Doves — those who, to some degree, prioritize unemployment concerns over inflation concerns — have ruled the roost at the U.S. Federal Reserve for the past several years. This is important to note because the kind of unconventional monetary policy tactics employed by the Fed over the past half decade could probably have only been developed and deployed as part of a dovish strategy. For example, if it were inflation and not jobs at the top of the agenda, quantitative easing may not have been so large an operation, and the target federal funds rate may not still be trapped at the zero bound. More importantly, the current conversation about the future of monetary policy would look a lot different.
The dovish dynasty arguably began with Alan Greenspan, who was appointed Fed Chair in 1987 by President Ronald Reagan. Although Greenspan took office at a time when inflation was well under control, he was no stranger to the enormous damage that runaway inflation could cause. Greenspan’s predecessor, Paul Volcker, had spent nearly his entire tenure fighting tooth and nail to maintain price stability, and, although Volcker retired victorious, it was not a fight that any Fed chair would want to relive.
Greenspan’s position on inflation is well captured in a 1996 debate about the future of the Fed’s long-term strategy — that is, a debate, among other things, about whether the Fed should maintain a primarily dovish or hawkish posture. Greenspan, who was then chairman, argued that the central bank should try to eliminate price inflation all together, suggesting a zero percent inflation target. Janet Yellen, who was then serving on the board of governors, countered that 2 percent is a healthier expectation. At the time, inflation was running at about 2.3 percent, and many economists feared it was heading higher.
But inflation didn’t get out of control. Shortly after that debate, the dot-com crisis knocked the economy off its feet and inflation decelerated. Jobs quickly became the Fed’s main concern as the unemployment rate climbed to above 6 percent in 2003. In response, Greenspan drove the federal funds rate as low as 1 percent, a time-honored tactic aimed at stimulating economic growth. It was this response that really marks the beginning of the dovish dynasty at the Fed.
Ben Bernanke, appointed by President George W. Bush, took the chair in 2006. By the time he took office the federal funds rate was back up to a historically normal level of around 5 percent, and Bernanke — who was considered by many to be Greenspan Lite — appeared set to keep it that way. But when the financial crisis reared its head, Bernanke demonstrated enormous flexibility, not only driving the federal funds rate into the zero bound but adopting and developing unconventional monetary tactics. As the unemployment rate soared toward 10 percent, jobs were unquestionably the Fed’s priority.
Yellen, who assumed office in 2014, has made no secret of her position as a dove. She championed the mantra of job creation even before becoming chair and has continued to do so since. And with the labor market still weak, her position has been generally well received by both policymakers at the public.
But as the Great Recession bumbles into whatever the next ‘great’ chapter will be, the debate between hawks and doves is seeing new life. After years of absence, price pressures finally appear to be building back up in the economy, and the specter of inflation is becoming more real. In July, the consumer price index for all urban consumers (CPI-U) was up 2.0 percent on the year, before seasonal adjustment, making four consecutive months where the inflation measure was approximately in line with the Fed’s target. The personal consumption expenditures (PCE) price index, which tends to get more love from the Fed, is up 1.6 percent on the year.
As a debate, the dove-hawk divide can quickly become dense and complicated, but as a conversation it really only revolves around two pillars: unemployment and inflation. The Fed has a dual mandate stating that it must seek to achieve one (maximum employment) in the context of the other (price stability), but it is often difficult if not outright impossible to implement a holistic policy.
This is particularly true at the zero bound, which is where the target federal funds rate has been trapped since 2008, buried beneath quantitative easing. This program, through which the Fed purchases assets in the open market in order to drive down longer-term interest rates, is aimed at stimulating business activity and ultimately increasing employment. One of the costs of the program, though, is increased inflation expectations.
Traditional economic thinking suggests that at full employment, increases in the money supply (things like quantitative easing) will increase prices (cause inflation) without increasing output. In other words, if the economy is already working at capacity, you can’t increase output by simply adding money to the system. This idea is contained in the equation of exchange.
But during recession, when unemployment is high and there is deflation — such as during the late-2000s financial crisis — expanding the monetary base can serve as an economic stimulant. Simply adding money to the system can help increase output when output is below potential. In deep economic recession or depression, putting more money in people’s pockets will lead to increased economic activity without increasing prices. As the economy heals and begins to return toward full employment, prices should begin to rise alongside output. At the point that full employment is reached, further increases in the money supply will only serve to increase prices, and not production. Keeping interest rates too low for too long can have a similar effect.
