Frances Coppola View - The Fed's Interest Rate Rise Was A Mistake

The U.S. economy’s current strong growth is mainly due to a short-term boost from President Trump’s tax cuts. But as any diabetic will tell you, a sugar high does not last. Unless it is accompanied by proper food, in the form of productive investment and growth-friendly reforms - and let's face it, we are not seeing much of either of those - it can end in a very nasty low.

I have concluded that the FOMC members have absolutely no idea what causes inflation. But they know that in the distant past, inflation rose when unemployment was below 4%. So they think they need to raise unemployment above 4% in order to prevent inflation taking off, even though there is no sign of inflation. This is what passes for logic in today’s central banks.

In my view it is not difficult to work out why inflation is low and wage growth poor despite low unemployment. In today’s globalized world, movement of capital around the world is largely uninhibited, and trade barriers are the lowest in history. If labor becomes too expensive in one jurisdiction, corporations can simply move production elsewhere, or buy in cheaper supplies from countries where labor costs are lower. This, not central bank policy, is what caused the Great Moderation, the extended period of low inflation and sustained growth that preceded the Great Recession. And despite the global trade slump since the Great Recession, globalization is still maintaining downwards pressure on wages. While there are workers somewhere in the world who can produce the same products as U.S. workers for a fraction of the cost, corporations can refuse to pay higher wages. This is why inflation remains stubbornly low despite low unemployment. People are working, but their wages are low and they dare not ask for a raise in case their job disappears.

 If people are not working as much as they want to, because the jobs are not available, then there is slack in the labor market. This too would place downwards pressure on wages, preventing inflation taking off. In today’s fluid job markets rife with casual, part-time and temporary jobs, unemployment is a hopelessly inadequate measure of labor market tightness.