Fed Responds to a Grim Reality

WASHINGTON — When the Federal Reserve’s vice chairman said in a 1994 speech that the central bank “had a role in reducing unemployment,” colleagues were publicly dismissive. The very word “employment” did not appear in a policy statement until 2008. The Fed was focused on inflation, officials said time and again.

That era is over. The signs have been there for some time, but they are now unmistakable. Ben S. Bernanke, the Fed’s chairman, made clear on Thursday that job creation is its primary concern for the foreseeable future.

The remarkable transformation of the Fed’s priorities is partly a response to the grim reality that more than 20 million Americans cannot find full-time jobs. It is made easier by the fact that the Fed has been so successful in stabilizing inflation right around the 2 percent annual pace that officials consider most healthy.

But as circumstances have changed, so has the Fed itself. Under the leadership of Mr. Bernanke — with considerable prodding and support from a board almost entirely appointed by President Obama — the central bank has gradually concluded that it has a responsibility to act more forcefully, and, equally important, that it has the ability to spur job creation directly.

These conclusions remain deeply controversial. Many monetary economists take the view that central banks should focus exclusively on controlling inflation, which creates an environment conducive to economic growth and job creation. Some argue that the Fed’s efforts to spur job growth by decreasing long-term borrowing costs will inevitably result in higher inflation, eventually reducing growth and employment.

And it is clear that many economic problems are beyond the reach of monetary policy. The Fed cannot force Congress to budget. It cannot repair consumer credit nor change Europe into something more sensible. Even the most optimistic analysts do not think its efforts will return unemployment to its precrisis level.

Mr. Bernanke’s predecessor, Alan Greenspan, once told his board that he did not want to mention job creation as a policy objective because the Fed would be making a promise that it lacked the power to keep. Mr. Bernanke, by contrast, has decided to make the promise and try to deliver on it — not just because he thinks that it is within the Fed’s power, but at least in part because he thinks it is important to try.

“Up until now the Fed has been very cautious in interpreting the dual mandate,” said Stephen D. Oliner, a scholar at the American Enterprise Institute who worked as a staff economist at the Federal Reserve for more than 25 years. “They have not really aggressively pursued a trade-off between inflation and unemployment. And what they’re now doing is they’re saying we’re kind of rebalancing to put greater weight on unemployment.”

The evolution of the Fed’s thinking has been visible in its public statements. It made no direct reference to the labor market in its policy statements until December 2008, according to a review by Daniel L. Thornton, an economist at the Federal Reserve Bank of St. Louis. In January, the Fed for the first time cited the unemployment rate as a primary reason for a new policy.

When the Fed started its last major round of asset purchases, officials said they were primarily concerned about the risk of deflation — the possibility that prices would actually begin to fall, with chaotic consequences.

On Thursday, Mr. Bernanke said the Fed was acting because of its “grave concern” about unemployment, including the long-term consequences for the many people and families that have now spent years without jobs.

In an important departure from past policy, the Fed also indicated that it was willing to tolerate somewhat higher inflation as the economy began to recover, although it remained determined to keep inflation around the 2 percent rate.

Some economists argue that Mr. Bernanke’s actions are consistent with the Fed’s longstanding approach, which has always struck a balance between inflation and economic growth.

“The actions are very different because of a very different situation,” said Frederic S. Mishkin, a former Fed governor and economics professor at Columbia University. “All of this I see as being completely consistent with what the Fed’s mandate has been and what the Fed has viewed that mandate to be.”

It is clear, moreover, that Mr. Bernanke continues to consider low, stable inflation as the single most important contribution that monetary policy can make to long-term prosperity. The Fed is addressing unemployment in the same spirit that people use little buckets to fight fires: water is better than nothing.

Nor has the Fed changed its longstanding view that trying to minimize unemployment tends to produce inflation — officials are confident that the economy has a lot of room to grow.

But other economists still see the focus on unemployment as an important rebalancing of the Fed’s approach to monetary policy — an attempt by Mr. Bernanke to combine the best practices of the last 30 years with a commitment to broader priorities.

The Fed’s focus on inflation began in the late 1970s with the appointment of Paul A. Volcker as chairman. The nation was plagued by galloping inflation, caused in part by the Fed’s previous focus on unemployment, and as Mr. Volcker succeeded in driving down inflation, and the nation prospered, his successors took away a simple lesson: Control inflation and jobs will follow.

Unemployment had faded from the Fed’s vocabulary by 1994, when the Fed’s vice chairman, Alan S. Blinder, told a disapproving audience at a policy conference in Jackson Hole, Wyo., that job creation deserved the central bank’s attention, too.

“There was an overweening concern about inflation compared to unemployment,” Professor Blinder, who left the board in 1996 and returned to work as an economist at Princeton University, said in a recent interview. “For many years, while the Fed had a dual mandate, it essentially never spoke about the unemployment part of it.”

He said he was glad to see that was finally changing.