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; theimportant thing about it is that when it goes up, it raises the cost of borrowingthroughout the economy. That, in turn, usually dampens investment andhiring activity, but the ultimate target is inflation. Raising theprice of borrowing, the idea is, will dampen the pace of economic growthand take some of the pressure off prices.
And so that's what they did last month, authorizing a slight boost tothe federal funds rate.
Now, those of you not on the FOMC: Raise your hand if you reallythink the economy is growing too quickly. True, the jobless recovery isbehind us, but we've still got a deep jobs deficit. We're 1.2 millionjobs down from the employment level in March 2001, when the recessionbegan. But that's just part of the jobs gap; we need millions morejobs 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 backin November 2001. Real hourly wages have fallen five out of the lastsix months. June job growth was 112,000 (including the loss of 11,000 manufacturing jobs), less than half the rate ofthe prior three months.First quarter GDP was revised down by one half of one percent, whichamounts to about $50 billion lower than we thought. Retail sales havesoftened as well in the last month, perhaps reflecting the lower realwage rates.
So why would the Fed want to "take away the punch bowl" at a time likethis? Because, in their own words (from the statement accompanying therate hike announcement), "incoming inflation data are somewhatelevated."
But read the whole sentence: "Although incoming inflation data aresomewhat elevated, a portion of the increase in recent months appears tohave been due to transitory factors."
The key words: "transitory factors." What they're trying to say here isthat whatever inflationary pressures are ongoing come fromthe supply-side–constrained supplies of certain food items, health care,and anything that uses gas. But the Fed's tool -- the federal fundsrate -- works to slow demand. Sure, that could take some pressure off thecommodities and services just noted, but with all this labor marketslack, this is a lousy time to slow demand.
In fact, it's much tougher for the Fed to scratch an inflation itchcoming from the supply side. They're more effective at pushing backagainst wage-push inflation, as when a very tight labor market enablesworkers to push for higher wages. In this environment, firms will tryto pass higher labor costs onto consumers; this shows up as fasterinflation. The Fed can then step in and raise rates, thus slowing growth, raisingunemployment, 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 apretty good case that lack of wage growth is a problem right now. Withfalling hourly wages, the only way working families can raise incomes isthrough more work (or more non-labor income -- not a big income source forthe working class). So it's a good thing jobs are coming back, butthey're still not plentiful enough. A few months ago, there were threeunemployed persons per job opening; now there's 2.6. Better, but notgreat.
The FOMC has a real challenge here. They want to show theworld they're hawkish on inflation, but they'd rather keep theirfingerprints off a higher jobless rate. Their statement put it thisway:
"The Committee believes that, even after this action, the stance ofmonetary policy remains accommodative and, coupled with robustunderlying growth in productivity, is providing ongoing support toeconomic activity."
Which is Fedspeak for, "we sure hope this little rate hike doesn't screwthings up ..."
As do we all.
Jared Bernstein is a senior economist at the Economic Policy Institute (EPI) in Washington, D.C.
