Yellen Channeling Slick as Surrealistic Economy Shows ’67 Claims

By Victoria Stilwell and Jeff Kearns  

Photographer: Andrew Harrer/Bloomberg

Janet Yellen, chair of the U.S. Federal Reserve.

The U.S. labor market is looking a little surreal these days.
Take the number of workers filing claims for unemployment benefits. As a share of the population, it’s the lowest since at least 1967 -- the year Grace Slick and her Jefferson Airplane bandmates dropped drug references in the San Francisco-spawned album Surrealistic Pillow, and 37 years before Janet Yellen became president of the region’s Federal Reserve bank. Yet the ranks of the long-term unemployed remain larger than at any time before the 2007-2009 recession.
That leads to two starkly different views of the U.S. economy. In one, job growth is increasing along with inflation, leaving Yellen, now at the helm of the U.S. central bank, behind the curve with recession-era monetary policy still in place. The other view portrays
a fragile recovery that owes its modest gains to the Fed’s near-zero interest rates. The job-market contrasts are dividing economy-watchers on when the Fed should start raising rates, which it hasn’t done since 2006.
“The difference of opinion is whether we’re in a state that’s about as good as it’s going to get or whether we’re in a very poor state, but with good policies and a bit of luck we’ll be able to do a lot better,” said Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel prize in economics. “Whether you can or not, of course, depends on circumstances and changes in the structure of the economy.”

Significant Slack

Even with employment rebounding, Yellen has cautioned it still may be too soon to start withdrawing accommodation. She will give the keynote speech to the Kansas City Fed’s symposium in Jackson Hole, Wyoming, on Aug. 22. The three-day gathering of central bankers begins a day earlier with the topic of “Re-evaluating Labor Market Dynamics.”
Testifying to lawmakers July 15, Yellen said the recovery is incomplete and slow wage growth signals “significant slack” in labor markets.
Yellen said the central bank has no “mechanical answer” for when to raise rates, and that before doing so, policy makers must be certain the economy is on a solid footing. While her overall view is positive, she said there are still “mixed signals” and “we have in the past seen sort of false dawns.”
The strength in jobs data in recent months is adding to Yellen’s challenge, as a growing chorus of economists says the Fed hazards overshooting its inflation target or stoking bubble-like conditions in risky assets by maintaining such easy monetary policy. The central bank has held its benchmark interest rate near zero since December 2008 and purchased assets that have ballooned its balance sheet to a record $4.4 trillion.

White Rabbit

The four-week moving average of initial jobless claims fell to 0.12 percent of the population at the end of July. That’s the lowest level in data going back to 1967, when Slick’s psychedelic hits “White Rabbit” and “Somebody to Love” carried the band’s Bay-area sound across national radio waves.
Jobless claims climbed by 21,000 to 311,000 in the period ended Aug. 9, a Labor Department report showed yesterday. While the level was the highest in six weeks, it’s well below the average 368,200 over the last three decades.
Separate reports this week showed job openings climbed to 4.67 million, the most since February 2001, while the number of people getting jobs rose to a six-year high. Payrolls added 209,000 jobs in July, the sixth month in a row that employment grew by 200,000 or more. That’s the first time that’s happened since 1997.

Inflation Target

Other data show a pickup in growth. Inflation has been inching toward the Fed’s 2 percent target, with the central bank’s preferred gauge at 1.6 percent for the 12 months ended in June. Gross domestic product rose at a 4 percent annualized rate in the second quarter to match the average pace of growth in the latter half of 2013, which was the best six-month stretch in a decade.
By pressing on with easy money policies in the face of such data, the Fed is playing “a very dangerous game,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. “What are you waiting for? Everything to get back to the cyclical peak to take rates off of zero?”
J. Alfred Broaddus, president of the Richmond Fed from 1993 to 2004, said while the risk of getting behind the curve on raising rates is increasing, “this is a different world” with economic data harder to interpret than ever before.
“If I were there now I would be conflicted,” Broaddus said. “This is a difficult time and there’s a lot that’s unprecedented here.”

Fed’s Outlook

Most Fed officials forecast they will need to raise the benchmark rate sometime next year. The median estimate of policy makers released after their June meeting shows they project a rise to 1.13 percent at the end of 2015 and 2.5 percent a year later. The next projections, due for release Sept. 17, will include their first forecasts for 2017.
St. Louis Fed President James Bullard said July 17 the Fed may have to raise rates more quickly than planned and that it’s “closer to its macroeconomic targets today than it has been most of the time since 1960.” Bullard, who doesn’t vote on policy this year, said the key rate should rise at the end of the first quarter of 2015, depending on economic data.
Philadelphia’s Charles Plosser voted against July’s FOMC statement because its pledge to keep rates low for a “considerable time” doesn’t take into account progress toward Fed objectives. Richmond’s Jeffrey Lacker, a critic of the Fed’s record easing who votes on policy next year, said in an Aug. 1 interview investors may underestimate how fast rates will rise.

First Increase

The target overnight bank lending rate will first increase to 0.5 percent after the Fed’s July 2015 meeting, according to the median of economists’ estimates in a Bloomberg survey. That’s two months sooner than economists had projected in a survey last month.
Fed funds futures show investors expect the first increase in borrowing costs will come in October 2015.
The Fed is on pace to wind down its third round of asset purchases in October of this year after two years of buying Treasury and mortgage securities. Officials in July tapered monthly bond buying to $25 billion in a sixth consecutive $10-billion cut.
Fed Vice Chairman Stanley Fischer said Aug. 11 the U.S. recession “left the road ahead unclear” for policy makers who are struggling to gauge labor market slack. Weakness in housing markets, drag from government budget cuts and slowing global growth are “prominent factors that have constrained the pace of economic activity,” the former Bank of Israel governor and World Bank chief economist said in his second speech since joining the Fed in May.

Full Recovery

As a result, it’s important that the economy has fully recovered before monetary policy is tightened, economists such as David Blanchflower argue. With limited tools available to combat another recession, the consequences of raising rates too early outweigh those of tightening too late.
With rates remaining low, “the worry people say is that if you carry on doing this, there will be a potential collapse in 10 years’ time,” said Blanchflower, a former Bank of England policy maker who’s now an economics professor at Dartmouth College in Hanover, New Hampshire. “And the alternative is, ‘Yeah, but there would be a collapse now if we stopped.’”
Some 3.16 million Americans had been unemployed for 27 weeks or longer in July. While that’s less than half of the 6.77 million peak reached in April 2010, it’s still higher than any pre-recession level.

‘Unambiguous Signal’

It’s still unclear just how much slack is left in the economy, and “the only way to find out is to continue aggressive easing until the labor market actually gives us an unambiguous signal one way or the other,” said Brad DeLong, an economics professor at the University of California at Berkeley. “Nobody really knows what the state of the labor market is.”
Many in Yellen’s camp point to stagnant wages as a sign of continued slack in the labor market that gives the Fed room to maintain its supportive stance.
Average hourly earnings rose 2 percent in July from the year before, matching the mean increase over the last five years and down from 3.1 percent in the year ended December 2007, Labor Department data showed in the latest employment report. Separately, the employment cost index also rose 2 percent in June from the previous year.
“Wage growth is way below normal right now,” said Ethan Harris, co-head of global economics research at Bank of America Corp. in New York.
Reaching full employment will ignite a slow rise in wage and price inflation, which is easier for the Fed to control than long-term unemployment, Harris said.
“It gives the Fed the time to watch,” he said. “If they do make a mistake, the cost is low.”