Is Janet Yellen the Best Candidate for Vice Chair of the Fed?

San Francisco Federal Reserve Bank President Janet Yellin is Obama's nominee for Vice Chair of the Federal Reserve Bank.  Why this policy dove may be a perfect short term answer, and a long term disaster.
Mission
The primary role of the Fed is the pursuit of maximum employment and price stability.  Sounds simple.
It's anything but.
I.  Maximum Employment
To pursue the goal of full employment, the Fed must make business conditions favorable to hiring.  That means that businesses must be able to borrow easily, expand and hire employees to facilitate such growth.  As you know, banks must keep a certain amount of their deposits with their local branch of the Federal Reserve Bank in order to have sufficient liquidity to prevent panics that contributed to the Great Depression.  When short term interest rates are low, banks can more freely lend to businesses because they don't have to keep as close an eye on their cash reserves.  Money's cheap.
When rates rise, banks keep a tighter rein on lending by strengthening borrowing standards.  It's harder to get a loan, business expansion slows and jobs are harder to get.
Why not have a continuing policy of low interest rates?
II.  Price Stability
Price stability is another way of saying low inflation.  Inflation is the amount prices go up every year.  Anyone who lived through the 1970s remembers that prices rose much faster than wages.  Every year our same dollars bought less and less. 
When inflation takes hold, it's hard to stop.  People want more money to afford what they could afford last year.  If they get raises, however, their businesses have to raise prices to cover higher payroll costs, so costs rise.  A vicious circle ensues, where labor wants raises and businesses want higher prices.  What stops the circle?  A recession, when businesses lay off workers and can contain prices.  The higher inflation, the more prolonged the recession.
The problem is, during the recession, the Fed is pressured to lower interest rates to stimulate the economy.  But, r
Once inflation takes hold, it's very hard to stop.
A Dovish Policymaker
Janet Yellin is described as an inflation "dove."  That means that her decisions have been "growth and employment" oriented and less focused on containment of inflation.  You may think, that with unemployment rates hovering in the double-digits, this is just what we need.  Certainly, that political opinion would be currently popular.  But, would it be a good long term policy?
Deficits and Inflation
No reputable economist of whom I'm aware would not have advised deficit spending to stimulate the economy during the last recession.  It was a necessary evil that prevented the country from likely sinking into a Depression.  But historically, the relationship between deficit spending and inflation is problematic.
Generally, when government borrowing increases, the amount of funds that remains for businesses and individuals to borrow decreases, and the competition for these fewer dollars causes rates to increase. 
So-called inflation "doves," who generally advise keeping rates low, can accommodate both government and business lending only by printing more money for the government to buy its own debt, causing the money supply to expand and debt to contract.
Expanding the money supply is inflationary.  Instead of raising taxes to pay its debt, printing more money makes the dollar less valuable.  The cost of everything goes up when your dollar is worth less.
The Federal Reserve Board of Governors
At its last meeting, only one Fed governor, that of St. Louis, voted against keeping interest rates low.  The majority (11 members) voted to keep rates low because their perception that the risk of sinking back into recession was more significant than the threat of inflation.  Dr. Bernanke, current Fed chairman, is considered one of the premier scholars of the Great Depression.  One significant factor in its length is thought to be insufficient economic stimulus.  It is a mistake about which Bernanke argues eloquently, and apparently the majority of the board agrees.
With a propensity of more dovish members, however, it is of some concern that one who has been one of the most consistent would be considered as the Vice Chair.  Generally, upon the retirement or failure to reappoint the Chair, the Vice Chair is likely to assume this influential post.
At a time when deficit spending is so high, the national debt is ballooning and the nation only recently stepped back from the brink of Depression, is it wise to choose a member who is so dovish about inflation that she stated last February, "If it were possible to take interest rates into negative territory I would be voting for that."?
Perhaps a candidate with a more balanced approach to the Fed's dual mandate would be a more reasonable decision.

Straight Talk About Debt

No issue is more politicized than deficit spending.  Blame abounds, but little insight is given into the components of our deficit, and what reasonable action must be taken.
For a history of US deficit spending, click here.  For an estimate of our current national debt, click here.

