Will a Fed Interest-Rate Hike Jack Up the Jobless Rate?
FEDERAL Reserve Governor John LaWare ducked this question: If the current unemployment rate of 5.4 percent is so low that it means inflation will accelerate, will the Fed act to boost the number of jobless?
``I don't think any of us like to believe we are manipulating the rate of unemployment,'' the Fed official responded.
Economists, though, reckon that monetary policy changes do influence employment. So a big issue now is what will happen to job creation if the Fed's policymaking body boosts interest rates next week by 0.5 percent, as anticipated, to restrain inflation. Testifying before Congress Wednesday, Federal Reserve chairman Alan Greenspan gave no signal of a change in heart.
Some economists say tighter monetary policy will be a mistake - that it could tip the United States economy into recession.
``The economy is bowling along with the best inflation performance in 30 years,'' says Jeff Faux, president of the Economic Policy Institute in Washington. ``So what is the problem?''
The problem, according to Mr. LaWare, is that the economy last year expanded 4 percent after inflation. ``This is a very substantial growth rate when most people believe the capacity of the economy has grown only 2.5 to 2.75 percent. This will soon use up all the slack in the economy,'' he says. ``Historic experience'' indicates that labor and industry push for higher wages and prices when capacity is short. ``There are not a lot of signs that we are slowing substantially going into the first quarter of 1995.''
LaWare, talking to the Executive Service Corps of New England last Tuesday, sounded much like he was going to vote for higher interest rates.
But the former commercial banker also spoke of the difficulty of making that decision. ``Economists would like you to believe economics is a science,'' he says. ``That is baloney.''
As an example of the fuzzy numbers the Fed looks at in deciding policy, he cited what economists call the Non-Accelerating-Inflation Rate of Unemployment (NAIRU). Some economists at the Fed's Kansas City branch last year estimated NAIRU as 6.8 percent. Others put it at 5 percent. If the jobless rate (now 5.4 percent) falls below the NAIRU figure economists anticipate a revival in inflation.
``That is a pretty broad spectrum,'' he complained. Perhaps, he suggested, it is ``somewhere in the middle.''
He further cited the economic argument that corporate reengineering, involving layoffs of thousands of people, has created job insecurity in the minds of employees. ``That tones down the demand for increases in wages,'' he said.
LaWare also noted economists' uncertainty as to how much the nation's industrial capacity has grown in recent years as it adapted new technology, expanded plants, and downsized staff, including those in middle management.
Perhaps, he seemed to hint, such ``unknowns, variables'' mean that inflation can be stopped without boosting unemployment.
Harvard University economist James Medoff told the Fed's seven governors Dec. 1, when the jobless rate was 5.8 percent, that NAIRU was 5 percent to 5.5 percent. ``I was the lunatic fringe then,'' he says. Most economists put NAIRU at 6 percent. Since then estimates of that rate have been dropping.
He describes the 6 percent rate as ``just a joke.... We still have some slack in the labor market. We could give 600,000 more people jobs without causing the rate of inflation to accelerate.''
But if jobs are created too fast, it could boost inflation, Mr. Medoff says. ``If raising interest rates will get us that 600,000 jobs slowly and prevent inflation from accelerating, do it.'' He prefers looking at a help-wanted ad index when analyzing the tightness of the job market.
Medoff keeps a measure of the quality of jobs that includes average pay plus benefits. It has declined every month since 1982. This reflects the shift of people from high-paying manufacturing jobs to lower pay and benefits in jobs in the service industries. ``People are nervous now because there are not that many good jobs out there,'' he says.
Mr. Faux wants the Fed to restrain itself from raising rates because of the danger of speeding this erosion of living standards. ``When you get a strong recovery, a little increase in prices and wages, the guy at the bottom benefits,'' he says.
Faux says inflation has not risen above 5 percent since 1914 except in wartime or following a dramatic jump in oil prices, as in 1974. ``The economy of 1995 is not the economy of 1975,'' he says.
Alan Meltzer, a University of Pittsburgh economist, sees a serious rebirth of inflation unlikely because of tight money. ``The Fed should pay some attention to the fact that the monetary aggregates [measures of the money supply] have not been rising for the past year,'' he says. Letting economic growth continue would do more for the disadvantaged than ``all the welfare programs the government could possibly put together.''