Fed Vice Chairman sees “hailing range”

Dean Baker correctly alerts us to the ominous statements made by the Federal Reserve Board Vice-Chairman, Stanley

Stanley Fisher VP FRB
FRB Vice Chairman Stanley Fischer

Fischer. Baker points out that 2% is a inflation target average; not a ceiling. It would be economically counterproductive to raise the Fed Funds Rate when the US economy is in the 8th year of recovery from the worst recession in US history since the Great Depression. Wall St. banks have resisted easing credit since they were unable to establish values for themselves and their cohorts in October of 2008. Yes, students of the economy remember the meeting Treasury Secretary Paulson had with 9 of the biggest banks in the USA. At that meeting the values of each of the banks was assigned to them via a dollar amount he had written on a slip of paper. Each received a portion of $125B of Treasury funds in the form of purchase of preferred stock.


The Federal Reserve’s control of the money big banks can access is used to encourage economic expansion or cool off an economy that is expanding too rapidly. If it hikes the rates, banks can charge higher loan interest rates such as mortgages and they can pay depositors higher rates.

The Fed’s monetary actions have not had much effect on the lending of big banks. Several years of 0% to .25% failed to produce the loans necessary to cause business expansion. Failing this, the Fed resorted to “quantitative easing”…twice also with little effect. The QE, as it is called forces banks to sell government bonds to the Federal Reserve thereby reducing the securities on their books and increasing their cash. The theory of QE is that without interest producing securities, banks are forced to find a market for this cash; hopefully retail borrowers.

A big part of the problem of bank lending is the domination of Wall St. banks in the banking industry. Wall St. banks have centralized credit policies that limit the lending of local bank managers. Businesses without hard collateral cannot meet the risk avoidance criteria of their local Wall St. bank branches. With slack lending through their thousands of retail branches, the Wall St. banks must look to businesses with a national presence. Here, they may be finding slack demand for credit. This slack demand is due to the fact that these businesses have excess productive capacity. That is, they are capable of producing more product but have no market for it. Currently, producers in the aggregate have almost 25% excess capacity; a full 5% below the average capacity utilization between 1972 and 2015. If you can produce more with what you already have, you have no need to expand, nor to borrow to finance that expansion.

This dilemma; having too much capital concentrated within centralized lending institutions while too little capital is in the hands of consumers is driving bizarre proposals such as Vice Chairman Fischer’s. The Federal Reserve cannot force the banks to lend and the banks can’t force these national corporations to borrow. If he has his way, this tepid economic recovery will slip into another recession a concern expressed by Baker and his colleagues at the Center for Economic and Policy Research.

Jackson Hole Showdown

Jackson Hole Summit
Federal Reserve Chairwoman Janet Yellen and European Central Bank President Mario Draghi at the Economic Policy Meeting, Jackson Hole, WY, USA. Photo by John Locher, AP

This editorial from the New York Times takes the side of Federal Reserve Chairwoman Janet Yellen against the “inflation hawks” in the aftermath of the Jackson Hole annual meeting of central bankers.  The NYT’s editors challenge the wisdom of raising interest rates citing the Federal Reserves own prediction of a 2.3% rate of economic growth in the US for 2014. I call it a “showdown” because Yellen had to prevail against such as Dr. David Kelly, Managing Director, and Chief Global Strategist for JP Morgan Chase who in this: JPMorganChase3Q14 market update argues for increasing interest rates for fear of inflation and higher wages.

Another source of support for Yellen’s position comes from Dean Baker at the Center for Economic and Policy Research (CEPR) in his weekly “Beat the Press” blog; my original source for the Times’ editorial. Baker’s post is decidedly in the camp of lowered unemployment and higher growth. Unlike the inflation hawks he remembers a similar instance. In 1997 there was clamor among economists for increasing interest rates to head off inflation. Federal Reserve Board member Janet Yellen was among those. Perhaps she remembers that the Chairman, Alan Greenspan ignored these cries, kept the rates low and saw unemployment fall to 5% in 1998 and to 4% by the year 2000. Yellen might also recall that the growing economy led to Federal budget surpluses for the last three years of the Clinton presidency. I might also add that contrary to Kelly’s claim that higher employment leads to lower stock prices due to lowered earnings per share (corporate profits); 1990-2000 was the biggest and longest running bull market in history; especially in each of the last three years which saw gains of more 25%.

Baker’s column goes further to cite a study by one of his colleagues that indicates that for every 1% drop in unemployment there is a nearly 10% increase in wages for the lowest quintile of wage earners. For a worker earning $20,000 a year this means another $2000 in earnings; a significant sum. This is the “tight labor market” effect that has Dr. Kelly of JP Morgan so worried.

It is astounding that rarely is the connection made between higher wages and increased consumer demand. Higher wages are almost consistently cited by such “global strategists” as Dr. Kelly to be inflationary. However, it takes a significant increase in consumer demand over a significant period to cause price increases, especially in an environment where productive capacity is still under-utilized by almost 20% as is the case in the USA today. The reason for this is that if corporations can produce more goods or provide more services without the need to expand plant and equipment, costs per unit do not increase significantly. Since almost 90% of our economy is driven by consumer demand, let’s hope that Yellen, our first Fed chairwoman can hold her ground, keep rates low and allow this tepid recovery to grow into a strong economy with more and better jobs and a higher standard of living first and foremost for those on the lower rungs of our society. All of us will be ahead.