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Fed History Shows Punch Bowl Goes as Jobs Rise: Cutting Research

Fed History Shows Punch Bowl Goes as Jobs Rise
A police officer stands outside the Marriner S. Eccles Federal Reserve building in Washington, D.C. Photographer: Andrew Harrer/Bloomberg

An improving labor market rather than accelerating inflation made the Federal Reserve decide to end its last three episodes of easy monetary policy. It may be about to happen again, says Barclays Plc strategist Barry Knapp.

He looked back to May 1983, February 1994 and the February-to-August period of 2004 to see what prompted the U.S. central bank to tighten policy, which former Fed chief William McChesney Martin likened to taking away the punch bowl just as the party gets going.

In all three cases, inflation measures were generally falling. It was employment, the other part of the Fed’s dual mandate, that spurred a policy shift, wrote Knapp, head of U.S. equity strategy at Barclays in New York.

The 2003-2004 period is most useful to examine because by then the Fed had begun releasing statements after policy meetings to explain its decision-making, he said. The statements indicated an evolution from “firing has stopped” to “hiring has picked up.”

“The triggers that marked the end of the recent extreme accommodation periods were employment, not inflation,” Knapp said in a May 22 report

Fed Chairman Ben S. Bernanke indicated May 22 that the Fed is seeking “real and sustainable” progress in shrinking unemployment before it begins to pare record stimulus, through such measures as reducing or tapering monthly bond buying.

The Fed’s embrace of transparency before the third period studied meant markets were less volatile the last time interest rates were increased. In 1983 and 1994, 10-year yields increased nearly 200 basis points as the Fed began to tighten policy.

In 2004, the end of a pledge to keep policy accommodative for a considerable period and strong payroll reports led to a 110-basis-point rise in yields.

While Barclays currently predicts the Fed will maintain its current rate of asset purchases into next year, Knapp said in an interview the labor market is again the Fed’s focus. A strong payroll report for May could prompt investors to anticipate a faster pullback in stimulus, he said.

* * *

European exporters may not need to worry about the sliding yen making their products less competitive in international markets.

While the yen has dropped 13 percent against the euro this year, economists at AllianceBernstein Holding LP say the decline may not threaten Europe’s trade position.

That’s partly because Japan accounts for just 2.4 percent of euro-area exports, about a 10th of the U.K.’s share, said AllianceBernstein economists Darren Williams and Guy Bruten in a May 17 report. Accounting for Japan’s role in Europe’s other export markets, they found Japan to be the euro area’s fourth biggest competitor.

The threat it poses is also diminishing. Japan has a 6 percent weight in the euro’s trade-weighted exchange rate index, down from 11.6 percent in the mid-1990s. That’s because of the emergence of China as a trade rival, leaving the euro area more vulnerable to shifts in the yuan than in the yen.

* * *

The ability of U.S. college graduates to find jobs may depend on where they’re looking, according to the Federal Reserve Bank of New York.

Seeking employment in bigger cities, where there are more employers and employees, can give people a better chance of matching their skills to a job, economists Jaison R. Abel and Richard Deitz said May 20 on the Fed bank’s Liberty Street Economics blog.

Their research showed the probability of a college graduate working in a job requiring a degree increases to 64.5 percent from 61.1 percent when the population size of a metropolitan area increases to the 99th percentile from the 55th percentile nationally.

This implies a college degree-holder finding a job is about 6 percent more probable in a place like New York City than in, for example, Syracuse, New York.

“The larger and thicker local labor markets of big cities appear to help college graduates find better jobs by increasing both the likelihood and the quality of a job match,” said Abel and Deitz.

* * *

U.S. employment is 1 percent weaker than the level suggested by a popular economics’ rule of thumb, meaning about 1.2 million people can’t blame their lack of work on the weak recovery.

That’s the conclusion of a paper published this week by the National Bureau of Economic Research, which looked at Okun’s Law. Created by the late Yale University professor Arthur Okun, it maps a statistical relationship between gross domestic product growth and changes in the jobless rate.

The findings suggest more than 1 million of the jobs lost since the end of the 2008-2009 recession can’t be attributed to cyclical factors. That challenges the view of some Fed officials, including Bernanke, who question the assertion that the economy is suffering from structural shifts that permanently lift unemployment.

“Eliminating this shortfall will depend upon the implementation of measures that improve the workings of the labor market, as well as other government policies that raise the natural rate of unemployment,” said Menzie D. Chinn of the University of Wisconsin, Laurent Ferrara of the Bank of France and the University of Paris Ouest’s Valerie Mignon.

* * *

A 17 percent slide in Japan’s working-age population over the next two decades is forecast to swamp policy maker efforts to propel the world’s third largest economy out of deflation.

In a May 20 report, Carl Weinberg of High Frequency Economics said fewer workers will make it harder for Japan to service a debt he predicts will grow unabated over the next 17 years. An increase in the ratio of retired workers to 32 percent of the population from 23 percent now means those who are working in 2030 will also have to give up more of their incomes to support retirees.

The need to finance public debt and help the old will mean investment will extend its decline of the last 15 years, said Valhalla, New York-based Weinberg. Writing three days before the Nikkei 225 Stock Average took its biggest one-day plunge since 2011, Weinberg said the benchmark index also will continue its 23-year decline.

“Demographics doom Japan to dismal deflation and economic depression,” he said. “This is no place to bet on equities in the long term.”

* * *

Long recessions can erode more than the skill of workers. They can also sap their work ethic.

A model of “social hysteresis” designed by Wolfgang Lechthaler and Dennis J. Snower of the Kiel Institute for the World Economy shows that without a job, people’s incentives to seek and retain employment fall. That in turn undermines their ability to secure fresh positions.

They based their analysis on what they called elite workers, who tend to like to work and are unhappy to be out of it. They therefore are more likely to be employed than less-educated, who are less likely to enjoy work.

“The deterioration of employment prospects during a deep, prolonged recession might induce some elite workers to lose their pro-work ethic,” Lechthaler and Snower said in the study, which was published this week by the London-based Centre for Policy Research. “In this way, temporary recessions may come to have permanent effects on aggregate employment.”

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