Why the Fed should taper
Some Federal Reserve presidents are talking taper.
Based on speeches this week, their apparent consensus may give Federal Reserve Chairman Ben Bernanke the support he needs to begin dialing back on the Fed’s $85 billion monthly purchases of Treasury bonds and mortgage-backed securities.
Tapering off has major political advantages for Bernanke, whose term ends in January, and who is unlikely to reappointed. First, history books will record that Bernanke took the first steps to avoid inflation — no matter what path is chosen by his successor.
Second, tapering in September takes the issue off the table before the confirmation hearings for the next Fed chairman. Bernanke is doing a favor for Federal Reserve vice chair Janet Yellen, Harvard University economics professor Lawrence Summers, former Fed vice chair Roger Ferguson, or any other candidate in the hot seat in the elegant Senate Banking Committee hearing room.
Columbia Business School Professor Charles Calomiris, author of several books on banking, told me on Thursday, “Tapering is already long overdue. The Fed is putting itself far behind the curve.”
Three Fed bank presidents seem to be broadly in agreement that dialing back on asset purchases will begin soon — unless the unemployment rate rises unexpectedly. Read weekly jobless claims data.
On Wednesday, Sandra Pianalto, president of the Cleveland Federal Reserve, said she would be open to tapering back the Fed’s $85 billion monthly purchases of bonds and mortgage-backed securities because the employment picture is brighter.
“In my view, there has been meaningful improvement in both current labor market conditions and in the outlook for the labor market since the FOMC launched the current asset purchase program,” Pianalto said. “Employment growth has been stronger than I was expecting, and the unemployment rate today is more than half a percent lower than I projected it to be last September.”
On Tuesday, Chicago Federal Reserve President Charles Evans said that he expects tapering to start in September due to stronger economic growth. Evans believes that GDP growth will increase to 2.5% later in the year, up from 1.7% in the second quarter of 2013 and 1.1% in the first quarter.
And on Monday, speaking in Portland, Ore., Dallas Fed President Richard Fisher called for tapering off due to the decline in the unemployment rate to 7.4%. He said, “We have to be careful in deploying the fuel we create, for like all fuels, ours is combustible. Employed recklessly or without safeguard, it can lead to an explosion of inflation; if we are too miserly, we risk an implosion of deflation.”
As former chief economist of the U.S. Department of Labor, I find it surprising that Fed presidents give the impression that the labor markets are performing well.
Despite the headline decline in the unemployment rate from 7.6% to 7.4%, July’s unemployment numbers were bad news for the economy.
The economy created 162,000 jobs, but hours worked in the economy decreased by a tenth of a percent. The average workweek shrank, and average earnings declined by two cents. Job gains for May and June were revised down by a total of 26,000.
Although the number of Americans employed in 2013 has increased by about 1 million, 82% of these jobs have been part-time, according to data from the Labor Department’s Current Population Survey. There have been 4.5 part-time jobs created for every full-time job.
The unemployment rate fell because fewer Americans participated in the labor force in July. The labor force participation rate declined from 63.5% to 63.4%, equivalent to 1978 levels, and the labor force declined by 37,000. Including population growth, an additional 240,000 Americans were counted as out of the labor force. The number of Americans who usually work part-time rose by 174,000.
With the exception of 36,000 new jobs in professional and business services, most jobs were created in industries that paid below average wages, such as retail trade (47,000), food services and drinking places (38,000). Only 6,000 new jobs were created in manufacturing.
All told, it is puzzling that this employment report, which seems worse than the June report, would encourage Fed presidents to suggest dialing back on asset purchases.
Their arguments should be the opposite. QE1, QE2, and QE3 are not achieving their stated goals of helping the economy, and are contributing to the possibility of inflation. So tapering should occur.
The Fed’s policies are redistributing funds from small savers, who cannot get a return on their savings accounts, to owners of stocks and homes, who have seen their assets skyrocket. The weaker dollar is driving up the dollar prices of commodities, increasing prices of gasoline and food. Low-income Americans spend a far higher share of their income on food and energy than the rich. The Fed’s policies amount to robbing the poor to pay the rich. See our streaming coverage of the markets.
Plus, the danger of inflation is lurking. As soon as banks ramp up their lending, inflation will take off. As Dallas Fed President Fisher said on Monday, “the excess, currently nondeployed money could prove the kindling of an inflationary conflagration unless the Fed is nimble in managing its effect as it works its way into the economy’s production and consumption of goods and services.”
That’s why the Fed should taper, not because the labor markets are doing better.
Whatever the reason, tapering in September gives Bernanke a chance to show the world that he is the one who moved first to head off inflation. His legacy will not be inflation, or hyperinflation. He will be remembered as the chairman who kept the Great Recession from turning into the Great Depression and who managed to keep inflation at bay.
Whether Bernanke’s successor will keep tapering, or will resume asset purchases, remains to be seen. But a start to tapering will help that successor with confirmation hearings by resolving the awkward question of when to start the process.
It’s likely that equity markets, which are smarter than economists, have already built in the possibility of tapering. Some fiscal and regulatory help from Congress and the president as the Fed changes course would undoubtedly be helpful. But that is a subject for another day.
Originally published on MarketWatch.com.