Fed Gets New Excuse to Keep Tightening Rates
Short version: A group of Fed researchers presented a paper that rebuts the slack in the labor market argument. The Fed, therefore, is likely to continue its rate hikes beyond the expected 5% funds rate.
Long version: Keep reading . . .
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In 2004 Katharine Bradbury, a Senior Economist at the Federal Reserve Bank of Boston, published research suggesting that "labor force participation rates post recession have not recovered as much as usual."
This was an early explanation for what has been one of the weakest post-recession labor recoveries in the post-war period. (We've detailed this many times in the past).
Last week, a different group of Federal Reserve researchers came to the opposite conclusion. This group determined "U.S. unemployment really is low and the jobless rate hasn't been artificially depressed by a failure of many discouraged workers to be counted as unemployed."
The heart of the study wades looks at the "failure of more people to seek work since the recession ended in 2001. The "participation rate" -- the proportion of working-age people working or looking for work -- peaked at 67.3% in 2000, fell to 65.8% in March 2005, and has since recovered to 66.1%, below where it stood for most of the 1990s. (WSJ)"
Amongst other factors, the research group noted that the hot job market of the 1990s pulled many more people into the labor pool than normal. They also blamed the "aging of the baby boom cohort" and other structural changes.
While the group's conclusions are arguable, the more important aspect of this is that it -- incorrectly or not -- gives the Federal Reserve the ammo it needs for continuing their tightening campaign. The Fed is now fighting a ghost: a tight labor market that doesn't exist, wage inflation that actually fails to keep up with price increases, and full employment that is hardly anything of the sort.
This adds to the liklihood that the Fed will do what Feds typically do: tighten rates beyond what's necessary to merely cool inflation. After all, an economy with full employment, a tight labor market and rampant wage increases are the perfect growing conditons for blossoming inflation.
If only those conditions actually existed . . .
The WSJ notes that some analysts (present company included) believe "the low participation rate means many people aren't seeking work because they believe no desirable work is available and aren't counted as unemployed. The economists believe the unemployment rate -- which at 4.8% in February was low enough to qualify as "full employment" in many conventional views -- may mask underlying labor-market weakness. A staff study by the Federal Reserve Bank of Boston a year ago argued the unemployment rate, then about 5.4%, might understate the actual degree of unemployment by one to three percentage points."
As the chart nearby makes clear, the participation rate has fallen dramtically since the recession.
The employment rate is a fraction: the numerator (top number) are those people working, and the denominator (bottom number) are those in the labor force. Total employment goes up -- and unemployment goes down -- when EITHER the top number rises (more people working) -- OR the bottom number falls (less people in the labor force) -- or a combination of the two.
A drop of more than 2 percent of the labor force -- 140 million people strong -- means that nearly 3 million former workers are neither working nor looking for work. Their departure from the pool makes the unemployment measure go down.
During most recoveries, the participation rate typically rises as these "discouraged workers" return to work.
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While I find the group's research conclusions suspect, I would point interested readers towards the report, pages 67 forward. A rich collection of charts tell provide lots of fodder for more discussion on the subject . . .
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click for larger charts
Participation rate rolling over
Classic Economist Error: Projecting a cyclical trend -- to infinity
Decreasing hours bely the "tight labor market" thesis
Various Labor Pool Participation Rates, Demographics
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Sources:
Fed Analysts Say Low Jobless Rate Doesn't Mask Labor Market Woes
GREG IP
WSJ, March 31, 2006; Page A2
http://online.wsj.com/article/SB114376258350612871.html
Brookings Panel on Economic Activity
March 30 and 31, 2006
http://www.brookings.edu/es/commentary/journals/bpea_macro/
forum/agenda.htm
The Recent Decline in Labor Force Participation and its Implications for Potential Labor Supply
Preliminary Draft (PDF)
by Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle, and William Wascher
Division of Research and Statistics, Board of Governors of the Federal Reserve System, March 2006
http://www.brookings.edu/es/commentary/journals/
bpea_macro/forum/200603bpea_aaronson.pdf
(Download 200603bpea_aaronson.pdf)
U.S. jobless rate misses "hidden" unemployed
By Reuters | June 14, 2004
http://tinyurl.com/3hmb6
Monday, April 03, 2006 | 06:54 AM | Permalink
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Comments
Great job!
When I get a job that offers more than intern wages and no benefits, then we can discuss "full employment". I think Fool Employment would be the appropriate term today.
I was talking to one person and he told me his company had sent all the tech writing jobs to India.
Another woman interviewed for a job with a GE division. They sent all their "instructional design" work to India. Now they need a project manager that is an instructional designer to redo their story boards because India doesn't have an instructional design degree so they don't know what they are doing. But, the manager said, they are cheap.
