The U.S. Labor Market and the Great Taper
The current obsession of the U.S. business press is the date at which the Federal Reserve Board will begin to curtail its quantitative easing policy of buying government bonds and mortgage backed securities. It has been buying bonds at the rate of $85 billion a month since 2008. This policy follows two previous rounds of quantitative easing. The intention is to provide a further stimulus to the economy in a context where the short-term federal funds rate is already at zero.
Federal Reserve Board Chairman Ben Bernanke indicated that the date at which the Fed would begin to cut back its purchases was approaching in public comments in late June. There was a large and immediate response in financial markets with the interest rate on 10-year Treasury bonds jumping by 1.0 percentage points to 2.9 percent. There was a corresponding jump in mortgage interest rates with the rate on a standard 30-year fixed rate mortgage going from less than 3.5 percent in May to over 4.5 percent by early July.
This jump in mortgage rates had an immediate impact on the housing market. House prices had been rising at a double digit annual rate nationwide and in many areas were rising at 30 or even 40 percent annual rates. While there are few areas where house prices are obviously out of line with the fundamentals of the market, these rates of price increase would soon push many areas in bubble territory.
It appears that the jump in mortgage interest rates destroyed the momentum of these incipient bubbles. In the last two years, an unusually large share of houses had been purchased by investors, with hedge funds and private equity funds being large buyers in many markets. The jump in interest rates appears to have slowed their involvement according to anecdotal accounts. This seems to be confirmed by data on new homes sales for July which showed a 13.4 percent decline from June levels.
The new home sales data are important because they measure contracts signed in the month, not sales closed. Since there is typically a period of 6-8 weeks between a contract being signed and a closed sales, the new homes sales data provides much more current information on the housing market than most other data sources.
This discussion of the housing market is important for a discussion of Fed policy since the containment of an incipient housing bubble would have been the best argument for tapering. However it appears the Fed has accomplished this goal without actually changing its policy. (This may not have been its intention.) This raises the question of what the Fed could hope to accomplish by cutting back its bond purchases in the near future.
The most recent data show an economy that is generating jobs at a rate that is only slightly faster than the underlying growth rate of the labor market. Over the last three months the economy generated an average of just 145,000 jobs. This is just 45,000 more than the 100,000 jobs a month the economy needs to keep pace with the growth of the labor market. With an employment level that is still almost 9 million below its pre-recession trend, it would take more than 15 years at this pace to make up the jobs deficit from the recession.
The unemployment rate has been ticking downward in the last year but this is almost entirely the result of people leaving the labor force. The employment to population ratio in August stood at 58.6, just 0.4 Percentage points above the low-point for the downturn and more than 4.5 percentage points below the pre-recession level.
There are still 7.9 million workers involuntarily working part-time compared to 4.2 million before the recession. And, there is no evidence of any incipient wage pressure. Nominal wages have risen by just 2.2 percent over the last year. This is almost identical to the rate of inflation, meaning both that there is no story of wage pressure leading to inflation and that workers are seeing virtually no growth in real wages.
In this context there seems little reason for the Fed to be pulling back from quantitative easing policy. There is no plausible story of the economy overheating now or anytime in the foreseeable future. As has been the case for most of the last five years, the economy needs all the help that it can get.
Probably the best argument for curtailing quantitative easing is that it was not doing much to help the economy. The biggest impact of quantitative easing was through mortgage refinancing. Low interest rates allowed tens of millions of people to refinance their mortgage at rates that were 1-2 percentage points lower than their prior mortgage. This would be the equivalent of a tax cut of $2,000-$4,000 a year for someone with a $200,000 mortgage. But most of the people who could profitably refinance have already done so, which means that low interest rates will have less benefit going forward.
Still, in the context of a deadlocked Congress, low interest rates are something that the government can do. With no obvious harm, it’s hard to see why the Fed should not do everything it can to try to boost the economy. This means continuing the pace of quantitative easing for some time into the future.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The End of Loser Liberalism: Making Markets Progressive. He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.