Why the Fed’s Policy on Interest Rates Is Key to Fighting Poverty

July 23, 2015

Dean Baker
PBS Newshour, July 23, 2015

View article at original source.

Despite being home to an industry of think tanks dedicated to combating poverty, Washington anti-poverty policy debates often suffer from a major dose of unreality. As poverty experts struggle with policies that might lift a portion of the poor into the middle class, policies that we know have a huge effect on poverty rates go undiscussed. Rarely mentioned in discussions of poverty is the Federal Reserve Board’s policy on interest rates, which has an enormous impact on the rate of economic growth and the level of unemployment.

As the Fed looks to raise interest rates soon, it’s worth noting that higher interest rates increase the cost of borrowing and effectively reduce car and house buying. All of this slows the economy as well as the rate of job creation. If the Fed raises interest rates, it will in effect prevent the unemployment rate from falling further and prevent low- and moderate-income households from seeing the benefits of a strong labor market.

Poverty experts typically treat Fed policy as something like the weather—it just happens, and there is not much that can be done about it. In fact, Fed policy is subject to human control and should very much be the focus of people concerned about poverty and mobility.

The facts are about as simple as it gets. High unemployment disproportionately hits the poor and disadvantaged. In the economic downturn, unemployment for college grads rose by 2.7 percentage points from 2 percent in 2007 to 4.7 percent in 2010. By comparison, for people with just a high school degree, unemployment rose by 6 percentage points from 4.4 percent to 10.4 percent. Those without high school degrees saw a rise of almost 8 percentage points from 7.2 percent to 15.1 percent.

We see the same story by race. For whites unemployment rose from 4.1 percent in 2007 to 8.7 percent in 2010. For Hispanics the rise was 5 percentage points from 5.5 percent to 10.5 percent. The unemployment rate for African Americans went from 8.6 percent before the recession to 16 percent in 2010. It was even worse for African American teens with unemployment going from 29 percent to 43.1 percent—a rise of 13.1 percentage points.

This last recession was not an oddity; when the unemployment rate goes up it always hits those at the bottom hardest. Of course the opposite is also true. In looking at the Bureau of Labor Statistics data on unemployment, it’s clear that those at the bottom benefit most when the unemployment rate falls. And according to Okun’s law, for every person who goes from being unemployed to employed, there is also a person who goes from being considered out of the labor force to being employed.

Thus, if we can knock down the unemployment rate by another percentage point, from its current 5.3 percent level to 4.3 percent level, we might be able to reduce the unemployment rate for African Americans by close to two percentage points and for African American teens by close to six percentage points. To flip this over and talk about employment, a one percentage point drop in the overall unemployment rate would translate into roughly 500,000 jobs for African Americans and 60,000 to 70,000 jobs for African American teens.

Lower unemployment won’t just have a large impact on employment for those at the bottom, it also will help to boost their wages. In my research with Jared Bernstein and John Schmitt, we found that a sustained 10 percent drop in the overall unemployment rate, for example from 5.3 percent to 4.8 percent, would be associated with a 10 percent increase in the hourly wage for a typical low wage worker. This implies that a worker earning $10 an hour would see her wage rise to $11 an hour. That translates into $2,000 a year in additional income for a full-time, full-year worker.

This is exactly the sort of story we saw in the late 1990s when the unemployment rate fell its lowest level in almost three decades, eventually bottoming out at a 4 percent year-round average in 2000. With low levels of unemployment, employers were competing for workers. Even places like McDonalds were offering hiring bonuses, and there were reports of suburban hotels and restaurants chartering buses to transport workers from the inner cities.

There are very few policies that the nation’s poverty experts can identify that will generate remotely comparable benefits for disadvantaged populations. And the great benefit of lower unemployment rates is that they don’t require a major political debate on the merits of a new anti-poverty program and how to pay for it, a long start-up period to get the program up to size or a major new government bureaucracy.

In this case, we can benefit tens of millions of low- and moderate-income people simply by preventing an agency of the government, the Fed, from acting. If we stop the Federal Reserve Board from raising interest rates too quickly and by too much, we can keep the rate of employment growth from slowing and allow the unemployment rate to continue to fall.

So we have alternative routes of dealing with poverty. We can get the Fed to allow the unemployment rate to continue to fall, or we can hire lots of poverty experts to craft clever plans. We’ll see which one wins out.

Support Cepr


If you value CEPR's work, support us by making a financial contribution.

Si valora el trabajo de CEPR, apóyenos haciendo una contribución financiera.

Donate Apóyanos

Keep up with our latest news