Fed Rate Hike Will Harm US Economy, Why Don’t Candidates Seem To Care? – OpEd


There was something for everyone in August’s US jobs report. The headline figure for jobs growth was less than expected, but the last two months were revised up. Wages grew, but the number of people out of the workforce remains worryingly high. What’s a central banker to do? Sadly the answer is exactly what they want to do, and no one—not even Donald Trump—seems to think that’s an issue.

At their annual retreat in Jackson Hole last month, several top officials of the Federal Reserve board reiterated their desire to raise interest rates, even if the recent market turmoil may have put these plans on hold for the moment.

The basic point remains the same: these officials argue the labor market is approaching full employment and they need to hike interest rates to slow the rate of job growth. If the economy keeps creating jobs at a rate near 200,000 a month, they say, we will soon have problems with inflation.

This case seems so far removed from reality that it borders on absurdity. While the unemployment rate is relatively low at 5.1 percent, the percentage of the population that is working is still down more than three percentage points from its pre-recession level. This implies that we are still 3–4m jobs below the trend path. Contrary to those who blame this drop on ageing baby boomers, even the employment rate of prime-age workers (ages 25–54) is down by nearly the same percentage.

There are two explanations for this sort of fall-off. One is that millions of thirtysomethings decided to retire early. The other is that the labor market is still very weak, leading millions of people to give up looking for jobs—they are then no longer counted as being unemployed. The Fed is apparently not choosing the commonsense explanation.

The inflation theory doesn’t make the case for a Fed rate hike look any better. The Fed is officially committed to maintaining an average inflation rate of 2 percent. The rate it targets has averaged less than 1.5 percent over the past seven years. This means that inflation could average almost 3 percent for the next four years and still leave the Fed on target. By contrast, inflation was just 1.3 percent over the past year.

The Fed’s plan to slow the economy will not only affect jobs, it will also reduce the ability of workers to secure wage gains. The tightness of the labor market has a huge impact on the bargaining power of workers at the middle and bottom end of the wage distribution. When we get tight labor markets, factory workers, retail clerks and fast-food workers have some choice of jobs. They can tell employers that if they don’t get pay increases, they will get another job.

The only time most workers saw substantial wage gains in the past four decades was during the low unemployment years of the late 1990s. If the Fed raises rates, it will be acting to ensure that workers don’t get to enjoy this bargaining power, meaning that most workers will not share in the gains of economic growth.

The really striking part of this story is that the Fed is crafting its plans for slowing job creation and damping down wage growth in the middle of a presidential campaign. There are almost two dozen candidates chasing after votes, most of them promising economic plans that will create jobs and boost wages.

Yet not one of these candidates has said anything about the Federal Reserve. This is like making plans to remodel an apartment building without taking note of the wrecking ball that is hanging in front of it. If the Fed slams on the brakes with higher interest rates, even the most brilliant plans for infrastructure improvement or tax incentives won’t be effective in creating jobs. As we have seen over the past seven years, the Fed can’t always boost the economy as much as it might like with lower interest rates, but it certainly can slow the economy by raising interest rates high enough.

If the presidential candidates are actually serious about creating jobs and strengthening the labor market, they should be talking about the Fed. While no one would expect the president to micromanage the board, it is certainly reasonable for the candidates to be talking about the sort of people they would appoint to the Fed in the same way that they would talk about the sort of people they would appoint to the Supreme Court.

The problem is that the Fed is a regulatory agency that has gone badly off the rails. It would be as though the Food and Drug Administration were refusing to approve cancer drugs that our best scientists recognized as safe and effective, even as tens of thousands of people died of cancer. If the presidential candidates are serious about strengthening the economy, they better start talking about getting the Fed back on track.

This article originally appeared in the Guardian and is reprinted with permission.

Dean Baker

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy.

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