"I must do it. But I fear to do it. Upon my soul I do." So said Alec Guinness' King Faisal to Peter O'Toole's Lawrence in Lawrence of Arabia when faced with demands that he place his Bedouin fighters under British command. And so in effect said Federal Reserve chairwoman Janet Yellen to the Economic Club of New York when faced with the prospect of raising interest rates by a full percentage point in four steps this year, as she previously quasi-promised - "not a plan set in stone". She is right on both counts: She must end the distorting effect of near-zero interest rates, and it is reasonable to fear to do it.
Yellen finds herself a dove increasingly faced with the need to don the feathers and attitude of a hawk. She flirted with such a metamorphosis in December, when the Fed's monetary policy committee raised rates by 0.25 percent, and indicated it would institute similar increases three more times this year, a program now "evolved" into wait-and-see.
Consider how often she and colleagues have come to the brink of a systematic increase in interest rates, only to recoil. She was waiting for the unemployment rate to drop to 6 percent. According to Friday's jobs report, it is now 5 percent. Then for the so-called U-6 rate, which includes workers too discouraged to job hunt and unable to find full-time work, to drop, which it has, to the lowest level since 2014. Then she was waiting for the labor force participation rate to increase: it has. Then serial interest rate increases would have to wait for inflation to turn up. It has. Then she moved the goal posts again, waiting for wages to turn up: they have, with average hourly earnings up 2.3 percent in the past year. All in all, the 215,000 jobs created in March bring average job creation in the past twelve months to over 200,000, which as we say in New York, "ain't chopped liver." Yet she still fears to do it.
For three basic reasons. First, "the pace of global growth", and especially China's economic woes, are roiling financial markets, raising risk, creating the possibility that investors will demand higher returns, "causing financial conditions to tighten". That would "likely slow US economic activity." Second, there is a difficult-to-explain dichotomy between the cheering jobs data and the failure of the economy to break out of an unimpressive 1 percent growth pattern. More jobs, not much more output, means that productivity – what workers produce in an hour – is declining. Unless, as some experts argue, the output figures fail to capture the value of the output of an economy that relies more on the creation of apps than on the rolling of countable tons of steel than was once the case. If productivity is to rise, businesses will have to invest in the capital that workers need to be efficient. But corporate boards aren't likely to come up with the cash soon: such investment fell in February.
Thomson Reuters I/B/E/S forecasts that by the time earnings season ends – it opens the week of April 11 -- first-quarter earnings of S&P 500 companies will have been shown to have dropped by almost 7 percent compared with last year, almost 2 percent if we exclude the tanking energy sector. That makes three consecutive quarters of decline, a "profits recession". The Fed is reluctant to create an added disincentive to invest in productivity-enhancing capital by raising interest rates during such a profits recession, and after such investment fell in February. If its actions are what determine the rate of business investment, such reluctance classifies as prudent.
Finally, the economic tea leaves, or the duck's entrails, or whatever other forecasting tools the Fed uses are difficult to read.
* The manufacturing sector is expanding for the first time in seven months, with new orders leading the way.
* Housing continues to pull its weight, with construction starts rising at a surprising rate.
* But the bloom might be off the auto industry's rose. Although new cars continue to move off showroom floors, discounting is increasing and many are financed with 72-month subprime loans.
* Consumers are enjoying rising incomes, but are not spending: The savings rate is up to 5.4 percent, its highest level since late 2012. In an effort to get consumers to open their wallets and purses, business-hungry banks are once again urging them to borrow against the equity in their homes, which is rising with house prices. TD Bank is sending an iPad-laden tour bus to DIY stores to make it easier for customers to apply for loans to spiff up their homes. Shades of 2007.
None of this should be taken to mean that Yellen might not be right to be cautious at a time when, as the Lindsey Group puts it, "the fundamentals of economic growth continue weak," and when the Fed is under enormous pressure. For one thing, bills are bubbling up in congress to strip the Fed of its independence. For another, globalization has made the U.S. economy more dependent than ever on factors that are beyond the ability of anyone to forecast: want to guess whether Xi Jinping will try to reform his economy or continue to shore up bust banks and state-owned enterprises? Whether Saudi Arabia will persist in attempting to destroy our fracking industry by pumping more oil than the market can absorb at existing prices? Whether Japanese and European central banks will move interest rates from merely negative to very negative? Yellen has to cope with all of that, not to mention publicity-seeking colleagues who are not unaware that disagreement with the chair will garner the largest headlines and the most interview time on business cable channels.
Finally, monetary policy is being called upon to do more than should reasonably be demanded of it. Because our national debt is crowding $20 trillion, and rising, and because Republicans do not trust the president to use any additional spending it might authorize efficiently, fiscal policy is neutered and will remain so until and possibly after the November elections. That leaves Yellen & Co all alone on the recession-fighting, growth-inducing firing line. One need not be a dyed-in-the-world Keynesian to recognize that leaving the central bank without support from a coordinated fiscal policy is not a sure way to get the economic growth rate closer to 3 percent than to zero. And one need not be a skeptic of the efficacy of monetary policy in general, and the Fed's variant in particular, to wonder if Yellen & Co should swallow its fears and gradually get out of the business of forecasting and of trying to micromanage the macroeconomy.