Pressure Cooler

At the end of June, that very powerful group of bankers, the Federal
Reserve's Open Market Committee (FOMC), got together under Chairman
Alan Greenspan's leadership to decide whether they should try to slow down
the pace of economic growth by raising the federal funds rate.

That's the interest rate that banks charge each other for loans; the
important thing about it is that when it goes up, it raises the cost of borrowing
throughout the economy. That, in turn, usually dampens investment and
hiring activity, but the ultimate target is inflation. Raising the
price of borrowing, the idea is, will dampen the pace of economic growth
and take some of the pressure off prices.

And so that's what they did last month, authorizing a slight boost to
the federal funds rate.

Now, those of you not on the FOMC: Raise your hand if you really
think the economy is growing too quickly. True, the jobless recovery is
behind us, but we've still got a deep jobs deficit. We're 1.2 million
jobs down from the employment level in March 2001, when the recession
began. But that's just part of the jobs gap; we need millions more
jobs to absorb the growth in the adult population since then.

The unemployment rate is stuck at 5.6 percent, the exact same rate we had back
in November 2001. Real hourly wages have fallen five out of the last
six months. June job growth was 112,000 (including the loss of 11,000 manufacturing jobs), less than half the rate of
the prior three months.
First quarter GDP was revised down by one half of one percent, which
amounts to about $50 billion lower than we thought. Retail sales have
softened as well in the last month, perhaps reflecting the lower real
wage rates.

So why would the Fed want to "take away the punch bowl" at a time like
this? Because, in their own words (from the statement accompanying the
rate hike announcement), "incoming inflation data are somewhat
elevated."

But read the whole sentence: "Although incoming inflation data are
somewhat elevated, a portion of the increase in recent months appears to
have been due to transitory factors."

The key words: "transitory factors." What they're trying to say here is
that whatever inflationary pressures are ongoing come from
the supply-side–constrained supplies of certain food items, health care,
and anything that uses gas. But the Fed's tool -- the federal funds
rate -- works to slow demand. Sure, that could take some pressure off the
commodities and services just noted, but with all this labor market
slack, this is a lousy time to slow demand.

In fact, it's much tougher for the Fed to scratch an inflation itch
coming from the supply side. They're more effective at pushing back
against wage-push inflation, as when a very tight labor market enables
workers to push for higher wages. In this environment, firms will try
to pass higher labor costs onto consumers; this shows up as faster
inflation. The Fed can then step in and raise rates, thus slowing growth, raising
unemployment, and reducing workers' bargaining power and, in turn, wage growth.

But like I said, wage growth ain't the problem -- in fact, you can make a
pretty good case that lack of wage growth is a problem right now. With
falling hourly wages, the only way working families can raise incomes is
through more work (or more non-labor income -- not a big income source for
the working class). So it's a good thing jobs are coming back, but
they're still not plentiful enough. A few months ago, there were three
unemployed persons per job opening; now there's 2.6. Better, but not
great.

The FOMC has a real challenge here. They want to show the
world they're hawkish on inflation, but they'd rather keep their
fingerprints off a higher jobless rate. Their statement put it this
way:

"The Committee believes that, even after this action, the stance of
monetary policy remains accommodative and, coupled with robust
underlying growth in productivity, is providing ongoing support to
economic activity."

Which is Fedspeak for, "we sure hope this little rate hike doesn't screw
things up ..."

As do we all.

Jared Bernstein is a senior economist at the Economic Policy Institute (EPI) in Washington, D.C.

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