear that for the foreseeable future it is important that the inflation rate EXCEED the FED target of 2% due to all the recent years where inflation has been below this number.
The most important fact pointed out by Powell is that the economy was still around 8 million jobs short before the pandemic-induced recession last year. With so much unemployment, the danger of accelerating inflation is almost nil.
As I argued in my last comment — complaints about the government’s over-generosity to ordinary citizens are a vicious class-based attack on the living standards of working people. Too many of our citizens think that it is simply unacceptable that workers can tell their potential bosses that they will not work if they are not well paid. On the contrary, I think we should all celebrate the rising wages. Promoting maximum employment, which is the key to raising wages and thus raising living standards, is far more important than controlling inflation.
Michael Meeropol is Emeritus Professor of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of macroeconomics: militant policies versus austerity policies
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