To understand the American economy, you have to answer four questions. How can it be that unemployment remains high at the same time as the number of job vacancies is rising? Will consumers keep buying cars and houses at anything like the current pace despite the recent increase in payroll taxes? How long will Ben Bernanke’s Fed keep printing money to keep interest rates close to zero? And finally, will Washington do what the president asks and get out of the way of an economy “poised for progress”?
The jobs market has analysts scratching their heads. Millions of Americans are dropping out of the workforce, driving the labour force participation rate to its lowest level since 1979. Yet the economy is recovering, and the 3.9m job vacancies are the highest since 2008.
University of Chicago researchers say many unskilled workers find the level and certainty of unemployment benefits more attractive than jobs that would be insecure and low-paid. They also worry that the skills of the 40% of workers unemployed for more than 26 weeks are no longer relevant in today’s jobs market. Home builders, for example, complain that many unemployed construction workers just don’t have the skills to build today’s high-tech houses. Add to that the possibility that this recovery will create fewer jobs than past recoveries: the Congressional Research Service says 97,000 steelworkers now produce almost 10% more steel than 400,000 did in 1980.
We won’t really know whether the recovery will be relatively “jobless” until it picks up steam, which might be sooner rather than later: there is some prospect that growth will indeed ramp up this year to something like 3% if consumers continue to snap up cars and houses.
It is more, rather than less, likely that they will despite recent weakness in retail sales. Bernanke’s low interest rates are causing share prices to break new records as investors hunt for the yield no longer available from safer investments in a zero interest-rate environment, and low mortgage rates are driving house prices higher. Rising share and house prices produce the “wealth effect”—feeling richer, consumers enter estate agents’ offices and car showrooms in a cheery frame of mind. With interest rates low, they can afford that bigger house and newer car.
Which brings us to the next question: how long will the Fed continue to pump money into the system? Its stated goal is to run the presses until unemployment drops to about 6.5%, but if that drop is due to workers leaving the workforce, too discouraged to continue looking for jobs, the money printing will carry on or, to use the jargon of the central bankers’ trade, quantitative easing will continue—QE3 will not be put into dry dock.
Until last week’s rather unsettling report that few jobs had been created in March, the discussion focused on when the Fed would wind down its efforts. That topic no longer attracts too much attention, although critics remain. The majority view on the Fed’s monetary policy committee is that the jobs market remains so weak that it is premature to consider slowing the presses. Some analysts worry that the Fed will find it difficult to reverse course in time to avoid triggering a serious inflationary spurt, but they are in the minority. With Janet Yellen, vice-chairwoman of the Fed’s Board of Governors, a supporter of the current loose monetary policy and an odds-on favourite to succeed Bernanke next year, zero interest rates and continued monetary stimulus will remain in place at least through 2014, barring an unforeseen pick-up in the jobs market.
It is more difficult to guess whether the president’s efforts to charm the Republican opponents whose motives he has maligned for over four years will result in the “grand bargain” over fiscal policy that has so far eluded the warring politicians. Obama has belatedly put on the table his budget—all 2,500 pages of it. That makes three versions up for consideration: proposals by the president, the Democratic Senate, and the Republican House. The best brief summary is that the Republican version brings the budget into balance a decade hence with no increase in taxes, while the other two proposals rely heavily on tax increases to bring deficit spending down to about 2% of GDP in 2013.
The distinguishing feature of Obama’s version is his agreement to reduce future healthcare and social security (pension) spending by changing the inflation escalator applied to those entitlements. This has antagonised many of his own supporters, and is designed to induce Republicans to abandon their “no new taxes” pledge in favour of the president’s plan for huge tax increases on wealthier Americans. As David Malpass, a Treasury official in the Reagan administration, points out, Obama wants to increase spending by 60% in the next decade. Taxes on capital gains, investment income and millionaires would jump.
Like the Senate and House budgets, the president’s is based on unrealistic forecasts of growth, interest rates and a host of other variables. And many of Obama’s spending cuts are not quite what they seem: they merely replace cuts already imposed by the sequester.
It seems unlikely that Democrats and Republicans will agree a “grand bargain” before serious campaigning for the 2014 congressional elections begins.
Republicans who acquiesce in tax increases will face serious challenges from Tea Party candidates who want to replace them as the party’s standard bearers. Democrats who agree to Obama’s reduction in the rate of growth of entitlements face a sulky stay-at-home strategy from their left-leaning constituents, and the president himself is less interested in a deal than having a stick with which to beat Republicans in 2014 so that his party can gain control of the House and free him to push through his spending plans.
There you have it: a jobs market that is difficult to understand, a Fed that is likely to keep interest rates low and share and house prices high, and a dysfunctional Washington that remains a drag on growth.