151,000 jobs created last month

Jobs numbers out today. Employment increased by 151,000 in August, and the unemployment rate is still at 4.9% according to the Bureau of Labor Statistics (BLS) report. This suggests that the slow recovery continues, and that to hike the rate of interest as it seems Janet Yellen suggested last week at Jackson Hole would be a mistake. By the way, Bill Gross, which sometimes sounds reasonable on spending and the effects of fiscal policy (or did in the past) suggested as an innovative solution the need for hiking rates twice before the end of the year. That signals, I think, what the market want, namely higher remuneration. But it would be a terrible idea. Even if the conventional story, best explained by John Williams from the San Francisco Fed, is deeply flawed. That is, the notion that the natural rate of interest (yeah, that concept) is now very low.

Yellen and Taylor on the Taylor Rule

 In her last speech, Janet Yellen argued that:

"For example, the Taylor rule is Rt = RR* + πt + 0.5(πt -2) + 0.5Yt, where R denotes the federal funds rate, RR* is the estimated value of the equilibrium real rate, π is the current inflation rate (usually measured using a core consumer price index), and Y is the output gap. The latter can be approximated using Okun’s law, Yt = -2 (Ut – U*), where U is the unemployment rate and U* is the natural rate of unemployment. If RR* is assumed to equal 2 percent (roughly the average historical value of the real federal funds rate) and U* is assumed to equal 5-1/2 percent, then the Taylor rule would call for the nominal funds rate to be set a bit below 3 percent currently, given that core PCE inflation is now running close to 1-1/4 percent and the unemployment rate is 5.5 percent. But if RR* is instead assumed to equal 0 percent currently (as some statistical models suggest) and U* is assumed to equal 5 percent (an estimate in line with many FOMC participants’ SEP projections), then the rule’s current prescription is less than 1/2 percent."

The point is clear, given the uncertainty about what the natural rate of unemployment and the equilibrium or natural rate of interest actually are, then there is some space for keeping the Fed Funds rate close to zero, where it is.

John B. Taylor cited the passage above to criticize Yellen's view. He said:

"So the main argument is that if one replaces the equilibrium federal funds rate of 2% in the Taylor rule with 0%, then the recommended setting for the funds rate declines by two percentage points. The additional slack due to a lower natural rate of unemployment is much less important. But little or no rationale is given for slashing the equilibrium interest rate from 2% percent to 0%. She simply says 'some statistical models suggest' it. In my view, there is little evidence supporting it, but this is a huge controversial issue, deserving a lot of explanation and research which I hope the Fed is doing or planning to do."

Taylor is okay with not having a clue about the natural rate of unemployment (tells you something about a theory that depends on a variable they never know where it is), but seems to think that the natural rate of interest is really 2%. I haven't seen the empirical analysis that shows that the natural rate of interest is 2%.

Frankly, if the methodology is the same as used for the natural rate of unemployment, meaning some average of the actual rates, I'd be somewhat underwhelmed. And I'm not even going to discuss the logical problems of the natural rate of unemployment (yes, there is no such thing). But if Taylor were right, we should have inflation around the corner. He has been complaining about the Fed policy for a while, and inflation hawks have suggested that hyperinflation would follow Fed expansionary policy for six years now. The question is when would Taylor and the inflation hawks be satisfied that inflation is not accelerating? The answer is probably never. The new Taylor rule should be hike the rate of interest in every circumstance then.

Robin Hahnel on the Fed & the pressure to raise interest rates

From The Real News Network

Translating from Fed speak, Janet Yellen is doing everything within her power to slow down the pressure that she's under to start raising interest rates here in the United States. We actually have a news network that today sort of asked the question, is Janet Yellen too socialist? And I think that's actually a good way for people to sort of understand what's going on. As much as any chairperson of the Federal Reserve Bank of the United States can be, she is actually trying the best she can to act in the interests of the general public, which is quite unusual. And so she is trying to delay as long as possible raising interest rates in the United States, mostly because she doesn't want to derail the sort of slow and tepid recovery that's going on and she understands that raising interest rates prematurely and too rapidly would have the significant danger that it would slow our recovery. And she's pointing out that there is no sign that there is inflation on the horizon, that the only reason the Fed should have to be raising interest rates really is if there is inflationary pressure and if there is a danger of inflation. And the people trying to convince the Fed to raise interest rates keeps claiming that we need to do this to prevent inflation, but they have no evidence on that side.

Originally posted here, with full transcript. Video below.

Janet Yellen and the weak labor market

Janet Yellen, basically in the same vein of what I suggested here, used the broader unemployment measure, called the U-6 by the Labor Department, which was 11% in February to argue that the labor market is not that well in the US.

Note that U-6 is total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force. And the number is very similar to my calculation of what unemployment would be if the participation rate had remained constant. One more reason not to hike the rate of interest any time soon.

Gerald Epstein on the Fed Signaling a Possible Policy Shift

Jerry Epstein was interviewed by the Real News Network. Among other things he said that:

"Typically in the past the Federal Reserve has been inviting a lot of investment bankers and financial market economists to the Jackson Hole Conference. This year's a little different. Janet Yellen and the Fed people didn't invite so many investment bankers. Instead, they invited a bunch of labor economists, which was a big change. Nevertheless, despite signals of an apparent shift in attention towards bringing unemployment down, Fed policy still remains toothless in helping out working Americans."

Full transcripts here.

