There is a remarkable amount of uncertainty hanging over the US economy right now. For once, it’s not uncertainty about what shocks may come from new policy measures; it seems very unlikely there will be any policy upheavals for at least the next year. Instead, the uncertainty has to do with the diagnosis of the economy’s current state and the effectiveness of potential treatments.
One might have hoped that more data, such as the January jobs report that came out at the end of last week, would have clarified the situation. If anything, though, it made things worse.
So, with answers hard to come by, here are three big questions hanging over the US economy at the moment:
1. Is the US labor market loose or tight?The headline from last week’s employment report was that the US unemployment rate had fallen to 4.9 percent. That’s low by almost any measure. It gets the rate back to where it was before the global financial crisis hit and it pushes toward a level economists refer to as “full employment.” That doesn’t mean that everyone is employed, obviously, but it does mean that there are sufficiently few unemployed that we need to start worrying about inflation, as employers start bidding up workers’ wages. Sure enough, over the past year, average hourly earnings have risen by about 2.5 percent.
But this story can be told another way. The actual increase in jobs has not been that impressive. The unemployment rate has only fallen because the number of people in the labor force has dropped dramatically. Some of that may have to do with demographics, but probably not all of it.
Kevin Warsh, a former Fed governor, linked this recently to the tenor of the current political debate. “The question is how could it be that the Fed is right that the economy is at full employment and that Donald Trump and Bernie Sanders could be getting 60 percent support from the American people between them? Does that sound to you like a poll result that would happen if the economy is growing as well as it could and unemployment can’t get any lower? Not at all.”
Warsh argued that, if one took into account people who had left the labor force and not returned, the unemployment rate would be roughly 8.5 percent. “And at 8.5 percent we can understand the politics of this moment much better.”
2. Are central banks still able to spur economies with monetary moves?Almost the first reaction of market participants, when economic news comes in these days, is to try to assess how it will push the policy choices of the major world central banks. It can lead to some perverse effects; bad news is really good, because the dismal situation will prompt the bankers to apply more monetary stimulus – to step on the gas, as it were.
Other than the US Fed, the other central banks have been stepping on the gas. Not only have they been pursuing quantitative easing, but we have seen the advent of negative interest rates in both Europe and Japan.
Is stepping on the gas the right metaphor, though? As long as everything is well-connected in a car, the more you step on the gas, the faster you go. Monetary policy can work a little differently.
With monetary policy, the effect may be different. As told by Mervyn King, former head of Bank of England and an upcoming speaker at the Chicago Council on Global Affairs, monetary policy serves as a bridge from a bright future back to a dimmer present. If you were going to wait a year to buy a car, get a house, or start a new business, rock-bottom interest rates might persuade you to make the purchase sooner rather than later.
But what if you’re in a prolonged slump and had no intention of making a major purchase this year or next? Then making it cheaper to slide purchases forward wouldn’t be expected to have much effect. This was one reason the classic critique of monetary policy in a slump was that it was “pushing on a string.”
There is nearly-palpable relief when the wizards of the central banks promise to cast their spells once again. It’s less clear that the magic really works.
3. Can the US economy flourish if other economies are floundering?In a speech last week, President Obama said, “The United States of America right now has the strongest, most durable economy in the world.” He made the claim to counteract some of the pessimism pervading 2016 campaign discussions. And, in terms of both the official unemployment rate and the growth of the economy, he’s got a point.
But a big question hanging over the economy is whether the United States can sustain its economic momentum while the rest of the world flounders. Growth has been slow, nonexistent, or negative in Europe, Japan, Russia, and Brazil. China is still reporting fairly impressive rates of growth – near 7 percent – but the country has been acting as if conditions may be worse than that.
One of the reasons it is difficult for one globally integrated economy to race ahead while others lag is that exchange rates will adjust. And that’s what has happened. Over just the last year and a half, the dollar has strengthened by roughly 25 percent against a trade-weighted index of major currencies. The immediate effect is to make US goods look expensive relative to those coming from other countries.
The optimists’ rejoinder is that the US economy is less open than most other major economies. In 2015, exports and imports combined to account for 27.5 percent of US GDP. While that’s lower than a lot of developing economies, it’s not that far off the European Union or Japan.
And there can be other connections. The Wall Street Journal, in a lead story, reports that big companies are cutting back on their capital spending and axing jobs. “The cautious approach suggests that executives remain wary as the strong dollar and weak growth in developing markets hurts their foreign sales…” Such a reaction can not only slow the US economy directly, but instill fear in consumers and investors in a way that exacerbates the reaction.
Harry Truman reportedly once expressed a desire to have a one-armed economist, having grown tired of hearing “on the one hand… on the other hand…” Now you know how he felt.