Federal Reserve (Fed) Chairwoman Janet Yellen spoke at the annual Fed meeting in Jackson Hole, Wyoming on Friday. The focus of the conference this year was the labor market. It was a middle of the road speech meant to disrupt markets as little as possible and still indicate the Fed is moving as planned and carefully watching data developments related to inflation and employment.
The Fed Chair was more candid than usual in revealing the challenge the Fed is encountering trying to determine the cause for stubbornly weak job growth. The Fed can’t yet determine the degree to which the high rate of long-term unemployment and the low labor force participation is a cyclical problem or a structural one. While the headline unemployment rate has improved, significant slack remains in the labor market. If the Fed decides the problems in the labor market are cyclical they can make the case for continuing their zero rate interest policy and asset purchases. If however, the Fed decides the problems are structural they can normalize rates and turn the spotlight towards the failure of fiscal policy.
The Fed is legally compelled by the U.S. Congress to maintain full employment in the economy. Full employment is assumed achieved when the headline unemployment rate is somewhere between 5.2 to 5.6 percent. This level is determined by both the Fed’s inflation rate target and the central tendency of the unemployment rate during U.S. economic expansions since 1945. The subtle point Fed Chair Yellen was trying to make in her speech Friday was that structural barriers to job growth resulting from public policy coming out of Washington, D.C. has reduced the Fed’s ability to achieve the full employment unemployment rate at or around 5.4 percent.
NAIRU, the non-accelerating inflation rate of unemployment, a full employment measure, is today likely to be somewhere well above 5.6 percent. This is what the Fed has to determine. A determination in the affirmative will expose the truth of the failings of our elected representatives in Washington, D.C. and in state houses across America. This is a delicate matter for the Fed as they get the legal basis for existence from the Congress. Fed officials already recognize the Big Bad Wolf reputation they’ve been stuck with since 2007. Even so, Yellen’s comments on Friday where more directed than usual in conveying the sense the Fed has; they’re pushing on a string. The zero interest rate policy and asset purchases can’t compensate for the negative employment impacts of too much immigration, too much debt, too many imports, too many regulations, too little quality education.
By the end of her speech it was clear the Fed is following their plan, data dependent and moving towards higher interest rates and normalization. The Fed has accumulated a massive balance sheet, printing more than $3.4 trillion since 2009. The Fed has few bullets left to stave off any unexpected economic downturn at the moment. They have to quickly begin to normalize rates and reduce their balance sheet if monetary policy can be depended upon to prop up aggregate demand when needed in the future.
The underlying message from Yellen’s speech is correct. Structural barriers to American strength and prosperity as result of policy coming out of Washington, D.C. over the past 45 years have finally been exposed by the weakest economic recovery the U.S. has experienced since WWII. The Fed has to begin to normalize interest rates and reduce their balance sheet. It is increasingly likely it will have to do so before they achieve a full employment rate of 5.4 percent as measured by the U6 unemployment rate.
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