“A fact can be a beautiful thing,” sings one of the characters in the award-winning musical, “Promises, Promises.” True. Unfortunately, a gaggle of facts can be somewhere between confusing and a curse, especially if you are a central banker who has specialized in promises, promises that a process of normalization will begin after seven years of zero interest rates. Now, faced with its next meeting less than two weeks hence, the Federal Reserve Board’s monetary policy committee has to decide whether to replace promises with action.
The most-watched set of facts was released late week. The economy added only a disappointing 173,000 jobs in August, a mere 140,000 in the private sector, the smallest increase since March 2008, and the labor force participation rate continues to decline, even after 66 consecutive months of job creation. Although August job figures are typically revised upward, these data support those who would have the Fed stay its hand. But the three-month average of new jobs is around 200,000, which is about twice the growth rate of the work force, the unemployment rate is down to 5.1%, usually regarded as full employment, and average hourly earnings continue to move up, all facts that dictate raising rates before inflation takes off. Jeffrey Lacker, president of the Richmond Fed and a voting member of the monetary policy committee, had said “It’s time to align our monetary policy with the significant progress we have made,” and repeated that call for an increase in interest rates after examining yeserday’s job report.
The recent Fed survey of business conditions around the country, the so-called Beige Book, is not of much help. Its general conclusion is that growth is continuing at a moderate pace, activity in the manufacturing sector is “mostly positive”, and that employment growth is only “slight or modest” -- hardly a clarion call for an interest rate increase that some key Fed officials say is necessary. But countering that are some “beautiful” facts.
Second-quarter growth clocked in at an annual rate of 3.7%. Exports jumped, cutting the trade deficit. Construction spending in July hit its highest level in more than seven years, after rising at an annualized rate of 26% in the three months ending in July. And this was no government-stimulus spending: it was private-sector spending on residential and non-residential construction that drove spending higher.
The news from the auto sector is equally good. Last month, consumers snapped up cars and small trucks (light vehicles in the jargon of the trade) at the fastest annual rate since July 2005. Low gasoline prices resulted in shortages of SUVs, and generous financing terms (no interest on 72-month loans) encouraged buyers to load their vehicles with extras, driving up the price of the average vehicle sold by GM by $660 compared with a year earlier, and opt for German-brand luxury vehicles. Car makers are expecting to keep “moving the metal” at a brisk pace for the rest of the year.
There’s more. Sales of existing homes in July rose by 10.3% above year-earlier levels, and were their highest since February 2007, before the recession took this sector down. Appliance sales are way up, and overall consumer spending is rising. Confirming Thomas Carlyle’s description of economics as “the dismal science”, none of this is unalloyed good news for the Fed. In deciding whether to raise interest rates, it has to consider that these growth drivers are the most sensitive to interest rates. Home buyers need mortgages, car buyers need low-interest loans, consumers often borrow to purchase appliances. So Janet Yellen & Co. have to worry whether even a modest increase in interest rates, especially if seen as the first of several, will have a greater impact on the economy than would be the case if the key growth factors were not so heavily dependent on cheap money. For firms selling cars, houses, and other big-ticket items, when it comes to interest rates, zero is a nice round number.
Making life still more difficult for those who have elected to stake their reputations on their ability to develop monetary policy that meets the Fed’s twin goals of full employment (unemployment at 5%) and tame inflation (2%) is the fact that much of the data its staff is poring over pre-dated economic turmoil in China and volatile movements in share prices here.
It also is difficult to decide just what weight to give to events in a world that has been too much with us economists of late.
* World stock markets, ours included, are beyond merely volatile. We just don’t know whether consumers will keep buying houses, cars, and big-ticket items when the get the next report of the new value of their IRAs and other savings plans.
* We can’t rule out the possibility of ripple effects from countries heavily dependent on shrinking Chinese markets even though U.S. exports to China account for only 1% of GDP; Goldman Sachs estimates that a 1% drop in China’s growth will cut a mere 0.06% off U.S. GDP; and China’s slowing demand for commodities will make many of them cheaper for manufacturers here, a blessing for consumers and exporters.
* The Japanese economy remains more or less stagnant, and it is not yet clear whether prime minister Abe’s “three arrows” (fiscal stimulus, monetary easing and structural reforms) have slain stagnation or the prime minister’s credibility as a policy-maker.
* Euroland’s non-robust economies are now confronting floods of refugees that for a time at least will require large dollops of financial assistance. France, its economy moribund, already spends more than half its GDP on government programs, Spain, Portugal and Italy have problems of their own, and Greece is hardly in a position to take on the burden of feeding and housing thousands of immigrants.
It all comes down to this: there is no compelling economic reason for the Fed to raise rates. We are in the seventh year of an ageing recovery, profits are under pressure, and businesses have more reasons to continue to sit on their cash piles than to spend them. The labor market has improved enough to be forcing employers in some sectors to raise wages but, especially if recent increases in productivity continue, is not tight enough to drive the inflation rate to dangerous levels. All reasons the G-20 finance ministers meeting in Turkey this weekend will align themselves with the International Monetary Fund and influential former treasury secretary Larry Summers in warning the Fed not to raise rates.
But Yellen’s discipline is not economics; it is political economy. If rates go up and the already-modest expansion slows down, congressional Democrats will move to limit the Fed’s independence. But continued failure to deliver on its “promises, promises” to raise rates would damage the Fed’s credibility, and antagonize inflation-hawkish congressional Republicans. Yellen might just respond to these conflicting pressures by raising rates one-quarter of one percent later this month or in December, while at the same time announcing that is all it intends to do for the foreseeable future so that it can study the impact of its first increase in seven years. Yellen will still have promises to keep and meetings to chair before she sleeps. But she will have eliminated the overhanging uncertainty of unkept promises and, at least temporarily, neutered critics, both right and left.