Fewer jobs, strong dollar put Fed in an awkward corner

The economy added 223,000 jobs in April — well below the 260,000 averaged during 2014 — pitching cold water on forecasts of stronger economic growth this spring and complicating the Federal Reserve's plans to raise interest rates.

Unemployment was 5.4 percent, largely because so many prime working-age adults are still not employed or looking for work.

Federal Reserve Board Chairwoman Janet Yellen speaks about global finance during a conference May 6, 2015 in Washington, DC.
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Federal Reserve Board Chairwoman Janet Yellen speaks about global finance during a conference May 6, 2015 in Washington, DC.

The Commerce Department initially estimated first-quarter growth at 0.2 percent but subsequently reported a much larger than anticipated March trade deficit. Consequently, first-quarter growth will likely be revised down to -0.2 percent, and economists are lowering growth forecasts for the balance of 2015.

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The oil and gas sector — a major driver of the economic recovery — has cut investment and jobs, and the ripple effects for supporting industries and communities have been pronounced. Consumers have been so far reluctant to spend much of the boost in their buying power from lower gasoline prices; hence the net effects from lower oil and fuel prices have not proven the boom to the economy that policy makers anticipated.

The strong dollar is a key factor behind the surging trade deficit—it makes imports from China and South Korea cheaper and U.S. exports competing with Japanese and German products more expensive. Without relief from an excessively strong dollar — made possible by Asian and European monetary policies targeting dollar exchange rates — resurrecting U.S. growth and decent jobs creation are nearly impossible.

The Federal Reserve would like to raise interest rates, because prolonged periods of rock bottom rates impose distortions on the deployment of capital in the economy. For example, savers and investors are driven to risky junk bonds to find adequate returns, and cheap loans empower traders and dealmakers on Wall Street whose influences on economic growth are akin to the contribution of processed sugar to the healthfulness of the American diet.

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Also, inflation is picking up. Anecdotal reports of employers such as Aetna, Hobby Lobby and Gap increasing wages are now confirmed by the Labor Department's closely watched Employment Cost Index. Core inflation — consumer prices net of volatile energy and food prices — have firmed in recent months and are approaching the Fed's target of 2 percent a year.

Raising interest rates could push up the dollar — further increasing imports and handicapping U.S. exports.

Without any change in Fed interest-rate policy, the economy is likely to grow about 2.3 to 2.7 percent the balance of this year, and that won't be enough to raise jobs creation to 2014 levels.

The sixty-four dollar question becomes: Will the Fed impose another hit on U.S. businesses competing in global markets by nudging up interest rates and the dollar against Asian and European currencies, and be satisfied with an even more disappointing pace of jobs creation?

One theory is that slower jobs creation is inevitable, because so many adults who have left the labor force — especially the 7 million idle men between ages 25 and 54 — are permanently out. Receiving subsidies for health care, food stamps and other government benefits that phase out as family incomes rise, it simply takes a much higher wage than many jobs now pay — or would pay with a higher minimum wage — to coax many adults into working.

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Without exchange-rate reform — international disciplines embodied in trade agreements that combat predatory monetary policies — and entitlement reform, the Fed could push interest rates into negative territory without instigating more growth and jobs creation. But without higher rates, cheap credit makes it the exchequer to the gamblers on Wall Street.

Ultimately, tough rules for currency manipulation in international trade agreements and entitlement reform — two items President Obama vehemently opposes — are necessary for the Fed to be effective.

Unfortunately, Yellen would rather publicly comment on the dangers of income inequality and stay silent on the dollar than challenge her patron in the Oval Office with the requirements of good economic policy.

Commentary by Peter Morici, an economist and business professor at the University of Maryland, and a national columnist. Follow him on Twitter @pmorici1.