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Fed's dual mandate will begin to erode: Steinbock

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In the next few months, the Federal Reserve will begin tapering, despite the ailing labor market. In the process, the Fed's 70-year-old dual mandate will begin to erode.

While private and government payrolls increased to 169,000 jobs in August, the growth rate of the past quarter had to be revised down by some 74,000 jobs.

To optimists, the good news was the unemployment rate, which edged down to 7.3 percent. But what it really meant was that more people continued to drop out of the labor force—despite 42 months of private sector job growth and half a decade of quantitative easing policies.

Fed chairman Ben Bernanke has defined the purpose of the asset purchases as "to increase the economy's near-term momentum," with the goal of improving the labor market and price stability. This would reflect the key objectives for monetary policy in the Federal Reserve Act: Maximum employment, stable prices, and moderate long-term interest rates.

But the reality is that the current structural unemployment does not make possible full employment; price development is deflationary, or disinflationary; and interest rates have been kept historically low while moderation has been achieved through nontraditional monetary policies.

Nonetheless, the Fed will begin tapering, despite the ailing labor market. In the process, its postwar dual mandate—full employment and low inflation—will crumble.

Lingering unemployment, slow growth

It was the effort to help the U.S. economy to achieve "escape velocity" that led the Fed to use its printing press to purchase $85 billion in securities monthly. These purchases will continue, the Fed says "until the outlook for the labor market has improved substantially."

In comparison to Europe, the U.S. labor market has performed significantly better. However, the improvement has not been "substantial." The current unemployment rate translates to 11.3 million unemployed. The rate is 6.4 percent for whites. In Europe, this would be slightly better than a comparable rate in the Netherlands (7 percent), but significantly weaker than in Germany (5.3 percent)—the two major remaining triple-A nations of the region.

(Read more: Why tapering doesn't mean QE is going away)

With 9.3 percent rate, the Hispanic unemployment was much more challenging, significantly higher than, say, in Belgium (8.9 percent). In turn, the African-American unemployment continues to rise. At 13.0 percent, it is significantly worse than that of Italy (12 percent), the ailing and pivotal economy of southern Europe, and about the same as that in Bulgaria (12.9 percent).

In brief, unemployment is challenging for whites, but there is hope in the horizon. The situation is bleak for Hispanics and unlikely to improve significantly anytime soon. Meanwhile, African-Americans have lost much of what has been gained since the civil rights years.

During the Obama administration, unemployment among young blacks not in school has soared to more than 43 percent. In the U.S. inner cities, the recovery has been a catastrophe whose full extent will be acknowledged only in the years to come.

If any improvement in the labor market indicators is to be sustained, economic growth should quicken. That, however, is not likely. Despite the inflated expectations of the first half of the year, the annualized growth is likely to remain around 1.6 percent in 2013 and, at best, around 2 percent in 2014—but only if downside risks can be avoided (read: Washington can find a consensus on a credible, bipartisan, medium-term debt-cutting program).

In view of current realities, tapering will begin sometime between early fall and December. The decisions will be determined by the evolution of the labor markets, the (present and future) chairman of the Fed and broader economic outlook.

However, the structural damage of the labor market is already a reality.

Structural damage

In the aftermath of the Great Recession of 2008/9, many Americans are not just looking for a job. Others continue to give up looking for employment. As they have left the labor force, the latter has shrunk and participation rates have decreased accordingly.

The labor force participation rate—those aged 16 and over who are working or actively looking for work—is now 63.2 percent. What's worse, that rate continues to decrease, slowly but surely. It is now the lowest since 1978

In turn, the share of the population with a job, which peaked at 65 percent after the Clinton-Gore years, has plummeted from 62.7 percent in December 2007 to 58.6 percent. These are levels last seen in the mid-1980s (and first in the mid-1950s!).

(Read more: Upbeat Fed outlook suggests QE tapering is near)

After, more than three years of recovery, it would be naïve to believe that the employment challenges are cyclical rather than structural.

Since the mid-1990s, the Labor Department has used a comprehensive alternative unemployment rate measure, which includes people who want to work but are discouraged from looking and people working part time. That figure was 13.7 percent in August, 5 percentage points higher than at the start of the recession. By that measure, 22 million people continue to be unemployed or underemployed.

Indeed, two-fifths of the 11.3 million people who are unemployed have been looking for work for 27 weeks or longer. Nothing like this has been seen in America since the Reagan recession in the early 1980s.

Crumbling ladders of opportunity

Unfortunately, things will not be getting better anytime soon. Actually, they may soon get worse—not least because U.S. debt burden is edging closer to $17 trillion.

A robust jobs recovery would require 200,000-300,000 new jobs per month. The current pace is closer to 180,000 a month and has not exceeded 200,000 since early spring when Washington agreed on its "mini-debt deal" and the automatic spending cuts.

(Read more: CNBC survey: Jobs data slightly pushes back Fed tapering expectations)

In coming months, the labor market is likely to offer more of the same, as the automatic spending cuts will broaden, a medium-term fiscal program must be instituted to avoid excessive debt, and pressures will increase for unwinding the QE policies—and higher interest rates toward the mid-2010s.

President Barack Obama has indicated that his administration's highest priority is to "rebuild ladders of opportunity" and reverse income inequality. It is a sincere and noble objective—and least likely to materialize anytime soon.

Dan Steinbock is the research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China). For more, see www.differencegroup.net.

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