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Fear of the Unknown at the Federal Reserve Bank of Philadelphia:
Submitted by Price on Sun, 08/03/2008 - 2:29am.
In June, there were 43,600 people officially unemployed in Philadelphia County. At 7% the unemployment rate in Philadelphia is now a full percentage point higher than in June of last year. As the U.S. economy goes so goes Philadelphia’s economy so the news that U.S. growth in GDP during the 2nd quarter came in slower than expected despite the economic stimulus is a worrisome development.
On Tuesday, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve will meet to set the federal funds rate. One of the current voting members of the FOMC is Charles Plosser the President of the Philadelphia Federal Reserve.
Plosser has called for the FOMC to “act preemptively” and begin raising the federal funds rate to slow the economy because he is concerned about containing inflation.
He believes that inflation is already too high and fears that unless the FOMC acts to raise unemployment further, wages will begin to rise in response to recent spikes in food and energy prices. Rising wages would in turn set off a new round of price increases and lead to a wage-price spiral.
There is one huge problem with Plosser's view, there is no evidence that wages are beginning to accelerate, to the contrary wages in recent months are growing more slowly which is precisely what you would expect when employment is falling. It is important to remember that wages are sticky and therefore don’t quickly adjust to current labor market conditions so Plosser could be worried that recent spikes in food and energy prices will show up in wages a year from now. But here again the problem is that an economic expansion just ended in which wages and incomes for all but the wealthiest failed to keep pace with the growth in prices. Indeed in the last two and half decades the only time there has been sustained and broadly shared wage growth was when unemployment rates reached historic lows in the late 1990s.
In a recent speech Plosser responded to this kind of criticism with the following argument:
“In recent months I have heard some analysts suggest that the current economic situation is not like the 1970s because unions are less prevalent and there is no evidence as yet of a wage-price spiral. Thus, a weak economy, with rising unemployment and declining payroll employment, will presumably prevent workers from demanding higher wages. But, again, that story has things backwards. It is not demands for higher wages that kick off the spiral, but the loss of confidence that the central bank will keep inflation controlled, which, in turn, leads to a rise in inflation expectations. The wage-price spiral is not the cause of the inflation, but the result. This means that if monetary policymakers wait until they see the evidence of a wage-price spiral, they will be too late — the public will have lost confidence in the Fed’s ability to keep inflation under control, and this will make the job of bringing inflation down much more costly and difficult.”
As Paul Krugman has explained Plosser is of the view that wage growth is influenced by the growth in consumer prices. So in his view if the central bank signals it will do nothing about rising prices, workers will demand from their employers wage increases that match or beat the rise in inflation which is the first step in a wage-price spiral.
The alternative view is that wage growth is shaped by trends in the labor market. This means that spikes in commodity prices will not translate into rising wages. It is of note that most workers nationwide and in Philadelphia have lost ground against inflation not in just the last six months but in the last six years.
Of course this is not an academic exercise, Plosser is aggressively advocating taking steps that would slow the economy and push unemployment higher in Philadelphia. He is doing this even as most economic indicators are signaling a worsening rather than improving economic situation.
Is it too much to ask that such a policy stance require more than a gut feeling? There is no evidence that inflation in food and energy prices has begun to seep into other prices in the economy. The economic and social costs of unemployment especially in a city like Philadelphia are substantial and should have significantly more weight than the fear that inflation might–someday–maybe–perhaps accelerate.
--Mark Price
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Price, you are making
a directly causal link between Plosser's attempt to "slow the economy" and increasing unemployment - to the point where you say proactively raising fed rates = "acting to raise unemployment."
First, out or curiosity, does he actually go so far as to say he wants to raise unemployment?
Second, aren't you making a bit of a jump there? For example, the economy has slowed recently but unemployment - in the admittedly inaccurate way that it is generally measured - on the whole has not increased significantly.
Just as I think Plosser's belief that inflation necessarily causes higher wages lacks any real logistical plausibility (employers raise wages when they think it will help them to make profits through attracting better employees, not because they have any stake in helping their employees better afford meeting their budgets), I wonder if there really is a direct correlation between rates of economy growth and employment rates - as you imply. As a general trend, obviously, there is lower unemployment when an economy is growing very quickly and unemployment is likely to be higher when an economy is completely stagnant or shrinking; but, as the situation in this country now suggests, when you have conditions that don't equal either of those extremes (e.g. slow growth as we have now), I would think that unemployment would vary fairly independently of economy growth rates.
