Month: September 2013

The Bureau of Economic Analysis announced here that Q2 real GDP increased at a seasonally adjusted annual rate of 2.5%, according to the final estimate. Growth in private domestic investment was revised down from 9.9% to 9.2% and government consumption and investment expenditures were revised up from -0.9%to -0.4%. Growth in private consumption was unrevised at 1.8%, but slowed compared to last quarter’s 2.3% pace.

The revised data leaves the broad picture of the economy unchanged. Output, consumption, and income continue to grow at a modest pace. Employment and total hours are steadily growing, albeit slowly. Unemployment is creeping toward 6.5% (the Fed’s stated threshold to possibly, maybe, some chance of, increasing the funds rate) and initial claims dropped 5k, staying near the cycle low.

Not much is new. In fact, not much has really changed in the behavior of the economy since the start of the recovery in June 2009 (NBER’s official date). The graph below shows the series mentioned above, plotted as a percentage of their level in June 2009. From about 2011 onward, the growth rate of these macro ‘fundamentals’ has been pretty stable. GDP has averaged slightly above 2 percent growth (relatively slow compared to past recoveries); consumption has growth been slightly higher at 2.8%. In terms of household income, with the exception of the blip up in late 2012 as a result of the ending of the payroll tax holiday, growth has been steady also.

So, where does that leave the Fed? After the recent non-taper event, Fed officials hailed the move as a sign that the FOMC committee doesn’t follow market expectations, but is rather guided by the data. That data apparently told them that it wasn’t time to start pulling back on large scale asset purchases as a way to begin to unwind the Feds current bloated balance sheet but rather that more stimulus is still needed.

So lets get this straight: the market largely anticipated that the Fed would begin to taper its purchases in September; expectations which the Fed largely dictated with the language of its June FOMC meeting:

Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time. If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.

The Fed then decided to ‘go against’ expectations, because incoming data suggested stimulus was still needed. Here is what was said by Bernanke after the September meeting [emphasis added]:

The Committee anticipated in June that, subject to certain conditions, it might be appropriate to begin to moderate the pace of purchases later this year, continuing to reduce the pace of purchases in measured steps through the first half of next year, and ending purchases around midyear 2014. However, we also made clear at that time that adjustments to the pace of purchases would depend importantly on the evolution of the economic outlook—in particular, on the receipt of evidence supporting the Committee’s expectation that gains in the labor market will be sustained and that inflation is moving back towards its 2 percent objective over time.

At the meeting concluded earlier today, the sense of the Committee was that the broad contours of the medium-term economic outlook—including economic growth sufficient to support ongoing gains in the labor market, and inflation moving towards its objective—were close to the views it held in June. But in evaluating whether a modest reduction in the pace of asset purchases would be appropriate at this meeting, however, the Committee concluded that the economic data do not yet provide sufficient confirmation of its baseline outlook to warrant such a reduction.

As noted above, there has been almost no change in the rate of improvement in the macro data since 2011. So what exactly did change between the June and September meeting that caused the Fed to alter its stance? From the St. Louis Fed:

“The main macroeconomic surprise in the U.S. since September 2012 has been a lower rate of inflation,” [St. Louis Fed President, Jim] Bullard said.  He added that near-term inflation expectations measured from the TIPS market suggested little inflation pressure before the recent FOMC meeting.

“While I expect inflation to rise during the coming quarters, I want to see evidence of such an increase before endorsing less accommodative policy action by the FOMC,” Bullard said.

In June, they believed that ‘inflation [will move] back toward our 2 percent objective over time”. Now in September, they still believe inflation will continue to rise, but that since it remains below 2 percent, QE will continue.

With the addition of inflation to the threshold calculus it seems that “forward guidance” should no longer be in the vocabulary of Fed policy–as it now has little meaning to market participants beyond a dual mandate objective.

A good thought spoiled. Or was it a good thought at all? Sure, it was with the best intentions…but how could it be implemented? And where does the Taylor rule fit in to the forward guidance policy…a rule that calls for an increase in the funds rate?

Evidently, (of course) forward guidance it is not a rule at all, nor was it intended to be.

Where does this leave us? Well, the economy is continuing to recover. Unemployment is coming down, inflation is moving slowly toward the FOMC target of 2%. Not much different from a year ago…not much should be different in October or December. Will policy decisions remain the same? Well, we

”will closely monitor incoming information on economic and financial developments in coming months…’

 

Remember: you can always find the full ‘Snapshot’ of the US Economy here and on the main page.

