Stocks rallied last week after the Federal Reserve (or the Fed, as it’s known for short) took a larger-than-expected step on September 18, cutting interest rates by half a percentage point. Generally, more “hawkish” about keeping interest rates high to fight inflation, Fed Governor Michelle Bowman dissented, a sign that the voting board does not suffer from “group think,” said ING economist James Knightley.
At the press conference following the decision to cut interest rates, Fed Chair Jerome Powell indicated that the board had recalibrated their policy stance to both maintain growth in the labor market and move inflation to a sustainable, lower rate of 2%.
The question for most Americans is how this will help them. The Fed’s previous moves to increase interest rates starting in March 2022 negatively impacted people’s ability to take out home mortgages, car loans or use credit cards. When its decisions have such a direct impact on people’s pocketbooks, it can be hard to understand what makes the Fed’s monetary policy decisions sound.
“The Fed can either increase or cut interest rates, and each action has both a benefit and a cost. When it increases interest rates that reduces inflation but tends to increase unemployment. When the Fed cuts interest rates that reduces unemployment but tends to increase inflation. Thus the Fed is doing a balancing act,” said Joyce Burnett, Professor of Economics at Wabash College.
Created in 1913, the Fed is made up of twelve regional banks, all designed to serve the public. Each bank has its own board of directors, people with private sector experience, who advise the regional president.
By design, the Fed is unregulated by the government. It advises the president and Congress on policy decisions, but Congress does appoint seven of the twelve regional presidents to the board of governors. Considering that many Americans are skeptical of the government’s trustworthiness with money, the Fed’s strength is its independence.
Now that former St. Louis Fed Chief James Bullard is the dean of Purdue’s business school, he’s helping Hoosiers understand what the Fed does and how it is trustworthy.
Part of Bullard’s job as head of the St. Louis Fed was researching with other economists, creating research models, gathering data, testing economic models and documenting the results to be reviewed independently by other economists.
In a talk he gave at a September luncheon for the Purdue University Center for Research in Economics (PURCE), Bullard spoke on the trends in economic study and policy, from twenty years ago to the present. In the past few decades, researchers have increasingly paid attention to income and wealth distribution, he said.
Considering that people frequently discuss the widening wealth gap, it’s valuable for economists to study the distribution of wealth, income and the ability to consume.
Early on, Bullard said, people in government didn’t want to talk about income distribution, but now he and others want to speak coherently about the topic and the studies conducted on it. He did not say what prompted the new direction but noted that avoiding the research and discussion allows people to make unsubstantiated claims about which policies have succeeded and which have failed.
Economists measure inequality by the Gini coefficient. The Gini coefficient goes from 0 (no inequality) to 1 (complete inequality) to measure wealth, income and consumption inequalities. Presently, the wealth gap is .8, which is high. The income gap is closer at .5, and the ability to consume is .32. The latter measurement accounts for who gets to consume, how much, and how hard do they have to work for this ability.
Bullard illustrated the consumption inequity gap in his talk with the following example. Consider how economic class groups celebrate the 4th of July. The wealthy head to the Hamptons (or other high-end resorts) while the rest of us have barbeques and fireworks in our backyards. The proportion of their income that Americans spend for the holidays is similar, a lot closer than the income and wealth gaps.
Working with other economists, Bullard tested an economic model based on an economic model that builds on twenty years of research. The model takes into consideration the initial conditions that shape each person’s economic trajectory – including their parenting, the conditions in which they grew up, and their childhood economic markers of health. In short, the model recognizes that some people are born into homes where they stand to inherit from their parents and benefit from legacy admissions at universities while others are born into homes where parents struggle to make the bills, may have never attended college and may not know how to balance their budgets.
Bullard’s model adds to the studies that examine if and what policies are making life better and more equitable for people. It accounts for numerous factors: the productivity profile of workers including the fact that people tend to make less money and save less in their younger and more mature years; for individual risks like sickness and unemployment; technological improvements at uneven rates; suboptimal interest rates in borrowing and investing; and for what Bullard calls “the four horsemen of policy” - monetary, labor, treasury and fiscal.
To tell if the model is accurate, Bullard and his co-researchers watched the calculations and outcomes to see if the consumption rate is the same across region and status and if the scale is proportional to people’s economic status. It also looks at the nominal interest rates and nominal growth rates are the same. (Nominal rates are the rates before inflation is taken into consideration.) The model matched historical trends except under extreme shocks such as the housing crisis from 2007-2009 and from 2020-2022. It turns out that models that look at how policies affect the economy struggle with such huge unpredictable shocks. In that case, the Fed and other economists must advise lawmakers and policymakers without an abundance of evidence supporting their advice. At that point, they’re working off the cuff, leaning on their discernment alone.
All around the world, economists are developing models, each seeking to understand economic trends, forecast outcomes and improve the evidence and advice they give to elected leaders. It’s up to us, the voters, to hold our leaders accountable for the kind of economic conditions we want in our country. We may not set treasury, monetary, labor and fiscal policies, but by the pressure we put on our representatives over living wages, more equitable access to housing, healthcare and transportation, we influence those policies.
With economists’ research on the question of the distribution of resources, leaders will have better data to evaluate when deciding how to respond.