As the Federal Reserve intensifies its efforts to tame high inflation, its top officials are casting a new light on its aggressive stance: as a blow to economic inequality.
This line of thinking marks a sharp departure from the conventional view of the Fed’s use of interest rates. Normally, the large rate hikes the Fed is planning for the coming months would be viewed as a particular threat to disadvantaged and low-income households. These groups are most likely to suffer when interest rate hikes weaken an economy, raise unemployment, and sometimes trigger a recession.
Instead, some of the most dovish Fed officials, who normally favor low interest rates to stimulate jobs, are now struggling to show how inflation is hitting poorer Americans hardest. Curbing high inflation, they argue, is a matter of fairness.
The burden of high prices “is particularly severe for households with more limited resources,” said Lael Brainard, an influential member of the Fed’s Board of Governors and longtime interest dove, in a speech on Tuesday. “That’s why our most important task is to bring inflation down.”
Brainard found that food and energy together account for a quarter of the price spikes that have pushed inflation to 40-year highs. Poorer Americans spend about a quarter of their income on food and transportation, she said, while wealthier households spend less than a tenth.
Congressmen from both parties generally agree that the Fed must deal with rising inflation by steadily raising interest rates, which will make many consumer and corporate loans more expensive. Indeed, most economists have said that the Fed has waited too long and is now at risk of having to cut lending too quickly and derailing the economy. Last month, the Fed raised interest rates from near zero to a range of 0.25% to 0.5%.
Still, some Democrats have expressed concern that higher rates will significantly slow hiring even if unemployment remains higher for black workers than whites, for example.
“We clearly have a long way to go when it comes to making sure everyone has a quality job,” said Sen. Sherrod Brown, an Ohio Democrat, at a hearing on Jerome H. Powell’s nomination for a second four-year term as Fed chairman. “Raising interest rates too early can dampen job growth.”
Tim Duy, US chief economist at SGH Macro Advisors, and several other analysts say the Fed is right to point out the damage inflation can do to Americans’ ability to afford basic necessities like groceries, gas and rent. But they also suggest that some of the Fed’s recent comments have exaggerated the notion that inflation is worsening economic inequality.
For example, Nathan Sheets, Citi’s chief global economist and former Fed economist, notes that inflation reduces debt burdens, which can disproportionately benefit low-income Americans. Wages usually rise to keep up with inflation. But mortgages and other debt usually carry fixed interest rates, making them easier to repay.
Brainard’s speech this week was one of the clearer examples of the Fed’s argument that inflation can exacerbate inequality. Brainard, who was nominated for the Fed’s No. 2 role and is part of Powell’s inner circle, said low-income households – defined as the poorest quintile – spend 77% of their income on basic necessities, including food and housing. In contrast, the richest fifth spends only 31% of their income on these categories.
Likewise, Mary Daly, Chair of the Federal Reserve Bank of San Francisco and a long-time moderate voice on the Fed’s policymaking board, surprised Fed-watchers this week when she declared that “inflation is as harmful as not having a job.”
“I understand… that if you have a job [but] You can’t pay your bills, or I feel like I can’t save up for what I need to do, then that keeps you up at night,” Daly said in a note to the Native American Financial Officers Assn.
Brainard noted in her speech that poorer people often pay higher prices for the same item. For example, higher-income households can afford to make large purchases or top up on an item if it’s being sold at a discount, thereby lowering their cost per item.
And as inflation rises, Brainard says, households buying branded grains can switch to cheaper private label products. But poorer consumers who are already buying cheaper items cannot make an equivalent price-cutting switch.
Powell himself began to steer his rhetoric in that direction during a testimony before Congress last winter, Duy said, when the Fed chair mentioned the harsh effects inflation is wreaking on disadvantaged Americans. Powell had not expressed that concern in previous statements in September.
It was a notable shift for the Powell Fed, which has focused more than its predecessors on inequality in the labor market. In August 2020, the Fed updated its policy framework to specify that its goal of maximum employment is “broad and comprehensive.”
This meant the Fed would consider unemployment rates for black and Hispanic workers, not just headlines, when setting its interest rate policy. The central bank also said it would stop raising interest rates in anticipation of higher inflation and would wait for the higher prices to materialize.
Brainard had highlighted a reason for a more patient approach in a speech in February 2021. In those remarks, she said that raising interest rates to stave off inflation “could limit progress for racial and ethnic groups facing systemic challenges.”
Powell and other Fed officials say their goal now is to reduce inflation by slowing, but not stopping, growth. Bringing down high inflation is important to sustaining economic growth, they say, and ultimately to keeping unemployment low.
Sheets suggested that the Fed can hike rates for now without worrying too much about hurting the job market because its interest rate is so low. Fed officials don’t think their interest rate will dampen growth until it hits around 2.4%.
Minutes from the Fed’s last March meeting, released Wednesday, showed officials want to reach that level “quickly,” and economists expect to do so by the end of this year. If inflation is still too high at this point, the Fed may need to raise rates further, to a point where layoffs occur and the risks of a recession increase.
“Then it’s going to be difficult and challenging for the Fed — when these near-term compromises emerge,” Sheets said.