Economic stimulus has masked problems, not fixed them

There has been a good deal of talk about a robust economic recovery, which is seen as demonstrating the wisdom of the administration’s policies. See, e.g., president’s remarks to the National Governor’s Association, 2/23/15.

As Joe [Biden] said, last year was a breakthrough year for the United States. Last year, the economy created more than three million new jobs -- and that’s the best job growth in any single year since the 1990s. The same was true for manufacturing growth. In fact, manufacturing jobs grew even faster than the overall economy. The deficit cut by two-thirds. Energy production at an all-time high. All told, businesses have now created over 12 million jobs over the last five years. And the best news of all -- wages have started to go up. So America is as well-positioned as we’ve been in a very long time.

But recent economic results are less encouraging than this summation, and there is ample reason to worry about what the future holds – for both the US and other economies. Time for an update and look ahead.

A. Output – In the second and third quarters of 2014, the real growth rate of the US economy spurted to 4.6% and then 5% on an annualized basis. This was preceded by a Gross Domestic Product (GDP) decline in the 1st quarter, however, and followed by slower growth in the 4th quarter. The full year growth rate of 2.4% was only slightly better than 2012 and 2013 results. Department of Commerce (BEA), 3/27/15. (download full report with tables as PDF)

Over the past 15 years, the 2012-14 results appear subpar except in comparison to the results during the 2001-02 (mild) and 2008-09 (sharp) recessions.

Table 1#

Looking ahead, forecast GDP growth is only a bit higher, e.g., 2.8% for 2015 and 2.5% for 2016 according to the Conference Board (updated 3/12/15).

And some analysts are dialing back their GDP forecasts, due to discouraging economic data. US private payrolls, factory data point to weak first quarter growth, Lucia Mutikani, Reuters,

U.S. private employers added the smallest number of workers in more than a year in March and factory activity hit a near two-year low, fresh signs that economic growth slowed significantly in the first quarter. The economy has been slammed by a harsh winter, a strong dollar and weaker global demand. While the effects of bad weather should start to fade, dollar strength could remain a constraint and limit a rebound in output.

B. Jobs – According to the latest government jobs report, the US unemployment rate for March 2015 was 5.5% versus 6.6% a year earlier. Summary data are recapped below. The employment situation – March 2015, Department of Labor (BLS), 4/3/15, Table A.

Table 2#

These results seem modestly encouraging, although one might wonder why the working age population (16 years and older) grew four times more than the labor force. Also, many workers are feeling dissatisfied because, for all the talk about a recovery, they have not experienced an increase in their personal spending power. Except for rich, Americans’ incomes fell last year,, 4/2/15.

In fresh data that adds fire to a growing debate over income inequality, the [Department of Labor] said that Americans on average saw income decline for the second straight year in the 12 months to June 2014. The average pre-tax income fell 0.9 percent from the same period a year earlier, to $64,432. But broken down into quintiles, those in the top 20 percent of incomes saw their money stream grow by 0.9 percent to $166,048 on average. Every other group lost ground, with the bottom 20 percent losing the most: their average income dropped 3.5 percent to $9,818. Those losses came despite an economy that was picking up pace and generating well over 200,000 jobs a month last year.

No wonder proposals to raise the minimum wage, etc. have political appeal, even though they would be more likely to harm than help workers at the bottom of the economic pyramid, e.g., teenagers looking for their first jobs. Pocketbook issues in an election year,
1/13/14 (part B).

In the president’s 2/23/15 statement, it will be recalled, “the best news of all” was that “wages have started to go up.” And sure enough, there is evidence of this. See, e.g., Walmart ups pay well above minimum wage, Chris Isidore,,

The company said 500,000 full-time and part-time associates, more than a third of its work force at Walmart (WMT) U.S. stores and Sam's Clubs, will receive pay raises in April to at least $9 an hour. That will be $1.75 above the federal minimum wage. By next February 1, their pay will go to at least $10 an hour.

Good news for the workers concerned, and Walmart’s decision was presumably made for sound business reasons, i.e., it’s getting harder to recruit and retain the employees that they need. Still, higher wage rates factor into the company’s cost structure and – all other things being equal – will necessitate higher selling prices to consumers. This leads to the next subject.

C. Inflation – Overall consumer prices were essentially flat between Feb. 2014 and Feb. 2015 as a result of a big decrease in energy prices (due to halving of world oil prices) that offset price increases for other items. Department of Labor (BLS), 3/24/15, table 1.