Facts

The stimulus package comprises approximately 10% of our current deficit. 
The majority of the deficit spending is comprised of:

1. Unfunded liabilities from tax cuts made by Jobs and Growth Tax Relief Reconciliation Act of 2003.  When enacted, the Congressional Budget Office estimated that the tax cuts would increase budget deficits by $340 billion by 2008.  That effect has been exacerbated by the just ended recession (see 3. below).
2. Unfunded liabilities from Medicare Drug Program.  When enacted, Medicare chief Mark B. McClellan said the drug package would cost $1.2 trillion between 2006 and 2015.
3. The opportunity cost in GDP lost because of the recent recession which began in 2008.  Generally, annualized GDP grows just under 3%.  For the 18 months ended June 30, 2009, annualized GDP contracted just under 2% - or 4.6% less than average.   From the last quarter in 2008 to the second quarter of 2009, our $12 trillion economy shrank an aggregate of nearly $400 billion - representing a huge loss of tax revenue, loss of employment, etc.,

No credible economist would argue that the stimulus package was unnecessary.  It was begun by necessity in the previous administration and continued into the current one.  It is not the source of our economic problems, and allegations to the contrary are clearly false.

Growth of health care costs is unsustainable.

Left unchecked, growth in health care costs, currently about 17% of our GDP, will bankrupt the US.  That is not overstated to create alarm.  It is a fact.
Those who take the position that we cannot afford to pass comprehensive health care reform are wrong. 
Health care costs are increasing 6.2% per year.  At that rate, in 25 years health care cost will be almost 30% of GDP.  In 50 years, it will be almost 50%. 
It's the biggest problem we have, and we must solve it in order to address deficit spending in any meaningful way. 
To counteract any effort to address this problem which may threaten their profits,

• $3.8 billion has been spent by the insurance and finance lobbyists and
• $3.69 billion, by health industry lobbyists,

according to Open Secrets, a non-partisan group referenced recently in an article by the Wall St. Journal.  No industries have contributed more, by the way.

Medicare first.

Only one group represents more clout than the two lobby groups discussed above.  Retired persons.  Grey panthers.  AARP.  Lots of boomers with time to spare, and raised during a time where the promise of Medicare (enacted in 1965) was sacred.  Prior to the aforementioned unfunded drug program in 2006,

• the number of Medicare recipients increased 2 times - from 20.4 million to 42.6 million 
• the economy grew 12 times - from $1 trillion to $12 trillion
• Medicare spending grew 47 times - from $7 billion to $339 billion

Big problem.  Anyone can see that costs are rising too fast.  So where should we start?

1. Increasing information technology for patients
2. Containing drug costs via use of generics
3. Limiting malpractice judgements (thereby limiting doctor's insurance premiums)
4. Opening group insurance rates to small business
5. Providing equal tax benefits to private insurance as employer-provided insurance
6. Lowering the deductible and raising the contribution limits on Health Savings Accounts

These policies would assure that the goal of cost containment would be foremost in the minds of legislators.  If we don't get this right, we go broke. 
It's as simple as that.

Stagflation and Its Potential to Derail Economic Recovery

Unemployment

We've previously discussed the fact that the current unemployment rate, while high, is not at the level it was in some previous recessions. We've also discussed that unemployment tends to last longer than recession, and is therefore called a "lagging" indicator.

But that's not the whole story. Further research shows that unemployment may actually be behaving differently than it has in past economic recoveries.

In the statistical measurement called "standard deviation," the US is deviating from the standard behavior of unemployment as measured by Arthur Okun, a prominent economist in the 1960s. The relationship he discovered was that between the degree to which the economy contracted and the concurrent rise in unemployment. This relationship, called Okun's Law, had been reasonably reliable - until now. At the current rate of decline in our economy, his calculations show that we should have a current unemployment rate of 8% - not 9.5%. We have lost almost 5% of all jobs - far surpassing the 3% we lost in the 1980s recession when unemployment last reached over 10%.

We previously discussed the fact that, during a recession, employers tend to keep employees at a level that will accommodate the return of growth after the recession ends. It is that "buffer" that results in a delay in hiring, as these employees increase their productivity during the growth phase, eliminating the necessity to add workers until the economic growth trajectory is well under way.

In this recession, however, further examination of employment patterns show that this "buffer" has not been kept. Does this mean that employers, jarred by inability to obtain credit by the frozen financial system, panicked and cut employment more than usual? Perhaps.

But, that does not explain the additional fact that, since 2001, overall hiring has been contracting. During the 1990s, employment expansion was at a rate of 8 workers for every 100 on staff. That expansion dropped to 7 workers per 100 during the 2001 recession. Hiring, however, stayed at that level after the recession was over, and has now fallen to 6/100.

Perhaps a part of this failure to hire can be attributed to

• A permanent loss of manufacturing and other jobs "outsourced" to countries who can produce goods at a lower cost than the US


• Less innovation = fewer new businesses. During war time, technology tends to be focused on the war effort as opposed to innovations in the private sector.


