David McClough Guest Column
August 23, 2014
With the release of the minutes from the latest meeting of the policy committee of the Federal Reserve, we learn that there are policy makers who think it is time to start raising interest rates while others contend that the economic recovery is too fragile.
Advocates of higher interest rates point to a decline in unemployment and consistent GDP growth since the third quarter in 2009. As the unemployment rate declines and output increases, inflation hawks contend that the economy is approaching full capacity. Once the economy reaches full capacity, the expectation is that prices will increase. Proponents of continuing the existing policy challenge this interpretation contending that the unemployment rate is declining due to the labor force contracting rather than robust job creation by a dynamic economy. Indeed, the labor force participation rate is currently at the level it was in October 1977 and is trending downward.
Fed Chairman Janet Yellen has expressed concern that the labor market is not recovering broadly enough to justify raising interest rates at the risk of slowing down an anemic expansion. Yellen will likely prevail in holding interest rates at near zero for the foreseeable future in light of the geopolitical uncertainty in the Middle East, Iraq, and Ukraine. These political concerns very likely contribute to the weakness of the European economy, which is a major trading partner of the US. All in all, we can expect the economy to crawl a bit longer before it can walk, let alone run, on its own.
Lest we forget, the economy has not “run” on its own for a very long time. It seems that the role of government intervention in the form of fiscal and monetary policy has created some unfortunate unintended consequences. Why doesn’t the economy recover naturally without government intervention in the form of spending and interest rate manipulation? Why are we reading that the recovery is fragile and growth is anemic five years since the recession ended? If the economy was truly thriving, wages would be increasing and living standards would be rising. For the past 15 years, living standards have declined for the majority of Americans.
An interesting pattern is observed in the data covering the past three recessions. Real median income begins to decline two years before the official start of a recession and continues to decline for two years before increasing once the recession ends. This pattern is observed for two of the previous three recessions. However, real median income continues its decline five years after the “end” of the most recent recession.
What does this mean?
Well, real median income refers to the income of the individual in the exact middle of the income distribution, which is to say that as median income declines, income declines for more than one half of the population. Average income may increase if the highest incomes increase enough to offset declines, but the median income is in the middle regardless of the average. Real income accounts for inflation and reflects what a given income buys given today’s prices. So, the decline in real income means that a particular income buys less today than it did in 1999. To summarize, real median income has declined for 15 years, which means that more than half the population is worse off today than in 1999, despite the increase in GDP reported on the nightly news.
What should be apparent is that government policy is not the solution to but rather a cause of, not only, the recession but also the feeble recovery that directly affects millions of people adversely.