Further Examination of Federal Reserve Reform Proposals

On MLK day, reform of the Federal Reserve should be noted as important to advancing the policy of what’s referred to as full employment, which MLK was very plausibly a strong advocate for. The link contains proposals for that objective, with particular attention being directed towards the malign effects banking interests currently mechanistically have on the Federal Reserve.

The Federal Reserve System has an unusual status as being a mix of public and private entities. The governors are of course explicitly part of the public sector, as presidential appointees subject to congressional approval. However, the 12 regional banks are private, being owned by the member banks in the district, which have substantial control over the district bank’s conduct.

This structure was put in place more than a century ago to fit the politics and the economy of the time. It is inconceivable that anyone constructing a central bank today would use the same framework. The archaic nature of the Fed’s design is perhaps best demonstrated by the distribution of the regional banks. Two are located in the state of Missouri. Meanwhile, the San Francisco region not only includes the whole state of California, but the rest of the west coast, and the states of Alaska, Hawaii, Nevada, Utah, Arizona, and Idaho, in all accounting for more than 20 percent of the nation’s economy.

While there were reasons that a mixed public–private central bank and regulatory system may have made sense at the start of the last century, this is no longer the case today. The United States is the only major economy with this sort of mixed approach. The Bank of England, the Bank of Canada, the Bank of Japan, and the European Central Bank are all purely public entities. It is recognized that the conduct of monetary policy, along with the lender of last resort and regulatory functions of the central bank, are necessarily responsibilities of the government.


While there does not seem to be much basis for concerns that the Fed will act to support the political party in power, there is a real concern about a structure that gives the financial industry a direct voice in the conduct of monetary and regulatory policy through their control of the regional banks. This is really an extraordinary structure without any obvious parallels in our governmental system.

Both aspects of this relationship make little obvious sense. The financial industry certainly has useful insights on the conduct of monetary policy, but it makes no more sense to give them seats at the table than the manufacturing or tech industry. Monetary policy has an enormous impact on the national economy and affects every sector in it; there is no reason to believe that the perspectives gained from working in the financial industry are uniquely valuable.

Similarly, the idea that an industry would be able to pick its own regulator is truly extraordinary. It is understandable that industry groups will try to lobby and in other ways influence the decisions of regulatory bodies. The pharmaceutical industry places pressure on the Food and Drug Administration (FDA) to approve drugs more quickly, the telecommunications industry lobbies the Federal Communications Commission (FCC) for looser standards on universal service, but in neither case are they given a direct role in appointing their regulators. No one would suggest that Pfizer or Merck should be able to appoint a commissioner on the FDA or that Verizon and Comcast should select one of the members of the FCC. The Federal Reserve Board is unique in this way, as the member banks within a district largely have the ability to control the selection of the bank president who plays a direct role in both determining monetary policy and regulation of the banks within the region.[1]


Inflation has been at relatively steady and low levels for most of the last three decades. In fact, since the Fed officially adopted the 2.0 percent average inflation target in 2012, the core inflation rate has consistently been below this pace. In other words, if we view the 2.0 percent inflation target as a proper goal of monetary policy, the Fed has failed by having too little inflation, not too much.


This subcommittee is considering a wide range of proposals that would alter the structure of the Fed. Several are quite useful in increasing openness and accountability. However, the ones which aim to give more control of the Fed in the hands of the banking industry, rather than officials appointed through the democratic process seem at odds with recent trends both in the United States and the rest of the world. It is difficult to understand the effort to privatize the conduct of monetary policy and to turn over control of financial regulation to the industry that is being regulated.


China May Lessen Its Currency Manipulation Soon

The Chinese currency management done over the past several years is a significant issue because it raises the U.S. trade deficit, and a higher U.S. trade deficit — as seen in recent years — means a contribution to a shortfall in U.S. economic demand. A considerable shortfall in economic demand has hurt the majority of U.S. workers, as it means the U.S. is importing too much and exporting too little. This policy actually matters quite a bit, as its macroeconomic implications effect the voting trends in the U.S. that then have an effect on world affairs.

A NYT article told readers that investors are worried because China may stop buying and could even start selling US Treasury bonds:

“Bond markets appeared to be further spooked on Wednesday by a report that China’s central bank, which owns $1.2 trillion in United States Treasury bonds, may be poised to slow or even halt its buying of United States debt. China has total reserves of just over $3 trillion.”


