If you wanted to boost economic growth, which of the following would you focus on?
- U.S. corporate taxes, which are the world’s highest and are driving businesses to relocate abroad
- A regulatory environment in which new regulations are being issued at a record pace; for 2015, the Federal Register contained a record 81,611 pages of new regulations
- Record government debt, which now exceeds $19 trillion
- Falling household income, with wages down an average of 5.9% since 2007
- Corporate profits, which fell 5.1% in 2015
- Low productivity growth, with the average growth rate less than a third of what it was during the previous period of 1995 to 2010
- The fact that, for the first time ever, more companies are failing in the U.S. than are launching
- The fact that, with a dearth of initial public offerings, there are half as many public companies as there were in the 1990s
- Low inflation
Regulations have been the one growth industry during the Obama Administration. Above is a copy of new federal regulations for 2015.
If you picked low inflation, congratulations. There is a place for you on the Federal Reserve Board.
The Fed’s focus on inflation is a result of its mandate to reduce or stabilize the unemployment rate and the rate of inflation. But its seeming obsession with a 2% rate of inflation is nonsensical. As we’ve pointed out, 2% appears to be an arbitrary number. Will the economy function better if the inflation rate is 2% instead of 2.5%? Why not 1.5%?
Martin Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, wrote in The Wall Street Journal this week that it’s nearly impossible to measure the true rate of inflation, given that the rapid pace of technological change makes today’s products much different than the products of even a year or two ago. How do you compare today’s smartphone with your previous cellphone? And if you can’t compare the two products, how can you determine how much prices have changed?
“The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980,” Feldstein wrote.
In the meantime, by keeping interest rates near zero in an effort to achieve its arbitrary inflation level, Feldstein argues that the Fed is subjecting the economy to much greater danger than low inflation.
“The S&P 500 price-earnings ratio is more than 50% above its historic average,” he notes. “Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.”
What Happens When Rates Rise
So will the Fed do the right thing and normalize interest rates? And, if it does, what impact will that have?
We caught a glimpse of what to expect last week. The stock market stumbled, as investors fretted that the Fed may actually do what it should have done years ago.
Just days after traders in futures markets concluded that there was no way, no how, no chance that the Fed would give short-term interest rates a boost at its midyear meeting, as The Wall Street Journal reported, “a batch of strong economic data, recent comments by Fed officials and a new release by the central bank on the deliberations at its last policy meeting have changed that perception.”
The Fed’s minutes report, “Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen and inflation making progress toward the [Fed’s] 2% objective, then it likely would be appropriate for the [Fed] to increase the target range for the federal funds rate in June.”
A few days before the minutes were released, traders put the probability of a June rate increase at just 4%. After the minutes were released, the probability rose to 34%. By late Wednesday, traders put a 56% probability on a move by July, up from 20% on Tuesday.
The lesson here is, don’t believe what you hear from the pundits. Media have been spreading news of the economic boom for years now. Consider this March quote from the economic cheerleaders at CNBC: “The United States added 242,000 jobs last month, far more than expected and the unemployment rate stands at 4.9 percent, near full employment. A total of 14.3 million private-sector jobs have been created since 2010. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, has also strengthened, posting for January its largest gain in 10 months.”
And yet the economy grew at an annualized rate of just 0.5% during the first quarter. Growth in gross domestic product (GDP) is the true measure of how well the economy is performing. And, based on the evidence, it is not performing well at all.
Given that the economy is practically, if not actually, in a recession—and, even more to the point, given that it’s an election year—don’t be surprised if the Fed continues to keep rates where they are. It can continue to use inflation as a red herring if it does.
Leading From Behind
“Leading from behind” has been an expression used to define President Obama’s foreign policy, but it’s also an accurate description of his economic policy, as he has passed along economic stewardship to the Fed, rather than working with Congress to solve the country’s economic problems.
The Fed does not set tax rates. It can’t deregulate and it has no control over government spending. The Fed controls monetary policy, which it uses to control interest rates and the value of the dollar (and, at least in recent years, to manipulate the stock market). By controlling the money supply, the Fed can have an impact on both the unemployment rate and the rate of inflation, but, as it has demonstrates throughout the Obama presidency, it can’t create economic growth. That’s the president’s job.
Given that the economy has been left in the hands of the Fed, it’s no wonder, that—barring an unforeseen surge—President Obama will be the first president in U.S. history to not have a single year in which economic growth exceeded 3%.