A Few More Workers…

The BLS Employment Situation report for August indicates a 169,000 increase in total non-farm employment. The gain in August was in line with expectations (which weren’t very strong to begin with), but the report also included large downward revisions to June and July (-74K in total). This lackluster report essentially means that the FOMC will likely keep its head down for a while longer.

The employment gains in August mostly came from the Trade, Transportation, and Utilities (+65K) and Education and Health (+43K) sectors. The chart below shows the change in employment by industry with the width of each bar representing the share of that industry’s employment out of total employment.

…But Fewer Participants…

The household survey also reveals a drop in the labor force participation rate from 63.4 to 63.2. The unemployment rate was essentially unchanged at 7.3%.

The participation rate continued its decline, falling to a level not seen since August 1978. This decline raises an interesting question about the Fed’s “forward guidance.” It has been reported over and over that the Fed will keep its accommodative stance until the unemployment rate reaches 6.5%, the “threshold.” However, as many have mentioned this threshold is not a “trigger.” So, suppose the labor force participation rate declines by 1 percentage point, from 63.2 (green line in the chart) to say 62.2 (the orange line). According to the Federal Reserve Bank of Atlanta’s Jobs Calculator given that participation rate, how many jobs need to be created per month to get to a 6.5% unemployment rate one year from now? The answer is….the economy would have to create approximately ZERO jobs per month!! And if it fell to 62.0% would even have to LOSE jobs! Surely, no one would argue that the labor market has improved enough to begin the taper! While forward guidance may indeed have been somewhat instructive, it appears that it is providing very little, if any, information for the future stance of policy, other than: if things are “bad” we will continue our accommodative stance, if they are “good”, we won’t. Choosing simple thresholds, targets, triggers, to make things more transparent may help to provide a framework, but the markets want to respond to the vast and myriad details….like a poor jobs report, etc.

A portion of the decline in participation since 2008 (note, however, that participation started to decline in the late 1990’s/early 2000’s) is likely a result of discouraged workers leaving the labor force, but there are also demographic factors that decrease participation. For instance, changes in the age distribution have had an effect the overall participation rate. As a share of the civilian population, the share of people over the age of 55 has increased. Since these workers naturally have a lower participation rate, this reduces the participation rate in the aggregate, albeit the participation of those over 55 has actually increased.

It’s important to know exactly why participation has fallen, particularly because of its implications on the unemployment rate, which the Fed seems to be using as its sole measure of labor market health in its forward guidance, as San Francisco Fed President John Williams pointed out this past week [the emphasis is ours]:

“Clearly, the unemployment rate plays an important role in our thinking and communication about future policy. Therefore, an important issue is whether it is giving an accurate read on where things stand relative to our maximum employment mandate. […]

Over the past few years, labor force participation has plunged below 64 percent, a level not seen in almost 30 years. This drop in labor force participation explains how the unemployment rate can be falling while the employment-to-population ratio has been roughly stagnant. The overall ranks of the unemployed have been declining because many people are leaving the labor force, rather than finding jobs. But, it’s important to remember that much of this decline in labor force participation reflects demographic trends, such as retiring baby boomers leaving the workforce. In addition, in recent years, there has been a big exodus of young people and so-called prime-age adults. Again, some of this is related to ongoing trends, such as an increasing share of young adults enrolling in school, and workers moving onto disability rolls.

Nonetheless, a portion of the exodus from the labor market is due to the recession and slow recovery. It appears that unprecedented numbers of young and prime-age workers have been bailing out of the labor force because the job market has looked dismal. Many of these prime-age workers who have left the labor force say they want jobs and are available to work. But they don’t think they can find work, so they’ve given up looking and therefore they’re not counted as unemployed. Many of these people will probably return to the job market as conditions improve.

All this gets quite complex. On the one hand, we have structural trends, like the aging of the workforce and young people spending more time in school. On the other hand, we have the effects of a weak economy, that discourages people from looking for work. From the standpoint of gauging the state of the labor market for monetary policy, it is crucial that we distinguish between structural developments in the labor market and the effects of a weak economy.

The idea behind that last point is that monetary stimulus is meant to address the latter issue (a weak economy) and cannot influence ‘structural’ things such as demographic changes. That’s certainly true in some sense. No amount of stimulus can slow down the aging of the workforce. But, that’s not to say that some of the policy actions the Fed has taken alters the way structural changes influence the labor market.