What Should Yellen’s Fed Do?

Popular Economics Weekly

The big question hovering over the markets (both stocks and bonds), is whether the Federal Reserve will finally begin to raise short term interest rates at next week’s FOMC meeting. Markets are uncertain, and only a few economists are saying anything. Why? Because of a tremendous (and artificial) fear of higher inflation, which shouldn’t be fearsome at all.

Nobelists Joseph Stiglitz and Paul Krugman say there is absolutely no reason to begin to raise the rock bottom interest rates yet. There’s still too many out of work—so much so, that wages and salaries are barely rising.

“If the Fed focuses excessively on inflation, it worsens inequality,” says Professor Stiglitz, “which, in turn, worsens overall economic performance. Wages falter during recessions; if the Fed then raises interest rates every time there is a sign of wage growth (a major effect on inflation), workers’ share will be ratcheted down, never recovering what was lost in the downturn.”

And much income has been lost, as Professor Krugman and the EPI have pointed out for years.

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Graph: EPI

“Since 1973, hourly compensation of the vast majority of American workers has not risen in line with economy-wide productivity,” say the EPI authors. “In fact, hourly compensation has almost stopped rising at all. Net productivity grew 72.2 percent between 1973 and 2014. Yet inflation-adjusted hourly compensation of the median worker rose just 8.7 percent, or 0.20 percent annually, over this same period, with essentially all of the growth occurring between 1995 and 2002.”

The question is why the Fed is even discussing the possibility of higher rates with so many still out of work. There has to be some kind of mismatch in this picture, as a record 5.8 million job openings (yellow line in graph) were just reported in Labor Department’s Job Openings and Labor Turnover Survey.

The number of hires and separations edged down to 5.0 million and 4.7 million, respectively. Within separations, the quits rate was 1.9 percent for the fourth month in a row, and the layoffs and discharges rate declined to 1.1 percent. This means that

There were 2.7 million quits in July, little changed from June. Although the number of quits has been increasing overall since the end of the recession, the number has held between 2.7 million and 2.8 million for the past 11 months. Quits are generally voluntary separations initiated by the employee. Therefore, the quits rate can serve as a measure of workers’ willingness or ability to leave jobs.

So what is Chairperson Yellen and the Fed Governors to do? Their goal is to maximize the purchasing power of consumers that power most economic growth. If consumers can’t or won’t spend more, then economic growth is stuck.

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Year-on-year wage growth is 2.2 percent, slightly higher, but inflation is falling, which means there are still too many out of work. The only way to increase wage growth is to allow a tighter labor market, which means keeping rates low as long as possible, without causing excessive inflation.

In fact, even 4 percent inflation would be preferable as a way to boost both jobs and economic growth. But will policy makers even allow such a thing? That’s the real (political) problem—the misconceptions about inflation.

Harlan Green © 2015

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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