Sluggish jobs market casts doubt on Fed’s forward guidance
Friday’s U.S. unemployment figures were surprisingly bad. Only 74,000 jobs were added to payrolls in December, barely half what analysts had expected. The news was a reminder of how far from normal the economy still is — and of how tricky it will be for Janet Yellen, who’s about to take over as chairman of the Federal Reserve, to explain the central bank’s policy.
That jobs number by itself is more worrisome than alarming. It’s a noisy statistic, subject to seasonal disturbances and big revisions. But it can’t be dismissed, either. It’s enough to suggest that the economic acceleration that looked to be getting under way in recent months isn’t yet a done deal. Some of the markets’ recent enthusiasm on that score needs to be reined in — and, thanks to these numbers, it will be.
At first sight, the big fall in the unemployment rate to 6.7 percent from 7 percent tells a much happier story. Sadly, no. The fall reflects a further drop in the number of people looking for work. A shrinking labor force reduces the economy’s productive capacity, to say nothing of the effect on the dropouts’ prospects. And the proportion of long-term unemployed — the workers most at risk of dropping out of the jobs market in future months — remains close to 40 percent of the total.
In one way, the implications for policy are clear: This is no time to be tightening either fiscal or monetary policy. Extending unemployment benefits, which already made sense on economic and humanitarian grounds, is now all but mandatory. If this can be financed by extra borrowing rather than by offsetting cuts in other spending, so much the better: Some new fiscal stimulus, however modest, wouldn’t go amiss.
The bad jobs news will make the Fed think twice about its plan to phase out asset purchases — the policy of quantitative easing, which it has been using to supply unconventional monetary stimulus. Until better numbers come along, this policy may be paused or even reversed, a possibility Chairman Ben Bernanke mentioned in his last news conference. Financial markets will also expect a delay in any decision to start raising interest rates. On news like this, the Fed will want to avoid any suspicion of wishing to tighten monetary conditions.
Yet the Fed faces a problem of its own making in explaining all this. It’s put increasing emphasis on detailed “forward guidance”: statements about its intentions. The current guidance includes a “threshold” of 6.5 percent unemployment — that is, the Fed has said it won’t consider raising rates before that number is reached. With unemployment at 6.7 percent, the economy is almost there. The reason, however, is a weaker-than- expected labor market, not a tightening jobs market that would stoke fears of inflation.
The Fed has recently suggested that, for all practical purposes, it will ignore its unemployment threshold. But what was the point, then, of using the threshold for forward guidance in the first place?
Judging the state of the labor market is a vital component of devising monetary policy. Yet the unemployment rate is only one of many measures, and a badly flawed one at that. Guidance that needs to be explained away is worse than none at all. The new jobs figures should convince the Fed that, when it comes to forward guidance, simpler is better.