The Federal Reserve May Not Be Expert Enough To Manage The Economy

May 24th, 2015
in Op Ed

Written by

Yesterday, Fed Chair Janet Yellen admitted:

Of course, the outlook for the economy, as always, is highly uncertain. I am describing the outlook that I see as most likely, but based on many years of making economic projections, I can assure you that any specific projection I write down will turn out to be wrong, perhaps markedly so. For many reasons, output and job growth over the next few years could prove to be stronger, and inflation higher, than I expect; correspondingly, employment could grow more slowly, and inflation could remain undesirably low.

Follow up:

This means that monetary policy is reactionary and not proactive even though the Fed takes steps to guide the economy. So it is important to understand what is her understanding of the state of the economy.

Chair Yellen's view of the labor situation is better than mine.

The unemployment rate has come down close to levels that many economists believe is sustainable in the long run without generating inflation. But the unemployment rate today probably does not fully capture the extent of slack in the labor market. To be classified as unemployed, people must report that they are actively seeking work, and many people without jobs say they are not doing so--that is, they are classified as being out of the labor force. Most people out of the labor force are there voluntarily, including retirees, teenagers, young adults in school, and people staying home to care for children. But I also believe that a significant number are not seeking work because they still perceive a lack of good job opportunities.

In addition to those too discouraged to seek work, an unusually large number of people report that they are working part time because they cannot find full-time jobs, and I suspect that much of this also represents labor market slack that could be absorbed in a stronger economy. Finally, the generally disappointing pace of wage growth also suggests that the labor market has not fully healed. Higher wages raise costs for employers, of course, but they also boost the spending and confidence of customers and would signal a strengthening of the recovery that will ultimately be good for business. In the aggregate, the main measures of hourly compensation rose at a rate of only around 2 percent through most of the recovery.

The lack of growth of median incomes are the evidence that we are not close to full labor utilization. I do not agree that most people out of the workforce were voluntary - they chose this route only because it was the best option in a crappy jobs market with low wages. This is a major divergence of opinion as it magnifies labor slack.

Chair Yellen thinks inflation is under control.

This improvement in the labor market has brought the economy closer to one of the two goals of monetary policy assigned to the Fed by the Congress--maximum employment. Less progress has been made toward the other goal, price stability. Consumer price inflation remains below the Fed's stated objective of 2 percent. The notion that inflation can be too low may sound odd, but over time low inflation means that wages as well as prices will rise by less, and very low inflation can impair the functioning of the economy--for example, by making it more difficult for households and firms to pay off their debts. Overall consumer price inflation has been especially low--close to zero--over the past year, as the big fall in oil prices since last summer lowered prices for gasoline, heating oil, and other energy products. But inflation excluding food and energy, which is often a better indicator of where overall inflation will be in the future, has also been low, below the Fed's 2 percent objective both now and for almost all of the economic recovery. Inflation has been held down by the continued economic weakness during the slow recovery and, more recently, by lower prices of imported goods as well as the fall in oil prices. With oil prices no longer declining, and with the public's expectations of future inflation apparently stable, my colleagues on the Federal Open Market Committee (FOMC) and I believe that consumer price inflation will move up to 2 percent as the economy strengthens further and as other temporary factors weighing on inflation recede.

Wow. The Fed embedded very low interest rates into the economy and does not appear to understand their effect on inflation. It is oil prices, cheaper imports and consumers low inflation views which caused low inflation according the Fed's view - and they are not seeing the causes behind oil prices, cheaper imports and consumers low inflation views.

According to Chair Yellen, there are three reasons for slow economic growth:

  1. ... the fact that the housing crash left many households with less wealth and higher debt, weighing on consumer spending...
  2. ... has come from changes in fiscal policy to reduce budget deficits...
  3. ... the restraining influences on the United States from the global economy.

Nowhere on this list do I see understanding of the long term effects of the economic drugs of quantitative easing or low interest rates. In life, there is no such thing as a purely positive action. Drugs have positive and negative affects - and there is no evidence that economic drugs are any different then pharmaceutical drugs. where is understanding of contraindications (monetary and fiscal policies which should not be used together), or adverse drug reaction from short or long term administration,

Being smart is not necessarily an advantage when it blinds one to assembling facts - or believing a fact is transitory - or misdiagnosing cause and effect. You cannot solve a problem unless you understand the cause. Believing an effect is a cause will always make your remedies fail.

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