Economic Challenges

It seems to me….

The Federal Reserve cannot solve all the economy’s problems on its own.” ~ Ben Bernanke[1].

The American economy is doing its best in more than a decade growing at a 3.7 percent annualized pace in the second quarter of 2015 as consumers are once again spending following a harsh phase of post-recession deleveraging.

Employers continue to increase employment adding 271,000 new jobs[2] in October 2015, a rate of about 3 million a year, dropping the unemployment rate to 5 percent which is a seven-year low. The economy typically needs only about 100,000 jobs a month to keep the unemployment rate from rising.

Wage growth is at 2.2 percent with hardly any increase in the past four years and remains well below levels reached during the previous three recoveries. Now, with unemployment so low, the Fed is confident firms will find themselves forced to boost pay to attract workers which should lead to modest inflation. This appears to be the case as wages on average have risen 9 cents to $25.20, 2.5 percent higher than 12 months ago – the largest year-over-year gain since July 2009. Unfortunately, although the unemployment rate is low and wage levels have shown some increase, labor-force participation among workers aged 25 to 54 has not yet recovered to prerecession levels indicating firms can still draw on a reservoir of available and underemployed workers which could keep wages and prices from rising as desired.

A forthcoming escalation in inflation is anything but certain. Inflation stood at 0.3 percent in July, remaining well below the Fed’s preferred target of 2 percent where it has been for more than three years. The effects of falling oil prices and a rising dollar which have depressed inflation over the past year should soon abate allowing inflation to climb back to 2 percent and perhaps higher if the Fed does not act soon. The financial risks from ultra-low rates have been reduced by tougher regulation.

The expansion is six years old, making it already the fourth longest since World War II[3]. Job gains are likely sufficiently strong for the Federal Reserve to lift short-term interest rates at its next mid-December meeting. The fear is that when the economy does soften, the Federal Reserve is lacking any flexibility and unable to do much if anything about it. The Fed has already expended its most effective tools and there isn’t any way a Republican Congress would even consider fiscal stimulus.

Emerging markets remain somewhat weak with even China experiencing a slowdown. Since total exports to China were $124 billion last year, only about 0.7 percent of the U.S.’s G.D.P., this is not really a consideration as U.S. banks are not holding a significant amount of Chinese government debt.

The economy is starting to feel an impact of the strong dollar (weaker exports) and cheaper oil (less oil and gas exploration); retail sales and surveys of businesses also have shown some indications of softness. There still is not much sign of a downturn as over the first nine months of 2015, U.S. gross domestic product rose at about a 2 percent annual rate, including a 1.5 percent third-quarter pace, which is broadly similar to the last several years. The drop in stock prices and rise in borrowing costs for riskier companies means that capital is more expensive; the dollar keeps strengthening on currency markets constraining further improvement.

The last time the Federal Reserve raised its benchmark interest rate was in June 2006 and they are moving to tighten money availability just as the global economy is weakening. The justification for an increase seems very reasonable. That is not just a concern to shaky emerging markets where rising U.S. interest rates could prove a magnet for foreign capital. The dollar, up by nearly 20 percent over the past year on a trade-weighted basis, may float even higher, squeezing American exporters and dragging down inflation. Small wonder markets indicate they expect inflation to remain below 2 percent for the next few years.

Raising rates too soon could be costly as a slowdown in growth could turn low inflation into deflation. The Fed then would have little option but to restart quantitative easing to stimulate the economy.

But if the Fed waits too long to tighten, then inflation will rise above 2 percent. Were that to happen, the Fed has unlimited capacity to raise rates and could do so safely knowing it had pushed the U.S. economy to its speed limit. If rates then had to rise steeply, the central bank would at least have more room to respond to future troubles by cutting again.

For months Fed statements have declared that inflation will soon return to 2 percent. There is little harm in waiting to be sure.

That’s what I think, what about you?

[1] Ben Shalom Bernanke is an American economist at the Brookings Institution who served two terms as chairman of the Federal Reserve, the central bank of the United States.

[2] U.S. Hiring On Fire In October, Jobless Rate Falls To 5 Percent, The Associated Press, http://www.mprnews.org/story/2015/11/06/jobs-report, 6 November 2015.

[3] Irwin, Neil. Is the Economy Really in Trouble? A Debate, The New York Times, http://www.nytimes.com/2015/11/01/upshot/is-the-economy-really-in-trouble.html?ribbon-ad-idx=5&rref=upshot&module=Ribbon&version=context&region=Header&action=click&contentCollection=The%20Upshot&pgtype=article, 30 October 2015.

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About lewbornmann

Lewis J. Bornmann has his doctorate in Computer Science. He became a volunteer for the American Red Cross following his retirement from teaching Computer Science, Mathematics, and Information Systems, at Mesa State College in Grand Junction, CO. He previously was on the staff at the University of Wisconsin-Madison campus, Stanford University, and several other universities. Dr. Bornmann has provided emergency assistance in areas devastated by hurricanes, floods, and wildfires. He has responded to emergencies on local Disaster Action Teams (DAT), assisted with Services to Armed Forces (SAF), and taught Disaster Services classes and Health & Safety classes. He and his wife, Barb, are certified operators of the American Red Cross Emergency Communications Response Vehicle (ECRV), a self-contained unit capable of providing satellite-based communications and technology-related assistance at disaster sites. He served on the governing board of a large international professional organization (ACM), was chair of a committee overseeing several hundred worldwide volunteer chapters, helped organize large international conferences, served on numerous technical committees, and presented technical papers at numerous symposiums and conferences. He has numerous Who’s Who citations for his technical and professional contributions and many years of management experience with major corporations including General Electric, Boeing, and as an independent contractor. He was a principal contributor on numerous large technology-related development projects, including having written the Systems Concepts for NASA’s largest supercomputing system at the Ames Research Center in Silicon Valley. With over 40 years of experience in scientific and commercial computer systems management and development, he worked on a wide variety of computer-related systems from small single embedded microprocessor based applications to some of the largest distributed heterogeneous supercomputing systems ever planned.
This entry was posted in China, Economy, Employment, Employment, Federal Reserve, Federal Reserve Board, Financial, Inflation, Jobs, Jobs, Stimulus, Stimulus, Wages and tagged , , , , , , , , . Bookmark the permalink.

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