Thank you corporate America. Thank you fed.
I have to think that if we had Kennedy's space race or Nixon's war on cancer today, we would just outsource it to India.
There is no skills shortage here and true unemployement is much higher than 4.8%.
Posted by: me | Apr 3, 2006 8:52:42 AM
Isn't the fed at a barely neutral rate? You've argued in the past that inflation is much higher than reported. If so, how can you be so sure that the fed is overtightening now?
Posted by: royce | Apr 3, 2006 9:20:59 AM
I'm still convinced this low participation rate is related to the housing boom. Why work when your house increases by 20,000 per year? Most people have trouble saving 0.1% of their salary. Obviously it has been much cheaper to stay home and invest in real estate!
Within the next couple of years, you're probably going to get a few more people looking for work when they realize their homes aren't appreciating anymore and their mortgage payments reset.
As for the Fed, you'll never see them stand up and scream "Run for the hills!". With Japan obviously curbing its carry trade and with 2 trillion of short term debt in need of refinancing, I think I'd be looking to keep the US dollar stable for a while.
I don't think economic growth and strong employment has much to do with rate increases right now. The Fed is using smoke and mirrors.
Posted by: D. | Apr 3, 2006 9:30:09 AM
FRB will blame anyone but themselves. they cut rates to 1% and left them there for years, they goosed the money supply +8% pa for years, they decided the explosion in derivatives required no regulatory oversight. now they see the results in housing, equities, commodities, real (non-adjusted) inflation and are slowly beginning to freak. too late, boys
Posted by: scorpio | Apr 3, 2006 9:44:28 AM
I agree with "D.". When your house value becomes the primary household wage earner, go to the beach instead of the office.
Posted by: MAS | Apr 3, 2006 9:51:35 AM
1) I said the Fed WILL overtighten -- not that they already have;
2) There's plenty of inflation --just not in wages;
3) Much of Wall Street thinks the Fed is almost done (I am providing the counter-balance)
4) The Participation drop off began long before the housing boom began
Posted by: Barry Ritholtz | Apr 3, 2006 10:00:47 AM
. . . 6% by the end of '06!
Posted by: GRL | Apr 3, 2006 10:24:45 AM
There's some dude in Hong Kong calling for 6% by June this year:
http://enziosclock.com/node/87
Any thoughts?
Posted by: just_observing | Apr 3, 2006 10:54:31 AM
There must be a psychiatric term for first redefining and reinterpreting your concepts and your reality, and later taking your own bullcrap seriously.
Usually that's done to rationalize something which would otherwise cause too much (internal) cognitive dissonance or emotional suffering. In this case with the Fed I'm not sure. There is more than one actor involved, and somebody else redefines the indicators that the Fed is using. But in a larger context the argument still applies.
Posted by: cm | Apr 3, 2006 11:41:42 AM
The effect of aging baby boomers is not trivial. Notice that only 40% of those over 55 are labor force participants(chart). That group is getting a lot bigger by the day.
Don't forget that there are 3.4 million more millionaires in '05 than '02. Facillitates earlier retirement.
Posted by: algernon | Apr 3, 2006 12:02:21 PM
I'm on a "Be nice to the Fed" kick instead of "Kicking the Fed" kick. Regardless of what is leaked, we really don't know what the Fed is basing their decisions on. That is, until they publish the minutes in 5 years or what ever it is. And, since they keep raising rates even though government statistics tell us they shouldn't be, they are likely thinking more along the lines of the cynical types who berate them.
That said, we know what Greenspan was thinking in 1999 and 2000 when he made the public statements that we seemed to be in some type of Pax Americana and he saw no reason for it to abate. I guess one thing they don't teach in economics is historical precedence and behavioral cycles. So, Greenspan recently made the statement that history hasn't treated significant asset appreciation kindly or whatever it was. So, at the ripe old age of 99, did he learn his lesson or do we take the counter trade as the successful investor did in 2000?
As if anyone could give a sh*t what I think, other than my mother no one listens to me, I am now starting to enter the extreme fear territory. All of a sudden Ted Kacyzinski types are making sense to me. I am feeling extremely paranoid. Anyone see metals this AM? JC! I think copper itself is up 20% this year. It is up 4% today. Global demand for copper is down 10% and a supply glut is on the way. Citigroup missed the entire bull in metals and just finally issued a buy on Phelps Dodge at 7,000 times 2006 earnings. Oil reserves are higher than anytime in the last five years and we have the blow hards telling us about Peak Oil as it retests all time highs. The CRB is heading for fresh highs as the Fed has raised rates three hundred thousand times. We are blowing upward and not downward off of more bubbles than we had in 2000. If this is not the action of a bubble, we are heading for a catastrophe of unknown proportions somewhere. What's that web site name for bomb shelters? BUBBLES in Oil, GOLD, GOLD, all metals, GOLD, SILVER, OIL, etc. There's no friggin gold standard. Gold collapses with every recession. This ain't 1929 when the Feds had a contract to buy gold and keep a price underneath it. Not to mention this housing mess. Not to mention the freaking absurd valuations on the small caps due to PE EXPANSION into rising rates more than earnings growth. WTF. I'm about ready to piss my pants here. For Christ's sake would someone get me my f*cking Xanax and a cigarette!
