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Much ado about no change

Opinion pieces and speeches by EPI staff and associates.


Much ado about no change

By Jared Bernstein

As predicted, those wild and crazy members of the Federal Open Market Committee (FOMC) decided to keep their feet off both the brake and the accelerator, holding interest rates steady at 5.25%, where it has been stuck since June last year. That was widely expected. The important thing is that, despite new evidence that the economy is slowing, their accompanying statement was virtually unchanged from that of their last meeting.

I think they’re falling behind the curve, and that could have serious negative consequences for economic growth.

Perhaps you have a life that doesn’t involve fascination with a bunch of high-powered economists who have gotten together every six weeks for the past year, decided not to do anything, written a few paragraphs to that effect, and gone home.

I don’t have that life. We Fed watchers troll those statements for signs that even though the tune’s the same, the words are different. That is, though they left rates alone, did the Fed suggest that their view of the economy has shifted at all?

Not at all. Today’s statement was almost a carbon copy of March’s statement.

Before we get to the significance of no change, a quick comment on context. The FOMC, under the leadership of Fed chairman “Big Ben” Bernanke, meets periodically to decide whether they should try to goose or restrain the pace of economic growth by lowering or raising the federal funds rate.

That’s the interest rate that banks charge each other for loans, and when it goes up, as it did 17 times since mid-2004, it raises the cost of borrowing throughout the economy. That, in turn, usually dials economic activity down a bit, with the ultimate target being inflation. Bernanke and company are solidly on record saying that they’ll sleep better when core inflation is growing in a range of 1-2 percent. (They like the core because it leaves out food and energy prices, which are both more volatile and less amenable to Fed rate changes).

By holding steady for the past year, the Fed has been signaling that they view the economy as not too hot, not too cold. However, Fed rate changes take some time to work through the system, so to be effective they’ve got to be forward looking.

Ergo, the importance of their statement, which tells us what they see down the pike, and hints at where rates might be heading. In March they wrote that their “predominant policy concern” was that “inflation will fail to moderate as expected.” Today, they said … are you ready? … “the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.” (For this they get the big money?)

In fact, things economic have changed for the worse since their last meeting. The two big numbers are gross domestic product, which came in at 1.3% for the first quarter of the year, and last month’s employment report, which revealed a significant slowdown in the rate of hiring. In the GDP report, slumping housing shaved a point off of the economy’s growth, as it had in the prior two quarters. On the jobs side, the private sector added 63,000 jobs, the worst showing in a couple of years.

Moreover, wage growth slowed, which is big for the Fed, since they worry that tight labor markets could lead to higher wages that get passed through to prices. With slower wage growth and fewer employment opportunities, a forward-looking Fed needs to start worry less about inflation and more about growth.

In other words, we want them to start thinking seriously about cutting rates to offset the various drags on economic growth right now. By failing to adjust their statement, they showed that they’re down-weighting these factors, and that’s leads me to worry that they’re already behind the curve.

Despite the fact that wage growth has been steady, not accelerating, Fed officials have expressed too much concern about what, in a global economy with severely diminished worker bargaining power, is the phantom menace of wage-push inflation. Also, as noted, these guys and gals are targeting inflation, not job growth, and most inflation readings have been in or only slightly above the upper level of their (awfully cramped, IMHO) comfort zone.

So, Big Ben et al: this is no time to be hawkish on price growth. Sure, the stock market is frothy, but every other important sector of the economy — housing, investment, manufacturing, jobs — is showing weakness that is sure to show up as slower inflation sooner than later. The housing slump, by shutting down the stimulus of mortgage equity withdrawals, is a particular source of concern, especially with wage growth slowing. Ask yourselves, oh great ones, if economic activity doesn’t soon accelerate, won’t consumption, that one consistently stalwart component of recent GDP reports, stumble?

So, get to work FOMC, and stop xeroxing last month’s statement. Times are changing and you need to reflect that in your June meeting so you can cut rates at your August meeting.

Jared Bernstein is a senior economist at the Economic Policy Institute in Washington, D.C.


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