Rates and Race: The Fed And Black Workers

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The Federal Reserve's changes to interest rates might hit high-unemployment areas harder than others—for better or worse.

Photo by: Dan Smith

The Federal Reserve's changes to interest rates might hit high-unemployment areas harder than others—for better or worse.

In March, as the national unemployment rate remained at 9.7 percent for the third straight month, the rate for black men rose to 20.2 This month’s edition of City Limits magazine presents a comprehensive investigation of the causes, consequences and political controversy of black make joblessness. In this web extra, we look at how Federal Reserve policies affect out-of-work blacks.

For decades, in good times and bad, unemployment has consistently been higher for black males than for any other demographic group. Amid a litany of possible explanations for the disparity—cultural differences, skill deficits, outright discrimination—what gets little attention is whether the Federal Reserve’s management of the American economy contributes.

The Fed, which is run by a seven-member board appointed by the President, was created in 1913 to prevent bank runs, but after World War II, it was given the broader role of ensuring full employment and stable inflation in the economy. It was credited for keeping the 1990s boom booming as long as it did, and it’s been at the forefront of efforts to restart economic growth after the recent recession.

The main tool the Fed uses to manage the economy is the “federal funds rate”—the interest rate banks charge other banks. When the Fed raises it, banks pass their increased capital costs on to consumers via higher credit card and mortgage rates. Thus, economic activity slows because borrowing money to invest in a business or buy a home becomes more expensive.

When the federal funds rate falls, economic activity – including job growth and hiring — usually picks up because money is “cheap.” But inflation becomes a danger, as consumers with more money bid prices up and workers demand higher wages.

Critics of the Fed it has done a poor job of balancing its twin goals, high employment and low inflation.

Most mainstream critics blame the Fed for not raising interest rates soon enough to head off a housing bubble.

But others have a different beef: That the Fed’s focus on inflation helped undermine employment. As Nobel laureate and New York Times columnist Paul Krugman wrote in late 2009, “a significant number of Fed officials, especially at the regional banks, are obsessed with the fear of 1970s-style inflation, which they see lurking just around the bend even though there’s not a hint of it in the actual data.”

The Fed raised interest rates 320 percent from 2004 to 2006, even though employment was barely growing during the “jobless recovery” of the Bush years. In 2007, the Fed repeatedly acknowledged that economic growth was slowing and that the housing market was in trouble but kept interest rates high out of fear of inflation.

Of course, inflation is bad: It weakens everyone’s buying power and hits people with fixed incomes particularly hard.

But inflation doesn’t affect all groups equally. Inflation actually helps people who owe money—say on a home mortgage—by reducing the value of the amount they owe. It hurts lenders whose IOUs are worth less.

Likewise, unemployment is not equal opportunity. Black unemployment runs much higher than whites’, but blacks make up only 12 percent of the workforce. So even when black workers are suffering mightily, the national averages that drive Fed policy might look fairly rosy and prompt the Fed to raise interest rates—the last thing out-of-work blacks need.

What’s more, there is some evidence that whatever policy the Fed undertakes has a disproportionately large impact on blacks and others who live in high-unemployment areas. “The cost of capital or cost of borrowing is higher in a Camden,” says Rodgers, using the hard-luck New Jersey city as an example. “So when the federal funds rate is raised, that has a more costly effect on the margins.”

Mainstream economic thinking since the 1970s, says University of Massachusetts economics professor Robert Pollin, has been that “there was nothing the government could do to improve employment” but that if inflation were kept at bay, the labor market would take care of itself.

Pollin believes that thinking is changing. The 2008 crisis spurred the Fed to dramatically slash the federal funds rate, and to reach deeper into its tool kit to keep the financial system above water. Pollin thinks that same unorthodox approach should extend to the unemployment problem, with the Fed taking steps like buying corporate bonds to fund high-employment businesses, targeting its investments at those that will create jobs in urban areas.

The Fed could employ mechanisms other than the federal funds rate—like preventing asset bubbles by requiring more cash to be set aside when investors purchase stocks, which would allow the interest rate to address other problems—to control inflation without hurting employment, but during the chairmanship of Alan Greenspan the Fed eschewed them. “The Fed has those tools,” Pollin says. “They just won’t use them.”

As the stimulus spending works its way through the economy, rising deficits are likely to restrain the Obama administration from spending much more on job creation. With fiscal policy—extra federal spending intended to pump up the economy—tapering off, the Fed’s control of monetary policy will be the primary government tool left to spur growth and head off a double-dip recession. Says Rodgers: “On the fiscal side of things, we’re potentially using up a lot of our arrows. The Federal Reserve’s ability to keep rates low will be even more important.”

If the Fed manages to keep inflation in check and the economy growing, jobless black men will benefit. The best medicine for high black unemployment, says Florida State University economics Professor Patrick Mason, would be “a very low unemployment rate that’s maintained for a very long period of time.” That was what happened during the economic boom of the 1990s, when low-skill minority males benefitted more than other groups in terms on increased earnings and employment.

Repeating that achievement won’t be easy. According to Pollin, at the rate the economy is likely to grow this year, “it’s going to take seven years to get to 5 percent unemployment.”