OK, I'M KIDDING! Just get me a Valium.
Posted by: B | Apr 3, 2006 12:37:44 PM
I think there is some truth to the idea that labor participation is dropping, and I think a lot of it is women who are leaving to get their last chance to have children. Many women have deffered the oportunity and are now, in their late 30's/early 40's going for it.
My wife just left her job to take care of our first baby and she's the youngest in her firm to do so (30) everyone else who is doing so is a "last chance" mommy. While this won't explain for all of it, it must be a contributor. Also, how many older people were working part time and then stopped once the drug benefit went into action?
Posted by: JoshK | Apr 3, 2006 12:55:19 PM
I'm with ya B.
Frankly, the bear camp looks totally defeated. Mark Hulbert's Newsletter Sentiment Index Bullish Percent jumped by 25% last week to 60% - very close to an all time high. Permabears such as Bill Fleckenstein, Ned Davis and Bob Prechter are nearly silent. Even Barry looks resigned to the market heading higher.
Today is a perfect example of why things are so confusing. Decliners are nearly 400 higher than advancers, but the Naz is up 12 points. On the flip side, breadth is good (but slipping a little), and the number of new highs is expanding.
It's not quite accurate to say that EVERYONE is bullish, but the only way the news could get any better would be for the Fed to stop raising rates and for oil to go down. My concern is that the longer the market goes up from here, the uglier the ensuing correction will be.
Like you, the spectre of a global recession looms large in my brain.
Posted by: Bynocerus | Apr 3, 2006 1:09:52 PM
Good analysis. I think all of the above are represented here.
I normally try to crack a joke but I think htis really scares me and therefore not appropiate.
Posted by: David Silb | Apr 3, 2006 1:10:12 PM
B--
We are just paying the price for the unbelievable amount of liquidity pumped into the system post 9/11. This is what we get. Overbought, overvalued markets in just about every asset class. How do we get out of this? Well, higher inflation will erode each of them slowly but surely, if we can only manage INFLATION EXPECTATIONS long enough. Not inflation per se mind you, but the expectation of inflation. That cheats the bond market and stock market out of their correcting information and keeps the game going. If we stretch it out long enough, perhaps we can get past this. We don't have a solution so the solution is to keep the game going as long as we can.
Posted by: Mark | Apr 3, 2006 1:35:19 PM
B -
Dude, take a deep, deep breath...we hear ya. (May I suggest listening to Groove Armada's "I See You Baby"...you might not be "shakin' that ass", but you sure as hell shakin' somethin' boy...)
Observe the madness, and think of this as some sort of cosmic joke (and wow, what a joke!).
That's all I can do: observe and be amazed, very amazed.
Whoah...
Posted by: just_observing | Apr 3, 2006 1:35:59 PM
"We don't have a solution so the solution is to keep the game going as long as we can."
...and pray!
To whatever God you subscribe to: markets, the American Dream, Jesus, Allah, Buddha, the Barry, etc.
Posted by: just_observing | Apr 3, 2006 1:42:01 PM
You know, I read somewhere that something like 60% of emails are misinterpreted in tone. Blogging is no different. I WAS JOKING! Well, sort of joking. I am quite uneasy about how this will shake out. Only because the dufus's keep pushing extended assets even higher. I know why it's happening and I'm quite confident of the outcome because I've studied those outcomes that have been repeated time and again. My concern is that I'm just not confident of how the big picture will shake out. Unlike the perma bears who get some type of gratification from pain and destruction, I prefer to see global growth and prosperity.....including my own.
Mark, the answer is an ugly answer but it likely goes something like this. The Fed has two problems and they know it. Both problems require different answers so they create a paradox and actions that are incongruent. They sure as hell aren't going to tell us and frighten the markets so they say it with a pretty smile. I suspect they have a plan that they are executing. If they are successful is the $64 question.
