US Videos

The Economy's Deer-in-Headlights Mind-Set

Jeremy Glaser

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I'm joined today by Bill Strauss. He is a senior economist and economic advisor to the Federal Reserve Bank of Chicago. We are going to talk about the outlook for the economy and Federal Reserve's policy.

Bill, thanks for talking with me today.

Bill Strauss: Good morning, Jeremy.

Glaser: Let's talk about jobs first. We're about three-and-half years into this economic recovery. Jobs growth might be improving a little bit but still is fairly anemic. What's your take on the employment situation, and what's your outlook looking forward?

Strauss: Well, when we look at the job market, it is still a struggling market where we got unemployment rates in October that were at 7.9%, basically 8%, and it's been at 8% or higher over the recovery period. This is just not a very good outcome for the labor market. It's true we've been adding jobs but not adding in a fast enough pace to materially bring down the more than 8.7 million people who lost their jobs in the downturn.

The outlook, according to both the Fed as well as outside forecasters' views, is that growth will continue in 2013 but at a pace of activity that is improved, but still not all that impressive, something anywhere from 2.3% to maybe 2.75% growth rate around trend or slightly above trend. This will once again help with growth in the labor market but not as impressively as we would like, so that unemployment rates by the end of next year are anticipated to still be in the upper 7% range.

Glaser: So, what's the biggest drag on that? What's keeping the labor market from really gaining traction?

Strauss: Well, I think it's a vicious cycle, but I mean I think it has to do with growth of the economy, which is, again, trying to get its recovery back from the financial crisis that we went through. But in addition, we've got the world economies which are not being of a great assistance here. Many European economies are in a recession. Europe as a whole is not doing very well. Then you got Asia, which has been growing quite strongly, but its growth rates are slowing.

So, in terms of supporting our ability of exporting in a way, we need incomes around the world to do a lot better, and that's being challenged at this point in time.

Read Full Transcript

Glaser: Certainly, something that has been helpful to the U.S. recovery has been consumer spending. Is that something that is sustainable, or are consumers going to have to retrench a bit?

Strauss: Well, I think it's certainly sustainable. We're going to be adding more and more workers to the labor pool, and that will help in terms of income growth. And there is pent-up demand that is being built up. When you think about the lack of household formation that has taken place, all these kids who are graduating high school or college, who are either living with roommates or going back home to live with the parents, those are probably not going to be long-term solutions to their housing needs. And it's a question of what will unleash that pent-up demand, and I think it's an improved labor market.

In addition to that, of course, we've got vehicle purchases, which are improving, but still below levels that we had seen over the past 10 years. The average age of a vehicle is getting older. So once again we can see some pent-up demand being created for replacements of some of those vehicles, and I think an improved labor market as well will ultimately free up some of that demand.

Glaser: So, taking a look at some of the policy responses on the fiscal side of the house. We have the fiscal cliff potentially coming up. Is that a major worry of yours, and how's it going to impact the economy?

Strauss: Well, I think it's absolutely a worry that's out there, and I think it's already impacting some of the activity that we're seeing from businesses in the second half of this year. I think most businesses anticipate that we're going to avoid it, and I think most economists believe that and even the policymakers in Washington, whether it's from the congressional side or the administration. In the third debate the president said it's just not going to happen; we're not going to have a fiscal cliff.

But I think with business, it's just the uncertainty that exists out there. It's like putting headlights into the deer's eyes on the road and the businessperson, like deer, just freezes in place, waiting to see resolution, so they can have that certainty before they go ahead and make some large-scale capital investments.

Glaser: Now, as Congress has been debating, the Federal Reserve has been more active. Certainly monetary policy has been fairly accommodative for some time now. There are some worries about that with inflation; we hear from investors sometimes. Is that a valid concern? Should people be worried about inflation due to the increasing size of the Fed's balance sheet?

Strauss: I think we all worry about inflation, and that's the job of the Fed, to worry about inflation. But the kind of path that we're on--where I have discussed the fact that we've got a weakening outlook for world growth, an economy in the U.S., which is growing at a relatively moderate pace, tepid perhaps, we'll see growth this year probably come in below what our trend capabilities are--it's a question of where is this demand going to come from? And people focus on the balance sheet of the Fed, which is what we call high-powered money or a monetary base, which has risen quite dramatically.

But ultimately as Milton Friedman famously said, inflation always and everywhere is a monetary phenomenon. But it's the money supply that people need to be thinking about. And because of a lack of demand for borrowing funds from businesses and consumers as well as a concern of putting money into markets that are still out of balance, such as the housing market or even the commercial real estate market, there is a lack of willingness to lend into these markets. So, we're not seeing the kind of loan creation that would generate substantial increases in the money supply.

So, while we've increased our balance sheet and our monetary base quite substantially, the money supply has been rising much more slowly at a little over 6% growth rate, which when you want to think about that from the standpoint of inflation, the inflation rate has been rising at a little over 2% over this time period, following and tracking the money supply, not the monetary base.

Glaser: Finally, just looking at the Fed's exit policy, do you think that they will be able to gracefully bring that monetary base down again or is that something that investors might need to keep an eye on?

Strauss: Well, we all have to keep an eye on how the Fed is going to handle this. We do have some new tools in place that will allow us to make adjustments to the growth of the money supply. So, in other words, if the economy starts to recover more quickly, which would be a good thing from our standpoint--it will be a great challenge to have, where perhaps the economy grows more aggressively, that will lead to unemployment rates falling more rapidly, and that could put some inflationary pressures at a faster pace than we anticipate--we have some tools in place, such as paying interest on excess reserves that will allow us to adjust some of that lending.

So, in other words, if we think that faster growth of the economy is causing lending to occur more rapidly than desired, leading to the money supply rising more rapidly, which could lead to inflationary pressures, we have the ability of perhaps offering to give banks a higher interest for not making that loan, and that could have a little bit of almost like throttle control on the economy to be able to adjust the speed of growth of lending and hence the money supply.

Glaser: Bill, I certainly appreciate you taking the time to talk us.

Strauss: Happy to join you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.