The March employment report brought to a close a disappointing quarter for the U.S. economy. With only 126,000 new jobs created last month, gains since January totaled 591,000. That’s a decent number, but down noticeably from the increase of 973,000 during the final three months of 2014. These latest figures on employment, along with other recent data on consumer and business spending, point to a marked deceleration in the pace of economic growth since New Year’s Day.
How much of this slowdown reflects purely transitory factors, including harsh winter weather in much of the country, remains unknown. Also uncertain are the extent to which the slowdown does persist and how much of it might be attributed to regulation and tax policies that discourage investment and employment. Quarter-to-quarter and even year-to-year fluctuations in macroeconomic activity are extremely difficult to explain in real time – and not easy to understand in retrospect either. The latest jobs data remind us of how challenging it is to use monetary policy to fine-tune the economy.
Despite the “noise” in high-frequency data, the recent string of disappointing announcements has altered considerably expectations for the date at which the Federal Reserve will begin to raise interest rates. Very few observers now believe that the Fed will raise rates in June, even though recent changes in the Fed’s own policy statement – removing the key word “patient” from the text – were supposed to open the door to the possibility of summertime rate hikes. Many Fed watchers, and even some Federal Open Market Committee members, are now are calling for rate increases to be postponed until the fall, or maybe even until next year.
Yet, in the minds of other FOMC members, there are dangers in delay. If, for example, the Fed postpones raising rates because of a purely transitory slowdown related mainly to the weather, inappropriately expansionary policy will lead to higher inflation. Of course, if the Fed reacts to more persistent changes in employment that turn out to be due mostly to nonmonetary factors, it will generate higher inflation while providing no solution to the true problems plaguing the labor markets. This kind of uncertainty indicates that policies tied too closely to the latest data are as likely to amplify as they are to stabilize short-run fluctuations. They also generate uncertainty and confusion as observers struggle to find, in each day’s data and news, clues to predicting the nature and timing of the Fed’s next action.
If the temptation to respond to volatile short-run data risks policy mistakes and induces uncertainty, the Fed could shift its focus to data that point to trends in economic activity rather than volatile data that move around this trend. To this end, maintaining stable rates of growth in the money supply over intermediate and longer-term horizons would control the general thrust of monetary policy and offer indications of whether the stance of policy was restrictive or expansionary.
The graph also shows that M2 growth declined precipitously in 2009 and 2010, suggesting that the Fed pulled back from its expansionary policies too soon after the financial crisis, contributing to the sluggish recovery and low inflation seen ever since then. Strikingly, this most recent decline in money growth predates the end of the Fed’s first round of quantitative easing: had policymakers paid closer attention to the behavior of the money supply, they might have avoided this costly error.
Since the middle of 2013, Divisia M2 growth has fluctuated between 5.5 and 6.5 percent. These most recent rates of growth are below those seen in 2011 and 2012; if this trend towards slower monetary expansion continues, it certainly would be cause for concern. On the other hand, the graph also makes clear that 6 percent money growth is still robust by historical standards and, if it continues, will likely support a return of inflation to the Fed’s 2 percent target. Either way, these money supply figures deserve more attention, as debates continue over the appropriate timing and pace of interest rate increases later this year.
Michael Belongia is a professor of economics at the University of Mississippi. Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.
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