Time for a Change: Reorienting US Monetary Policy for Maximum Productivity

As the US Federal Reserve prepares to update its statement on achieving its dual mandate of maximum employment and stable prices, I firmly believe it is necessary to reconsider this framework and focus on maximizing productivity. Since 2008, annual US productivity growth has slowed to 1.6 percent, down from 2.4 percent for the prior 18 years. This trajectory necessitates a revision of the dual mandate's goals, as a focus on reaccelerating productivity will enable the Fed to achieve its objectives without the negative unintended consequences, including worsening income inequality and higher debt levels.

Key Takeaways:

• The dual mandate's adoption in 1977 helped restore credibility to the Fed, but its negative consequences have multiplied over time, including worsening income inequality and higher debt levels.
• Annual US productivity growth has slowed to 1.6 percent since 2008, down from 2.4 percent for the prior 18 years.
• The Fed's willingness to run interest rates at low or negative levels has increased leverage in the economy, contributing to greater income inequality and exacerbated socio-economic challenges such as housing affordability.
• A shift to making increasing productivity the new goal for US monetary policy would inherently support the dual mandate as a more productive economy can generate stronger growth, improve living standards, and support low unemployment without raising inflation.
• The Fed should maintain positive real yields that incentivize savings over consumption and favor investments that boost productivity and earn a real return on capital rather than debt accumulation.
• The Fed should refrain from automatically reacting to financial market machinations unless asset price declines or liquidity issues threaten to impede investment growth or bank lending.
• The Fed should modestly reduce benchmark policy rates but still keep them in positive territory after taking into account inflation.
• The Fed should be cautious about reducing or ending its current "quantitative tightening" program too early, as this would risk the progress it has made on inflation.
• By encouraging companies to invest in capital formation, higher productivity growth should follow, particularly in interest rate-sensitive parts of the economy, such as manufacturing and small businesses.

Statistics:

• US productivity growth has slowed to 1.6 percent since 2008 (Source: Brij Khurana)
• The top 1 percent of US households hold 31 percent of total wealth, up from 24 percent in 1990 (Source: Brij Khurana)
• The Fed supported a long rise in asset prices, which contributed to greater US income inequality (Source: Brij Khurana)
• Positive real yields could incentivize savings over consumption and favor investments that boost productivity (Source: Brij Khurana)
• The US economy has been resilient in the face of recent higher interest rates, largely due to persistent fiscal deficits and AI-related spending (Source: Brij Khurana)

Sources:

• Brij Khurana, "Time for a Change: Reorienting US Monetary Policy for Maximum Productivity"
• "The dual mandate's adoption in 1977 helped restore credibility to the Fed, but its negative consequences have multiplied over time" (Source: Brij Khurana)
• "Annual US productivity growth has slowed to 1.6 percent since 2008, down from 2.4 percent for the prior 18 years" (Source: Brij Khurana)
• The Great Financial Crisis led to companies issuing debt and repurchasing shares amid negative real rates (Source: Brij Khurana)
• "The Fed should maintain positive real yields that incentivize savings over consumption and favor investments that boost productivity" (Source: Brij Khurana)
• "The Fed should be cautious about reducing or ending its current 'quantitative tightening' program too early" (Source: Brij Khurana)