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Tags: Fed | tax | unemployment | policy

Fed Failing at Dual Mandate

By    |   Friday, 29 August 2014 07:53 AM EDT

The Federal Reserve is seriously debating how it can accomplish its dual mandate to minimize inflation and unemployment. The general consensus by the Fed is that it has failed and has no clear action plan for the future.

When the gold standard was completely abandoned in the early 1970s, stagflation and a severe recession ensued, resulting in high levels of inflation and unemployment.

The 1977 Federal Reserve Reform Act explicitly directed the Fed to assume a dual mandate to stabilize inflation and long-term interest rates while maximizing employment. The Humphrey-Hawkins Act of 1978 further reinforced these objectives.

However, for decades, economic policy leaders largely ignored the dual mandate, since price stability seemed to coincide with economic growth. Unfortunately, that is not the case today — prices of real goods and services have stabilized, but growth is anemic.

At the Kansas City Fed Economic Policy Symposium in Jackson Hole, Wyo., last week, key players began to acknowledge that the correlation between low inflation and economic growth might be inaccurate and labor markets are more complex than originally thought.

The problem lies in how unemployment is defined. Current measures exclude the underemployed, who take lower level positions or work part time, as well as those not actively seeking employment despite a real desire to do so.

While the Fed's highly accommodative monetary policy brought unemployment of those actively seeking work below 6.5 percent, this measure did not accurately reflect the true nature of the labor market, since many people who wanted work could not find it.

In essence, there was a stealth overabundance in the labor supply that was depressing wage growth for the masses.

The massive expansion in the money supply lowered interest rates, causing a tremendous increase in financial asset prices, including bonds and equities. Most of this new wealth was concentrated in the upper financial echelons, further increasing wealth inequality and exacerbating the conditions of high unemployment and low-wage growth while keeping inflation in the real economy relatively low.

The following statistics from the Bureau of Labor Statistics and the Economic Policy Institute starkly illuminate the problem:

1) The civilian employment population ratio is at the lowest level in more than 30 years, down from 64 percent in 2000 to 59 percent today, just 1 percentage point below the 1980 level of 60 percent.

2) The share of long-term unemployment for 27 weeks or more grew 4.5 times from 10 percent of the total in 1990 to 45 percent in 2010. At the end of 2013, it stood near 38 percent.

3) The labor participation rate for the 16-to-24 year-old youth category fell 17 percentage points, from 77.5 percent in July 1989 to 60.5 percent in July 2014. The labor participation rate represents the share of the working-age population either employed or actively seeking a job.

In response to these data, the Fed has embarked on the construction of a new index to more accurately depict the status of our labor markets. The Labor Market Conditions Index consists of 19 indicators that include broad categories of unemployment and underemployment, employment, workweek hours, wages, vacancies, hiring, layoffs, quits and surveys of consumers and businesses.

In addition to new data sets, the Fed needs to focus more intently on proper macroprudential regulation to ensure adequate capital reserves are maintained. This will minimize financial market volatility and stabilize long-term economic growth.

Unfortunately, now matter how hard the Fed tries, I do not believe it is within their jurisdiction to completely rectify this problem. Prudent fiscal tax policy is essential to incentivize the required long-term investment that can generate sustainable and strong growth in employment and income.

My tax reform plan would help create a ripe environment that promotes this type of investment by expanding the tax base, lowering tax rates and reducing the cost of production and associated price increases.

The proper mix of fiscal and monetary policy is essential for stable, long-term economic growth.

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The Federal Reserve is seriously debating how it can accomplish its dual mandate to minimize inflation and unemployment. The general consensus by the Fed is that it has failed and has no clear action plan for the future.
Fed, tax, unemployment, policy
Friday, 29 August 2014 07:53 AM
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