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15 Feb

I recently watched much of Janet Yellen’s two-day interrogation by congress. She is the head of the Federal Reserve, a position that bestows her with oracular respect when the economy is good and besots her with derisive incompetence when the economy is bad. There was much fulminating by the representatives, our representatives, over a lack of wage growth for typical American in recent years (although the truth of this extends back to the 1980’s) and whether the Fed’s recent low interest rate policy has been a betrayal to the second of its two mandates; (defined by congress) to both keep inflation in check and to promote full employment.

There was and has been a striking misunderstanding of economics displayed by our representatives; first in thinking this dual mandate to the Fed was an economically sound idea (it was certainly politically sound, as it gave them a scapegoat to shift blame from their own lousy law-making) but second in thinking that poor wage growth relative to inflation is somehow the Fed’s fault.

Look at this chart:

Unions and Wages

The red line is union membership from 1915 to 2013. The blue line is the share of national income going to the top ten percent during that period. The correlation of almost perfectly negative. So what does this have to do with wage growth, or the lack of it? Well, the total pool of wages has to be divided up somehow. If the share of wages is growing for the top 10 percent, the proportion received by everyone else has to fall. Clearly the weakening of unions, by both policy and law, has been the main driver of middle class wage stagnation. And this has nothing to do with the Fed.

What the Fed can do is to help smooth over periods of economic instability to help provide a foundation for improving employment. Such a period would look like the times we are in right now, with growing concerns over China, oil, and corporate hording of cash. This would be a far more realistic second mandate than full employment. Note that I am not saying the Fed should try to assuage such economic concerns, but that it is at least able to contribute to doing so.

Still, this too is a fraught path; for markets don’t always know what they want. I ran into one of the elder sages in my office at the coffee machine the other day. He said that due to current market turmoil (S&P 500 down dramatically since the beginning of the year), it looked like a mistake for the Fed to have raised interest rates by that quarter point toward the end of last year. I reminded him that the market (in this case read Wall Street) had then already been clamoring for months for the Fed to raise rates. His reply, referring to the Fed, was that ‘they are a fickle bunch.’ I thought to myself, really? They are the fickle ones? Not us?

Clearly it is problematic to have the Fed cater to its audiences. Bank and investor timeframes are too short to be appropriate for broader economic management. And congressional concerns tend toward finding scapegoats or political leverage, neither of which has much to do with economic stewardship.

Perhaps the thing to do is leave the Fed as independent as possible. And for us to try to see its mission with clearer eyes. The economy is far larger than our personal preferences for politics or profiteering.

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