The American economy continues to grow, albeit slowly, and the jobs markets has been generating enough jobs to keep us at or close to full employment without triggering inflation. The economy added 156,000 jobs last month, not seriously out of line with the 75,000-125,000 jobs that observers such as Loretta Mester, president of the Cleveland Federal Reserve bank, say the economy needs in order to provide jobs for our growing population and maintain full employment. The jobs increase was made possible in part by a rise in the so-called labor force participation rate to its highest level since March, meaning that workers continue to leave the couch for the labor market, just as Federal Reserve Board chair Janet Yellen predicted they would.
All of which would suggest that the Fed’s monetary policy gurus could let the New Year ring in without raising interest rates, increasing the number of corks that will pop on Wall Street and in the offices of major exporters. But "could" doesn't mean "will". When Janet Yellen was appointed to chair the Fed's board of governors, I read her pre-appointment speeches deploring the social consequences of unemployment and, tongue-in-cheek, predicted in one of these weekly emissions that I could predict the date on which she would raise rates—"Never". But now there is a reasonable prospect of a modest interest rate rise in December.
For one thing, the presidential and congressional elections will be behind us and the long national nightmare of a contest between two detested candidates will have come to an end. Fed chair Janet Yellen says she and her colleagues, one of whom is a financial contributor to the Clinton campaign, pay no attention to the political calendar, and they might believe they are telling the truth. No matter. If the prospect of an election were a restraint on the Fed, it no longer is. And Yellen is facing an increasingly divided monetary policy committee, with three members having dissented from the hold-the-line decision of Yellen and the majority at their last meeting. Fed chairs do not like such division.
More important, in her most recent appearances before Congress, Yellen has come close to promising a rate rise before year-end. If that quasi-promise is unfulfilled, the Fed's current credibility problem will become more severe. It long ago hinted that it might raise rates when the unemployment rate hit 6 percent. That target, when met, was raised to 5 percent. When the new, lower target was hit, the Fed decided to wait until the labor force participation rate began to rise. When it did, the goal posts were moved once again. The Fed decided that problems in China, then the headwinds created by Brexit, then the failure of inflation to rise made it unwise to raise rates. Now just as it seems likely to prove my "Never" was more than a joke, it will almost certainly have to raise rates or cause the laughter from market-makers to drown out Yellen's next speech. After all, the pieces seem to be in place to make a rate rise defensible:
* Wages are rising at an annual rate of almost 3 percent this year, inducing almost 3 million people to re-enter the labor force in the past year;
* The income of the median household—the one in the middle of the income distribution—rose by 5.2 percent to $56,500 last year from 2014, boding well for a continued rise in consumer spending that is expected to raise holiday spending by better than 3 percent over last year and end the persistent fall in corporate revenues;
* The unemployment rate is close to the lowest attainable level;
* The inflation rate as measured by the Fed is running at 1.7 percent, sufficiently close to its 2 percent target to permit a rate increase.
Yellen & Co. also have to be sensitive to three other and perhaps more important criticisms of a continued zero-interest rate policy. First, zero rates have produced a global borrowing binge that along with government entitlement programs has made "the entire developed world … insolvent" according to widely respected hedge fund manager Paul Singer. The International Monetary Fund puts the record-breaking level of global debt at $152 trillion and rising, "a risk to financial stability." The longer the Fed delays reversing its policy, the worse the consequences will be.
Second, many thoughtful critics argue that delaying a rate rise is playing havoc with pension plans, which are under-funded to the tune of a staggering $5-$6 trillion according to Stanford University professor Joshua Rauh, and many of which continue to assume they will earn an astonishing 7.6 percent on their assets according to the National Association of State Retirement Administrators. A perverse effect of low interest rates is that they reduce earnings of pension funds, which requires them to "de-risk" by buying more bonds for their portfolios. The increased demand for bonds raises their price, lowering interest rates further, requiring further de-risking. "Pension schemes end up competing with central banks to buy government debt, creating a mutually reinforcing negative spiral," Ros Altman, until recently UK Minister of State for Pensions points out at a Goldman Sachs forum.
Finally, Fed policy is enriching the already-rich by keeping the price of assets up—shares and homes, primarily—at the expense of small savers who can earn virtually nothing on their tiny rainy-day funds. That exacerbates the rising inequality that has brought the entire system of market capitalism into question, a criticism to which Yellen is more than a little sensitive judging by the speeches she made while in academic life.
Not that there is uniform agreement that the economy is strong enough to withstand the beginning of successive increases in interest rates. Larry Summers, a leading Democratic policy adviser, continues to read the economic tea leaves through a Keynesian lens to be saying that we are in a period of secular stagnation—demand so low that investment is discouraged and growth held to puny levels. Sales of autos, although still strong by historical standards, are weakening, and are being held up only by price discounting and credit offerings of 72 months at zero interest rates. Housing starts are due to fall because builders are find it difficult buy land that can be developed at a cost that makes starter homes competitive with renting. A rise in rates will strengthen the dollar, driving already-falling exports lower, and an already-rising trade deficit higher. Corporate profits continue to decline, driving business confidence last month to the lowest level ever recorded.
The optimists probably are winning the rate-rise argument right now—until the possibility of a Trump presidency is mentioned, at which point they begin agreeing with his prediction that we are in a bubble about to burst.