The Federal Reserve’s decision to begin nudging up interest rates—in the clear absence of any inflationary pressures—is disappointing. Since 2008 the Fed has been the policymaking institution that has most consistently worked to restore the economy to health, even as it had to fight through headwinds imposed by fiscal austerity. They deserve much praise for this, but today’s actions are a worrisome backwards step. Despite years of steady progress restoring the damage inflicted by the Great Recession, a full economic recovery remains incomplete.
And even a full recovery to pre-Great Recession health in the labor market is too modest a goal—real wages for most American workers actually fell in the last years of the economic expansions preceding the Great Recession. To deliver strong and equitable wage growth, which the economy hasn’t seen since the late 1990s, policymakers should target genuine full employment. This means aggressively plumbing the depths to which unemployment can fall—tightening policy and slowing growth only when signs of durable increases in wage and price inflation actually appear in the data. Aggressive pursuit of full employment is the only policy measure that has delivered strong and equitable wage growth in the past generation, and the vast majority of American workers are unlikely to see any real wage increases absent it. The Fed should try to deliver these raises.
Today’s rate hike isn’t the end of Fed decision making, and most of the damage from today’s increase can be contained if future hikes only happen in response to real inflationary pressures. The potential benefits to holding off on further rate increases and allowing further improvements in unemployment are enormous: greater work opportunities for millions of Americans and higher wages for tens of millions more. The potential damage to raising rates too late is minimal. Wage and price inflation are still far below what they should be in a healthy economy, and a return to economic health will actually require a period of above-trend inflation, so overshooting these long-run targets would not constitute a policy mistake, but a return to economic health. Finally, when it is decided that the pace of economic growth has become too rapid and inflation has been too high for too long, higher interest rates will be able to reliably stem this pressure.