Most everyone knows about the Federal Reserve’s dual mandate. Set by Congress, the charge for the U.S. central bank is twofold: Create the conditions for stable prices (i.e., low inflation) and maximum employment. (The third mandate—to moderate long-term interest rates—flows naturally out of keeping inflation steady.)
Increasingly, though, the third mandate is changing, according to Jeff Klingelhofer, a managing director and portfolio manager for Aristotle Pacific Capital, an investment advisory. And that new task is social cohesion.
It’s a tough call for an entity that has seemed somewhat battered in recent years, bruised by its failure to catch COVID-era inflation in time and, increasingly, in a fight with the president of the United States, who is pressing on the Fed’s nominally independent head to lower interest rates.
“It’s out with the old—financial stability—and in with the new: social stability,” Klingelhofer told Fortune.
Klingelhofer notes that, before the 2007–2009 Global Financial Crisis, the Fed used to be very proactive in raising interest rates, hiking them well before any sign of inflation. Post-crisis, when unemployment was stubbornly slow to fall, critics accused the Fed of hiking rates too quickly and stymieing the recovery. (The Fed’s first rate cut came in late 2015, with unemployment at 5% and the Fed’s preferred measure of inflation at just 1%.) Inflation didn’t come close to hitting the Fed’s 2% target for seven years after the hike. Years later, two Fed governors admitted they got the balance wrong and should have kept rates lower for longer.
In 2020, that shifted. The Fed, by keeping rates low, “learned the biggest wage gains went to the lowest earners,” Klingelhofer said. “Coming out of COVID, the third mandate was social stability, compression of the wage gap.”
But the central bank also got burned with its prediction that inflation would be “transitory.” That miss, coupled with the fastest and steepest rate-hiking cycle in modern history, has made the central bank loath to move too quickly on cutting rates this time.
This shift is evident in the tenor of Chair Jerome Powell’s speeches, starting at Jackson Hole, Wyo., in 2022.
“Without price stability, the economy does not work for anyone,” Powell said in 2022, adding that the Fed was “taking forceful and rapid steps to moderate demand…and to keep inflation expectations anchored.”
“We will keep at it until we are confident the job is done,” he said.
That experience has pushed the Fed from proactive to reactive, Klingelhofer said. “They’ll need to see inflation below 2%, and think it’ll stay there.”
If a recession hits, “I don’t think the Fed will step in as they have in the past,” he added. “Maybe if it’s a deep recession, with high unemployment, and inflation falls below 2% dramatically—maybe.”
Low rates inflate assets
Historically low interest rates had another effect—they redistributed wealth upward by encouraging asset bubbles. In this way, as a recent body of economic research has shown, low rates have contributed to skyrocketing wealth inequality.
Low interest rates tend to juice stock-market appreciation, benefiting the 10% of the population that owns more than 90% of stock, and encourage investors to create novel assets as they chase bigger returns. These benefits accrue most to those who have the biggest financial assets—i.e., the wealthiest—while doing little for the poor.
And while low rates encourage higher employment, “the 1% of Americans who own 40% of all the assets just get tremendous gains before that first job is created for the middle class,” said Christopher Leonard, who criticized the Fed’s ultra-low-rate policies in The Lords of Easy Money, a 2022 book describing this dynamic. In this way, he said, the Fed exacerbates the gap between the ultra-rich and the rest of us, which he called “the defining economic dysfunction of our time.”
It’s another argument against cutting rates, in addition to the risk of reigniting inflation—whose burdens, as Powell repeatedly notes, “falls heaviest on those who are least able to bear them.”
“The alchemy of low interest rates is over,” Klingelhofer says. He isn’t convinced the Fed has that much influence on rates like the 10-year Treasury, which closely influences mortgage rates. These bonds trade in international markets where investors buy or sell them based on how they perceive the risks of U.S. debt.
“Where should 10-year Treasuries be? With inflation at 3%, and the government running 6-7% deficits, 4.5% feels roughly correct,” he said.
In fact, some economists say the Fed’s cutting rates would be perceived as a recession indicator—and would have the opposite effect, sending bond yields and interest rates soaring.
As Redfin economics research head Chen Zhao told Fortune previously, “the Fed only controls that one Fed funds rate. Everything else is determined by markets.”
This story was originally featured on Fortune.com
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