December 22, 2014
Dean Baker
The Hankyoreh, December 22, 2014
View article at original source.
The strong November jobs report (the economy added 321,000 jobs in the month) has given new momentum to the drive to have the Federal Reserve Board raise interest rates. Many commentators seem to be celebrating the prospect of the Fed raising interest rates, writing as though higher interest rates from the Fed is a goal of economic policy. This is a seriously confused picture.
Any serious discussion of the Fed’s interest rate policy has to start by recognizing that interest rates are a tool. Low interest rates can help to spur growth and create jobs in a period of economic weakness. High interest rates slow growth and can help stave off inflation if too much demand is creating inflationary pressures.
The federal funds rate set by the Fed has been essentially zero since November of 2008, well below the 5.5 percent average of the prior quarter century. This low rate has been a response to the economy’s weakness. We lost almost 9 million jobs in the downturn and the economy is still almost 7 million jobs below its pre-recession trend level of employment. Federal Reserve Board Chair Janet Yellen has repeatedly noted the continuing weakness in the labor market as a reason to put off an increase in interest rates.
At the same time, there is no evidence whatsoever of accelerating inflation, which would be the ostensible reason for raising interest rates. Over the last year, the overall consumer price (CPI) index has risen by just 1.7 percent, below the Fed’s 2.0 percent target. In recent months, the CPI has actually fallen, as lower oil and gas prices pushed the overall index downward.
The core CPI, which excludes food and energy, has risen by just 1.8 percent over the last year. That’s virtually identical to the 1.7 percent rise from last year and down slightly from the 2.0 percent and 2.1 percent rates from the prior two years. Clearly there is no story of accelerating inflation in these data. Other price indices show similar patterns. Inflation remains low and stable with no evidence of an inflationary spiral anywhere.
In this context, it is difficult to see why the Fed would be looking to raise interest rates. There is no inflation to contain, so why would it implement a policy whose purpose is to contain inflation?
This is an issue with real consequences for tens of millions of people. Higher interest rates will slow the economy and keep people from getting jobs. The first rate hike may not have much impact, but there is little doubt that if the Fed keeps raising rates it will succeed in slowing the economy and reducing job creation.
This is a huge deal not only for the people who are denied employment, but also for the much larger segment of the labor force who will have their bargaining power undermined by the continuing weakness of the labor market. The only period since the early 1970s when most workers were able to achieve consistent real wage gains was during the low unemployment years of the late 1990s. During this period the unemployment rate fell below 5.0 percent and bottomed out at a year-round average of 4.0 percent in 2000.
While the 5.8 percent current unemployment rate is not high in comparison with the rates seen over much of the last four decades, it is held down by the fact that more than 5 million workers have dropped out of the labor force since the start of the recession. Many of these workers would return to the labor market if they thought that good jobs were available. Save
The stronger job growth that we have seen in recent months is certainly encouraging, but it will take several years of job growth at this pace to strengthen the labor market to the point where most workers are able to achieve wage gains. Premature rate hikes from the Fed will derail this process.
It is certainly regrettable that the economy is so weak that it has been necessary to keep the interest rate at zero for six years and that it will likely to be necessary to keep rates near zero for a considerable time into the future. But raising the rates to more normal levels doesn’t return the economy to a more normal level of output.
The Fed’s interest rate policy has to be based on an assessment of the relative risks of inflation and a weak labor market. It is clear that we continue to suffer from a weak labor market. It is also clear that we face no imminent threat of any acceleration of inflation. That raises the obvious question. Why does anyone think that the Fed should be raising interest rates?
