THE FED AND THE ECONOMIC EXPANSION The economic expansion may look anemic compared to the expansions of the 1960s and 1990s in terms of cumulative real GDP growth, yet an examination of the labor markets tells a very different and much more positive story about the economic expansion of the 2010s. The durable economic expansion of the 2010s has also been a major success story in reducing the unemployment rate. Plain and simple, when the labor force is growing more slowly, a small increase in real GDP can still lower the unemployment rate. This was the case in the expansion of the 2010s, when the unemployment rate dropped from the recession high of 10% to below 4%. Sustained unemployment rates below 4% are rare, and on this count the expansion of the 2010s shows it is a first-class performance.

Of course, the Fed has often displayed a tendency to worry about low unemployment rates lead to higher inflation. Historically, the policy response was to take short-term interest rates well above the prevailing inflation rate, invert the yield curve (short-term rates higher than long- term bond yields), puncture high debt loads and eventually cause a recession.

The Fed’s preoccupation with labor markets as a driver of inflation comes out of the 1970s. Unfortunately, economic ideas that have lost any quantitative basis can take decades to fade away. The core US inflation rate has been averaging around 2%, moving in a narrow range of between 1% and 3% since 1994 – or over two-and-a-half decades. Put another way, there was no correlation between inflation and labor markets in the 1990s, the early 2000s, or the 2010s.

Chart 3: Declines in the Civilian Unemployment Rate

2 1 0

-1 -2 -3 -4 -5 -6 -7

0 10 20 30 40 Source: CME Group Economics, Federal Reserve Bank of St. Louis FRED Database (UNRATE) 50 60 70 Number of Quarters of Expansion. 80 90 100 110 120 1960’s 1990’s 2010’s

Still, the Fed under Chairman Jay Powell did seem set on raising rates in 2018 with a strong desire to push short-term rates well above the rate of inflation. Whether it was the equity swoon of Q4/2018, President Trump’s jawboning for lower rates or the bond market forecasting lower rates, the Fed switched gears and stopped hiking rates at the end of 2018. Then, in the summer of 2019, the Fed moved to lower rates a notch. The main reason cited by the Fed for lowering rates was fears that the trade war could negatively impact global growth and slow the US economy. At the time of the Fed rate cut at the end of July 2019, the US consumer was doing well, unemployment was below 4%, and various measures of inflation were between 1.5% and 2.0% -- very close to the Fed’s long-run target – and inside the range that core inflation had established since 1994. The only negative factor the Fed could find to cite was the anemic state of business investment, a clear casualty of the trade war.

In any case, regardless of the reasons, this Fed has taken interest rate policy off the table as a possible reason for the durable economic expansion of the 2010s to end, and so this expansion will need to find another reason if it is to meet its demise.

20 | ADMISI - The Ghost In The Machine | July/August 2019

Percentage Point Decline in the Unemployment Rate. 1st Month of Expansion = 0.

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