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.
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.”
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.
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.