While China’s decision to stop buying, and possibly start selling US Treasury bonds, is presented as a bad thing in this piece, it is exactly what anyone who had complained about China’s currency “manipulation” (e.g. Donald Trump) would want to see. This “manipulation” (which should more accurately be called “management” since it is entirely open) involved China’s government buying US government bonds and other assets in order to prop up the dollar against the yuan.

By buying dollar-based assets, instead of selling its dollars in international currency markets, China was increasing the demand for dollars, thereby pushing up its price. If it stops and reverses this process, it will be lowering the value of the dollar relative to the yuan. This will make goods and services in the United States more competitive internationally, thereby reducing the US trade deficit.

Rather than being a hostile gesture toward the United States, this is exactly what Trump claimed he was going to make China do in his campaign. He said that he would a take a tough line with China and make it end its currency management.

It is also worth noting that if the dollar declines in the months ahead it would be the exact opposite of what most economists (including the Trump administration’s economists) had predicted as the outcome from the tax cut. They had predicted a flood of foreign investment, which would have the effect of increasing the value of the dollar and the trade deficit.

Government Budget Deficits as Overblown Concerns

Government budget deficits can actually be beneficial if the spending that results in them is in the public interest. This is contrasted with large trade deficits, however, which in wealthy countries have a negative impact on demand in the economy. Both of these truths are important to know for public policy debates.

There are three ways in which deficits or debt can be seen as a problem. First, large deficits can overheat the economy leading to high interest rates or high inflation. Second, a large debt can impose a significant interest burden on the government and implicitly on future taxpayers. The third way is that excessive indebtedness can cause a country to become uncreditworthy, making it difficult or impossible to finance the government. None of these issues plausibly apply to the United States at present.

The first point is the classic story in which large amounts of government borrowing pulls capital away from the private sector. This would be bad news because businesses and state and local governments would have to pay higher interest rates, which would reduce their investment. With less investment, we would see less productivity growth, which would mean that we would be poorer in the future.

There are times when excessive deficits may crowd out investment, but this is clearly not one of them. Interest rates are extraordinarily low. In fact, they are far lower than in the years at the end 1990s when we were running surpluses.

There also is no evidence that excessive spending has led to inflation. The Federal Reserve Board has been struggling for most of the last decade to raise an inflation rate it views as too low.

The second issue is that the debt service — the amount of interest that we pay on the debt each year — will impose a large burden requiring either higher taxes or cuts in other spending or some combination. There also is no basis for this concern at present.

The interest that the government pays on its debt each year comes to around 1.0 percent of GDP, after we subtract the amount that was paid to the Federal Reserve Board and then refunded back to the Treasury. By comparison, the interest burden was more than 3.0 percent of GDP at the start of the 1990s.

It is also worth noting that the much larger interest burden of the 1990s did not prevent us from having a very prosperous decade. In other words, there is a long way to go before we face any serious problem by this measure.

Finally, there is the argument that we could end up in the same situation as Greece was in a few years back, where no one wants to lend money to the U.S. government. There are two major reasons the United States will not end up like Greece.

First, we borrow in our own currency. The U.S. prints dollars; we don’t have to worry about being able to borrow them. By contrast, Greece borrowed in euros, which it did not print.

This brings up the second point; we could print so much money that we face hyperinflation, like Zimbabwe did in the last decade. In principle, that could happen, but the problem in that case would be having a weak economy, not having a large debt. As long as the U.S. economy remains strong and grows at a respectable pace, we will never end up like Zimbabwe.

If we need proof of this fact, we need only look at Japan. The country has a debt that is two-and-a-half times as large as the U.S. debt relative to the size of its economy. Nonetheless, it can borrow long-term at a near zero interest rate. Its inflation rate has also been near zero as the government has been desperately trying to increase inflation for the last two decades.

In short, the country has many real problems. Tens of millions of young people struggle to pay for college. Young parents struggle to pay for quality child care and tens of millions of people have inadequate health care insurance.

These are all issues that deserve our attention. The federal debt is just a huge distraction.

Racial Unemployment Gap Being Reduced by a Tightened Labor Market

There are numerous benefits to full employment policies. Of course, while there is a relatively tight U.S. labor market, some part of the low unemployment story is due to the significant number of workers who have dropped out of the labor force. The point I make repeatedly is that there’s a lot of important work to be done, people willing to do it, and an economic system that isn’t putting the two together. The U.S. is notably forgoing $1 trillion a year in added output because there isn’t enough demand in its economy.

