What the Fed Should Do Next
They know what they need to do.
If the Federal Reserve was looking for reasons not to raise interest rates when its policy-making committee meets later this month, it now has two. Today's new and surprisingly weak U.S. employment numbers, added to investor anxiety about a possible British exit from the European Union, make a plausible case for leaving short-term interest rates unchanged.
That would be a mistake. The Fed needs to step back and consider. A British exit and volatile U.S. jobs numbers notwithstanding, the balance of evidence continues to shift. The case is strong for moving monetary policy back toward normal -- gently but purposefully, and without further delay.
The U.S. labor market is hard to read. Employers added just 38,000 jobs in May -- surprisingly low, even allowing for the fact that the figures are volatile and a strike at Verizon kept 35,000 workers off the monthly payroll count. On the other hand, the unemployment rate, reflecting exits from the labor force, fell to 4.7 percent, suggesting a pretty tight market. Pay was up as well, for an increase of 2.5 percent over the previous year.
These conflicting numbers make it hard to measure slack in the labor market -- hence the scope for boosting output and employment through further stimulus. The main question is how many of the workers who've stopped looking for jobs would get back into the labor market if employment opportunities improved. The evidence suggests that a diminishing but still significant number of people would do so. This is the case for keeping monetary policy loose.
Bear in mind, though, that monetary policy is currently extremely loose by any conventional measure, and still would be if the policy rate was raised another quarter-point. Very low interest rates and a massively expanded central-bank balance sheet (thanks to a prolonged spell of quantitative easing) are distorting asset prices and creating problems for the future. What's more, as a way to stimulate demand, they seem less and less effective.
In short, the case for maintaining stimulus is strong, but the case for doing it with monetary policy isn't.
Ideally, the U.S. would normalize its economic policy by combining fiscal stimulus with a more cautious monetary policy. The country badly needs to repair and improve its infrastructure. Borrowing for that purpose would be good for the economy and, under current conditions, easily affordable. The Fed doesn't control fiscal policy, but it can and should signal that it's no longer willing to carry the whole burden of reviving the economy, and that the balance of fiscal and monetary stimulus is dangerously out of kilter. It needs to avoid the suspicion that it's dithering and that super-low interest rates will be available indefinitely.
Despite Britain's possible exit from the EU and the jobs numbers, this month's meeting of the Federal Open Market Committee would not be too soon to send that message.
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