Double problem – Econlib

Today’s jobs report contained two pieces of information that suggest the policy may be a bit too expansionary. First, payroll employment rose more than expected by 272,000. (The household survey was weak, but that data is considered less reliable.) Second, nominal wages rose 0.4% (an annual rate of almost 5%). If you think in terms of the Fed’s dual mandate, both data point to it lightly. things are tilting toward the view that the policy is too expansive. That doesn’t mean we can be sure that policy is too expansionary, just that this statement is now more likely to be true.

The 10-year T-bond market responded with a sell-off, meaning longer-term yields rose:

Markets are currently anticipating a Fed rate cut later this year. This may happen because inflation is declining, or because the real economy is in danger of sliding into recession. Today’s news made both outcomes seem a little less likely. Wage inflation averaged 4.1% over the past twelve months, a rate that is inconsistent with the Fed’s price stability goals, even if you define price stability as inflation of 2%. Over time, wage inflation tends to be about 1% to 1.5% above price inflation. Unfortunately, progress in reducing wage inflation appears to have stalled over the past ten months. The next two or three lectures will be very important.

I don’t have a strong opinion on where the Fed should set its interest rate target at this point. I have strong views on past monetary policy, which has been far too expansionary over the past three years. The longer these policy overshoots last, the stronger the case for moving to a policy regime that targets a certain level, with the Fed committed to correcting previous policy mistakes. I thought that was what they were planning to do in 2020, but it turns out that the “average inflation target” was not an accurate description of their new policy regime.

This post is titled “double trouble,” even though the payroll employment figure could be considered good news. The figures are problematic for a Fed that appears to be hoping it will soon be able to cut its target interest rate. In my opinion, it is a mistake for the central bank to favor lower interest rates, just as it was a mistake for the Fed to favor higher interest rates in 2015. They should not favor lower or higher interest rates; they should promote macroeconomic (nominal) stability. Let the market decide what kind of interest rates are consistent with macro stability.

P.S. This comment in theft caught my eye:

Jason Furman, a former administration official now at Harvard University, said the increase in unemployment could be the most important part of Friday’s data release.

“If we wake up next month and the unemployment rate is 4.1 percent, I think that will happen [the Fed’s] attention,” Furman said. “If you have unemployment above 4, an interest rate cut would come into play sooner.”

In the 1970s, the Fed assumed that rising unemployment was a sign of insufficient money. That was not the case. The Fed should never focus on the unemployment rate, because no one knows exactly what the natural unemployment rate is at any given time. The Fed should focus on a nominal variable, preferably nominal GDP. It is often true that rising unemployment is a signal that easier money is needed, but not if the NGDP is growing at 5%.