Since jobs have been the Fed’s main priority, the monetary pedal has been pushed to the metal. And, in part thanks to the amount of juice the Fed is giving the economy, the labor market has improved. In July, the headline unemployment rate in the United States edged up 0.1 point to 6.2 percent, close to the lowest rate since the financial crisis. Total non-farm payroll employment increased by 206,000, the sixth straight month of 200,000+ job gains, and the total number of unemployed persons clocked in at 9.7 million.
But it’s not totally healed, and in fact getting a good read of how healthy the labor market actually is has been challenging. Because of this, doves tend to favor keeping policy accommodative for longer, keeping the Fed’s foot on the gas pedal for as long as it can. The Economic Policy Institute made the dovish argument in an August report, saying that “In the short run, the Fed should keep providing support to economic activity and jobs until we reach a genuine full recovery from the Great Recession. At a minimum, this means keeping short-term interest rates low until wage growth is in line with the Fed’s overall inflation targets and the labor market is back to pre–Great Recession health.”
In the medium term, the EPI argues that the Fed needs to “Realize that even the pre–Great Recession labor market was far from healthy and continue to spur the economy to push unemployment down until—but not before—accelerating inflationary pressures reliably emerge in the data.” In short, the EPI, and many monetary doves, believe there is still slack in the labor market, and the Fed should do whatever it can to reduce it.
But not all policymakers agree with this principle. Although the EPI argues that “Slowing the recovery in the name of combatting hypothetical inflationary pressures would leave millions in considerable and unnecessary economic distress and would exacerbate troubling longer-term trends in wages and incomes for the vast majority of American workers and their families,” there are still some monetary hawks in the economic hegemony who argue that we should be tightening policy sooner, rather than later.
Richard Fisher, president of the Dallas Fed, is one of those Hawks, and in a July speech he addressed the issue head on. “Let me cut to the chase,” he told an audience at the University of Southern California, “I am increasingly concerned about the risks of our current monetary policy.”
Fisher has three primary concerns, which we would rather quote directly than paraphrase.
“First, I believe we are experiencing financial excess that is of our own making. When money is dirt cheap and ubiquitous, it is in the nature of financial operators to reach for yield. There is a lot of talk about ‘macroprudential supervision’ as a way to prevent financial excess from creating financial instability. My view is that it has significant utility but is not a sufficient preventative. Macroprudential supervision is something of a Maginot Line: It can be circumvented. Relying upon it to prevent financial instability provides an artificial sense of confidence.
Second, I believe we are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long. We did a good job in staving off the deflationary and depression risks that were present in the aftermath of the 2007–09 financial crisis. We now risk falling into the trap of fighting the last war rather than the present challenge. The economy is reaching our desired destination faster than we imagined.
Third, should we overstay our welcome, we risk not only doing damage to the economy but also being viewed as politically pliant.”
Fisher references an article by Neil Irwin at the New York Times, which unpacked the idea of the everything boom and its natural followup, the everything bubble. Irwin surveyed assets from around the world — from government bonds in Spain to corporate bonds in France to equities in the U.S. — and highlighted the concern that has been frothing at the lips of excitable market analysts for months (if not years at this point): compared to historical averages, most asset classes are expensive.
Fisher himself provides a list of signs that things may be getting out of hand.
- “The price-to-earnings, or P/E, ratio for stocks was among the highest decile of reported values since 1881;
- The market capitalization of U.S. stocks as a fraction of our economic output was at its highest since the record set in 2000;
- Margin debt was setting historic highs;
- Junk-bond yields were nearing record lows, and the spread between them and investment-grade yields, which were also near record low nominal levels, were ultra-narrow;
- Covenant-lite lending was enjoying a dramatic renaissance;
- The price of collectibles, always a sign of too much money chasing too few good investments, was arching skyward.”
The picture painted by these signs is concerning, especially to a hawk like Fisher. Fisher believes that the Fed has cross the line from helping the economy recover to fanning the flames of exuberance, and that a change in policy is needed. Otherwise, we risk another financial catastrophe.