Table 3

While consumers appreciated this result, it will probably prove temporary. Energy prices can be expected to rebound at some point, accentuating price increases for other items.

Even so, the current period of price stability has its critics. Notably, the US Federal Reserve System has established a target rate for inflation of 2% per year on grounds that lower inflation fueled by slack demand could flip over into deflation and lead to long-term economic woes. Federal Reserve launches another monetary policy experiment [QE3],

The Fed’s approach has grown increasingly sophisticated . . . since Congress decreed (Humphrey-Hawkins Act, 1978) that the central bank should promote full employment as well as price stability. It is now deemed appropriate to tolerate some degree of inflation so as to promote full employment, and there has been much sophisticated thinking about how to measure the tolerable rate of inflation – e.g., strip food and energy prices out of the “core” inflation rate because they go up and down so much.

In its efforts to stimulate the economy, the Fed has not only held short-term interest rates at practically zero for an extended period but also engaged in substantial market purchases of longer-term financial assets. The central bank’s 2012 asset purchase program (Quantitative Easing 3) has been phased out now, but no action has yet been taken to start raising short term interest rates – and it’s unclear when this will be done.

SOME OBSERVERS say the Fed must move very cautiously in raising rates, given the possibility of boosting the US dollar to unwarranted levels versus other currencies, tanking the stock market, and nipping a fragile economic recovery in the bud. Indications are that their views will be carefully considered. Fed test: raising rates without provoking [turmoil in the financial markets], Joseph Lawler, Washington Examiner,

In a speech in San Francisco on [March 27], [Federal Reserve Chair Janet] Yellen tried to further downplay the significance of the coming rate hike. "The significance of this decision should not be overemphasized," she said while laying out her view of the economy and how the Fed will conduct monetary policy in the years ahead. Instead, she explained, the more consequential factors for markets are how quickly unemployment and inflation will return to normal, and how high and quickly the Fed will raise interest rates after the first hike.

As might be expected given the interconnectedness of the global economy, concerns about quick action by the Fed are also prevalent abroad. See, e.g., the world’s next credit crunch could make 2008 look like a hiccup, Ben Wright, UK Telegraph,

• Let’s say that US interest rates do rise sooner and faster than the market expects. That means bond prices, which always move in the opposite direction to yields, will plummet. US Treasury bonds are like a mountain guide to which most other global securities are roped - if they fall, they take everything else with them. Who will get hurt? Everyone. But it’ll likely be the world’s banks, where even little mistakes can create big problems, that suffer the most pain. The European Banking Authority estimates that the average large European lender still has 27 times more assets than it does equity. This means that if the stuff on their balance sheets (including bonds and other securities priced off Treasury yields) turns out to be worth just 3.7pc less than was assumed, it will be time to order in the pizzas for late night discussions about bail-outs.

•[Regulators] have brought greater transparency to the derivatives market, demanding better reporting and that a higher proportion of contracts be routed through central counterparties or clearing houses, which sit between the two sides of a trade and sort out the mess if anyone goes bust. But, again, the risks haven’t been magicked away. Clearing houses are designed to deal with one or two counterparties going down. But what happens if more go kaput? The clearing house itself would face collapse, be judged too big to fail and, well, you already know how this story ends.

OTHER OBSERVERS worry that interest rates will be raised too slowly. If so, wage-push inflation could spike to dangerous levels – forcing the Fed to slam on the monetary brakes and triggering the recession that everyone is so anxious to avoid.

Some segments of the labor market are already tightening up. If the Fed hopes to keep short-term interest rates near zero until full employment is achieved in all areas, including providing jobs for part-time workers and those who have gotten discouraged and stopped looking for work, wage-push inflation will get started long before the goal is achieved. As for the 2% inflation target, undershooting it shouldn’t hurt anyone. The Fed needs to step up the pace of its rate increases, Martin Feldstein, Wall Street Journal,

Recent academic research, and a study at the San Francisco Federal Reserve Bank, implies that what matters for accelerating inflation is not overall unemployment but unemployment among those who have been out of work for less than six months. For this group of short-term unemployed, the inflation threshold is estimated to be between 4% and 4.5%. The latest count by the Bureau of Labor Statistics puts the unemployment rate for that group at less than 3.9%. This could mean inflation will soon begin to rise year after year without any further decline in overall unemployment.

