Fed Chairman Ben S. Bernanke could not have been more precise about the projected cutbacks in the monthly $85-billion bond-buying program. He said in December that the Fed would continue the program until the national unemployment rate fell to 6.5%. And the person nominated to succeed him, Janet Yellen, who is widely viewed as an inflation dove, isn’t likely to raise that target.
That announcement was a historic shift not only in Fed policy (which had heretofore set inflation triggers but not unemployment triggers) but also in the transparency of Fed policy (would Alan Greenspan ever have been so explicit?).
Yet Wall Street continues to behave as if it either didn’t hear the Fed commitment or doesn’t believe it. Pundits respond to every economic report with prognostications about the impact on the timing of Fed tapering. Last week’s belated employment report for September unleashed another torrent of taper speculation.
The monthly employment reports are in fact the key to the Fed’s tapering decision. But Wall Street hasn’t done the math required to pinpoint the onset of tapering.
Last week’s employment report pegged the national unemployment rate at 7.2%. So, we are 0.7 percentage point away from the Fed’s mark. With a current labor force of 155 million people, that means the economy has to create 1.1 million jobs before the Fed starts tapering. In September, 148,000 jobs were created. At that rate, the Fed seemingly could start tapering in May 2014.
But that forecast is way off the mark. The current 1.1 million job shortfall is a very low benchmark for projecting Fed tapering. The population (including immigration) continues to grow every month, bringing more labor force entrants. Then there are the 2 million-plus nonparticipants sitting on the labor market sidelines because they have become too discouraged or marginalized to actively look for a job (thus, not being counted as unemployed in the government’s employment reports). Yet, if economic growth does accelerate, these sidelined workers will reenter the labor market in droves.
To push the unemployment rate down to 6.5%, we’ll have to find jobs for this persistent stream of reentrants as well as those now counted as unemployed. To accommodate the reentrants will require at least an additional 2 million net new jobs a year.
This dynamic perspective pushes the Fed’s taper decision a lot further into the future. The timing of that decision depends on the rate of monthly job creation. The math is easy: We simply ask how many jobs have to be created each month to bring the unemployment rate down to 6.5% by a specific date. Suppose we think the Fed might start tapering one year from now, in November 2014. In that 12-month period, we’d need to cover the current 1.1-million job shortage plus 2 million jobs for the reentrants.
That means we’d need an average of 260,000 new jobs each month. Anyone want to take that bet? We haven’t seen that kind of job growth since 2007. Which means we probably won’t witness Fed tapering next year, especially with the painfully slow growth we continue to experience.
So when will tapering begin? If we generate 200,000 new jobs every month, tapering starts in November 2016. If we see an average of only 148,000 new jobs each month, we won’t ever see Fed tapering.
If the Fed sticks to its guns, tapering is still a long way off. Wall Street should focus on the monthly employment reports if it really wants to predict when it will happen. Or, better yet, it should focus on the obstacles to economic growth still emanating from Washington.
Brad Schiller is emeritus professor of economics at American University and the author of “The Economy Today.”