The Fed Can't Fix What Ails the Economy
In Congressional testimony this week, Federal Reserve Chair Janet Yellen pointed to several economic maladies warranting continued activism by the central bank. But what ails the U.S. economy cannot be fixed by monetary policy.
This has been an exceptionally weak recovery when gauged by the labor market. About half of the decline in the unemployment rate can be accounted for by "discouraged workers," who have dropped out of the labor force and are no longer actively seeking jobs. For that reason, the unemployment rate is increasingly becoming a misleading gauge of the labor market.
In Monday's Wall Street Journal, Mortimer Zuckerman wrote cogently of "The Full-Time Scandal of Part-Time America." As he put it, "Way too many adults now depend on the low-wage, part-time jobs that teenagers would normally fill."
Low economic growth is one reason that job growth has been weak. Growth in full-time jobs has also been slowed by Obamacare. The act mandates that employers provide health insurance for those working 30 hours a week or more. The predictable consequence is that employers are reluctant to hire full-time workers. Better two half-time workers than one full-time employee.
There are many other forces at work in labor markets, few of which are influenced by anything the Fed does. Until recently, there were extended unemployment benefits. These discouraged workers from actively seeking jobs. That effect combines with benefits, like food stamps, to act as a tax on taking a job. Casey Mulligan, an economics professor at the University of Chicago, has written extensively on the employment tax. If people don't take jobs, employment cannot grow.
Some of what occurred in the recession is a continuation or acceleration of trends long in place. The male labor force participation rate has been declining since 1950. It was about 87% then, and is 69.2% today. The overall labor force participation increased for a long time because of rising participation by women. That has flattened now.
The fact that men increasingly do not work has profound social consequences. But, again, this is not a problem that monetary policy can address.
Janet Yellen has long been associated with the belief that the central bank can influence employment. She has also commented on the weakness in current labor markets, and the fact that the numbers overstate strength there.
Yet yesterday she observed that the labor market is improving more quickly than expected, and therefore the Fed might raise interest rates sooner than expected. Perhaps the Yellen Fed has decided to declare victory, and extricate itself from the trap of its own making. But that does not change the fact that labor markets remain weak.
It is hubris to claim the Federal Reserve can control variables, like the unemployment rate and labor market weakness, over which they have no systematic influence. But Fed policy is not just ineffective; it is malignant.
The main effect of Fed policy has been to create asset bubbles in financial markets, decoupling these from the underlying economy. As we learned painfully in the recent financial crisis, overheated asset markets are not a source of strength - they are the source of future problems.
Gerald O'Driscoll is a senior fellow at the Cato Institute.