It’s been nearly a year since Janet Yellen, in her first testimony press conference after a Fed Open Market Committee (FOMC) meeting, told the world just what she was looking for before raising the Fed Funds Rate (and everything that rises along with it). The openness was remarkable for a Fed Chair and a sign of a new era as a woman took control of what is arguably the most power job in the world.
Since that time, we have followed “Yellen’s Dashboard” with periodic updates to just just how we’re doin’. Nearly everyone agrees that interest rates will rise sometime this year, probably around June, as she has told us. But how does that stack up against her very public criteria? It’s worth checking in with some math to see where we are with rates and what we can expect.
The five elements that Yellen discussed were not the most important figures in the economy generally. She chose measures which have been stubbornly lousy through the Managed Depression on purpose. While things have been looking good for some people, others are clearly being left behind. Yellen made it clear – the Fed under her leadership isn’t going to let that happen.
That’s why we have such unconventional measures in the dashboard. U6 unemployment is an important one, and the only measure of employment we should be using. The duration of unemployment has also been a terribly stubborn problem lately. But workforce participation and the rate at which people are willing to quit their jobs are a bit surprising. The list rounds out with growth in wages, something that is just starting to rebound.
Barataria took the liberty of putting these five together and coming up with a scale where January 2000, before the Depression started, is the absolute measure of goodness and the low point over the last 15 years is the measure of badness. Where we stand today between those marks is converted to a 0-20 scale so they all add up to 100. How has Yellen’s Dashboard performed?
|Long Term Unemployment||3.5||3.6||5.1||6.5||6.5||5.9|
As you can see, the great progress in 2014 is not continuing right now. It’s leveled off a bit and not gaining as we would like. Between that and the low inflation caused by plummeting oil prices there is little pressure on the Fed to raise rates.
But what should the Fed Funds Rate be? This is also worth an update, since a lot has improved. The short answer is that the Fed seems to use something like the “Taylor Rule” to calculate the rate, giving themselves room for a lot of fudge. This is too complicated for those of us with only limited data on our hands. In 2003, Harvard Economist Greg Mankiw proposed a simpler version that eliminated most of Taylor’s variables and produced a very simple formula:
Federal funds rate = 8.5 + 1.4 * (Core inflation – Unemployment)
You can see how that has worked since 2000 in this chart, with the actual Fed Funds Rate in red:
There are three great features to this chart. The first is the ballpark, perhaps even decent correlation before 2009. Then, the Mankiw rule dives below zero – a rate that isn’t supposed to happen without major upheaval. That marks the start of “quantitative easing” as a policy, ended in 2014, which is to say goosing the economy with a fixed amount of money rather than an interest rate. And then the calculated rate turns positive in 2012 but the actual does not – reaching almost to 3% today. This is the period of a very hot stimulus by historical measures and the time when Bernanke, and later Yellen, started looking out for workers.
Where should the Fed Funds Rate go? The short answer is that the FOMC could, and perhaps should, raise rates just about as much as they want at any time. But the measures that Yellen gave us show that the economy is not picking up steam as rapidly as she would like.
There is every reason to expect an interest rate rise this summer, but it is likely to be a small one – perhaps a quarter percent. It should be enough to get everyone over the addiction to cheap money and start looking beyond the liquidity trap that has defined investing since 2008. But that’s about all it is likely to do.
Yellen made it very clear what she is looking to see improve before rates really go up. Despite some early progress, jobs are not gaining ground as fast as they were. There is still time to see progress this year and next, into the projected end of the Depression in 2017, but despite a very hot stimulus by the Fed we are not overheating yet.
There are some technical details in this post – please follow the links for more information. Also, please vote for Barataria as “Best Weblog About Politics” in the 2015 Bloggie Awards. Thank you!