“Transitory” is out, “elevated” is in. QE (Quantitative Easing) is out, QT (Quantitative Tightening) is in. Negative interest rates are out. We now know what medicine the Fed has in mind for the US economy. But we can’t be certain of the efficacy of the planned doses. Cooling a red-hot economy is no walk in the park.
Jobs, Jobs, Jobs
The great American job-creating machine rolls on. It added 467,000 jobs in January, at a time when Omicron was running at its peak. The unemployment rate, at 4.0 per cent, is down 2.4 percentage points in the past year, the number of unemployed persons by 3.7 million. Little wonder that lay-offs are at a record low as employers grapple their workers to them with hoops of steel, while quit rates are at a record high as workers survey the 11 million unfilled job openings. Predictions that robots would fill the gap have proved more science fiction than an prescient view of a development in the labor market. In short, the labor market is strong enough to tolerate a tightening of monetary policy without creating a reserve army of the unemployed.
This is not, however, unambiguously good news for the Fed, as a tight labor market creates upward pressure on wages, which in turn raise costs and add to similar pressure on prices. The reported 5.7 per cent jump in hourly wages this past year, a post-covid high, was more than wiped out by the 7 per cent jump in the prices of stuff the workers’ families loaded into their supermarket carts.
Diversity Comes To The Fed
As Fed chairman Jay Powell considers his options, he faces a board unlike any he has confronted, inflation with important differences from early bouts, an economy far different from that on which predecessor boards operated, and a society that questions the competence of its governing institutions.
Start with the board, Model 2022. It will be very different from prior boards. President Biden’s three nominees have focused on racial and gender disparities, climate change, and the regulation of bankers. The Fed, of course, read these issues into its remit well before Biden made his selections. Still, it is one thing to accept climate risk and inequality as appropriate for consideration, and quite another to deem them the central issues that should concern the board. Which makes it difficult to predict which way the newbies will jump as policy to cool inflation develops.
A New Problem For The New Fed
This new group of policy makers faces a new sort of inflation, different in a major way from those it has dealt with in the past. The spurt in prices is partly rooted in supply-side constraints, rather than the more familiar Keynes-style shortfall in demand. In addition to labor shortages, ports cannot handle the volume of goods headed to America, the construction industry cannot find enough materials to build the homes buyers are demanding, microchips are in such short supply that vehicle production is constrained. But monetary policy is not equipped to cope with such supply-side problems, at least not directly.
Then, too, the vehicle in which we are travelling, call it economy, Model 2022, is very different from the one that careened off the growth road in 2007-2009 when it hit a ravine-sized pot-hole that was the over-stretched housing market. The pandemic, China’s most lethal export, has left some of the firms that survived its consequences weakened sufficiently to make their ability to survive a Fed-induced slowdown uncertain. And consumers, with some 58 per cent telling University of Michigan pollsters they are anticipating a recession, are wary, now that various benefits have expired, and they have whittled down their bloated savings. The sound of zipping wallets is heard in shops.
A New Social Dynamic For The New Fed
Perhaps most important, Americans are uneasy after two years of coping with the pandemic. Suicides are up as is drug addiction; crime is rampant, with gangs of organized thugs looting stores, cops assassinated, miscreants not prosecuted; illegal immigrants, some with criminal records, are being awarded airplane tickets to their cities of choice; carers never know when they wake up in the morning whether their kids’ schools have been shut by the teachers’ union, or they can go to work; if the latter, they wonder if public transportation is safe.
It is not unreasonable to wonder whether such a society, its confidence in government economic policies at its lowest since 2014 according to the University of Michigan poll, will calmly tolerate an economic slow-down, especially if inflation continues to nibble at the value of workers’ pay cheques.
Data Can’t Substitute For Judgement
The Fed plans to calibrate its response to incoming data. Two problems. First, those data are subject to massive revisions, witness Friday’s revision of the November and December from a disappointing 199,000 to a buoyant 510,000. Second, the patient’s reactions to the Fed’s adjustment of the dosage of its anti-inflation medicine will not become immediately apparent. Investment decisions will be revised only after boardroom review and multiple Power Point presentations, while consumers will not immediately adjust to the higher cost of borrowing by forgoing purchase of the cars they have been dreaming of when auto companies are able to make those vehicles available. In the end, the Fed will be forced to rely on its judgements.
Unfortunately, those judgements have too often resulted in recessions. Perhaps this time around its policymakers will not emulate Napoleon who, wrote historian AJP Taylor, “learned from the mistakes of the past how to make new ones.”