This commentary was written by Dr. Daniel Thornton of D.L. Thornton Economics. Thornton spent over three decades at the St. Louis Fed as vice president and economic advisor.

Thornton: The Fed’s Preference for Full Employment vs Price Stability: What Its Behavior Reveals - z 08.31.2022 rabid inflation cartoon

The Full Employment and Balanced Growth Act of 1978, better known as the Humphrey-Hawkins Act, required the Fed to pursue a so-called dual mandate—full employment and price stability. At the time the Act was passed, the Volcker Fed was dealing with doubt digit inflation and was concerned that the dual mandate would interfere with its efforts to reduce inflation. One policymaker suggested that this problem could be dealt with by arguing that inflation led to unemployment so the Fed was pursuing its dual mandate by pursuing a policy of low and stable inflation. Alan Greenspan made the same argument during his nearly 19 years as Fed chairman.

Inflation was relatively low and stable beginning in the early 1990s, so policymakers began paying more attention to the full employment part of Fed’s dual mandate. The Fed explicitly acknowledged this in its December 2008 policy directive, noting that its objectives were “maximum employment and price stability.” However, the Fed didn’t acknowledge the change publicly until the September 2010 meeting when the Fed’s policy statement noted that its objective was “to promote maximum employment and price stability.” Since then, the Fed has been increasingly concerned with and open about achieving the full employment part of its dual mandate.

The Fed’s policy actions since early 2020 reveal its preference for achieving full employment relative to price stability.

In response to the pandemic, the Fed held an unscheduled meeting on March 3, 2020, and announced that it cut its federal funds rate target by 0.5% percent. Just 12 days later it held another unscheduled meeting to announce that it reduced the federal funds rate target another 1%, to between zero and 0.25%. The Fed also noted it would maintain this target until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.

The Fed noted further that it would increase its holdings of Treasury securities by at least $500 billion and its mortgage-backed securities by at least $200 billion. Just eight days later, the Fed announced that it would purchase securities in the “amounts needed to support the smooth market functioning…”

On August 27, 2020, the Fed changed its inflation target from 2% to an average of 2% over time. In announcing the change the Fed said:

“The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee’s ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

This statement didn’t explicitly say that the change was made to give the Fed more freedom to pursue the “full-employment” part of its Congressional mandate. However, it is difficult to rationalize another reason. The Fed’s assertion that inflation expectations will be more firmly anchored if some uncertainty is introduced into its inflation target makes no sense. It is difficult to see how setting a target of 2% that will be averaged over an unspecified period of time can anchor expectations better than having a fixed target of 2%.

The Fed decision to let the economy achieve full employment before taking any aggressive policy action is reflected in the fact that the inflation rate was nearly 8% before it took its first action. Moreover, the Fed’s response was anemic. On March 17, 2022, the Fed announced that it increased its target for the federal funds rate by 0.25% and that it would begin reducing the size of its balance sheet on June 1, but never indicated the pace of the reduction.

Given its desire for the economy to achieve full employment, it was in no hurry to act. On May 4, the Fed announced that it increased the target by 0.50%. It increased the target by 0.75% at each of its regularly scheduled meetings in June, July and September. It took the Fed six months to increase its target for the federal funds rate 3 percentage points. During the pandemic it took the Fed just 12 days to reduce the target by half that amount.

A comparison of the Fed’s asset purchases from the end of February 2020 to the end of September 2020 with its sales from the end of February 2022 to the end of September 2022 also demonstrates that the Fed was much less aggressive in fighting inflation. The Fed increased its holdings of securities by about $2.2 trillion during the former period and reduced its holdings by about $100 billion during the latter period.

The Fed’s lackluster response to inflation clearly indicates that it is much less concerned about fighting inflation than it is maintaining employment. This is ironic in light of the fact that inflation hurts everyone, while a reduction in employment primarily affects those who become unemployed.

Furthermore, the income loss due to inflation is permanent for nearly everyone. If inflation averaged 8% this year, people whose income increases by 8% next year would still have lost 8% of their purchasing power during the year, even if the inflation was zero the next year.

Those whose incomes increase at a slower rate than inflation suffer a much larger and a more persistent loss. Even if their former purchasing power was eventually restored, the loss of purchasing power during the intervening period is permanent.

It is also the case that inflation is most damaging for low-income workers, anyone whose income tends to increase slowly, and especially those whose income is largely fixed and will never “catch up.” Multiple years of high inflation will have devastating consequences for such people. Consequently, it is hard to rationalize the Fed’s lackluster approach to fighting inflation.


This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.