Is Another Round of Quantitative Easing Coming?

Today was a special Jobs Day Tuesday as the Bureau of Labor Statistics released the September jobs report, which had been delayed due to the government shutdown. It wasn’t very good. Total non-farm payrolls increased by 148,000, which was less than the expected 180,000, while the unemployment rate dropped from 7.3% to 7.2%. The labor force participation rate remained unchanged at 63.2%. The July (-15,000) an August (+24,000) revisions combined for an increase of 9,000 jobs.This report was disappointing, but what’s even scarier is the trend lines.

Here’s the three-month moving average going back to the end of 2011:

3 month moving averageThere’s a pretty good chance that something is wrong with the way the BLS seasonally adjusts the numbers. Every winter has been much better than the following summer, but the trend is still not good. We’re into Obama’s second term and the economy is still barely growing. The reasons for this aren’t clear, but the government likely has a lot to do with it. Sequestration is terrible policy that is taking a chunk out of the economy at the wrong time. Austerity is the last thing we need right now. The expiration of the payroll tax cut at the start of this year is likely having some effect as well. And, of course, shutting down the government and risking a default is about as boneheaded as it gets. Instead of constructing policies looking to get the economy back going, the federal government (read: Republicans) have stood in its way.

The Federal Reserve has been concerned about fiscal policy and chairman Ben Bernanke has repeatedly emphasized that Congress needs to do more. Except that’s never going to happen. The question then is will the Fed do more? The economy is slowing down, not recovering. The FOMC had hinted at tapering in September, but pushed it off due to weak data and the impending fiscal fights. The market had assumed that the Fed was going to reduce its bond purchases regardless of the underlying data. By delaying the taper, the central bank attempted to regain its credibility and prove to investors that it’s data-dependent. Now, this is another test of that credibility.

This was a bad report and the economy is trending downwards. More fiscal fights loom and sequestration will be worse in 2014 than it was this year. Inflation is still running well below the Fed’s 2% target. If the Fed is really data-dependent, it will seriously think about making its policy even more accommodative either through QE4 or another mechanism.. The economy is no longer improving at a moderate pace. It’s slowing and there’s no chance that fiscal policy will help. It’s time for the Fed to pick up the slack.

The Unemployment Rate is Just One Indicator

One criticism of the Fed’s recent communication strategy has been that it relied too heavily on the unemployment rate as an indicator of the health of the labor market and communicated that reliance to the market. As I wrote earlier, the unemployment rate is falling, but the economy is barely improving. In his June prepared statement, Fed Chairman Ben Bernanke said:

And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains

The Fed projections at the time expected the unemployment rate to be at 7.2-7.3% in the fourth quarter of this year. In August, the unemployment rate fell to 7.3%, well ahead of the Fed’s projections. Except this was not the result of above-average economic growth. On the contrary, financial markets tightened and the August jobs report was disappointing.  The drop in the unemployment rate was not representative of the overall economy.

Bernanke had hinted that the unemployment rate would be around 7% when asset purchases fully ended, but it had not even begun tapering yet. That was one major reason that so many journalists and investors expected the taper last week. Yet, this is once again not the Fed’s fault. The central bank could have done better in a number of areas. The long silence from the Fed governors provided little guidance for investors and Bernanke should have emphasized more that the Fed uses many different pieces of economic data to judge the labor market, not just the unemployment rate. But fundamentally, this was the market misreading the Fed.

Investors took one economic indicator and assumed the Fed would base its monetary policy on it. Worse, they knew that the drop in the unemployment rate was not the result of improving economic growth. It should have been common sense that the Fed would not that into account. But it wasn’t. There’s no doubt the Fed and Bernanke could have been more clear, like NY Fed president BIll Dudley was today and Bernanke was in his press conference last week. There, the chairman emphasized that the Fed looks at other economic indicators as well:

Last time, I gave a 7 percent as an indicative number to give you some sense of, you know, where that might be. But as my first answer suggested, the unemployment rate is not necessarily a great measure in all circumstances of the–of the state of the labor market overall. For example, just last month, the decline in unemployment rate came about more than entirely because declining participation, not because of increased jobs. So, what we will be looking at is the overall labor market situation, including the unemployment rate, but including other factors as well. But in particular, there is not any magic number that we are shooting for. We’re looking for overall improvement in the labor market

Too many commentators overreacted to what Bernanke said in June. The 7% unemployment rate number was treated as a trigger, not a threshold, even as Bernanke emphasized that it was the opposite. The unemployment rate was treated as the pivotal economic indicator influencing Fed decision-making. If you take a step back and look at the economic growth the past three months, there were few reasons the Fed would taper and many it wouldn’t.  The most important thing is that the economy underperformed Fed expectations. Yet, it was conventional wisdom that the taper was coming. That doesn’t mean Bernanke couldn’t have been clearer in June, but it means it was a fundamental misreading by journalists and investors. The Fed’s over-reliance on one economic indicator doesn’t change that.

The Graph That Made (Almost) Everyone Hate Deficits

Kevin Drum penned a post last night about why people hate deficits so much. He runs through a few options, but settles on the following:

Liberals have done an abysmal job of explaining why deficits are good during periods of high unemployment, so ordinary citizens have no reason to think deficits are anything other than bad.

I think this all hearkens back to the graph from Obama Administration economists Jared Bernstein and Christina Romer in January 2009 showing the expected unemployment rate with and without the stimulus. American Enterprise Institute’s James Pethokoukis has updated the graph with the actual unemployment rate (this is his update from September of last year):RomerBernsteinAugust1

It’s tough to prove that deficit spending in times of high unemployment works when the stimulus seems to have failed so badly. Of course, Bernstein and Romer’s graph was so far off because the economy was much weaker than anyone realized at the time, not because the stimulus failed (it didn’t). But, try telling that to your average person. For most people, that graph is confirmation that deficit spending does not work. That’s a very deep hole for liberals to start in.