• As aging baby boomers leaving the work force, the total number of workers lessens and unemployment rates appear larger. As an example, with a total work force of 100, if 5 people are unemployed, the unemployment rate is 5%. With a total work force of 90, if 5 people are unemployed, the unemployment rate is 5.5%

Whatever the explanation, there is a big difference between a sustained decrease in hiring, as there has been since the 2001 recession and thereafter, and job losses due to a recession. Jobs lost in economic downturns have historically returned, but only when confidence that economic recovery was well in force.

Stimulus

Some argue that the unemployment problem is partially addressed by the stimulus program. This is only partially true, because government programs aimed at repairing the infrastructure, e.g., roads, bridges, etc., are temporary in nature.

Confidence

Jobs lost in economic downturns have historically returned only when economic confidence returned to the private sector. Certainly, no employer wants to add workers unless she feels that a sustained recovery is under way.

Sustainable Jobs

The Obama administration has opined that new job growth be in technological advances in green energy, which will address the national security issues of oil imports, the international need to reduce greenhouse gases, and provide a cost effective alternative to depleting international sources of fossil fuels. With the current lack of emphasis in math and science in the educational system, this goal will be difficult to achieve in the short run. Regardless of the source of so-called sustainable jobs, however, it is crucial that job growth be achieved - and soon.

Falling Wages

One need only look at the economic problems in the State of California and publishers like the Boston Globe to see that we are experiencing a period of falling wages. Wages, expected to be flat during periods of recession, are in danger of falling as businesses and municipalities cut expenditures to the bone.

Additional Stimulus

Should unemployment rates continue to fall precipitously, and wages fall as businesses try to survive, the government may be tempted to provide additional stimulus. That, in my opinion, would result in the disastrous recipe for stagflation. Stagflation = Stagnant (or falling) Wages + Inflation.

But, inflation is very low, you may argue. True, but the national debt, approaching $10 trillion dollars, must be repaid. And, as debt is piled on, higher and higher rates must be paid to borrowers who lend us money. Higher rates mean higher cost of borrowing in the public and private sector, which result in higher costs. Higher costs plus stagnant wages = Stagflation.

What Now

The goal of sustainable job growth is an absolutely critical part of the answer. That means that we will need

• An immediate retooling of our workforce in skills necessary for sustainable jobs


• Education emphasis on math and science


• Accommodative policies to encourage investment in sustainable business


• Immediate policies enacted to reduce deficits


• Bi-partisan support for such policies to encourage confidence.

The last issue is critical. Without confidence, business will stay stagnant. It's a tall order, and there's an immense economic outcome at stake. Failure to achieve sustainable job growth will result in a more serious long term economic problem than has faced our country to date. It is up to every one of us to voice our opinion to our representatives and demand that action be taken immediately, or accept a generation of economic decline.

Unemployment - A Commentary

The previous article is one that provides data with respect to the current unemployment situation as compared with previous economic cycles and in previous Presidential administrations from Truman to date. This is my personal opinion about that data, and a response to criticisms regarding the adequacy of the stimulus program signed on February 17, 2009 to address the unemployment problem.

As stated previously, 10% of the stimulus money has been spent. Asking whether the program is successful at this point is analogous to asking whether your outfit is appropriate after having put on your panties. There is not sufficient information available to answer the question. If the administration is correct in its allegation that, by early August, 500,000 jobs will have been created or saved by the $75 billion spent thus far, job losses will be 2 million instead of 2.5 million. 10% of the stimulus will have improved job losses by 20%.

Some allege that the fact that the unemployment rate is at 9.5% shows that the stimulus program is a failure. Data show that to be false, based solely on the fact that unemployment rates are well within historical parameters of previous recessions. Further, in the recession ended November, 1982, unemployment averaged 9.8% for a full year after the recession ended. It is, as has been said by countless pundits, a lagging indicator.

Others say that stimulus money could have been put to better use by lowering business taxes. It is true that the US has on of the highest business tax in the world, second only to Japan. Those who hold this opinion feel that lowering business taxes would result in immediate hiring. History shows that opinion to be false.

In reviewing hiring behavior in prior recessions, data show that businesses rely upon increasing productivity of existing staff as the business cycle improves, delaying the necessity to add new staff until the cycle is well past recessionary levels. Consequently, it would be more likely that businesses would use tax savings for other purposes.