Why interest rates will (likely) stay low

Or they need to stay low. That's what the editorial board of the NYTimes says, quite correctly in my view, after the Jackson Hole speech by Janet Yellen last Friday. Yellen is more cautious and it is not exactly clear what will happen next. She said:

Earlier this year, ... with the unemployment rate declining faster than had been anticipated and nearing the 6-1/2 percent threshold, the FOMC recast its forward guidance, stating that "in determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee would assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation." As the recovery progresses, assessments of the degree of remaining slack in the labor market need to become more nuanced because of considerable uncertainty about the level of employment consistent with the Federal Reserve's dual mandate.

I'm not going to try numerology or any other dark science to foresee the future decisions of the FOMC, but it is clear that pressures for tightening are increasing.

I think overall the speech suggests slightly more weight to the dovish view, and that interest rates, at least for now, will remain low. She said:

... the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions... [and]... wage inflation, as measured by several different indexes, has averaged about 2 percent, and there has been little evidence of any broad-based acceleration in either wages or compensation. Indeed, in real terms, wages have been about flat, growing less than labor productivity. This pattern of subdued real wage gains suggests that nominal compensation could rise more quickly without exerting any meaningful upward pressure on inflation.

Yes, then she cautioned that "the current very moderate wage growth could be a misleading signal of the degree of remaining slack." But that's basically to say that they will act if inflation signals appear. The interesting thing is that although the whole discussion of the risks of inflation is associated to the slack (or lack of) in the labor market, and other measures of the current level of activity vis-à-vis the optimal level (unemployment or output or GDP gap), she admits quite candidly that: "historically, slack has accounted for only a small portion of the fluctuations in inflation." It is a remarkable admission of the absence of evidence for the dominant model that orients monetary policy. The natural rate is dead, long live the natural rate!

Baker & Bernstein on The Incipient Inflation Freak-out

By Dean Baker and Jared Bernstein 

As predictable as August vacations, numerous economists and Federal Reserve watchers are arguing that the nation’s central bank must raise interest rates or risk an outbreak of spiraling inflation. Their campaign has heated up a bit in recent months, as one can cherry pick an indicator or two showing slightly faster growth in prices or wages. But an objective analysis of the recent data, along with longer-term wage trends, reveals that the stakes of premature tightening are unacceptably high. The vast majority of the population depends on their paychecks, not their stock portfolios. If the Fed were to slam on the breaks by raising interest rates as soon as workers started to see some long-awaited real wage gains, it would be acting to prevent most of the country from seeing improvements in living standards. To understand why continued support from the Fed is unlikely to be inflationary, consider three factors: the current state of key variables, the mechanics of inflationary pressures and the sharp rise in profits as a share of national income in recent years, along with its corollary, the fall in the compensation share.

Read rest here.

Cheap Talk at the Fed

By Dean Baker

Federal Reserve Board Chair Janet Yellen made waves in her Congressional testimony last week when she argued that social media and biotech stocks were over-valued. She also said that the price of junk bonds was out of line with historic experience. By making these assertions in a highly visible public forum, Yellen was using the power of the Fed’s megaphone to stem the growth of incipient bubbles. This is an approach that some of us have advocated for close to twenty years. Before examining the merits of this approach, it is worth noting the remarkable transformation in the Fed’s view on its role in containing bubbles. Just a decade ago, then Fed Chair Alan Greenspan told an adoring audience at the American Economic Association that the best thing the Fed could do with bubbles was to let them run their course and then pick up the pieces after they burst. He argued that the Fed’s approach to the stock bubble vindicated this route. Apparently it did not bother him, or most of the people in the audience, that the economy was at the time experiencing its longest period without net job growth since the Great Depression.

Read rest here.

Fed doesn't think that the natural rate of unemployment is 6.5%

Previously there was some talk about the Fed keeping the fed funds rate low as long as unemployment was higher than 6.5% and inflation was close to the 2% unofficial target. Since last month the unemployment rate crossed that barrier, and is now at 6.1%, there might have been doubts about what would Janet Yellen do or simply What Would Janet Do (WWJD).

The good news is that, quite correctly, Yellen seems to believe that the recovery is still weak, the labor market is slacking and there is no sign of impending inflation acceleration. So the natural rate (which does not exist) is NOT 6.5% for the Fed.

Polly Cleveland: What’s Crippling the Recovery–Lack of Investment Demand or Too-Big-to-Lend Banks?

By Polly Cleveland

Under incoming Federal Reserve Chair Janet Yellen, the United States Federal Reserve Bank will begin to “taper” its program of “Quantitative Easing” or “QE”. Under QE, the Fed every month buys billions of U.S. Treasury bonds and other Federal securities from the big banks. QE keeps down longer-term interest rates, which will, it is hoped, encourage investment and stimulate the economy. QE has indeed supplied the biggest banks with cheap money for profitable trading in the international financial markets, enabling them to recover from the 2008 crisis—and continue paying big bonuses. It has in fact kept interest rates near zero for big banks and corporations. By purchasing bonds from the “government-sponsored enterprises”, Fannie Mae and Freddie Mac, which buy high-quality mortgages, QE has kept mortgage rates down and hence values up for prime real estate. That’s nice if you qualify, or if you’re a bank holding real estate collateral. By keeping bond yields very low, QE has also sent investors piling into the stock market looking for better returns, creating a stock market boom—nice if you own or issue stocks. So QE has done quite well for big bank executives and other members of the One Percent.

Read the rest here