The Federal Reserve, in its rush to prevent prices and wages from rising too fast, underestimated how fast American employers were hiring workers, and boosted interest rates before the economy was ready — costing U.S. workers up to a million jobs since 2015, economists Adam Ozimek and Michael Ferlez concluded in a paper for Moody's Analytics' Regional Financial Review.
"The Fed's incorrect beliefs" have cut growth and hiring by a "substantial" margin, they added — noting that the central bank's own leaders, talking in central-banker code, have admitted the Fed was wrong when it started raising interest rates in late 2015.
For example: "Policy was less accommodative than thought at the beginning of normalization," acknowledged Jerome Powell, President Trump's Fed chairman, at a symposium in Jackson Hole, Wyo., on Aug. 24.
Translation into English, please? Try this: "Members of the [Fed Open Market Committee, which sets interest rates], including me, now believe that the neutral real interest rate [which doesn't grow or shrink the economy] and the natural rate of unemployment [where the only people not working don't want to] are lower than we had realized," wrote Neel Kashkari, who heads the Fed's Minneapolis branch bank.
The roots of the Fed's confusion reach back at least to the Great Recession. The Fed moved quickly, as Lehman Bros., Bear Stearns Co., and other investment banks bloated by rotten mortgage debt collapsed, business orders stalled, and layoffs rose until one in nine American workers was unemployed. It pushed temporary bailouts for commercial banks, cut interest rates to zero, and bought piles of mortgage bonds and other financial assets to calm lenders and borrowers and prevent a deeper collapse.
"The Fed deserves praise for preventing a far worse outcome" — but "made a mistake" when it began boosting rates in December 2015, after years of keeping the price of money close to historic lows, according to the paper.
(This is not Moody's official corporate position, Ozimek, who is based at Moody's Economy.com unit in West Chester, told me. His boss, Mark Zandi, who often testifies in Congress and was considered for a top regulatory job in the Obama administration, "was arguing with me about this" just last week. But outfits that employ economists tend to let them follow the data where it takes them.)
You can track how the Fed bumbled a key policy-making and interest-rate-setting benchmark, the "unemployment rate gap," which gauges the difference between how many people are working and how many jobs the economy can sustain without inflating wages and other prices. The Fed posts a quarterly Summary of Economic Projections, which is supposed to show where unemployment is headed over the next few years, absent unusual shocks, and with a steady Fed hand guiding "appropriate monetary policy."
Ozimek and Ferlez checked the Projections against what actually happened, and found that in 2015, when the Fed began boosting rates under Obama's Fed chair, Janet Yellen, actual unemployment stood at 5 percent; it has since dropped to 3.9 percent. The Fed projected it would stay around 4.9 percent. The drop caught the Fed by surprise, causing it to cut the "longtime" projection, so far, to 4.45 percent. That's a "significant error," Ozimek and Ferlez noted in the paper, pointing out that Powell has since said he expects unemployment may even continue falling below today's lower rates.
"Based on what it knows now" and given the Fed's congressional mandates to keep prices flat and unemployment low, the Moody's economists concluded, "the Fed should not have started raising rates" for at least two years after it did so.
Higher interest rates translate to less borrowing, more bad loans, and slower growth. Factoring in actual inflation (which has remained low) as well as higher employment than the Fed expected, Ozimek and Ferlez pump jobs, interest rate, and price data through Moody's macroeconomic model and estimate the premature rate hikes have cut U.S. annual growth by 0.4 percent to 0.8 percent as of the second quarter. In other words, the hikes have shaved one-eighth to one-fourth of a percentage point off the recent economic expansion — costing between 500,000 and 1,000,000 million jobs.
Are the economists crowing, "I told you so?" Ozimek was a "dove" on interest rates in early 2015, before the Fed started boosting rates. In 2016, he warned that the Fed has a history of overestimating the "natural" rate of unemployment and justifying interest-rate hikes that held back job growth and wage increases. (They acknowledge there are other Fed arguments for raising rates when it did — to help banks, or to regain leverage over the economy in advance of the next recession.)
But what's the damage, really? As President Trump likes to remind everyone, even with interest rates higher than a couple of years ago, the economy continues growing, and bosses continue hiring, and complaining they can't find enough young people willing to work at today's wages.
Still, "raising rates too soon is delaying a full recovery, which is not a good way to insulate the economy from a recession," Ozimek told me.