While the success of the stimulus package is certainly not a given at this point, those who suggest that there is sufficient data to opine that it is a failure are relying upon 10% of its expenditures and five months in order to draw this conclusion. Further, those who believe that the funds would better serve the unemployment situation with lowering business taxes are at odds with historic recessionary hiring trends.

Unemployment

The latest "doom and gloom" prediction is centered around the unemployment rate.

Misery Index

The Misery Index consists of adding the unemployment rate to the rate of inflation, or the percentage of those out of work plus the percetage by which prices are rising.

Historically, the misery index has been

• Truman Administration (1948 - 1952) Average 7.88 (High 13.63, Low 3.45)


• Eisenhower Administration (1953 - 1960) Average 6.26 (High 10.98, Low 2.97)


• Kennedy Administration (1961 - 1962) Average 7.14 (High 8.38, Low 6.40)


• Johnson Administration (1963 -1968) Average 6.77 (High 8.19, Low 5.70)


• Nixon Administration (1969 - 1973) Average 10.57 (High 13.61, Low 7.80)


• Ford Administration (1974 - 1976) Average 14.93 (High 19.90, Low 12.66)


• Carter Administration (1977 - 1980) Average 20.27 (High 21.98, Low 12.60)


• Reagan Administration (1981 - 1988) Average 11.19 (High 19.33, Low 7.70)


• Bush I Administration (1989 - 1992) Average 9.68 (High 12.47, Low 9.64)


• Clinton Administration (1993 - 2000) Average 8.80 (High 10.56, Low 5.74)


• Bush II Administration (2001 - 2008) Average 8.10 (High 11.47, Low 5.71)

The time weighted average Misery Index since 1948 is 9.64. The current Misery Index is 9.8: Unemployment is 9.5, and Inflation is .3. To put this into perspective, we are now 1.6% higher than the average since 1948.

Unemployment Rate

Some economic theorists have used the unemployment rate to justify their opinion that

• The stimulus package isn't working
• There should be another stimulus package, i.e., the stimulus package wasn't sufficient

Let's take a look at that hypothesis.

Of the $787 billion dollar stimulus package, approximately $75 billion, or about 10%, has been paid out. The Obama administration estimates that the stimulus package will have helped create (or save) 500,000 jobs in the two hundred day period from signing the bill February 17 to early August. 10% of the stimulus package will therefore have improved the number jobs lost by 20%. In other words, without the stimulus package, the jobs lost in the two hundred days since the stimulus package was in effect would have been 2.5 million instead of 2 million.

The Obama administration believes the government will ultimately meet its spending targets, increasing spending toward the end of the year as states fund their projects. Ultimately, the measurement of success is whether the economy improves, and, as shown below, it may be too early to make that judgment.

To use consistent time measurements, since 1948 there have been eleven recessions. Let's look at each, and the accompanying rate of unemployment.

Nov. 1948 - October, 1949 (11 months) - Average unemployment rate 10.69%

July 1953 - May, 1954 (10 months) - Average unemployment rate 4.43%

Aug., 1957 - April, 1958 (8 months) - Average unemployment rate 5.69%

April, 1960 - Feb., 1961 (10 months) - Average unemployment rate 5.94%

Dec. 1969 - Nov.,1970 (11 months) - Average unemployment rate 4.88%

Nov. 1973 - Mar. 1975 (16 months) - Average unemployment rate 6.09%

Jan. 1980 - July 1980 (6 months) - Average unemployment rate 7.07%

Jul.,1981 - Nov. 1982 (16 months) - Average unemployment rate 9.09%

Jul, 1990 - Mar. 1991 (8 months) - Average unemployment rate 6.225%

Mar. 2001 - Nov. 2001 (8 months) - Average unemployment rate 4.813%

Dec. 2007 - Jun. 2009 (18 months) Average unemployment rate 6.76%

(Note: Data are not available for July. Most economists opine that the the third quarter 2009 will be flat, and fourth quarter will show a slight increase in GDP)

For comparison purposes, the two most severe recessions in the period under review were Nov. 1973 - Mar. 1975 and the current one. The last five months of those recessions averaged an unemployment rate of 7.72 and 8.88, respectively. The last five months of this recession was 15% worse than the 1973 - 1975 recession.

Further, the average unemployment rate in the last five months of the recession ended Nov, 1982 was 10.18%, and it averaged 9.8% for the year after that recession was over.

Our current numbers are well within historical precedents, and to assert that the stimulus program is ineffective at this point is not supported by data, obtained from the U.S. Bureau of Labor Statistics.

In our next discussion, we'll talk about the deficit to see whether the alarm expressed by some over its size is warranted.