The unemployment data released by the U.S. Department of Labor on Jan. 4 certainly got everyone’s attention. The stock market tanked and concerns about the economy gained strength and credibility.
In the wake of the unemployment data release even President Bush felt compelled to acknowledge that a lot of people were worried about the economy.
At this point, though, he does not believe that the situation warrants a federal economic stimulus package, and his thought on this was echoed by House Speaker Nancy Pelosi.
Wall Street, however, is looking for some sort of economic action to boost the market — now — and many analysts see the unemployment data as a good reason to cut interest rates. Unfortunately, things aren’t quite as simple as that.
In deciding whether to cut interest rates, the Federal Reserve has to balance the threat of inflation against the threat of economic slowdown or recession. And even that is not an easy decision, for a lot depends on what is driving the inflationary forces and what is causing the slowdown.
If inflation is being pushed by a generalized overheating of the economy, then the normal tonic would be to raise interest rates to cool things down a bit.
If inflation is being driven by cost increases in resources, though, especially outside costs like imported oil or other raw materials, then raising interest rates will not have the same effect. In fact, in that situation, the Fed risks chasing inflation with interest rate hikes until the economy finally stalls and lands with a painfully loud “thunk.”
The good news is that if rising oil prices are the principal force driving inflation, as they appears to be, then the economy will have to adjust to the higher prices on its own terms. Small changes in interest rates are not likely to have much effect on that process. That means that right now the Fed still has the option of lowering interest rates if it believes that it would do some good in calming the market.
Whether it would do any lasting good, however, is an open question. Financial markets seem to be going through a crisis in confidence. And although Fed Chairman Ben Bernanke exerts a very powerful influence on the market, he is not the Wizard of Oz awarding medals for heroism to cowardly lions. He cannot really create confidence by conferring it upon doubt-filled market participants.
The tough thing for the Fed to figure out is whether the slowdown is due to the economy’s struggle to adjust to higher fuel costs or to a contraction in the housing, construction and credit markets adjusting to the subprime mortgage meltdown.
This is an important distinction. If it is due to subprime submergence, we are probably close to touching bottom and regaining our footing. Bad as it is, the subprime market by itself can only do so much damage. The monetary policy issue, then, becomes a relatively short-term one of trying to keep credit markets liquid and fully functional to contain the losses — both in financial and psychological terms.
If growing unemployment is due to cutbacks in spending and hiring because of higher fuel costs, though, we are looking at a painful, long-haul adjustment process. It is also a process in which problems and distortions of the economy lend themselves more to the tools of fiscal policy — federal spending, taxation and cash-flow adjustments — than to interest rate changes or other monetary policy tools.
One big difference between monetary and fiscal policies is the time-frame for action. On the monetary side, the Fed can act overnight, or even more rapidly, to effect change or respond to economic events.
By contrast, while the president and the Treasury Department can promptly take some small actions, fiscal policy is largely in the hands of the Congress, which typically moves quite slowly, if at all. This year, for example, disagreements with the president and amongst its members themselves have stalled congressional action on even basic fiscal policy matters such as the federal budget.
Whatever the president, Federal Reserve and Congress choose to do, it is important to keep some perspective. The unemployment data that sent the market into a dark mood brought the jobless level to 5.0 percent. In Germany, for example, hardly a Third World economy, they have enjoyed 21 successive months of improved employment data, which brought their current unemployment level down to 8.4 percent.
These days, many of the presidential candidates are making references to the events and people of the 1960s. Whether or not that is a good campaign idea, with respect to the underlying strength of the U.S. economy there is certainly one 1960s expression that deserves to be revived: Keep the faith.
James McCusker is a Bothell economist, educator and consultant. He also writes a montly column for the Snohomish County Business Journal.
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