U.S. monetary policy is usually about as interesting as watching tumbleweeds on a calm day. Most people just don’t pay attention. For evidence, a recent poll showed three-quarters of Americans have no idea who Janet Yellen is.
Yellen and the Fed have been in the news quite often lately as policymakers decide when to raise interest rates. Right now, as part of an extended plan to help the economy, rates are near zero. Some people think this policy is a good idea, others believe it’s really, really bad. No matter, whenever the Fed does hike rates, the decision will have a major effect on the stock market, banks, home buyers and sellers, as well as business owners looking for capital.
The Fed is in a tricky spot. With the economy improving over the past 15 months, an incremental rise in rates would be reasonable. The labor market has rebounded well and it’s become common for private sector job growth to average over 200,000 positions each month. Inflation, while not at the Fed’s annual 2% target, is happening – just go buy a few things at the grocery store and look at your bill. Higher rates tend to keep inflation in check, which is why the Fed watches price indices so closely.
This begs, then, the obvious question: If labor and inflation support a hike, why should the Fed hold back on raising rates? Well, for starters, the first quarter looks like it was a difficult three months for GDP. Blame it on the snow, the West Coast port logjams or whatever political party you don’t like – the reality is Q1 GDP growth might be nada. In fact, recent quarterly GDP growth in the U.S. is averaging about 2.5%, which is pretty weak. The concern is that this low-growth trend is part of a longer-term, stuck-in-a-rut cycle.
Besides a flat-lining GDP, another reason for the Fed to sit tight is because wage growth is anemic. The last jobs report showed wages increasing, on average, by just three cents in the U.S. in February. Economics 101 teaches you the economy is driven by consumers buying stuff. They can’t buy more stuff unless they have more money to spend.
A third good reason for Fed patience was outlined recently by former Treasury Secretary Larry Summers. “Several countries, including the U.S., have paid the price for raising rates prematurely,” Summers said. “The Fed was itching to get out of abnormal monetary conditions in 1937, and it produced a recession that made the Great Depression seem great. In Europe, in 2011, they felt the need to normalize monetary conditions, even though inflation hadn’t taken off. They ended up regretting it.”
This is, frankly, an unusual time in the history of global economics. U.S. corporations and consumers are being cautious with their money. The middle class in America is getting poorer. The nation with the world’s largest economy, China, cannot sustain its growth and prefers to manipulate its currency rather than let the free market dictate its value. And Europe is pulling out of recession only because it copied U.S. quantitative easing policy. One wrong move by the Fed this summer and rest assured a lot more people will know who Janet Yellen is – and it won’t be pretty.