Yellen’s big risk

By law, the objectives of the U.S. Federal Reserve’s monetary policy are maximum employment in the United States and stable prices. Any change in interest rates hinges on inflation and employment data. In theory, what affects the U.S monetary policy are economic conditions of the United States. The Fed is the central bank of the U.S., not the world. There is no such thing as a central bank for the world. Governments can join hands for common purposes, but they do not place interests of others before their own. An international society spares no emotion when national interests are at stake. Nowhere in the Federal Open Market Committee (FOMC) mandate does it say that monetary policy should concern itself with the global economy.

But Janet Yellen, the Fed chair, made an unexpected comment after announcing that the Fed decided not to raise interest rates in September after the FOMC meeting on Thursday. Although the Fed remains relatively upbeat about the American economy, “the situation abroad bears close watching,” she said. “Heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets.” Yellen sounded as if the Fed was postponing the normalization of interest rates, which have been close to zero percent for nearly decade, because of global jitters.

But Yellen’s real intentions are different. The Fed is still resolute on a rate hike this year. Yellen herself said, “Every meeting is a live meeting” and that October “remains a possibility.” The FOMC meets in October and December. What stalled the tightening campaign were not-so-great economic conditions in the U.S. The U.S. unemployment rate was 5.1 percent in August, within the unemployment target of 5.0 percent and 5.2 percent set by the Fed. But the number of new hires was only 173,000 in August after growing more than 200,000 monthly from May to July. The fact that the new-hires number slowed while the unemployment figure improved suggests that fewer are looking for jobs. Unemployment data is based on people eligible to work seeking jobs. If people give up looking, the figure goes down. If there are fewer job-seekers because of poor prospects, the economy is headed for a downturn.

The bigger concern is inflation or lack thereof. Core inflation as gauged by personal consumption expenditures, or the PCE price index excluding food and energy, increased 0.2 percent in July on month and 1.2 percent over the past year. That is still far off from the Fed target of 2.0 percent. Since the Fed embarked on the quantitative easing program in March 2009, it unleashed over $3.8 trillion by the time it was through with three rounds. According to the quantity theory of money, prices rise when the money supply increases. But prices have stayed stubbornly low despite massive injections of money into the economy. It suggests that the enduring quantity theory, which monetary policy-makers rely on to raise prices, no longer works in the real economy.

The mystery of inflation was the main theme at the annual economic symposium hosted by the Kansas City Federal Reserve Bank that invited central bankers around the globe to Jackson Hole, Wyoming, last month. Gita Gopinath, a economics professor at Harvard University, urged a rethinking of inflation policy, pointing out that the relationship between prices and exchange rates isn’t well understood by policy-makers. If there are ample dollars in the market, dollar-denominated products’ value should fall. Import prices instead should rise. But there is no change in prices in the U.S., which pays for imports in U.S. dollars, the key global currency. In short, prices are unaffected by changes in the exchange rate and nominal value. Economists are advising that price variables should no longer be the primary determinant in deciding monetary policy.

But the conservative Fed cannot easily give up its traditional role and ways of thinking. This is what places Yellen and her FOMC colleagues in a bind. Despite improving data, the U.S. recovery is still fragile and can be interrupted by global factors.

Yellen most dreads making the wrong move. The Fed can lift interest rates only when it is fully confident that the U.S. is on a stable path to recovery. If the economy stumbles after a rate hike, the blame will entirely fall on Yellen and the Fed. The Fed jeopardized the U.S. economy before with pre-emptive policy action. After President Franklin Roosevelt took the U.S. off the gold standard in order to get the economy out of the Great Depression in 1933, U.S. policymakers were free to pour as much money as they wished into the economy. Money flowed in from Europe and the economy picked up. Amid troubling signs of inflationary pressure due to a surge in money supply, then-head of the Fed Marriner Eccles moved to tighten credit by raising banks’ reserve requirements three times from 1936 to 1937. His actions have been blamed by historians for being responsible for the 1937-1937 “double dip.”

Yellen cleverly pointed to volatility in China and other emerging economies as the reason for delaying an interest rate hike. But what really determined the decision was the U.S economy. Pessimism and concerns about the global economy only got worse after the rate hike delay. Emerging economies have become more unstable. What is most damaging to an economy is uncertainty. A ship without direction in foggy and unpredictable weather and water conditions is headed for trouble.

Korea is among the economies most susceptible to U.S. interest rate changes. The country’s household debt reached the dangerous level of over 1,130 trillion won ($949.3 billion) in June. There is little progress in structural reforms. Our growth engines are quickly losing steam. Foreign investment banks now predict the local economy will grow around 2.5 percent next year, the lowest rate since the Asian financial crisis of the late 1990s. But domestically, people seem less worried. Pessimism does no good, but neither does too much optimism. What’s more worrisome is that economic ministers appear to care more about next year’s election than economic affairs. Crises always come unannounced.

JoongAng Ilbo, Sept. 23, Page 36

*The author is the business and industrial news editor of the JoongAng Sunday.

by Kim Jong-yoon