The Bureau of Labor Statistics jobs report for May came out last week and reported that 75,000 new jobs were created. When adjustments for the previous months were made, the net increase in jobs for May was closer to zero.
As one might expect, many people have wondered/worried if the current economic expansion is either slowing or over. To indirectly affirm these wonderings/worries, the Chairman of the Federal Reserve, Jerome Powell, has suggested that the Fed may cut its Fed Funds target rate from 2.5 percent to 2.25 percent. This would end, at least temporarily, the Fed’s recent efforts to raise Fed Funds and reduce the size of its asset portfolio that had grown since 2008, when the various forms of quantitative easing characterized monetary policy. Again, the Fed is seen as attempting to correct coming economic instability.
Whenever things like this have transpired over my working years, I recall my favorite economic history book by Milton Friedman and Anna Schwartz entitled “A Monetary History of the United States from 1867 to 1960.” Published in 1963, Friedman and Schwartz reviewed the actual historical record of the gold standard, silver standard, various banking panics including my favorite of 1933, the founding of the Federal Reserve, its reform in 1936, the Accord and other events.
It is wonderful reading. I have worn out two copies. With respect to the Federal Reserve, one of Friedman and Schwartz’ major conclusions was that the Fed had been one of the greatest sources of economic instability over the history of the republic. Given this history, why is Mr. Powell attempting to fix things?
I think it is general human nature to feel, if in a position of power, that one can and should fix problems or wrongs. It follows that these same people feel like they must also make good things better. Why then the Friedman and Schwartz conclusion that, given the good intentions policy makers, they end up making bad times worse and good times less good?
See, the policy game is not rigged. The policy game is just too hard to play.
If the economy is, in fact slowing and we are just seeing it now, it began in the past. There is a lag — what we call the recognition lag — between when bad times start and when they are first seen. Estimates for this lag range between 6 to 9 months. Next, there is the time needed to formulate the right and most effective policy to address the problem that we may now be seeing. Given the structure of Fed policy making, this lag — the action lag — is probably very short; maybe 1 month.
So, we see a problem, we have formulated new proper policy (we hope), now how long does it take — the impact lag — for the new policy to address the observed problem? Here we have a problem. Friedman has referred to the impact lag (the outside lag for the true policy wonks) as long and mysterious. In some sense, it is hard to quantify (no one knows).
Given all these lags, policy makers are in a pinch. They are addressing problems after the problem started, with policies that may or may not be proper, in an environment where their effectiveness may never truly be seen. In the end, the odds are better that the Fed does the wrong thing at the wrong time and not the right thing at the right time — no matter how well-intentioned they might be.
This is a good bit of economic research suggesting that the economy started behaving differently around 1980. Some have argued further that the formation of monetary policy has gotten better. These are issues that need to be addressed to settle the issue of policy getting better or the economy now adjust better to bad policy. These are interesting questions. However, time lags did not go away.
I often wonder if it might be best to do nothing. Just be supportive and not proactive. Let our great economic machine do what it does with out interference. The economy is fundamentally stable. Why not leave it alone. Remember, the road to hell is paved with good intentions.