The Week in Federal Reserve News: No Taper!
This is a big week for those interested in the Federal Reserve—which should be everybody. The Fed has been the only economic policymaking institution with any real power that has been actively trying to lower unemployment and push the economy back to full recovery from the Great Recession over the past two years. If you’re looking for a job, more hours, or the confidence that you can ask your boss for a raise and might actually get it (because there aren’t three well-qualified but jobless people lined up outside to take your slot), you really should be interested in the Fed and what it’s doing.
The first bit of big Fed news is Larry Summers’ withdrawing from consideration to replace Ben Bernanke as the next Chair of the Federal Reserve. This seemingly clears the way for Janet Yellen—the current Vice-Chair of the Fed—to be offered the position. If Yellen is not offered the slot, it would be a bizarre and consequential mistake. She is eminently qualified for the job, and, most importantly right now, she has the correct diagnosis for what is keeping the U.S. economy from full recovery from the Great Recession (a continuing shortage of aggregate demand) and is committed to using the Fed’s power to hasten this recovery (by continuing its program to buy assets to keep interest rates low and inflation expectations from falling).
One irony is that in this regard the differences between her and Larry Summers were relatively small (though there are plenty of other differences between them that should have led to a preference for Yellen); but the differences between Yellen and some of the other names on the Federal Reserve short-list are large indeed. If the next Fed Chair ends up to be somebody besides Yellen, this will send a strong signal that the Fed as a whole will be less committed to using the tools at its disposal to reflate the economy. And given the Fed’s power to move the economy simply through expectations, this will be a terrible signal to send indeed.
The second bit of big Fed news will be made (or not) at the end of today’s meeting of the Federal Open Market Committee (FOMC). The FOMC determines the stance of monetary policy for the economy as a whole. Since the Great Recession, monetary policy has been clearly aimed to boosting economic activity and buoying inflation expectations. Given that activity remains severely depressed and that inflation expectations have been stable (or even slightly declining) in recent months, it would seem odd indeed to decide that this monetary policy stance should be dialed back. But, many Fed critics are arguing that the Fed should indeed dial back; specifically, they argue that the Fed should reduce the rate at which it’s currently buying long-term assets (Treasury bonds and mortgage backed securities). In the business section jargon, they want the Fed to “taper” these purchases.
I recently gave testimony to the U.S. House of Representatives’ Financial Services Committees’ Subcommittee on Monetary Policy and Trade on just this issue. To sum it up quickly: tapering would be a terrible idea. There is no evidence that inflation expectations are rising, or that economic activity has improved enough to force demand-pull inflation anytime soon. Plus, the Federal Reserve is missing both targets in its dual mandate: unemployment is unambiguously too high (and this even though the unemployment rate is actually painting too-rosy a picture of how the economy is doing), and inflation is too-low even by the Fed’s dangerously conservative inflation targets. In monetary policy terms, this is the equivalent of a blinking red light demanding that monetary policy be more, not less, expansionary.
Lastly, it’s hard to not note one piece of data that sits uneasily with demands that the Fed be hyper-vigilant about even so-far hypothetical inflation. The standard story for why the Fed must slow the economy to keep inflation from rising is that rapid growth leads to tight labor markets that empower workers extract excessive raises from their employers.
But, looking at the non-financial corporate sector (a sector where the majority of the nation’s economic activity takes place, and one that has particularly good data coverage), unit labor costs (the cost of labor in each unit of output) since the Great Recession ended have declined substantially. The only reason that prices in the non-financial corporate sector have risen is because unit profits are up over 60 percent. The idea that the number one priority of the Fed is to beat down unit labor costs that are not driving up prices at all in recent years seems hugely destructive, and another reason why we need a Fed Chair who will look at real-world data to make policymaking decisions.