May 22, 2015
Dean Baker
Bankrate, May 22, 2015
View article at original source.
Chair Janet Yellen and the Federal Reserve Board made the right call in not raising interest rates last month. There is no reason to be raising rates now, nor is there likely to be any basis for rate hikes in the immediate future.
The ostensible purpose of raising interest rates is to slow the economy to head off inflation. Even before the weak first-quarter report on the gross domestic product was released, it should have been evident that there was no problem of the economy growing too rapidly and little reason for concern about a takeoff of inflation. The economy had grown at a 2.4 percent rate from the 2013 annual level to the 2014 annual level. This is only slightly higher than most estimates of potential GDP growth, which is usually in the range of 2.2 to 2.4 percent.
Furthermore, the economy is still far from making up the ground lost since the downturn. At 5.4 percent in April, the unemployment rate is not hugely above the 4.6 percent pre-recession level, but this is largely due to the fact that so many people have left the labor force.
Part of this story is demographics, with aging baby boomers retiring. But even if we just focus on prime-age workers (ages 25–54), the employment-to-population ratio—the percentage of people who are employed—is still almost 3 full percentage points below its pre-recession level. If we use the 2000 business-cycle peak as the basis of comparison, the employment-to-population ratio for prime-age workers is down by more than 4 full percentage points.
This indicates an enormous level of slack in the labor market. It is not plausible that millions of prime-age workers suddenly decided they don’t feel like working.
If there are good grounds for keeping the Fed’s foot on the accelerator, it is difficult to see the rationale for putting on the brakes.
The core personal consumption deflator increased by just 1.3 percent over the past year. This is well below the Fed’s 2 percent target. And, the recent direction of inflation has been downward, with lower energy prices feeding back into lower core inflation. The rate of wage growth has remained near 2 percent for the past five years.
As a practical matter, it would be desirable to see some uptick in the rate of wage growth, since that will be necessary if workers are simply to get their share of the gains of productivity growth. If this results in some acceleration in the rate of inflation, that also would be a positive. Higher inflation would mean simply a reduction in real interest rates. It also would help to reduce the debt burdens of millions of students and homeowners.
In short, it is exceedingly difficult to see anything positive that the Fed could hope to accomplish from a rate hike. The potential harm in the form of slower growth and fewer jobs is quite clear. The Fed was right to hold the line.
