What Will the Federal Reserve Do??

Popular Economics Weekly

Now the fat’s in the fire. Both stocks and bond prices have been falling of late, due to the fear that the Fed will end its $85 billion per month QE purchases of Treasury and mortgage securities too soon. Fed Chairman Bernanke had said that if employment continued to improve, the Fed might begin to “taper” its purchases as soon as its June FOMC meeting.

And today the Bureau of Labor Statistics reported the May unemployment report rose from 7.5 to 7.6 percent because 420,000 more people are looking for work, though 175,000 more payroll jobs were created in May! So what’s the Fed to do? On the face of it, the Fed can’t begin to end QE purchases because its stated goal of 6.5 percent unemployment isn’t close to being reached.

Graph: Calculated Risk

And both inflation indexes and consumer incomes show there is still insufficient demand for more goods and services that would cause the U.S. economy to grow closer to its normal longer term GDP growth rate of 3.5 percent. It grew just 2.2 percent last year, and predictions for 2013 are not much better.

This graph of personal consumption expenditure prices illustrates the problem. Prices have been falling, and when prices fall, so do profits. Hence wages and so employment remains stagnant, stuck where it has essentially been over the past 3 years. Then why are we worried?

Inflation hasn’t been running at the 2 to 2.5 percent average that prevailed before the Great Recession, in other words. Hence those calling for an early exit from QE are doing the country a disservice. It means fewer new jobs and therefore more remaining unemployed. The Bureau of Labor Statistics said some 13.6 million are “marginally attached” to the labor force and still looking for full time work. The unemployment rate for them is an even larger 13.8 percent — down from 13.9 percent in April — if everyone who wants a full-time job but can’t find one is included. Millions of Americans still cannot find work nearly four years after the recession ended.

So who is calling for an early end to QE? No less than Former Fed Chairman Alan Greenspan, for one. "Bond prices have got to fall. Long-term rates have got to rise. The problem, which is going to confront us, is we haven't a clue as to how rapidly that's going to happen. And we must be prepared for a much more rapid rise than is now contemplated in the general economic outlook."

But interest rates generally rise and fall in tandem with inflation, and inflation is still falling. That means getting closer to full employment, which is when inflation historically becomes a problem. So we have a long way to go before worrying about interest rates rising too fast.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen