By Francis Konan, New York – Monetary policy as in any modern state is under the control of the Central Bank. The later makes decisions to manipulate the state of the economy.
In the same line, the Fed (the US Central Bank) in order to revive the economy in 2008 decided to lower its interest rates. This was supposed to bounce demand, revitalize production by the same means to create jobs and reduce the unemployment rate.
Twelve years later things seem to have changed. The unemployment rate came down from 10.3% to 5.4. The long recession has given way to a sustained economic growth. Recently voices have risen up to demand an end of a monetary policy that advocate very low interest rates. On the other hand, the Fed continues to maintain its monetary policy of low rates.
In this article we will explain the reasons that should prompt the Fed to raise or not to raise interest rates.
The Inflation Rate
The Fed has set itself the objective of raising interest rates if inflation reaches the fateful level of 2%. Currently this rate is around 1.5%. Rising oil prices could throw upward inflation. Could it however reach the 2% level? Things could get complicated when experts predict that 2017 may be the year the inflation rate is expected to reach 2%. Do we wait until 2017 to see an increase in interest rates?
Another channel that could create «some» inflation is the rise in nominal wages relative to labor productivity. This is possible if employers face a demand for goods and services so high that they have no choice but to increase nominal wages to attract a surplus of workers. The last time this happened was in 2000 during the Clinton era when the economic was almost at the full employment level.
If the inflation rate policy is easily quantifiable, the unemployment rate threshold in regard to the Fed interest rates remains silent. The Fed has no exact figure. Somehow she repeats to wait to see some improvement from the labor market.
Let’s see the behavior of this market according to the latest publications of the Bureau of Labor and Statistic (BLS). The latest statistics show that the unemployment rate of the Month in April remained flat around 5.5%. Some experts are hoping the Fed could raise rates if the unemployment rate decreases from 5.5 to 5% view. The national unemployment rate is not a very good measure of the current situation. We should rather focus on the structure of the unemployment rates. That is the reason why the unemployment rate of long and short duration could be of significant value.
The short term unemployment (less than 5 weeks) slightly increased from 245,100 to 275,900 people between April 2014 and April 2015. This increase could come either from an excess of new entrants to the job market or from the inability for companies to create short-term employment. The encouraging signs, however, come from long-term unemployment (between 5 to more than 27 weeks). Since 2014 the number of people in this category is in major decline (from 341,300 to 252,500 people) proving the end of the so-called structural unemployment. At the same time it is an indicator of a certain gradual economic recovery. There is no doubt the central bank could use this argument to support a prior increase in interest rates.
GDP, the forgotten index
Throughout the debate on monetary policy in the US one of the most forgotten index is the quarterly growth rate of GDP. According to the latest publications of the Department of Employment, GDP recorded a decline of 0.7% in the first quarter (January-February-March). This weakness is due to a non-resident investment downturn and rising dollar encouraging higher imports and lower exports.
To increase or not to increase
In a depressed growth environment, asking the Central Bank to increase interest rates could worsen the situation. The dollar is already overvalued and does not need to be propelled by an increase in key interest rates. The dynamics of the labor market alone are not enough to justify an increase in interest rates, given the fact that the other aggregates (inflation rate and above the GDP growth rate) do not have a good “face”. One must wait until the growth rate moves back in the positive zone, before talking about a rate hike. I doubt that the US economy may reach 5% unemployment rate by the end of the year. We must give time to time to have a clear picture of the situation.
Francis Konan is an Economist, graduated from the University of Economics and Management of Vienna (Austria), a graduate of the Institute of Advanced Studies Vienna (Austria), graduated from the Faculty of Economics & Management University of Abidjan (Cocody).
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