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Why Janet Yellen is wrong

A 211,000-jobs increase for November will finally push the Federal Reserve over the line and into a quarter-of-a-point rate hike later this month. The question is, how much and how fast will the central bank raise its target rates?

My advice to Janet Yellen is to move at the pace of an injured snail. But Yellen is determined to start "normalizing" policy. She seems to be betting the rhetorical ranch on a December move. And it doesn't appear to be based on any specific metric but rather, it's as if she's intent on defending the Fed's reputation.



Federal Reserve Board Chair Janet Yellen
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Federal Reserve Board Chair Janet Yellen

I don't think this is the kind of rules-based monetary policy that former Fed head Paul Volcker or Stanford economist John Taylor have been calling for. Yellen doesn't like rules. The closest she gets is a 2-percent inflation target. But you know what? Over a normal lifetime, 2-percent inflation will quintuple the price level, doing enormous damage to consumers, savers, businesses, and the economy.

Stock markets cheered the November rise in jobs. I suspect two reasons for this: The economy is rising, although at a tepid pace. And the Fed is expected to move rates higher at a slow and gradual pace.


I sure hope the stock-market reading is correct. Because if you look deeper, inflation-sensitive, forward-looking market prices are showing much more deflation than inflation.

Gold is down. The dollar is up. Commodity indexes are falling along with bond-market inflation expectations. And actual inflation is near zero.

If these were normal times, a price-rule approach to monetary policy would suggest easier, not tighter, actions. But after seven years of zero-interest-rate policy and an explosion in the Fed's balance sheet, these are not normal times.




Incidentally, there are glitches in the latest jobs report. The private work week and aggregate hours worked fell. Manufacturing hours worked have been slumping for months. And the ISM manufacturing index has dropped below 50 (a contractionary signal).

Year-over-year wage growth has slowed. And while the unemployment rate remains at 5 percent, the broader U-6 labor-impairment rate increased a tick to 9.9 percent. That points to a lot of discouraged workers and far too many part-time workers. It's also a key reason why 63 percent of Americans think the country is moving in the wrong direction, according to a Real Clear Politics average of recent polls.

What's more, business-investment indicators are falling significantly. Business investment is the key source of decent-paying, middle-class-wage-earning jobs. Because business investment has slumped (it never really recovered), various measures of middle-class take-home pay remain below peak levels.

And the business-investment picture may worsen as the broadest measures of corporate profits, which have been flat for two years, are now dropping.

Profits are the mother's milk of stocks and the lifeblood of the economy. But productivity (output per hour) is stagnant, even as compensation has slightly increased. Therefore, unit labor costs that businesses pay are growing faster than the prices businesses receive. So profit margins are turning negative.

Even this tepid, 2 percent, so-called recovery may be running out of steam.

The long-term slump in business investment is one of the key factors behind the slowdown in productivity, which is so important to growth, jobs, and wages. And Congress still has not moved to slash the prohibitively high corporate tax rate, which is holding back all manner of activity and forcing cash and firms to move offshore.

That, plus overregulation and a steady flow of anti-business rhetoric from the White House, is blocking the creation of new capital, which is so vital to productivity.

If you penalize businesses, forget about good jobs and rising incomes.


Yellen believes more people working and earning causes inflation. But that's wrong. Excess money and a cheap dollar cause inflation. Democrats, who have been opposed to raising interest rates, think taxing success and printing money will lead to a better economy. Wrong again. Higher taxes stem investment and sink the economy, and when combined with easy money, generate higher inflation.

Bad 2016 scenario for Hillary Clinton.

Republicans, meanwhile, are missing the point. Rather than rooting for higher interest rates, the GOP Congress should slash the corporate tax rate to 15 percent from 40 percent, permit full tax-expensing for new investment, make repatriation of $2.5 trillion parked overseas as easy as possible, and then seek a price rule based on a sound and stable dollar. All that will spark a new era of growth, and yes, real interest rates will rise and the Fed can lift its target rates. That's a political winner.

Until we get the right growth model, one that leads to prosperity and price stability, the economic outlook won't get any better. And the election is still up for grabs.


Commentary by Larry Kudlow, a senior contributor at CNBC and economics editor of the National Review. Follow him on Twitter @Larry_Kudlow.