The first problem is the American economy. Yes, there is a liquidity bubble. Yes, the Fed may have gone too far going to 1%. But, maybe the deflationary pressures were so intense they needed to go to 1%. Economy didn't respond at 1%. The economy finally responded with rates at 1% AND a tax cut where that easy money found a purpose. So, moving bubbles around was likely the purpose so as not to repeat the 1930s Great Depression. Fed haters might ponder that question. So now how do we save the American economy with somewhat of a soft landing? Well, give lip service by tightening but continue to pump up the money supply. Rationalizes the M3 readings before they cut it. Also a rational reason for doing so. Do the people really want to know the real answer or do we keep smiling and hope we can find a way out of this with minimal pain? They have to pump up the money supply beyond normal because this time around they need to raise the Fed Funds rate beyond what they normally would. The reason for that is likely the second problem. (Although not entirely as a result of the second problem because the CRB won't abate.)
The second problem is our financial mess. While our mess is not really different than any other country's financial mess, it is inconsistent with the dollar being the, excuse the pun, gold standard as defined by Bretton Woods I & II setting the dollar as the world's reserve currency. So, given the dollar has not appreciated off of the historically low range after raising rates fifteen times, a stoppage might cause the dollar to collapse outside of it's historical range and create a dollar crisis. Where would the world be without the dollar as the world's reserve currency? Would the dollar remain the world's reserve currency? Do we need a world's reserve currency? What would the new range of the dollar be? This is all unprecedented territory. So, while they raise rates to keep the dollar afloat, they need to pump up our money supply to keep from totally cratering the US economy. Is it different this time? Well, if those actions are indeed what the Fed is doing and the implications are somewhat accurate, then yes it might be. The implications for the financial markets are enormous and well beyond my understanding. Likely beyond theirs as well. No one really knows what happens when a dislocation so severe takes place. There is no one smart enough to program all of the variables into the what-if models to predict the outcome.
I don't know this to be true. I'm just a schmoe. But it is the only sense I can draw from incongruent Fed behavior.
Posted by: B | Apr 3, 2006 2:13:06 PM
I don't think the Fed is so dumb. They have the ability to create and to destroy money. I think only a very naive observer thinks that the Open Market Desk is only working the short end. They are slowly selling the entire curve. The probably started with the short end in order to guage the response and have now moved into the long end. They'll take the money off the table and bonds will go down.
Now, considering that the Fed doesn't trade stocks or real-estate, the next step is the real guess.
Posted by: JoshK | Apr 3, 2006 2:23:34 PM
Check that. Breadth is slipping a lot.
Posted by: Bynocerus | Apr 3, 2006 2:41:46 PM
"I WAS JOKING! Well, sort of joking."
I know. ;-)
Sometimes I get the impression you're part of that 10% of us who are awake, and you'd like to shake the other 90% by the shoulders...and shake hard (and most of the people reading this blog are the 10% who are awake).
Yeah, this "is all unprecedented territory" and there's "no one smart enough to program all of the variables."
Exactly.
So, B, the only thing I can suggest is to let go and go along for the ride. Please, I don't mean to be patronising. I think you know what I'm trying to say anyway, but some of your more opinionated emails lead me to believe that you get caught up in all this just a bit too much at times.
Take care.
David Silb -
Maybe it's inappropriate to joke about what may happen, but what else is there to do? I guess we've got to avoid being malicious about it, but otherwise...?
Posted by: just_observing | Apr 3, 2006 2:42:19 PM
Actually,
There are times I am bored. My posts will end in about a month when I'm off to something new. Then you won't have the luxury of my psychotic rants. LOL!
Posted by: B | Apr 3, 2006 3:08:21 PM
"I don't think the Fed is so dumb."
Dumb, no. As influential as they wish? I think not. Just like with the rest of globalization, no one knows what to expect. I mean, we were sold NAFTA and I don't think anyone would argue labor is better off for it. Perot was right, listen to the sucking sound of Delphi jobs racing offshore, airline maintenance rushing offshore.
So while they thought our standard of living would improve, they are coming to the realization that it isn't.
Equally smart men, Buffet, Soros, say the dollar must go down. The fed is manipulating but is running out of tricks.
I have said before, I lived through Nixon price controls, Carter gas lines, drafted under Johnson, lost my job to hostile takeover under Reagan, but the worst economy and times of my life have been when my job went to India under Bush. I am not a young mother who wants to babysit. I have lost my peak earning years, and I am not alone.
Posted by: me | Apr 3, 2006 3:20:16 PM
of course, another way to view the Fed's no longer publishing the M3 numbers is because they might at long last be serious about curtailing that growth.... they just dont want us to see it happening. but that may give more credit to Ben than he's yet due.
Posted by: scorpio | Apr 3, 2006 3:26:21 PM
Prechter ?
Robert Prechter has a new Socionomics Institute (including an on line documentary, and two volume history book). The short version is his "Key Aspects of Socionomic Theory."
I don't do Eliot Wave or buy all of his theories, but as I've
mentioned, the book Prechter's Perspectives was quite fascinating.
Posted by: Barry Ritholtz | Apr 3, 2006 3:54:05 PM
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