One wants to always be careful not to over interpret any jobs report — the numbers are noisy in the monthly data. But when a number pops out that makes sense in terms of both theory and empirical evidence, it’s legitimate to take note.

In this spirit, note that the African American unemployment rate hit 6.8 percent last month, the lowest on record, with data going back to the early 1970s. In addition, the gap between black and white unemployment, measured as the black rate minus the white rate, hit 3.1 percentage points, also the lowest on record.

Now, you may well be saying, “Wait up; 6.8 percent doesn’t sound all that low, especially given that the overall jobless rate remains at a 17-year low of 4.1 percent.”

I agree. Where is it written that minority rates must be multiples of white rates? Some of the difference is due to educational differences, but not as much as you might think. Similar differentials in black/white jobless rates exist for all education levels. Racial discrimination is, of course, alive and well and in play in these gaps.

But that key observation underscores my larger point: A persistently strong macroeconomy is highly potent medicine for treating economic inequities, including racial ones. It’s not all that’s needed, by a very long shot. Purging discrimination and unequal punishment from the criminal justice, for example, is essential if we’re ever to achieve racial justice. But it’s not a coincidence that toward the end of his life, the Rev. Martin Luther King Jr. was pushing hard on a full-employment agenda.

The economics is straightforward. Discrimination — which doesn’t have to be only racial discrimination; employers might discriminate against workers who’ve, for example, been unemployed for a long time or have been out of the job market — is a “luxury” that employers who engage in it can’t afford when the economy tightens up. You either hire someone you might avoid if the labor supply queue was a lot longer, or you leave profits on the table.

So, while we shouldn’t get too excited about that relatively low monthly rate — given the high statistical variance in these data, it could jump back up next month — we should recognize and applaud these critical important macro-dynamics and the clear trends they’re delivering, as seen in the figure above.

The author of the article also co-wrote a useful book that covers the benefits and importance of full employment. It’s called Getting Back to Full Employment and can be read online for free (pdf).

Saving $1.5 Trillion Annually on Healthcare

Bringing the per capita costs of U.S. healthcare in line with other wealthy countries would save over a trillion dollars a year.

Austin Frakt and Aaron Carroll had an interesting Upshot piece in the NYT on why the U.S. spends twice as much per person as other wealthy countries for its health care. The piece cites research pointing out that people in the United States do not use more health care services than people in other countries. The reason that we pay more for health care is that actors in the industry, such as doctors, drug companies, insurers, and medical equipment manufacturers, get more money than their counterparts elsewhere.

The piece concludes by noting a couple of mechanisms for containing costs, but then argues:

“If attempted nationally, or even in a state, either of these would be met with resistance from all those who directly benefit from high prices, including physicians, hospitals, pharmaceutical companies — and pretty much every other provider of health care in the United States.

“Higher prices aren’t all bad for consumers. They probably lead to some increased innovation, which confers benefits to patients globally. Though it’s reasonable to push back on high health care prices, there may be a limit to how far we should.”

It’s striking to see economists reluctant to use mechanisms that would bring payments in the health care in line with payments in the rest of the world because they “would be met with resistance from all those who directly benefit from high prices.”

Efforts to reduce trade barriers that had the effect of destroying jobs and cutting pay for autoworkers, textile workers, and other manufacturing workers were also met with resistance. Economists not only supported these efforts, they treated them as an almost holy cause. They insisted on “free trade,” as the ultimate good.

For some reason, Frakt and Carroll believe that comparable efforts (we can also use trade in the health care sector to reduce costs) to reduce excess payments in the health care sector are a bad idea because the people who would see their pay and income reduced will be unhappy. In this context, it is probably worth mentioning that there is hugely more money at stake in bringing our health care costs in line with the rest of the world than with reducing trade barriers with items like steel and cars. The latter can save us at most a few tens of billions a year. If we paid the same amount per person for health care as people in Canada or Germany, the savings would be more than $1.5 trillion annually, more than $4,000 per person per year.

Economic Policy Institute Head Steps Down

Working with Jared Bernstein, Larry Mishel is the originator of the famous graph that shows the split between productivity and wages. Mishel is also notable for helping some important and good economists early in their careers. He’s therefore one of the people I am willing to give a tribute to on this site.

