Press Releases

News from EPI EPI Releases Guidebook for Understanding How the Fed Works and How to Make it Work Harder for Main Street

The current debate over whether the Fed should or should not raise interest rates is the latest battle in a much broader discussion over who is more likely to benefit from Federal Reserve policy decisions. Has it been ordinary American workers and their families, or the financial sector and those who own and manage large corporations?

In a new report from the Economic Policy Institute, The Federal Reserve and Shared Prosperity, Thomas Palley examines and explains the sometimes-byzantine world of the Federal Reserve, including the 36 Federal Reserve district and branch banks located in 27 states. Palley argues that we will not achieve shared prosperity for most Americans without a change in orientation by the Fed to prioritize low unemployment rather than low inflation.

“For the 30 years before the Great Recession struck, the Federal Reserve consistently took care of Wall Street first while not caring much about Main Street,” Palley said. “Since the Great Recession, there has been some shift toward helping ordinary Americans, but even more is needed, and we fervently hope that Chair Yellen sees this.”

According to the report, misguided efforts to keep inflation very low have led the Fed to largely abandon concern with full employment. This retreat from the Fed’s historical mandate to promote maximum employment consistent with price stability has been condoned by both Republicans and Democratic elites.

“Both Republicans and Wall Street Democrats are scared of full employment because it would raise wages across the board,” Palley said. “The central problem is a faulty view that portrays wage growth as a cost to the economy, rather than as a principal purpose of the economy, which is to generate a decent standard of living for all.”

Besides providing a useful primer on how the Fed works and which interests it has traditionally favored, the report outlines a more job- and wage-friendly monetary policy in which policymakers and the Fed would:

  • Make full employment the country’s foremost economic policy priority (suggested by an unemployment rate well below 5 percent).
  • Abandon the 2 percent inflation target that traps the economy shy of full employment.
  • Stop the war on wages (a de facto war arising from, among other causes, the Fed’s shortchanging of full employment and its adoption of a 2 percent inflation target).
  • Abandon the focus on the employment cost index, which gives monetary policy an anti-wage tilt by encouraging the Fed to raise interest rates whenever wage growth accelerates. Because profits are a record-high share of business output, there is ample room for wages to rise without triggering inflation if firms are forced to accept profit margin compression as the bargaining power pendulum swings back toward workers.
  • Resist calls for preemptive interest rate hikes to prevent inflation, which would strangle wage growth, entrench income inequality, and impose hardship on millions of working families, in favor of a “test the waters” approach that puts on the brakes only as inflation threatens.
  • Not underestimate unemployment and labor market slack and not use these underestimates to justify raising interest rates.
  • Restore quantitative monetary policy. Tools beyond the blunt instrument of setting interest rates can target particular problem areas (such as asset price bubbles) without inflicting collateral damage on the rest of the economy. Such tools include margin requirements and asset based reserve requirements.
  • Reform exchange rate policy. Exchange rates, though formally controlled by the Treasury, are affected by Fed policies and have favored multinational corporations and financial-sector interests, at great cost to manufacturing and all the other sectors hurt by rising trade deficits and wage competition.
  • Finance public infrastructure investment, perhaps through a national infrastructure bank whose bonds the Fed could purchase.