Economic Monitor – Weekly Commentary
by Scott J. Brown, Ph.D.

Mind Your Language!
September 15 – September 19

The Federal Open Market Committee is widely expected to take another trip to Taper Town on Wednesday, reducing the monthly pace of asset purchases by another $10 billion, one step closer to ending the program in late October. The more interesting issue is whether we’ll see any change in the Fed’s forward guidance on short-term interest rates – specifically, whether the FOMC will jettison the “considerable time” language. Probably not, but there will be plenty of other points of interest contained in Fed officials’ revised economic projections and in Janet Yellen’s post-meeting press conference.

Two years ago, the FOMC began its current Large-Scale Asset Purchase program (LSAP, but more commonly referred to as “QE3”). As it did, the FOMC said it expected that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” In its forward guidance on short-term interest rates, the FOMC indicated that “exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.” That time frame was pushed out from the previous policy statement (“at least through late 2014”). At the December 2012 meeting, the FOMC shifted to economic thresholds for its forward guidance; short-term rates would remain exceptionally low as long as the unemployment rate was above 6.5%, the one-year-ahead inflation outlook was less than 2.5%, and inflation expectations remained “well anchored.” As the unemployment rate drifted toward 6.5%, the Fed had to rethink this guidance. At the March 19 policy meeting this year, the FOMC indicated that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” That language was carried forward in the policy statements in April, June, and July. Some Fed observers think it’s time for a change.

The “considerable time” phrase echoes similar language used ahead of the previous tightening cycle in 2003, when the FOMC indicated that it expected to keep short-term rates low (the federal funds target was 1% at the time) for “a considerable period.” That phrase was included in four policy statements in late 2003, but did not appear in the January 2004 statement. The Fed began raising the federal funds rate target in June (at which point, policymakers indicated that rate hikes were expected to come “at a measured pace”).

At this week’s policy meeting, Fed officials will update their projections of growth, unemployment, and inflation. These forecasts also include expectations of the federal funds target rate at the end of the next few years. This week, the Fed’s Summary of Economic Projections (SEP) will extend these forecasts to 2017. In her March 19 press conference, Chair Yellen cautioned against reading too much into the dots (“I would simply warn you that these dots are going to move up and down over time a little bit this way or that”). That’s true, but there is important information in those projections.


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In June, as in previous projections, the federal funds rate forecasts of the Fed governors and district bank presidents were all over the map. All but one Fed official expected that the federal funds rate target would not be raised this year. All but three expected rates to begin rising sometime in 2015. However, there was a wide range for where the target was expected to be at the end of 2015 and 2016. If one assumes that rate hikes will be made in “measured steps” of 25 basis points, the individual year-end forecasts for 2015 would imply an equally wide range for the expected date of the first rate hike (three for July, three for September, one each for March, April, June, October, and December, with three for 2016). One thing to watch for in the September SEP: will the individual federal funds rate forecasts bunch up a little more around specific year-end targets (and implicitly, dates for the first rate hike)?

Some Fed officials have suggested that it’s time to jettison the “considerable time” language and tie the rise in rates back to the economic data. Fat chance. Inflation hawks gotta squawk, but the inflationistas are a small minority at the Fed. Still, it’s not unusual for the majority to tweak the language of the policy statement slightly to put the hawks a little more at ease.

Fed officials know that short-term interest rates will have to be raised at some point, but they don’t want financial market participants to misinterpret their intentions. The bottom line remains: monetary policy in 2015 will depend on the evolution of the economy in the second half of 2014.


As The World Turns ...
September 8 – September 12

U.S. economic data were mixed last week, but there was nothing in the August Employment Report to suggest that growth is slowing down. A surprise move from the European Central Bank pushed the euro lower, but there appears to be a lot more that the ECB can do. Attention will soon turn to the Fed’s September 16-17 policy meeting, where another $10 billion taper in the monthly pace of asset purchases is factored in. The Scottish Independence Referendum (September 18) has generated more suspense than was anticipated.

Nonfarm payrolls rose less than expected in the initial estimate for August, restrained partly by two factors. Seasonal auto plant shutdowns were much more moderate this year – fewer auto layoffs in July, less of a rebound in August (which shows up as a seasonally adjusted gain in July and a seasonally adjusted decline in August). Labor strife at a New England grocery store chain contributed to a 17,000 drop in employment at food & beverage stores. Together, these factors may have reduced August payrolls by about 25,000, explaining some (but not all) of the shortfall in the headline payroll figure.


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The unemployment rate edged down to 6.1%, but the decline was concentrated among teenagers (19.6%, vs. July’s 20.2%) and young adults (10.6%, vs. July’s 11.3%). The unemployment rate edged higher for the prime-aged cohort (5.3%, vs. 5.2%) and older workers (4.6%, vs. 4.5%). One month does not make a trend and there’s a fair amount of statistical noise in these data. The employment/population ratio for the prime-aged cohort has been trending higher, but the level suggests that there is still considerable slack in the labor market.

Average hourly earnings rose 2.1% y/y, but this is barely keeping pace with inflation. Lackluster wage growth is a restraining factor for consumer spending growth, preventing the recovery from building a larger head of steam.


