Fed Chair Janet Yellen has told a story of waiting to raise rates and trying to milk the last drops of job growth (unemployment rate slack)out of the economy. But now with this low unemployment rate on the books,Janet's back is to the wall. The hawks will press not just for one hike of a quarter percentage point but for more... soon. We are in the inflation-fighting red zone,where inflation risks are elevated and ever present. The Fed will have to playdefense in this zone much more aggressively to keep inflation out of the end zone.At least that is the premise of the hawks.
This is a problem for the Fedand for Janet Yellen. She has continued to stick to the script of describingeconomic conditions with reference to the unemployment rate. The Fed makespolicy by referencing the actual rate of unemployment and the expected rate ofinflation. And the Fed has been willing from time to time to change the triggerrate used for the unemployment level. But it is now running out of room. The inflation objective is fixed in somesense but because Fed officials project policy today from the inflation rateeach of them sees in the medium term, in reality the inflation rate does notmatter.
The Fed hikes rates today based on its inflation expectations and it judges that from theunemployment rate. Now with the unemployment rate too low on nearly everyone'sscorecard, the solution will be to raise rates higher, sooner faster.
To avoid this, the Fed will could shift to articulate policy in a different way. Maybe it will change the game. But the monetary policyparadigm has been described to us in this way for so long it might be hard forthe Fed to change it. And the hawks will want rates higher regardless.
As things stand, the Fed is out of options. And the hawks are in the driver's seat. TheFed is at the end of its discretionary rope. And while all that is true,weakening job growth is accompanied by weak hours-worked and very little wageinflation. In short, the dogma of the monetarists is fulfilled by the low ratealone.
The unemployment rate is now too low and they are projectingmore inflation. But inflation in fact is not faster, wages in fact are notaccelerating, and there is in fact little evidence that the symptoms thatshould accompany a low unemployment rate (as measured by U3) are in play. Thatonly complicates the story if it is told from a framework other than the labormarket. But the Fed has not been willing to do that. So that leaves theunemployment as the last game in town.
Yellen's back is up against the wall, and it may be thewrong wall, with the hawks in charge.
Commentary by Robert A. Brusca, is chief economist of Fact and Opinion Economics, an economic-consulting firm in New York City. Prior to that, he was chief economist at Nikko Securities and a financial economist and Fed watcher at Irving Trust. Brusca started his career on Wall Street working at the Federal Reserve Bank of NY, where he was chief of the international financial-markets division. He was also the very first guest on CNBC.
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