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What Did Janet Yellen Say Now?
TND Guest Contributor: Paul-Martin Foss |
Federal Reserve Chairman Janet Yellen gave a speech last week that, coming as it did on a Friday, received rather less attention than it otherwise might have. But having examined her predecessor’s economic thinking yesterday, let’s take a look at Yellen’s speech and critique some of her thinking as well.
The unemployment rate has not yet declined to the 5.0 to 5.2 percent range that most FOMC participants now consider to be normal in the longer run. Involuntary part-time employment remains high by historical standards. Labor force participation is still somewhat lower than I would expect after accounting for demographic trends. And wage growth continues to be quite subdued. But I think we can all agree that the recovery in the labor market has been substantial.
Other than that, how was the play, Mrs. Lincoln? Compare the labor market today to what it was like before the crash, not even during the best of the boom times but just in what might be considered an average year. The unemployment rate wasn’t terribly high, labor force participation was higher, and underemployment was not a problem. We still have severe problems in the labor market, exacerbated by a whole host of factors, but accommodative monetary policy isn’t going to solve that.
The Fed keeps moving the goalposts for when they might start raising rates, first talking about 6.5 percent, now 5.0 to 5.2 percent. What happens if the unemployment rate starts to tick upward again? Jobs data is coming out this Friday, and there will be at least two more releases before the Fed might consider raising rates in June. One of the reasons the unemployment rate has been moving downward is because so many people have given up looking for jobs and just dropped out of the job market. So what happens if the labor market really is getting better, more people re-enter the job hunt, and the unemployment rate moves upward for that reason? Will the Fed hold off on its rate increases?
In assessing the actual strength of the labor market and the broader economy, we must bear in mind that these very welcome improvements have been achieved in the context of extraordinary monetary accommodation. While the overall level of real activity now appears to be much closer to its potential than it was a year or two ago, the economy in an “underlying” sense remains quite weak by historical standards, for the simple reason that the increases in hiring and output that have been achieved thus far have required exceptionally low levels of short- and longer-term interest rates, reflecting a highly accommodative stance of monetary policy. Interest rates have been, and remain, very low, and if underlying conditions had truly returned to normal, the economy should be booming.
Extraordinary monetary accommodation is an understatement. The Fed has kept interest rates at near-zero for an unprecedented six years, it has more than quintupled the size of its balance sheet, bringing it to over 25% of US GDP, it continues to increase that balance sheet by reinvesting interest and principal payments from the securities it holds, and yet it wrings its hands about the agonizing decision to maybe, just a little bit, if Wall Street doesn’t get too mad at us, raise the federal funds rate by a quarter of a percent or less. News flash: if you have to do things that you’ve never done before, create money on a scale that would make the Roman emperors looks like sound stewards of the monetary system, and your economy still is not recovering, it means that something is seriously amiss. Continuing with the same policies that have already failed is not going to fix things.
In addition, holding rates too low for too long could encourage inappropriate risk-taking by investors, potentially undermining the stability of financial markets.
Coming from Chairman Yellen this is hilarious. How many times in the past has the Fed attempted to deflect blame for previous crises by saying that it was not in fact holding interest rates too low for too long that caused the crises, and yet now Yellen is acknowledging that that in fact is a danger. But if six-plus years of zero interest rates is not “too long” in her mind, I’d hate to see what she thinks a long time is.
I have argued that a pickup in neither wage nor price inflation is indispensable for me to achieve reasonable confidence that inflation will move back to 2 percent over time. That said, I would be uncomfortable raising the federal funds rate if readings on wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.
And here we come to the crux of the problem. The Fed is wedded to the idea that prices must rise. If prices aren’t constantly rising, something has gone wrong and the Fed will intervene with accommodative monetary policy. But prices don’t always have to rise. In fact, the natural trend is for prices to fall, as increased production and technological improvements make goods cheaper to buy. But the Fed can’t admit that fact, and so it is geared towards one thing: creating inflation.
The fact that prices naturally fall, or that in the aftermath of a bubble bursting prices need to fall in order to allow malinvested resources to be put to more productive use, is anathema to the Fed. That is why the Fed constantly tries to create more money to get prices to rise. You can imagine the FOMC chanting a mantra at the beginning of each meeting: “Prices must rise 2%, prices must rise 2%, prices must rise 2%…”.
What we’re seeing in the economy right now is still the aftermath of the financial crisis. With a massive housing bubble bursting and the effects of that bursting bubble spilling over into the rest of the economy, what was needed was a correction in prices. Asset prices needed to fall, workers needed to find new jobs, malinvested resources needed to be put to better use. Liquidate the debts, allow assets to find more productive uses, and then the economy could recover.
But what the Fed did was immediately pump more money in the system in order to keep housing prices elevated and keep the malinvested capital structure just the way it was before. So prices want to fall, but the Fed keeps pumping money into the system to keep them up. All this inflation is covering up an economy that wants to see prices fall. And because of the continued leeriness on the part of investors in getting back into the housing market, the new money that is being created is flowing into other sectors, leading to new bubbles.
This is similar to what caused the Great Depression. Technological innovations and increased production in the 1920s meant that prices wanted to fall. But the Fed kept the price level propped up under the guise of “price stability” by pumping money into the banking system. The resulting bubbles that formed eventually burst and caused the Great Depression. If the Fed would just get out of the way and let prices fall, realizing that prices set by the free actions of consumers and producers allow markets to function properly, we might see a full recovery from the financial crisis. But as Chairman Yellen’s speech highlights, that is unlikely to happen. Hang on tight, because we’re headed for another crash.
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About Paul-Martin Foss:
Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, an Arlington, VA-based think tank dedicated to educating the American people on the importance of sound money and sound banking.
Prior to founding the Menger Center, Mr. Foss worked in the U.S. House of Representatives for seven years, including six years as Congressman Ron Paul’s legislative assistant for monetary policy and financial services, and one year as Deputy Legislative Director for Congressman Thomas Massie.
As Congressman Paul’s legislative assistant, he assisted the Congressman in his duties as Chairman of the Subcommittee on Domestic Monetary Policy by helping to develop hearing topics, agendas, and briefing Congressmen and their staffs on monetary policy topics. Mr. Foss also was responsible for the management of Dr. Paul’s monetary policy and financial services legislation, including the “Audit the Fed” and “End the Fed” bills, and was co-editor of Ron Paul’s Monetary Policy Anthology, a multi-thousand page compilation of hearing transcripts, lecture transcripts, and other documents related to Dr. Paul’s chairmanship.
Mr. Foss received his Bachelor’s degree from The University of the South (Sewanee), and Master’s degrees from the London School of Economics and Georgetown University’s Edmund A. Walsh School of Foreign Service.
This article appeared on the Carl Menger Center for the Study of Money and Banking and is reprinted with permission, “Creative Commons 4.0.”
Source: http://thenewsdoctors.com/what-did-janet-yellen-say-now/
