WILL THE FED PUT AMERICA BACK TO WORK?
If you thought the Federal Reserve's work on firing up this economy was finished, think again. The Labor Dept.'s disappointing report on August employment, which came on the heels of other recent signs that the recovery is still more smoke than fire, gave the Fed good reason to do some more stoking.
A few hours after the Sept. 4 release of the job data, which showed a surprisingly sharp contraction in business payrolls, the Fed did what most analysts only a few weeks ago thought would be unnecessary: It eased monetary policy in the face of a stagnant economy for the 18th time since the recession began in July, 1990.
With a solid recovery still elusive, the Fed shaved a quarter-point from the federal funds rate, dropping it to 3% (chart). This key rate on interbank borrowing is down from 814% at the start of the recession, and it is at its lowest since 1963. The sad state of the labor markets suggests that further easing may well be forthcoming.
The weakening U.S. dollar in foreign exchange markets complicates the Fed's efforts to trim interest rates further. However, the sagging of the greenback isn't likely to preempt another easing move as long as the combination of a floundering economy, weak money growth, and low inflation demands it.
If the central bank eases policy again, it will also cut the discount rate--which the Fed left at 3% in its latest action--by at least half a point, and banks will cut their prime rate. But the big question remains: Will lower rates revive the economy? The Fed has only six half-point cuts in the discount rate left in its arsenal.
That should be more than enough. The lowest interest rates in three decades need not sound so dire, if they are viewed in the context of current inflation. The last time inflation was 3% or less for two years running--which is likely for 1992 and 1993--was also three decades ago.
In fact, after subtracting inflation, the real federal funds rate is currently about zero, but it has been much lower than that on many occasions in the postwar era. In that context, an even lower federal-funds rate would be far from an historical anomaly. In the past, the real funds rate typically has fallen well into negative territory before the onset of a healthy recovery.
Moreover, lower interest rates directly address one of the economy's core problems: its gargantuan private-sector debt. For example, net interest paid by nonfinancial corporations has fallen from a record 31.7% of cash flow at the end of 1990 to only 25.8% in the second quarter. That is the lowest percentage in four years, and it is largely the result of corporations refinancing their debt at lower interest rates.
Lower rates are helping households shore up their balance sheets in the same way, but their progress has been slower, in large part because a weak job market has held back growth of consumers' incomes. That's because corporations are boosting their earnings, but they are doing it by eliminating jobs.
Indeed, nonfarm industries slashed payrolls by 83,000 workers in August--a month when a temporary government-jobs program for teenagers boosted employment by nearly that amount. Excluding the government, private-sector jobs fell by a stunning 167,000--the largest drop since the recession losses in early 1991.
The job losses were broad. Only 41.7% of the 356 industries in the government's survey added workers to their payrolls last month (chart). That's the least in about a year and a half. The two biggest losers in August were retail trade, which handed out 71,000 pink slips, and manufacturing, which let go 97,000 workers. The factory workweek was unchanged at 41 hours, so industrial production in August appears to have declined.
Still, the August report did have some bright spots that have important implications. First of all, the overall nonfarm workweek jumped from 34.3 hours to 34.7 hours. So, despite the job losses, total work time managed to rise, suggesting that nonfarm output continued to gain ground last month.
The other good news is that average weekly earnings posted a huge 1.8% increase--the largest monthly gain in more than 10 years. Again, despite fewer jobs, personal income in August is likely to show a stout advance.
In general, the disparity of movements in jobs and hours and the unusually big increases in hours and pay suggest some quirks in the Labor Dept.'s seasonal-adjustment process that appear to have distorted the picture of the August labor markets. Both hours and pay in September are likely to give back some of their outsized August gains.
Moreover, the effects of Hurricane Andrew and the end of the summer-jobs program will depress September payrolls. As a result, the unemployment rate, which slipped to 7.6% in August from 7.7% in July, is likely to edge back up.
Soft labor markets continue to hamper household efforts to spruce up their finances. Thanks to lower interest rates, many consumers have made strides in reducing the liability side of their balance sheets. They are refinancing mortgages and paying down debt (chart). But with no new jobs, income growth will suffer, and that will keep consumers from spending.
Wage growth picked up in August. The average nonfarm wage rose 7 per hour, to $10.65. That jump, plus the longer workweek, is what fueled the big advance in nonfarm weekly pay. Although that gain ensures an increase in personal income last month, growth in weekly pay is still too weak to provide a sustained boost to consumer spending. Over the past year, weekly pay has risen just 2.6%. That's the same sluggish pace as a year ago--and lower than the rate of inflation.
With pay gains falling behind the cost of living and jobs being permanently lost, the numbers show that more households are having difficulty making ends meet. The delinquency rate on installment debt rose to a record high of 2.88% in the first quarter. Mortgage payments overdue by at least 30 days also edged up a bit in the second quarter, to 4.77%, although the rate remains below its recent high of 5.28% hit in the second quarter of 1991.
Most consumers, however, are adjusting to slow income growth by reining in their spending, especially on big-ticket items. Sales of new U.S.-made cars have fallen for two straight months, dipping by 7% in August to slightly below the 6 million mark at an annual rate.
Light trucks are taking up some of the slack in car sales. These vehicles, including jeeps and minivans, accounted for 40.8% of U.S.-made cars and trucks sold in August, up from 36.6% a year ago (chart).
Other households are coping by paying off their outstanding bills. Consumer installment credit dropped by $1.1 billion in July, the sixth consecutive decline in borrowing. Debt outstanding has fallen to $721.5 billion--the lowest level in more than two years.
Auto financing rose by $521 million, but that hardly offset the $2.6 billion plunge in car loans in June. And consumers used their credit cards less in July. Revolving debt fell by $143 million in the month. Such debt has risen by just 5.4% over the past 12 months, much slower than its 8.6% increase in the previous year. Weak demand for credit reflects the softness in consumer spending.
Some homeowners may get a lift to their cash flow by refinancing their mortgages. The Mortgage Bankers Assn.'s index of applications to refinance remained at a fairly high level in August. The latest Fed easing opens the way for further reductions in mortgage rates--and more applications to cut monthly mortgage payments.
That means more money for spending. And increased demand will spur businesses to offer what households really need: more new jobs. For the Fed, that means pushing interest rates low enough to shore up consumer and corporate finances and get America back to work.JAMES C. COOPER AND KATHLEEN MADIGAN