Not Believing the Economy Will Collapse As QE Is Eased

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Will the higher interest rates already being felt (supposedly caused by the Fed’s more definitive yet indefinite quantitative easing tapering announcement) kill the economy? This time Nobel Laureate Professor Paul Krugman stated:

One answer might be that the Fed has quietly come to agree with critics who argue that its easy-money policies are having damaging side-effects, say by increasing the risk of bubbles. But I hope that’s not true, since whatever damage low rates may do is trivial compared with the damage higher rates, and the resulting rise in unemployment, would inflict.

Professor Krugman makes the following points asking why the Federal Reserve would be backing off accommodative monetary policy when the following economic situations exist:

  • the USA is in a low-grade depression;
  • the decline in unemployment reflects a decline in the number of people actively seeking jobs, rather than an increase in job availability;

Professor Krugman is spot on describing the economic situation.  The real question becomes whether monetary policy is currently effective in addressing these ills. My position is that QE (qunatitative easing) and ZIRP (zero interest rate policy) were useful at the beginning to repair Wall Street, but monetary policy did little to repair Main Street.

First, let is dispel any correlation (or any scientific proof) that monetary policy has anything more than a passing relationship with employment. Employment is reacting to a different dynamic than monetary policy.

Change Monthly, Fed Balance Sheet (blue line, left axis) and Private Non-Farm Employment (red line, right axis)

Monetary policy has winners and losers.  The winners so far are the financial markets, and the few homeowners and businesses who have been able to refinance with low interest rates. But the losers are consumers in general – losing by being deprived of income. Consider that someone’s interest payment is another’s interest income.

Personal Interest Income Per Capita (blue line) and Inflation Adjusted Personal Income per Capita (red line)

The red line on the above graph shows that since the beginning of the Great Recession the average American has lost over $1,000 in interest income – and much of this money was lost in the 65+ segment with their bonds and Certificates of Deposits.

Ratio Real Personal Interest Income to Real Personal Income per Capita

It does not take a Doctorate of Economics to understand that interest income is depressing disposable income. And without income, you depress consumption.

It is not accommodative monetary policy which is the driving dynamic in creating employment – but consumption. Monetary policy is the tool to repair financial markets. Time to start repairing Main Street by getting more money into their hands. Consumption does not happen UNTIL YOU SPEND MONEY (and consumption does not happen repairing balance sheets).

As pointed out in this post, Too low of interest rates can also damage an economy. The Wall Street economy might falter as quantitative easing is withdrawn.  After all, the markets are addicted to gambling with cheap money. But do not confuse the markets or Wall Street with Main Street – slightly higher interest rates may be what the doctor ordered.

Other Economic News this Week:

The Econintersect economic forecast for June 2012 again declined marginally, and remains under a zone which would indicate the economy is about to grow normally. The concern is that consumers are spending a historically high amount of their income.

The ECRI WLI growth index value has been weakly in positive territory for over four months – but in a noticeable improvement trend. The index is indicating the economy six month from today will be slightly better than it is today.

Current ECRI WLI Growth Index

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Initial unemployment claims improved from 354,000 (reported last week) to 346,000 this week. Historically, claims exceeding 400,000 per week usually occur when employment gains are less than the workforce growth, resulting in an increasing unemployment rate.

The real gauge – the 4 week moving average – improved from 348,250 (reported last week) to 345,750. Because of the noise (week-to-week movements from abnormal events AND the backward revisions to previous weeks releases), the 4-week average remains the reliable gauge.

Weekly Initial Unemployment Claims – 4 Week Average – Seasonally Adjusted – 2011 (red line), 2012 (green line), 2013 (blue line)

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Bankruptcies this Week: Mercantile Bancorp (MBI)

Data released this week which contained economically intuitive components (forward looking) were:

  • Rail movements are beginning to show a modest growth trend.
  • Personal income now has a slight positive trend line.  If it holds, this is economically positive.

All other data released this week either does not have enough historical correlation to the economy to be considered intuitive, or is simply a coincident indicator to the economy.

Weekly Economic Release Scorecard:

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