Cutting Already-Low Interest Rates May Not Help Employment Growth

Although the economy has been expanding for more than two years and most interest rates are at or near lows not seen for decades, pressure appears to be building up on the Federal Reserve to ease monetary policy even further.

For one thing, the economic growth rate is nothing to write home about. The statistics describing the first quarter’s gross domestic product show that the expansion is proceeding at roughly half its usual rate.

In and of itself, this is not all that bad. Slow growth tends to keep business and labor from getting too frisky when it comes to raising prices or wages, and this helps to keep the rate of inflation down. Low inflation, in turn, tends to keep monetary policy easy and interest rates down.

This time around, however, slow growth has been accompanied by a surge in productivity. Output per hour worked last year rose the most for any year in exactly 20 years. While this helps U.S. firms compete with foreign companies and is necessary to raise domestic living standards in the long run, in the short run it tends to retard growth in jobs.

This might be acceptable were the economy growing faster, but combined with today’s feeble growth rate, the result is a decided scarcity of new jobs--and a feeling among the body politic that something has gone wrong.

For example, 25 months into past expansions, nearly 5 million new jobs had been created; this time, the number of jobs is only one-fifth as many. To make matters worse, many of today’s new jobs are part time, or full-time jobs without the usual benefits, such as medical coverage, sick pay, overtime pay and vacations.

As pointed out in my last column, the soaring cost of hiring people is one reason for this lack of growth in “quality” jobs. At the same time, however, advances in technology and the declining cost of leasing and operating computers have given businesses the opportunity to replace people with machines and still grow.

In this regard, lowering interest rates further might very well result in even fewer new jobs, since the cost of leasing computers would probably fall. However, conventional wisdom has it that lower rates are always helpful to the economy--especially when the government is unable to inject a dose of fiscal stimulus.

This brings up the second reason there may be pressure on the Fed: the fact that President Clinton’s $20-billion jobs program was filibustered to death by Republicans in the Senate.

The Administration had been counting on the program to stimulate the economy by creating some 500,000 jobs revolving around repairing and rebuilding the country’s infrastructure and building electronic “highways” for data transmission, training and education.

President Clinton also wanted to see the economy better prepared to withstand the effects of his budget deficit reduction program, which is to involve substantial tax increases combined with modest cuts in spending. Tax increases are also being talked about as a means of paying for the Administration’s forthcoming medical coverage program.

Incidentally, all this talk of higher taxes--which started with the President’s mid-February economic messages to the nation--has acted to slow the economy even more. Consumers got scared, because they concluded that people in virtually all income brackets--not just the wealthy--were going to have to cough up more tax dollars. So they cut their spending almost immediately after the President’s addresses.

For their part, businessmen--who, of course, are consumers, too--reacted swiftly as well. They slashed orders and output schedules. Not surprisingly, the gross domestic product in the first quarter grew at less than 40% of the rate it did in the previous quarter, when attitudes were brighter.

This slowdown in the economic growth rate is the icing on the cake for those who are pressuring the Fed to ease rates. Since consumers pulled in their horns faster than businesses did, all of the first quarter’s growth, and then some, could be traced to inventory building. The April survey of the nation’s purchasing managers suggested that the first order of business--for the next few months, at least--will be to reduce stockpiles to more acceptable levels.

Thus even if sales improve, very little will feed back to production or employment in the near term. So the second quarter’s GDP statistics could be about as bad as the first’s.

In this environment, pressure on the Fed to ease credit will be intense. But this might hurt the economy even more than it would help. Since the banking system is already awash with liquidity, this could revive inflation fears. And households, which are net savers, are already suffering from low rates cutting into interest income.