Fed's Mission Is Accomplished. So Why No Change?
The Fed's mission is accomplished -- unless it has some ulterior motive. Thursday we saw jobless claims hovering near a 40-year low, so employment is thriving. Friday's data showed that consumer price inflation was continuing to firm and that retail sales were strong.
All of which points to: mission accomplished. The strong and growing level of wage growth along with continued declines in labor slack suggest that full employment has essentially been achieved. Even U6, the most broad-based measure of unemployment and underemployment, is now at the same levels it was at in the summer and autumn of 2004 when the Fed began an aggressive rate tightening cycle.
Most measures of core inflation -- core CPI, Cleveland Median CPI, and Cleveland trimmed mean inflation -- are at or above 2 percent. The one exception, of course, is the Fed's preferred measure of inflation, core PCE. If the Fed makes monetary policy in order to achieve dual goals of full employment and 2 percent inflation, which is its mandate and what it communicates to the public, then the course is clear.
However, it's questionable that this is actually what the Fed has been up to in recent months. Increasingly it seems the Fed is deferring to market rates in the Treasury market and to always-nebulous global concerns. But what's the harm in the Fed being "behind the curve"? We saw that last week as well: Earnings reports from JPMorgan, Wells Fargo and Citigroup showed the banks' loan growth was dragged down by continued low interest rates.
This dovish monetary policy is a predictable pattern from policy makers whose formative years included the crises of 1997-98 and 2007-9. It's a mentality geared to prevent the crises we've lived through and understand rather than unknowable ones from the future. But artificially low interest rate policy has clear costs.
First, while nobody will cry for banks, ultra-low rates continue to pressure bank earnings as net interest margins continue to compress. It's hard to argue that suppressing bank earnings is the way to stimulate credit expansion. Second, low rates harm pension funds and insurance companies, which are some of the primary buyers of fixed-income products. Perhaps low interest rates reduce the risk of a financial crisis but increase the risk of a pension fund solvency crisis. Because we've experienced the former but not the latter, the former is given more weight. And if insurance companies can't earn an adequate return on their investments, they'll be forced to increase costs and reduce product offerings to customers, including households.
And it's households, perhaps surprisingly, that might be bearing the brunt of Fed monetary policy at this point in the cycle. Early on in the recovery, low interest rates allowed households to refinance high-cost debt and supported the housing market. Now, however, high-cost debt has been refinanced, and the housing market's biggest issues are insufficient inventory and construction labor shortages. Low interest rates just mean that households have to save more for retirement than they would if interest rates were higher, detracting from consumption.
Perhaps most disturbing is the impact current monetary policy is having on the dollar, and hence a tradeoff being made between households and corporations. As my colleague Matt Busigin explains, by holding interest rates in the U.S. lower than they otherwise would be, the Fed is keeping the dollar weaker than it otherwise would be. This makes imported goods more expensive to U.S. consumers than they otherwise would be. And who does the weak dollar help? U.S. corporations that sell abroad, which also are benefiting from low interest rates by borrowing money to fund stock buybacks. Current monetary policy is effectively a wealth transfer from U.S. households to multinational corporations. Is that really what the Fed wants to accomplish?
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