Fed Policy and U.S. Employment Growth

March 31, 2010

The Federal Reserve has a dual mandate to preserve low, steady, and predictable inflation but also to maximize employment.  The Fed’s behavior regarding its key federal funds rate during the past ten years correlates extremely well with what was happening to jobs growth.  Unfortunately, the only decent growth in non-farm payroll jobs was experienced over a relatively compressed portion of this entire period. 

The ten years subdivide into three natural stages.   Over the four years between May 2000 and May 2004, non-farm payroll employment declined at a rate of 10.9K per month.  The U.S. jobless rate was 4.0% in May 2000, rose to a peak of 6.3% in June 2003 and had settled back to 5.6% by May 2004.  No interest rate increases were engineered in those four years, but reductions totaling 550 basis points from 6.5% to 1.0% were implemented.

From May 2004 until May 2006, U.S. jobs expanded at a 190K per month average pace.  That was a little greater than the monthly average increases of 184K over the ten years to May 2000, 162K in the ten years to May 1990, and 161K in the ten years to May 1980.  The jobless rate slid back to 4.6% by May 2006, near to its cyclical low of 4.4% hit last in May 2007. Point is that for two years and two years only during the last ten years or so, U.S. jobs growth had a semblance of normalcy, and only at that time did the Fed take advantage of the opportunity to pursue normal interest rate settings.  During a period of two years starting in June 2004 and ending in June 2006, the FOMC implemented a 25-basis point rate hike at each of its 17 scheduled meetings, lifting the Federal funds rate by 425 basis points in total from 1.0% to 5.25%, and no easing moves were made in the period.  It’s not an oversight that I used May 2004 and May 2006 for my starting and ending jobs data during this period, because those represented the latest information at the Fed’s disposal when it made its decisions.

Over the past 45 months through and including February 2010, U.S. non-farm payroll jobs dropped on average by 40.8K per month, and unemployment climbed as high as 10.1% reached last October.  No Fed tightening moves occurred during this third stage, and rate cuts totaling 500 bps in the Fed funds rate to 0.25% were made.  Combining the earlier and later multi-year periods during which the Fed eased, one finds a span of 7.75 years over which jobs dropped by 25.4K per month and the Fed funds rate got lowered by a total of 1050 basis points.  In retrospect, analysts didn’t need to look at price data to know which way the Fed was thinking.  U.S. monetary authorities had carried out their congressionally-mandated mission, leaning against the inflationary wind when labor market trends were normal or a little friskier than normal but supporting the jobs market for the much longer amount of time when the labor market misfired.

Former Fed Chairman Greenspan rejects criticism that overly loose credit policy contributed to the bust of the financial system.  He prefers to accept blame for some of the lapses in regulation and places most of trouble on low long-term rates caused by heavy inflows of Chinese and other foreign capital.  Between end-2002 and end-2003, however, the Fed did not respond to a 25% rise of U.S. stock prices, and the housing market transitioned from lively to dangerously frothy in 2004 when the Fed began tightening only in baby-sized steps. 

I believe the biggest mistake was not in overly delaying the onset of rate tightening but rather in moving in increments of just 25 basis points even at the start.  When rates are so far below historical norms as 1.0% was in mid-2004 and 0.25% is now, why not lift rates in increments of 50, 75 or even 100 basis points?  Those few central banks such as in Australia that are already tightening have done so by 25 basis points at a time, suggesting that small and cautious remains the favored strategy.  However, the Fed meets fewer times per year than other monetary policymakers and should not take its cue from other banks.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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2 Responses to “Fed Policy and U.S. Employment Growth”

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