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The Fed Goes High

Last week the Federal Reserve Board raised interest rates for the third time in the last year and a half. This move did not get nearly as much attention as it deserves. The decision to raise interest rates was a conscious decision to slow the rate of economic growth and job creation. It will raise interest rates that people pay on credit cards, car loans, home mortgages and other types of debt. It will also raise the cost of borrowing for businesses looking to invest and state and local governments borrowing for infrastructure. As a result, we will see less spending and borrowing and therefore slower economic growth. The Fed is slowing the economy because it fears that too rapid growth will trigger inflation. I think this view is wrong, but before making the case it is worth making a couple of basic points about the logic of the Fed’s rate hike. First, the Fed is raising interest rates because it is concerned that the economy is creating too many jobs. Last month, the Labor Department reported that the economy added 235,000 jobs. The concern at the Fed, and among many other economists, is that the demand for labor is outstripping the supply of labor. This will lead to upward pressure on wages, which will then be passed on in higher prices, potentially leading to a wage-price inflationary spiral. Note that this concern is 180 degrees at odds with the “robots are taking our jobs” story. The robots taking our jobs story is one in which we don’t have enough jobs and we have too many workers. The Fed obviously is not concerned about robots taking all the jobs or it wouldn’t feel the need to raise interest rates. It’s worth noting that the data agree with the Fed here. Productivity growth, which measure the rate at which jobs are being replaced by technology, has been extraordinarily slow in recent years, averaging less than 1.0 percent annually over the last decade. People not getting jobs because of Fed rate hikes are disproportionately less-educated workers and members of disadvantaged groups. By contrast, productivity growth averaged 3.0 percent between 1947 and 1973 and also between 1995 and 2005. In other words, despite stories of self-driving cars and other technological breakthroughs, the robots are taking jobs at a much slower pace today than in past years. The other point is that the people not getting jobs because of Fed rate hikes are disproportionately less-educated workers and members of disadvantaged groups. It is very difficult to devise good policies to help people from depressed areas. By comparison, it is relatively easy to allow these people to get jobs by keeping interest rates low and letting the economy continue to expand. The Fed’s rate hike goes in the wrong direction. The Fed and the other economists supporting a rate hike do have a case. The unemployment rate is relatively low and the recent rate of job creation is certainly far faster than the rate of labor force growth due to demographic factors. This means the labor market is tightening. Nonetheless there are important reasons for believing the economy is still far from hitting any capacity constraints. The percentage of prime-age (ages 25 to 54) people working is still 2.0 percentage points below pre-recession peaks and 4.0 percentage points below the peaks hit in 2000. There is no plausible explanation as to why so many fewer people now have the skills or inclination to work. Few, if any, economists anticipated this drop. It’s not clear that their understanding of the labor market is better today than it was in 2000 or 2007. Other factors are also inconsistent with a tight labor market. The number of workers involuntarily working part-time continues to be well above pre-recession levels. Also, the share of unemployment due to people who voluntarily quit their jobs, a key measure of workers’ confidence in the labor market, remains at near recession levels. Furthermore, there is little evidence that either wage growth or inflation is accelerating. The average hourly wage increased at just a 2.5 percent annual rate over the last quarter, slightly lower than its pace in late 2016. Broader measures of compensation, which factor in the drop in employers’ payments for health care insurance, show even weaker gains. In addition, the inflation measures themselves show no evidence of acceleration. The core consumer price index, which excludes volatile food and energy prices, has been rising at the same 2.2 percent rate for more than a year. If rent is excluded, the rate of inflation would be just 1.3 percent. Also, the core personal consumption deflator, the index targeted by the Fed, remains at 1.7 percent with no sign of acceleration. The Fed targets a 2.0 percent average rate for this index, meaning that it should want to see some rise above 2.0 percent to keep to its target. These are all reasons for believing the Fed’s rate hike last week was a mistake. However it is important to keep in mind that a quarter point hike has relatively little impact. What matters far more is a sequence of rate hikes. If the Fed makes further hikes in a context where there is little evidence of inflationary risks then it could needlessly be keeping millions of people from getting jobs. It will also be weakening the bargaining power of tens of millions of workers, to the benefit of corporations and higher paid workers. That would be a very serious policy mistake if it happens, and one that we should not blame on robots. Do you have information you want to share with the Huffington Post? Here’s how.

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