Certain categories of workers are in high demand, giving them leverage to seek higher compensation, even though inexperienced younger workers with generalized backgrounds remain a dime a dozen. Not hard at work, but hardly working, Stephen Moore, Washington Times,

The great conundrum of the U.S. economy today is that we have record numbers of working-age Americans out of the labor force at the same time we have businesses desperately trying to find workers. *** For skilled and reliable mechanics, welders, engineers, electricians, plumbers, computer technicians and nurses, jobs are plentiful. If you’re good at a trade and a reliable worker, you can often find a job in 48 hours. Says Bob Funk, president of Express Services, which matches almost a half-million temporary workers with employers each year, “If you have a useful skill, we can find you a job. But too many are graduating from high school and college without any skills at all.”

From another angle, the Federal Reserve has issued a tidal wave of dollar-denominated debt since 2008, which must eventually be repaid. Global finance faces $9 trillion stress test as dollar soars, Ambrose Evans-Pritchard, UK Telegraph,

The most recent Fed minutes cited worries that the flood of capital coming into the US on the back of the stronger dollar is holding down long-term borrowing rates in the US and effectively loosening monetary policy. This makes Fed tightening even more urgent, in their view, implying a "higher path" for coming rate rises. Nobody should count on a Fed reprieve this time. The world must take its punishment.

David Stockman (President Ronald Reagan’s first budget director, who learned the hard way that cutting government spending is easier said than done) seems to relish relating how wrong all of the players have been. The great immoderation: How the Fed is sowing the next recession,

Ben Bernanke was stupendously wrong – brilliantly “stable” US economy stumbled to the edge of an abyss – worst economic business cycle plunge since the 1930s – US households had borrowed themselves silly – Bernanke terrorized the congressional leadership and a clueless president [Bush 43] – energetically doubled down on same monetary toxins that cased the 2008 crisis – Fed’s balance sheet soared by 4.5X over 7 years – produced the third immense financial bubble of this century – US economy has reached a condition of peak debt – top corporate executives mostly manage corporate stock prices and their own option-based incentive programs – nearly all corporate earnings are being used for dividends and stock buybacks versus reinvested – we already know what happens next.

D. Synthesis – In the aftermath of the “Great Recession,” both monetary and fiscal policy were adjusted to provide massive stimulus for the economy. The fiscal stimulus was subsequently dialed back, albeit not eliminated, due to political opposition. The monetary stimulus has continued unabated, although there is now talk about phasing it out.

Sooner or later, excessive monetary liquidity is certain to spark intolerably high inflation followed by another recession. It hasn’t happened so far because the economy has been too slack, but if Martin Feldstein et al. are right time is running out. An uptick in economic growth – however welcome in the short run – could boomerang by hastening the day of reckoning.

The only way out (if there is still time left) is to end the government stimulus programs (fiscal and monetary) that have kept the economy limping along without establishing a basis for sustainable recovery. Basically, such measures have served as an excuse for government officials to avoid making the economic reforms that were really needed. And the pattern of avoidance has been evident around the globe, not just in this country. See, e.g., Japan’s devaluations a warning for Europe; Monetary easing without reform has reduced real wages, Wall Street Journal,

The main explanation for Japan’s stagnant business investment and falling real wages is Mr. Abe’s failure to enact the “third arrow” of reform. Businesses face the same disincentives to invest as ever—overregulation, high taxes, protectionism and lack of competition. The unreformed labor market is a particular offender. Job creation is concentrated on part-time workers as companies shy away from hiring full-timers who come with onerous restrictions on firing. That explains why real wages aren’t rising despite a tight labor market. The same lack of reform typifies the eurozone.

We believe Congress should balance the budget and end the Fed’s mandate to factor full employment into its decisions. The Fed should return interest rates to more normal levels and concentrate on maintaining overall price stability. And instead of trying to prop up the economy and making a hash of it, the government should focus on reducing the burdens (taxes, mandates and regulations) imposed on the private sector. SAFE has offered numerous suggestions along these lines; it’s time to put some of them into practice. See, e.g., Is DC supporting the economy or undermining it?

Re your suggestion that this country has been following misguided economic policies, I would ask “misguided” from whose perspective? Half of Americans or more prefer a welfare state because they have grown accustomed to the benefits, including student loans that will in due course prove uncollectible. Public policies that result in winning elections are not misguided in political terms, and we are nearing the point of no return. – SAFE director

For all the talk about inequality, the vast majority of the population will keep sinking with the current economic policies – as has been happening since 2009. Conservatives have a genuine opportunity to offer a more promising future if they have the wit to see it.


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