Federal Reserve Board should focus on higher GDP growth to reduce income inequality and poverty

Posted by Shyam Moondra

During the administration of President Barack Obama, we have had a slow-growth economy and lower inflation. However, Obama left a record 40 million Americans under poverty level (defined as income of $30,750 for a family of four) in spite of his significant increase in welfare spending to the tune of $1 trillion (Obama was the first president to spend more on welfare than on defense). The current administration of President Donald J. Trump pushed for higher sustained economic growth via lower taxes, reduced regulations, and more favorable trade deals with global trading partners. In a short period of one-and-half years, the unemployment rate has gone down to 3.7%, the lowest in the last 49 years, and unemployment among African-Americans and Hispanic population has gone down to the lowest level ever. So the key to reducing income inequality and poverty is sustained 3-4% GDP growth and not limiting inflation to an arbitrary 2.5% as currently targeted by the Federal Reserve Board (FRB).

The FRB expeditiously wants to increase the funds rate to a "normalized" level which is somewhat arbitrary because what was "normal" yesterday may not be "normal" today, depending on a multitude of issues related to global trade, regulations, and tax policies. In anticipation of higher inflation caused by growing economy, the FRB has been increasing interest rates that are negating the positive results achieved by Trump’s fiscal and trade policies. Higher interest rates are already slowing down housing and auto industries that are the backbone of the U.S. economy. Also, higher interest rates are making dollar stronger relative to other major currencies, which is exacerbating the trade deficit problem and making it harder for Trump to achieve his goal of cutting trade deficit by half. Therefore, the FRB’s monetary policy designed to keep inflation under control is acting against Trump’s policy of high sustained growth designed to reduce income inequality and poverty in America. If Trump’s policies reinvigorate the manufacturing sector in the U.S. (new 700,000 high-paying manufacturing jobs have already been added since Trump was inaugurated), the average wage level will go up. Therefore, the FRB shouldn’t be exclusively concerned with inflation, so long as wages are increasing at a faster rate. If the FRB is overly aggressive with their interest rate increases, the corporate world would reduce capital investments in anticipation of economic slowdown which would hurt the economy in the long-term. Higher economic growth and capital expansion must go hand-in-hand to achieve higher employment levels while keeping inflation under control. In recent years, Germany has had near zero interest rates for many years and yet it became the most prosperous country in Europe.

Rather than be solely focused on anticipatory inflation and using the outdated Phillips Curve (inflation vs unemployment) as its guiding principle, the FRB needs to find a way to maintain high growth while at the same time keeping inflation in check by aligning monetary policies with fiscal policies to create an environment where businesses feel confident about making new capital investments. The FRB has been creating these artificially manufactured boom-and-bust cycles by adjusting interest rates lower or higher, but these cycles make it impossible to make a dent on poverty which can be reduced only by sustained high economic growth.

To get the optimum results for the country, we need the FRB to come up with a new model which has the funds rate fixed at a nominal rate, say between 1 and 2% (and it should be changed only in emergency situations), while using other tools at its disposal to focus on growing economy at 3-4% a year.  We need a collective monetary and fiscal policy approach to achieve the best possible results for the American people in terms of higher growth, higher wages, lower unemployment, lower trade imbalances, and increased wealth creation. If we can maintain the current GDP growth with low inflation while freezing funds rate at the current level, we should see a significant reduction in income inequality and poverty in the coming years.