A quick note before we enter the Fed’s two-day meeting. I am reposting a note from a few weeks ago when I conjectured that Chairman Yellen was not the keeper of the Greenspan Put. In the present realm of depressed wages, Yellen would err on the side of allowing corporate profits to soften if it meant an increase of wages for the middle level wage earner. Corporate profits as a percentage of GDP are at elevated levels because capital has been well rewarded from the effects of globalization while the massive increase in the global wage pool has kept downward pressure on wage rates in the developed world economies. Throw in the historical low borrowing rates set by the world’s central banks and the result is enhanced corporate profits. The FED has been enamored with the idea of “forward guidance” and went so far as to put in a quantitative threshold as a measure of its commitment. The Bank of England has already dispensed with its numeric-based forward guidance and seems to have accepted a more nuanced and qualitative response to its mandate.
The FED has previously discussed its threshold to be an unemployment rate of 6.5 percent as a level of interest but NOT A TRIGGER to automatically raise interest rates. Therefore, the FED will be issuing GUIDANCE on a much more SUBJECTIVE basis heavily influenced by qualitative measures of what the unemployment data really mean. Ms. Yellen will have room to wait because the 6.5% unemployment rate is not the same as when employment was targeted as a catalyst for creating inflationary pressures. The FED has used the idea of OUTPUT GAPS as a measure of when wage pressures may result in inflation, or what has been referred to as the NAIRU (Non-Accelerating Inflation Rate of Unemployment). If the economy is growing, the probability of slack in the labor pool diminishes and wages will go higher. The problem with the advent of NAIRU was that it came to the fore in the mid-1970s. There was upward pressure on wages as private sector unions represented a greater part of the work force and rising prices would be met by union pressure to raise wages. The diminished power of the private sector unions has meant workers have settled for pay that has lagged inflation. (Public sector unions are another story, which will be covered elsewhere.)
The FED has measured a threshold for a previous time in U.S. economic history, which will allow Chairperson Yellen to backtrack on forward guidance by the new use of several qualitative measures. Thresholds have been shackles of Fed’s own design. How Ms. Yellen chooses to remove the shackles in an effort to stimulate wage growth will the challenge that awaits the new Fed chair. But the 2014 election is already raising issues about the heightened risks of wage inequality. This Fed will not undermine the administration’s effort to correct the great wage disparity of the previous three decades.
Link to blog post: February 13, 2014–Just a Song Before I Go (Graham Nash)