Extract from new forthcoming Berkeley E Journal of Macroeconomics: Advances, “The Welfare Cost of Inflation with Banking Time”, Max Gillman, 2018.
Below is Section 2 of this article:
“US Law on the Target Inflation Rate”
According to the US Federal Reserve Bank the FOMC (Federal Open Market Committee) has since 2012 adopted an explicit inflation target of 2%. In January 2012 the FOMC stated ( https://www.federalreservehistory.org/essays/humphrey_hawkins_act#footnote3)
“The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate (Board of Governors of the Federal Reserve System 2012).”
The same January 2012 FOMC statement continues that it will not specify the level of employment to be targeted:
“The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment” [bold added].
In contrast, current US law in the form of the 1978 Amendments to the 1946 Full Employment and Stability Act precisely sets both the targeted US inflation rate and the US unemployment rate. For inflation, it states that the US inflation rate should be 3% by 1983 and should be 0% by 1988 and afterwards, unless it conflicts with the employment goal. For unemployment, rates of 4% for aged 16 and over, and 3% for aged 20 and over, are to be met within 5 years of the passing of the 1978 Act (so by 1983).
Further, the Act specifies that only the President or Congress can change these goals. The US Federal Reserve Bank (Fed) is not allowed, by any existing law, to change these goals. Therefore, it is not authorized, without Presidential or Congressional mandate, to set a 2% inflation rate target as it did in 2012, because the target is currently specified in law as zero percent unless it conflicts with achieving the unemployment target. And it is not authorized to change the target unemployment rate of the 1978 Act.
(Public Law 95-523, passed October 27, 1978, is known as the Humphrey-Hawkins Act or officially within its Section 1 as “Full Employment and Balanced Growth Act of 1978”. https://www.govtrack.us/congress/bills/95/hr50/text
Alternatively, a pdf of the law is found at https://onlabor.org/wp-content/uploads/2016/12/STATUTE-92-Pg1887.pdf)
The Fed seemingly has a big loophole in that the 1978 Act specifies that the inflation rate target may be higher if it conflicts with the unemployment rate targets. But when the Fed set its 2% inflation target, it also specifically stated that the inflation target does not affect the unemployment rate, in that this is set by “nonmonetary factors”. So the Fed closes the loophole offered to it under the 1978 Act by saying the inflation and unemployment rates are “largely” unrelated.
However the Fed’s logic for not setting an unemployment rate goal is faulty. Rather than its authority to set unemployment rate targets being based on some envisioned relation between the inflation rate and the unemployment rate, the Fed has no authority to set unemployment rate targets since the fact is that these are already set in the 1978 Act, which provides no authority to the Fed to alter these targets. It is the specific US 1978 statutory law, which specifically precludes the Fed from having authority to change the unemployment rate targets, that implies that for the Fed: “it would not be appropriate to specify a fixed goal for employment”. The end result is that today the Fed has given no Congressionally valid reason for setting a 2% inflation rate target in deliberate contradiction of the 1978 Act’s target of a zero inflation rate.
There are four relevant sections of the Act, 4.b1.-4.b.4, which respectively set out the unemployment rate goal, the inflation rate target for the first five years, the inflation rate target for all years after 1988, and the authority for changing these targets.
“Section 4.b.(1). reducing the rate of unemployment, as set forth pursuant to section 3(d) of this Act, to not more than 3 per centum among individuals aged twenty and over and 4 per centum among individuals aged sixteen and over within a period not extending beyond the fifth calendar year after the first such Economic Report; and
Section 4.b.(2) reducing the rate of inflation, as set forth pursuant to section 3(e) of this Act, to not more than 3 per centum within a period not extending beyond the fifth calendar year after the first such Economic Report: Provided, That policies and programs for reducing the rate of inflation shall be designed so as not to impede achievement of the goals and timetables specified in clause (1) of this subsection for the reduction of unemployment.”
“Section 4.c.(2). Upon achievement of the 3 per centum goal specified in subsection (b) (2), each succeeding Economic Report shall have the goal of achieving by 1988 a rate of inflation of zero per centum: Provided, That policies and programs for reducing the rate of inflation shall be designed so as not to impede achievement of the goals and timetables specified in clause (1) of this subsection for the reduction of unemployment.”
Section 4.d states that only the President or Congress may change these goals:
“if the President finds it necessary, the President may recommend modification of the timetable or timetables for the achievement of the goals provided for in subsection (b) and the annual numerical goals to make them consistent with the modified timetable or timetables, and the Congress may take such action as it deems appropriate consistent with title III of the Full Employment and Balanced Growth Act of 1978.”
Using data from the US Bureau of Labor Statistics, the unemployment goal of 4% for over 16 years of age was achieved for briefly in December 1999, and for several months into 2000, when it dipped into the 3+% range. Now, in April, May, and June 2018, the rate has been again below or equal to 4%.
(https://fred.stlouisfed.org/series/UNRATENSA)
The rate for ages over 20 has been below 4% since September 2017.
The legislatively binding US law, which sets the US inflation rate to be 0% permanently, seems to be contraindicted permanently such that a permanent 2% inflation rate target is set “de facto” by the Fed. Would this contradiction of US law be based on the inability to meet some unemployment goal, it might be acceptable as an interim policy. But, 1) the Fed FOMC openly admits in January 2012 that monetary policy has little if any ability to affect the long term employment rate (as quoted above). And 2), the goals of the 1978 law on unemployment are now largely met, although having taken longer than the five years allowed. This achievement of the statutory US unemployment goals seems to imply unambiguously that the inflation target should now be zero.
To summarize and emphasize the conundrum here: First, the Fed claims the 2% inflation target is not chosen to achieve the unemployment goal, since it cannot affect unemployment. Second, the unemployment goal appears to have been met as of now anyway. Third, the inference results that the Fed appears to be contravening statutory law of a 0% inflation rate by their self-established 2% target. If so, then by US law, the Fed 2% inflation target is a judicially challengable over-reach by the Fed relative to US statutory law. While economists can consult the lawyers, this is clearly controversial, if not illegal, policy practice by the Fed, even though there not much of a fuss made over it by academics. Economists though can propose ways to quantify the cost of the Fed’s contraindiction of the zero inflation rate in favor of the 2% target. This is done here through the standard approach of the welfare cost of inflation, in terms of a 2% rate compared to zero.
Max Gillman 