WHEN LAWRENCE MISHEL came to Washington during the height of the Reagan revolution, the options for a young leftist economist looking to make a difference were nearly non-existent.

“The liberal position was represented by the Brookings Institution,” Mishel told The Intercept, “which at the time was very free trade uber alles, hostile to industrial policy, not interested in workers and unions. The debate was between Brookings on the left, and [the American Enterprise Institute] and the Heritage Foundation on the right.”

And then there was the Economic Policy Institute, a new think tank designed to fill the ideological gap and shift America’s economic debate to the left. In 1987, Mishel joined EPI as a research director, later becoming vice president and eventually president in 2002. As his thirtieth year at EPI winds down, Mishel gets to see the Democratic Party finally move closer to the positions the think tank has always had. Now, he is stepping aside.

“The hallmark has been to center that an economy is only working if it’s working for the benefit of the vast majority,” Mishel said. “We hammered that every day.”


From the beginning, EPI elevated the daily struggle of those on the economy’s margins. Starting in 1988, Mishel and colleagues produced a biennial report, The State of Working America, with comprehensive data on wages, incomes, jobs, and wealth. The reports found a discordant trend in the economy: wage stagnation amid increasing productivity. Prior to the late 1970s, these two measures followed one another: as workers produced more goods, they made more money. When that changed, others made excuses for this bifurcation while EPI insisted that conscious policy choices shortchanged workers and funneled the gains to the very top, as evidenced by rising CEO compensation and the erosion of living wages. In other words, EPI argued, natural forces didn’t lead workers to their plight — those in power pushed them there.

If these themes of rising income inequality sound familiar today, they were practically a foreign concept at the outset. In 1994, Mishel and Jared Bernstein created a now-famous chart showing the split between productivity and the median hourly wage.



Much of EPI’s work under Mishel served to reject pernicious myths about the economy, hardened into perceived wisdom by self-interested forces. EPI’s research found that social and economic disadvantage, not failing teachers or schools, depressed student achievement. It refuted that high school graduation rates were collapsing, an alternative fact used to push vouchers or charter schools. It proved that automation played little role in inequality. It laughed off the idea that CEOs were paid nearly 300 times more than the average worker based on a competitive race for talent.


As Mishel steps aside, he believes America needs a broad set of policies to rebuild worker power, things like raising the minimum wage to $15 an hour, empowering union organizing, ending worker misclassification in the “gig economy” to deny benefits and overtime pay, preventing arbitration agreements that limit worker options in a dispute, and banning non-compete clauses that stop workers from moving to similarly situated employers. These moves to strengthen worker bargaining power, collectively and individually, cut a path to robust wage growth for the 99 percent. “It will take bold proposals,” Mishel said. “If not, we won’t have a vibrant middle class, or a democracy.”

Mishel’s mission in 30 years at EPI was not only to identify the economy’s problems, but to demonstrate how to fix it. And he consistently brought complex insights down to a level of popular understanding, striving to reach the ordinary worker rather than the academy. The way he talked about the economy mirrored who he fought for. A garrulous man with a shock of white hair, Mishel cherishes that EPI has become a fixture in Washington, and that the poles of the economic debate have finally trended in his direction.

Minimum Wage Increases to Benefit 4.5 Million U.S. Workers

The minimum wage would be about $20 in the United States today if it had kept pace with productivity growth since the 1970s. Marginally higher minimum wages than the $7.25 federal level are therefore inadequate, but they do represent some gains.

At the beginning of 2018, 18 states will increase their minimum wage, providing over $5 billion in additional wages to 4.5 million workers across the country. In a majority of these states, minimum wage increases (ranging from $0.35 in Michigan to $1.00 in Maine) are the result of legislation or ballot measures approved by voters in recent years. Eight of these states (Alaska, Florida, Minnesota, Missouri, Montana, New Jersey, Ohio, and South Dakota) will have smaller automatic increases that adjust the minimum wage to keep pace with price growth. This automatic inflation adjustment preserves the buying power of the minimum wage, which has steadily eroded over time.


Increasing the minimum wage is a crucial tool to help stop growing wage inequality, particularly for women and people of color who disproportionately hold minimum wage jobs. As low-wage workers face a growing number of attacks on their ability get a fair return on their work, Congress should act to set a higher wage floor for working people.