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In Praise of Disconnects

Irwin M. Stelzer

Thank goodness for disconnects. For three, to be precise.

The first is the disconnect between Donald Trump and Jay Powell, the man he appointed to chair the Board of Governors of the Federal Reserve System. It wasn’t too long ago that they seemed joined at the hip. The president, a real estate developer who throughout his career prayed for—well, wished for—ever-lower interest rates to ease the burden of the enormous debt that he and other developers traditionally took on, was looking for someone to replace Janet Yellen, who persisted in inching interest rates ever-higher. Powell, he figured, was just the man for the job. Not one of those academic economists who don’t understand that real men like low rates. A Wall Street guy who would consign the Fed policy of gradual rate increases to the dustbin of history. He was wrong.

It didn’t take long for Powell to disconnect from the president, assert his independence, and provide just what markets needed in the era of Trump. The first was stability, policy continuation to offset what have been the nervous-making swings in mood of a president whose idea of the long-run is the time until his next tweet. The second was continued gradual tightening of monetary policy to offset the incontinent loosening of fiscal policy by politicians eager to present the electorate with tax cuts funded by the printing of a trillion dollars of IOUs over the next decade.

But that sensible approach did not prevent Powell from beginning a second disconnect, a quiet move away from his own staff at the Fed. That staff has not had a flawless record of forecasting turns in the economy, most recently missing the signals in 2007 that complicated bundles of dicey mortgages are even more risky than the individual mortgages in the bundle. It has taken the economy just about a decade to recover fully from that policy error.

Primary among the forecasting tools on which the Fed staffers rely are models that take past data, tease out relations among such variables as growth rates, inflation, job creation, and many more, and imbibe the resulting stew to give them strength to divine the interest rate that will produce an economy that runs neither too hot nor too cold. Job market too tight? Wages will soar and produce inflation. Better raise rates. Except that wages haven’t soared and inflation remains tame—so far.

Enter Powell. Before becoming chairman, he served on the Fed board long enough to form a view of what that traditional approach to monetary policy can do, and also what it can’t. The main thing missing is attention to the structural changes in the economy that might make the past something less than prologue. It is only recently that a new elephant has sidled into the room, name of Amazon, with one Jeff Bezos as its handler. Bezos is devoted to keeping downward pressure on prices, to preventing the usual players—department stores, super markets, manufacturersfrom raising prices as the economy’s growth rate speeds up. In a sense, he and other new players are inflation-fighters, fighters that just might keep prices from rising explosively even as the economy grows at the annual rate of 4.2 percent, achieved in the second quarter of the year.

Throw in a new phenomenon that might, again, just might, be acting as a damper on inflation-inducing wage rates: employer monopsony—the power of a single buyer of labor in a local area to make an offer that workers simply can’t refuse unless they are prepared to pull up stakes and head for areas in which many employers are competing for workers. This is a worrying enough phenomenon to have central bankers wondering whether it explains the failure of real wages to rise more rapidly than prices—more or less to remain stagnant—in an economy with a 3.9 percent unemployment rate. And to wonder how to incorporate this phenomenon in their policy decisions.

But there is a danger of overreaction to what might be overhyped changes in the economy. Yes, Amazon keeps pressure on corporations seeking to raise prices.

But not enough pressure to prevent corporate profits from jumping 16.1 percent in the second quarter, the largest year-on-year increase in six years. And yes, in some areas buyers of labor seem to have the upper hand, yet 51 percent of workers say they are satisfied with their jobs, the highest level in a dozen years. Hardly what one would expect of exploited workers with nothing to lose but their chains.

Of course, if Powell is satisfied that Amazon and labor market monopsony are dampers on inflation, he can keep interest rates lower than would otherwise be the case, and allow the economy to grow at the faster pace for which Trump yearns. Too early to tell.

One thing we do know. Powell is sufficiently disconnected from the economists who have been making monetary policy to be looking to financial markets for guidance in setting interest rates, at least in addition to and perhaps instead of the equations and models that have guided policy in the reigns of Alan Greenspan, Ben Bernanke, and Janet Yellen, who sat in his seat for a combined three decades.

The final disconnect for which we have reason to be thankful is between politics and the economy. The economy and the markets roll along, the former at a satisfactory rate, the latter moving from record high to record high, with only an occasional pause. This despite a politics that produces tweets, tariffs, and turmoil, the latter to include impeachment proceedings against the president in the likely event that Democrats gain control of the House in November, and that some of the Trump’s recently convicted former associates decide to “rat” and “flip” in return for shorter sentences, to use the mafia-style jargon of which the Don(ald) is so fond.

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