I guess part of the reason why I'm asking this is because I've been pretty skeptical all along of the Fed's recent policies that are based on a calculation that it's worth it to risk higher inflation in order to stimulate investment. My feeling is that such policies reflect a bias towards helping Wall Street even when there's a risk of inflation because inflation disproportionately hurts people with lower income.
D.E.II sorry about the delay
Hi D.E. II, sorry about the delay. No, I don’t believe Plosser says that he would like higher unemployment.
Raising interest rates would raise the cost of borrowing for firms which slows business investment which slows the pace of job creation which leads to higher unemployment. I don’t think I’m being unfair by pointing out the expected outcome of a policy choice. Of course I think you have company in your discomfort with my link, business reporters that focus on FOMC decisions often fail to report the implications of the committee’s decisions for employment.
D.E. II wrote:
Is a U.S. unemployment rate of 5.7% so bad? D.E.II, I will admit that I always suspected that your real identity was Dr. Phil Gramm!
I’m kidding of course.
I agree it is hard to see a practical difference between a rate of unemployment of 5.7% or 7% or 10% except of course if you happen to be one of those people to not have a job. The most liberal definition of unemployment, the underemployment rate (a.k.a the U6 measure) is now at 10.3%, it was at 8.3% a year ago. By most measures the job market is in bad shape, could it be worse? Absolutely. Does where the job market stands now indicate that this period, if it turns out to be officially declared a recession, has been a mild recession? I don’t think we know that and will not for some time.
Consider the figure below, it assumes a recession started in December of 2007 and compares the loss in payroll employment to the same period in the last recession.
Holy Phil Gramm! Between December 2007 and June 2008 the economy shed just under half a million jobs, in the last recession the economy at this point had shed just under a million jobs. However in a very important sense we are comparing apples and oranges. In order for the BLS to release employment estimates in a timely fashion it must estimate some employment growth. Eventually those estimates are replaced by the actual numbers. The current job loss figures contain estimates which may be revised and are being compared to fully adjusted job counts from 2001. The good people of the Philadelphia Federal Reserve maintain a database of vintage employment estimates which allow us to jump in the time machine and go back to 2001 and see the employment estimates as they were first released. The next figure presents fully adjusted employment counts (labeled benchmarked) from 2001 as well as the employment counts as they were initially released (pre-benchmarked).
At roughly the same point in the last recession the economy looked as if it had shed just under half a million jobs. When those counts were adjusted (benchmarked) the job loss figure rose to just under a million. It will be sometime before we know in official statistics how bad this current period is.
That said given how poorly wages and incomes have performed over the course of the expansion even a mild recession is very very bad news for most families especially now that falling housing prices are beginning to erode the main source of wealth for most families.
D.E. II wrote:
Just to keep pace with new entrants, the economy needs to add more than 100,000 jobs each month, the economy is shedding jobs not adding them. I think the job market is in bad shape.
D.E. II wrote:
The FOMC has been cutting the federal funds rate since last summer, and I think that was a good decision because recessions are bad and should be avoided. I don’t believe the policies of the federal reserve have contributed to the rise in energy and food prices. Although there are reasons to worry about inflation I think the risks of a worsening recession are significantly greater at this point.
--Mark Price
Price, when did you decide to run for office?
I see that you are practicing your guilt by association skills. What's next, are you going to go after me because of which church I attend? *
Ok, you've given a reasonably good answer to my questions. But I remain skeptical about the "progressive" value of policies that risk the cost of higher inflation for the benefit of "stimulating the economy." I guess my follow-up question to you (assuming that despite your negative campaign practices, you still accept follow-up questions) would be whether there aren't other, more specifically targeted policies that would increase unemployment without doing so at the risk of contributing to inflation?
* in case there's any confusion - no, I didn't take your Phil Gram slander seriously, and I assume that you will see my snarkiness in a similar light.
Oh yeah, and Price
Wouldn't you say that cutting rates lowers the value of the dollar - which increases the price of oil, which in turn leads to higher food prices?
Re : Fear of the Unknown at the Federal Reserve Bank of Philadel
The Federal Reserve System was designed so that each of the Reserve district banks would play a significant role in regional economic stability. Subsequent changes in legislation have centralized control of monetary policy in the Board of Governors and Federal Open Market Committee. Public interest in the System has naturally followed the policy power shift to the Board in Washington, D.C.
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Madhu