Hurry up and wait. Hurry to the announcement by the Federal Reserve Board’s monetary policy committee, and then wait for the next one. After 2,417 days of keeping its key interest rate at zero, on Wednesday of last week the Fed policy team decided that a few more weeks or months at that level might be a good idea. The Fed knows that zero is not a sustainable level for interest rates, but also wants to be certain it doesn’t abort the none-too-robust recovery. My guess is that Fed chairwoman Janet Yellen knows she has to move soon, but figured that doing so right before key data releases in the next few days and next week just wasn’t worth the risk of announcing an increase and then wishing she hadn’t. She was quickly proved right.
The day after the Fed announcement the Commerce Department reported – preliminary, to be revised -- that the economy expanded at an annual rate of 2.3 percent in the second quarter, and that its first-quarter estimate of a 0.2 percent decline had been revised to a positive 0.6 percent. The good news is that consumers have returned to the shops and the malls to share with some of their savings from lower petrol prices with retailers. In part this consumer bonanza is the result of falling energy prices due to the fracking revolution and the return of Iran to the oil market as a major seller offering discounts in order to regain market share from its sworn enemy, Saudi Arabia.
The less good news, and more important from the point of view of the Fed, is that business spending on equipment and on structures remains weak, falling at annual rates of 4.1 percent and 1.6 percent, respectively. Most economists do not believe that consumers alone, even though they account for about 70 percent of GDP, can propel the economy forward at an annual rate much above, or even at 2 percent if business spending continues to weaken. Even if consumers continue to spend, and even if the economy continues to grow at the rate of 2.3 percent for the final two quarters, the year will come in at a bit below 1.9 percent, not exactly a boom calling for interest rate increases to avoid impending inflation.
Then came more bad news for the Fed, which had trumpeted “solid job gains” as a sign the labour market was sufficiently improved to support a rise in rates. Not so fast. On Friday the Labor Department reported that wages and salaries had increased a mere 0.2 percent in the second quarter, the smallest increase since these data were first recorded 33 years ago. “The numbers … are atrocious”, commented Eric Green, chief economist at TD Securities. The Fed will know more on Friday when the latest jobs report is published, but if wage growth is one of the indicators of a robust labour market, Yellen will have some difficulty using conditions in that market as a basis for a rate increase this year.
The Fed’s second condition for raising rates is a rise in the annual inflation rate to 2 percent. The central bank’s preferred measure of inflation had risen a mere 0.2 percent in the twelve months ended in May, but perked up to a 1.8 percent annual rate for the second quarter, excluding the volatile food and energy components. The policymakers’ problem is that with oil prices more likely to fall than to rise during the remaining half of the year, and with China’s economic difficulties driving down its commodity purchases and commodity prices, inflation is not certain to reach the Fed’s 2 percent target. Which is how economists at the International Monetary Fund see things. Nigel Chalk, the IMF’s US mission chief says, “Right now, we see inflation indicators actually declining in the US…. So we feel that there’s some space for them to wait and see more wage and price inflation before moving.”
Yet 15 of the 17 members of Yellen’s policy group, have expressed a desire to raise rates this year. If they do, they will have to argue that recent soft wage data are an aberration, and that inflation will head up when coming wage increases drive the inflation rate to 2 percent.
Inflation as a statistic and inflation as a reality in the lives of consumers are often very different things.
· For the elderly, the soaring cost of health care and medications is the relevant fact of life, the fall in the price of computers and sports equipment is of lesser concern.
· For workers who commute long distances, the drop in the price of petrol is what matters; for stay-at-homes, rapid increases in the cost of cable and satellite services remain a troubling problem.
· For those who own their own homes, low interest rates keep the cost of variable-interest rate mortgages at attractive levels; for renters, current rapid increases in rents are the more relevant phenomenon.
But for the Fed, reality is its index. As is pressure from congressional Republicans to begin raising rates lest new housing and stock market bubbles put paid to the current economic recovery. Were Yellen to continue to keep rates at zero, and an asset bubble to form and burst, political pressure to audit the Fed, in effect to reduce its independence, might become irresistible. After all, conservatives worried about another bubble, and Democrats who have always wanted to bring the Fed to heel are a lethal combination from the point of view of Fed independence and Yellen’s reputation.
The Fed will have opportunities to decide how to navigate the reefs and shoals as it sails into 2016 when its monetary committee meets in September, October and December. The betting at mid-week was on September or at the latest December. By week’s end, virtually stagnant wages and low inflation had the odds moving to March 2016, unless the economy does more than amble along at its current moderate pace. Which it might do if the housing and auto sectors continue their stellar performance. A modest 0.25 percent rate increase would not curtail demand for bigger houses with bigger garages to accommodate the bigger cars consumers are snapping up, and would satisfy critics fearful of another asset bubble. But if imposed this year it would require some artful explaining.