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While the U.S. economy is improving, the euro area’s economy is looking feeble. Real GDP rose 0.7% in four quarters ending 2Q14 and momentum has faded. Inflation in the euro area was 0.3% over the 12 months ending in July. Deflation, a decline in the general price level, is to be feared, but not to the same degree it was a decade or more ago. Japan’s experience suggests that deflation need not be a death spiral (where frozen consumer spending and business investment lead to even weaker growth and even lower prices). Still, very low inflation can create significant problems for an economy.

Fiscal policy in the euro area, as with the U.S. last year, is going in the wrong direction. Reducing the size of the government may indeed be a worthwhile goal in a healthy economy, but in a gradual recovery, it is simply bad news (“contractionary” policies are contractionary!). None of that appears likely to change anytime soon. French President François Hollande recently sacked his finance minister after he opposed austerity.

That leaves the European Central Bank as the only game in town, but there are limits to what a central bank can achieve when faced with the zero lower bound on interest rates. The ECB’s asset-purchase program may help, but it’s unlikely to be enough. Draghi indicated that asset-backed securities would be accepted as collateral, not purchased outright (hence, technically not “quantitative easing”). However, in his press conference, Draghi indicated that the ECB’s Governing Council did discuss QE and officials were split in both directions (some wanting to do more, some wanting to do less).

Scotland will vote on independence on September 18. The “no” vote is expected to win, but polls currently suggest that it’s a lot closer than was anticipated a month or two ago. Scottish independence would generate some economic dislocations in the short term. Hence, financial market participants should pay attention – that is, once they’re done listening to Yellen.


Aging, Automation, and Other Labor Market Issues
September 1 – September 5

One of the key characteristics of the current economic expansion has been the decline in labor force participation. Some of that has been attributed to the aging of the population – baby-boomers stepping into retirement – but is that what’s really going on? The polarization of the labor market is a growing issue. Technological advances have divided the workforce into high-skill, high-wage positions and low-skill, low-wage positions. However, this polarization may simply be due to the severity of the economic downturn. And the unemployment rate? Well, it’s really not all that accurate.

Labor force participation is down by more than 3 percentage points since the recession began. That’s equivalent to about six or seven million missing workers. Some of that decline has been attributed to an aging workforce. The Federal Reserve has suggested that the aging of the population accounts for about a third of the decrease in participation. White House economists put it at about half. However, the Household Survey data show that participation for those aged 55 and over is actually a bit higher than before the recession and has been trending roughly flat. The decrease in participation has been more pronounced among younger workers, although prime-aged workers (25-54 years) have also experience a decline in participation.


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Older workers have been more likely to continue working. One theory suggests that many were looking to their homes as their main retirement vehicle. With the housing collapse, these potential retirees have presumably had to work a little longer (perhaps a lot longer) to fund their retirements.

The recession and gradual recovery has been especially hard on teenagers and young adults. These individuals are not getting the job experience that they would normally get in a strong economy, and their wages are likely to be generally lower for decades. This isn’t a problem unique to the U.S. It is a worldwide issue.

Technological advances have long played a key role in economic growth, but improvements have often met a mixed reception. For example, the Luddites, an early 19th century group of textile artisans, were known for smashing labor-saving textile machinery (the term “Luddite” now refers mockingly to individuals who shun new technologies). The rise of computer technology has generated concerns over the last several decades that many occupations would be made obsolete. However, as David Autor, an MIT economist and author of one of the more interesting papers presented at the KC-Fed’s recent Jackson Hole conference, notes, “journalists and commentators overstate the extent of machine substitution for human labor and ignore the strong complementarities.” Short-term job losses due to rising productivity have eventually been more than offset by subsequent employment gains.

The polarization of the labor force over the last couple of decades has been clear, but while technology has played a part, there have been other important factors, principally globalization and the economic downturns that followed the tech bubble and housing collapse. As the economy continues to recover and labor market slack is taken up, polarization should be less of an issue. Still, education is sure to remain the most important factor in labor market outcomes.

The more mind-bending aspects of Autor’s paper have to do with the more recent advances in technology. Throughout their development, computers have excelled at doing logical, ordered tasks. They haven’t done so well in using judgment. Autor quotes the philosopher Michael Polanyi: “we know more than we can tell.” Tacit understanding often exceeds explicit understanding, according to Autor. A doctor may study physiology and anatomy, but it is his experience that allows him to practice medicine. A driver’s manual may tell one how to drive a car, but the actual task is much more complex than following a simple set of rules. For computers this is beginning to change. Advances in artificial intelligence allow computers to learn more like a human would (and much faster). Combine that with the rapid progress in robotics, and the future looks to be a fascinating place (or at least until Skynet becomes self-aware). Jobs will be lost in this transition (cab drivers, for example), but other jobs will come along, typically things we can’t even imagine right now. In 1900, 41% of U.S. workers were employed in agriculture. By 2000, this share was 2%.

Finally, it’s common knowledge that the decline in labor force participation has biased the unemployment rate lower. However, there’s also some evidence that respondents have been more reluctant to respond correctly to government queries. Hence, the unemployment rate is even less valid. That’s why we focus on a wide range of labor market indicators.


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