Will the Fed Kill the Recovery Again?

The Labor Department reported that the economy added 295,000 payroll jobs in February, the 12th straight month of job creation of better than 200,000 a month. And the Dow Jones Industrial Average promptly dropped by nearly 300 points.

What gives? Do capitalists hate workers?

Well, perhaps; but the immediate explanation is concern about the Federal Reserve. If unemployment keeps falling, the Fed is more likely to raise interest rates. And if the Fed raises rates, that's bad for the stock market because bonds start to be a better investment than stocks; and the expectation of flat or declining stock prices feeds on itself and sets off a wave of stock selling.

Supposedly, the assumption that the Fed will raise rates in the not too far distant future has been already "priced in" to share prices. But that's malarkey. Markets react emotionally, not always rationally.

But is there any earthly reason for the Fed to raise rates? The inflation rate is actually well below the Fed's own target of 2 percent, and there is no sign of price pressure on the horizon. Wages have a long way to go before they begin to catch up with recent wage losses.

The official unemployment rate is now down to 5.5 percent, the lowest level since before the economic collapse of 2008. As unemployment falls and as the economy continues to recover, the inflation hawks will increase pressure on the Federal Reserve to tighten money. Wall Street would rather see higher joblessness than risk even the slightest bit of inflation.

For years, as the Fed has engaged in large scale bond purchases to keep interest rates low. Fed-watchers and some of the central bank's own regional bank presidents who sit on its policy-setting open market committee have been urging the Fed to reverse course. The latest assumption to by the chorus of inflation-hawks is that the Fed could and should raise rates as early as June.

But those who have been warning that hyper-inflation is just around the corner keep being proven wrong again and again. And even as the official unemployment rate falls, prices are steady and wages are going nowhere fast.

The growth of earnings for private-sector workers was just 2 percent in February compared to a year earlier, actually a shade lower than the January gain of 2.2 percent. More than 6 million people are out of the workforce because they can't find jobs. And the percentage of the adult population in the labor force, at about 62.8 percent in February, continues to be at or near record lows.

The improving jobs picture fails to translate into improved earnings because of profound structural changes in the economy. More and more people are in temp, part-time, or contract jobs. The threat of outsourcing keeping wages from rising. Unions continue to be crushed.

At the bottom of the labor market, a shortage of workers willing to work for a pittance has compelled Wal-Mart and other exploitive corporations to raise wages modestly. And increases in the minimum wage in several states have also improved earnings at the low end. But these gains simply do not translate into inflation.

For most of its history, the Federal Reserve has been dominated by bankers and orthodox economists, who kill the recovery at the first sign of inflationary risks. Happily, the Fed today is led by Janet Yellen, a very uncharacteristic Fed chair who spent most of her career as a labor economist, of all things. Yellen is aware of the changes in the structure of labor markets and is unlikely to jump the gun on raising rates, though it's always possible that she could be outvoted.

The risk today is not that an improving jobs picture will set off inflation. It's that even tight labor markets, by themselves, will not generate enough pressure for wage increases, because workers have lost so much bargaining power.

Full employment helps, but the gains that are overdue to America's workers will also require better enforcement of America's labor laws and stronger unions. Even if unemployment came all the way down to 4 percent, the usual definition of full employment, wages would likely grow only modestly.

With too many people in both parties committed to deficit reduction rather than the public investment that America needs, the Federal Reserve and its commitment to low interest rates is about the only game in town keeping the recovery going. The last thing we need is inflation-panic and tighter money.

Robert Kuttner is co-editor of The American Prospect and a visiting professor at Brandeis University's Heller School. His latest book is Debtors' Prison: The Politics of Austerity Versus Possibility.

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