Last week’s December jobs number was billed as an economic tiebreaker after a string of mixed data. The release depicted a softening employment environment. The U.S. economy created 113,000 jobs in January against expectations of 185,000. Over the trailing three months, the economy has added an average of about 150,000 new jobs per month versus 200,000 per month reached last summer/fall. With the jobs market downshifting, can the Fed do more?
What the Fed Can Control
The U.S. Federal Reserve sets monetary policy. The U.S. president and Congress set fiscal policy. The two policies should coordinate, but often don’t. With excess credit still burning off globally, deleveraging acts as a natural economic depressant. Even though the Great Recession ended five years ago, the pace of global economic recovery has been disappointing. In traditional recoveries, when central bankers make money cheaper and more available, credit demand rises, making natural economic growth exponential. Unfortunately, while central bankers can control the price and supply of available credit, they cannot control demand.
What the Fed Cannot Control
MV=PQ. PQ equals the size of the economy. MV equals the money supply (M) multiplied by the velocity (V) with which it circulates. While the Fed can control the money supply, they cannot directly control velocity. Therefore by rule, a highly stimulative Fed can be offset by an economy unwilling to borrow, spend and invest. Even though the Fed has set short-term interest rates at zero and increased the monetary base by a factor of five, velocity has fallen like a rock. With the Fed maxed out, the burden falls on expansionary fiscal policy to stoke velocity or money demand. Expansionary fiscal policy rewards businesses and investors for taking risks with lower tax burdens, less regulation, fewer litigation pursuits and fewer redistributive subsidies. The economics of expansion call for this.
Unfortunately, after long and painful recessions following financial crises, populist policy responses prevail throughout history. The politics calls for higher taxes, more regulations, more litigation and more redistributive policies. Unfortunately, it’s these interventionist politics that depresses velocity at precisely the moment when the economics call for acceleration. While the Fed may control the monetary base, fiscal authorities heavily influence velocity.
A Matter for Perspective
The U.S. economic growth rate of 2 percent reconciles the deleveraging headwinds, the monetary stimulants and the fiscal depressants. This pace may disappoint most Americans accustomed to a more responsive economy. However, the Europeans and Japanese would welcome a sustainable 2 percent growth rate. Americans accustomed to a 3 percent GDP growth environment must acclimate to a 2 percent growth environment. This will lead to disappointing job gains, persistently low inflation and inconsistent economic releases. Fortunately, U.S. corporations sell into a global economy growing at a more familiar 3 percent growth rate thanks to the economic integration of the emerging market populations. U.S. investors have abundant opportunities. U.S. workers have fewer than they should. Offsetting global deleveraging requires the coordinated stimulative efforts of central bankers and legislators. Our slower growth rate is a choice.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.