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The Dialog: A change within the Federal Reserve's mandate may imply a down cost to finish racial inequality

The task of slicing the US economic pie has traditionally been entrusted to Congress. The job of the Federal Reserve is to make sure there is enough to get around. But that could change soon.

Under the proposals of the Democrats in Congress, the Fed's mandate would be adjusted for the first time since 1977, when its goals were explicitly set out: promoting maximum employment, stable prices and moderate long-term interest rates. With the new proposals, the central bank would have an additional role in reducing racial inequality.

In short, the central bank could be given the cake cutter to make sure everyone gets a fair share.

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If passed, the Federal Reserve Racial and Economic Equity Act would shift some of the responsibility for eliminating systemic racial inequality away from Congress. Given the nation's politicians have so far failed to level the playing field, this may not be a bad thing.

My work with economist Valerie Wilson shows that the economic position of black Americans corresponds to their relative position in 1979. Black men earn, on average, 31% less than white men and black women 19% less than white women.

If you factor in the incarcerated population, black Americans are no better off than they were in 1950.

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As a former Labor Department chief economist who researched racial inequality, I believe the proposed changes to the Federal Reserve's mandate would improve the economic status of black Americans, and that the Fed can do this in three important ways.

1. Combating illegal unemployment

The Fed's primary tool for managing the US economy is setting interest rates. Adjusting the benchmark interest rate changes the cost of credit for businesses and consumers, which in turn can stimulate or suppress their spending. When the unemployment rate is extremely low, as it was before the pandemic, the Fed can raise interest rates. This slows down private consumption and investment and protects against inflation.

The problem is that the Fed is currently focused on the national unemployment rate, which is reported on the news every month. That number obscures the huge disparities between different regions and populations, not to mention ignoring the growing proportion of underemployed Americans.

Currently, the Fed uses the national unemployment rate as a guide for setting its interest rates. But even in times of prosperity, the unemployment rate for black Americans is roughly twice that of whites.

As a result of the Fed's alignment with the national unemployment rate, which is roughly the same as the white rate, interest rates will rise before many black Americans can take full advantage of a deep and protracted economic boom. My research with former Fed economist Seth Carpenter shows that black unemployment rises faster when the Fed hits the brakes. Black teenage unemployment suffers most from these brake pumps.

In line with a change in the mandate to reduce racial inequality, central bankers could remove the key rate as a target and use the undeclared unemployment rate instead. This would continue to maintain strong economic growth for white Americans, but it would allow the Fed to set interest rates so that they are tailored to the economic needs of blacks as well.

2. Open credit

The Fed can also use tools given to it under the Community Reinvestment Act to reduce racial wealth disparities and give black Americans better access to credit. The 1977 law requires the Fed to use its regulatory powers to encourage financial institutions to meet the borrowing needs of the communities in which they do business, especially those in low and middle income areas.

The new proposals specifically urge the Fed to aggressively implement the law.

This is important as many black consumers continue to face discrimination when they receive loans and mortgages.

3. Report discrimination

Proposals for a new law would ensure that policymakers and the public are fully informed about the economic differences between the races. Under the terms of the proposal, the Fed would be required to report on recent racial, ethnic, gender, and educational income and wealth gaps, with the Fed chairman expecting to identify racial gaps in the labor market through regular statements from Congress. The chairman would also have to make public how the Fed intends to close these loopholes.

This is important as the proposed law could diminish the traditional role of Congress in applying fiscal measures such as taxes and spending to address inequality problems. Instead, the Fed's new responsibility for data collection and analysis would put additional pressure on lawmakers to act.

I believe this could have profound long-term effects not just on individual black families but on the economy as a whole. The availability of much more data that clearly shows the size of the racial gap would put pressure on Congress to find ways to help black Americans accumulate wealth and means to secure and affordable housing. This would likely translate into lower healthcare costs, higher housing values, and lower crime. This, in turn, could result in lower spending on social services, with savings being used for municipal businesses that increase overall productivity.

Similarly, highlighting racial disparities in employment could force Congress to come up with proposals for equitable childcare and education in black communities, as well as better transportation and reliable technology, which would increase worker productivity.

No silver bullet

Changing the role of the Fed is not a panacea. But at least the provisions of the proposed bill – to make reducing inequality part of the Fed's mission, to ensure that economic racial disparities are not ignored, and to require solid reporting of labor disparities – could provide a response The federal supply on racial differences moves the needle to improve the prosperity of black Americans.

And it is because America's reckoning with systemic racism has taken on renewed urgency and scrutiny after the assassination of George Floyd.

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Despite this new impetus, the deed faces a tough battle. It is unlikely to become law in the current political circumstances. And even if the Democrats manage to win the Senate and the presidency in November, the chances of the bill's success are uncertain.

However, as more Fed governors are appointed over time to support the proposed mandate, the elements of the law could become policy and practice. This updated mandate would represent a down payment from one of the most powerful institutions in the country to end systemic racism.

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