A few quick Fed points…

February 19th, 2015 at 8:09 am

1) The sharply stronger dollar, as Martin Wolf points out, pushes against Fed tightening: it reduces inflation, weakens demand for our exports, and by most analysts accounts, will lower real GDP growth by something on the order of 0.5% over the next year, given its recent appreciation.

2) In their just released minutes, the Fed board clearly identified with the asymmetric risk that many of us Fed watchers have been emphasizing: “Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.”

3) Some recent reports suggest a tension among FOMC members as to whether they should be data driven or just basically assume that inflationary pressures lurk around the next corner, despite what the data say. The minutes from January revealed that “a number of participants emphasized they would need to see either an increase in market-­based measures of inflation, compensation or evidence that continued low readings on these measures did not constitute grounds for concern” (i.e., disinflation).

4) Remember, nobody knows what the “natural rate of unemployment” is, which is kind of a big deal in this space. The fact that our unemployment rate, now around the mid-fives, is close to the level that many US economists, including those at CBO and the Fed, consider to be the “natural rate” and yet neither nominal wages nor prices have accelerated only serves to underscore this point.

Given economists’ traditional understanding of such dynamics, this means that either the natural rate of unemployment is considerably lower than we think it is or the jobless rate is mis-measuring labor market slack.

I believe all three are true. That is, the natural rate is lower than we think (and very difficult to reliably estimate). Allen Sinai says it’s now 4.3%.

Two, there’s still more slack in the US job market than the measured unemployment rate reveals. I’ve got a new post on that in the making.

And three, our “traditional understanding of such dynamics” is incomplete. Specifically, we’ve historically paid too little attention to a key wage determinant: bargaining power.

So, there you have four factors pointing towards holding rates steady at zero for the near term. Which factors point the other way? There’s the tightening job market, for sure, but see #4 above. Given our uncertainty re key parameters, surely the best move is to stick with the data and keep your anti-inflation powder dry. Which sounds a lot like where at least some members of the FOMC are in fact at…at least for now.

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7 comments in reply to "A few quick Fed points…"

  1. D. C. Sessions says:

    I do wonder how much the “wages” that we report are distorted by inequality as well. If all “wage compensation” is going to the upper reaches of the salary scale, it’s not going to drive inflation nearly as much as the broadly-distributed wages in prior years and that goes into the usual models of inflation.

    • Smith says:

      The wages measured are often/usually/always non-supervisory wages, so inequality doesn’t play the role it does in elevating or inflating GDP beyond real world (meaning what most people, 99%) experiences.

  2. Matthew says:

    The issue isn’t that the natural rate is “lower than we think.” The headline unemployment rate doesn’t measure the same thing heading into recession compared to coming out of one–heading into recession, labor force participation is high and falling, while during the recovery phase it is low and rising. What we will see over the next year or two is an unemployment rate hovering in in the mid-fives as the labor force expands. Comparing today’s headline unemployment rate to the peaks of previous business cycles is downright insane.

    • John says:


      The thrust of your post is close to my own thinking on the natural rate of unemployment. I think the natural rate is a function of headline unemployment and the civilian labor force participation rate — especially the participation rate for civilians in their prime working years (age range of 25-54 years).

  3. urban legend says:

    The stagnation of the minimum wage most of the last 20-30 years is a powerful indicator of labor’s loss of bargaining power: it can’t even put enough pressure on Congress and the President to make sure it keeps up with the modest inflation we have seen.

  4. urban legend says:

    The U-6 in 2000 reached 6.9%. At 11.2% now, we aren’t even close.

    Remember, the U-6 is based on what people actually say they want. The U-3 is derived by applying an arbitrary cut-off to who qualifies as wanting a job regardless of what they say. It may be a useful measure for many purposes because it is data that can be compared over time, but as the wage data demonstrates, it has lost its power as a measure of labor “slack.”

    There are many reasons why people who really do want work would not go through the officially required active search activity in the prior 5 weeks. Not only does the wage data reinforce the value of the U-6 as the better measure of real unemployment, but the explosive growth of the employment-to-population ratio in the late 1990s into 2000, coming out of the recession of the early 1990s and without the impetus of baby boomers or women entering working age in disproportionate numbers, is evidence that the U-6 is a pretty accurate indicator of who will come out of the woodwork and take jobs when they are plentiful.