Janet Yellen's Meddling Is Robbing Us of a Recovery
The statutory language enabling the Federal Reserve system and the Federal Reserve Board is found in 12 U.S.C. Chapter 3. The language is tedious but not surprising. For example, the phrases "household formation" and the word "household" are not to be found.
Yet to understand what is slowing the economy, Federal Reserve Chair Janet Yellen is examining households and a great many other concepts that fall outside the Fed's jurisdiction.
Yellen, for example, is concerned about the slow rate of household formation. "We need to see some pick-up in household formation in order to see continued recovery in the housing market," she said in hearings before the Joint Economic Committee last Wednesday.
Low household formation is a symptom of a slow-growing economy. From the period 2009 to 2013, measured family households rose 2.6 percent, compared with 4.2 percent between 2001 and 2005.
The Federal Reserve has a dual mandate to keep employment high and inflation low. Last month the unemployment rate declined by four tenths of a percentage point, from 6.7 percent to 6.3 percent.
Some might think that this is good news, enabling the Fed to begin to gradually raise interest rates. After all, a year ago, in its forward guidance, the Fed identified an unemployment rate of 6.5 percent as the level at which monetary accommodation could be scaled back.
But, in economics, especially in matters of forward guidance, life is not so simple. The major cause of the 6.3 percent unemployment rate was a decline of the same magnitude, four tenths of a percentage point, in the labor force participation rate, defined as the percentage of individuals who are working or seeking employment. The labor force participation rate stands at 62.8 percent, equivalent to 1978 levels, before the dramatic movement of married women into the labor force in the 1980s.
Low household formation is one result of a declining labor force participation rate, because people need incomes to buy or rent homes. Young people who are not in the workforce cannot afford to buy or rent homes, and labor force participation of young people aged 20 to 24 has declined from 75 percent in 2003 to 71 percent in 2013.
The low labor force participation rate poses problems for Chair Yellen. A labor economist by training, she understands very well that a lower unemployment rate does not equal a healthy economy. The healthy economy was supposed to come from multiple rounds of quantitative easing and continued low interest rates that would stimulate aggregate demand and revive labor markets.
But the strategy failed. The Fed's monetary policy has not succeeded in raising GDP growth. The extent of the failure can be seen by comparing the Fed's forecasts for 2013 real GDP growth with the 1.9 percent actual rate of GDP growth in 2013.
In 2010, the Fed forecast that 2013 GDP growth of about 4 percent. In 2011, it forecast 2013 growth of 3.2 percent. In 2012, the forecast growth for 2013 was adjusted down to 2.6 percent, and in 2013, it was lowered to 2.3 percent.
Forecasting 2013 growth in 2013 should not be too hard for the Fed, with its large staff of economists, but the Fed still overestimated-real 2013 growth came in at 1.9 percent, consistent with a rate of growth of about 2 percent since the recovery.
The overestimate continues. Fed is forecasting GDP growth in a range of 2 percent to 3 percent for 2014. Since first quarter growth was 0.1 percent, this translates into growth over the next 3 quarters of over 3 percent. This does not appear likely at present.
Neither has the Fed succeeded with the labor markets. The decline in the labor force participation rate has taken the bloom off the 6.3 percent unemployment rate.
With the failure of the Fed's stimulus, Yellen has to look elsewhere, so she is blaming family formation. However, it is possible that low family formation is a result of the Fed's failed policies. Continued monetary accommodation is weakening the currency and discouraging investment and job creation.
According to Shadow Open Market Committee member Mickey Levy, "The fact that Yellen focuses so much on nuances of labor markets and wages is symptomatic of excessive monetary fine tuning. So much of the lingering weaknesses in labor markets and new family formation reflect real challenges and are way beyond the scope of monetary policy."
Levy's point should not be lost on the Fed. Although arguably the most powerful economic institution in America, the Fed is not omnipotent. Other than certain interest rates under its control, the Fed cannot change any of the myriad factors that affect economic growth, including household formation. Yellen and the other governors of the Fed should take notice: focus on what the Fed can actually control, not what is beyond its reach.
This piece originally appeared in RealClearMarkets
This piece originally appeared in RealClearMarkets