Opinion

The extraordinary experiment that Janet Yellen must finish

Raising interest rates would hurt most workers. But there would be another victim too: economists.

Last Friday was monthly jobs day, and the news was the same as it has been for years now: good, but not good enough. In September the economy created 248,000 jobs, dropping the unemployment rate to 5.9 percent, the first time it has been below 6 percent since 2008. What does this fundamentally change? Nothing.

All of the major story lines about the economy remain the same: First, we can see that job growth appears to be strengthening, slowly but surely. Since 2010, when the official recovery began, monthly job growth average over the year has increased substantially. Second, despite that steady increase, there are not even close to enough new jobs or growth to make up for the gigantic hole left by the Great Recession. Third, despite the growth in total jobs, new jobs are overwhelmingly lousy and low-paying. Finally, long-term trends in the distribution of economic growth are exceedingly worrisome.

This brings us to the Federal Reserve, the institution with the most control over jobs and growth. (With Congress barely capable of tying its shoelaces, they're the only game in town.) The Fed is now winding down its unconventional stimulus program and is currently debating when to start raising interest rates.

The reason they're thinking about tightening money (and thereby slowing down the economy) is that monetary policy operates with a considerable time lag. Therefore, under traditional models, the central bank is supposed to estimate where inflation will be in a few months to a year and then try to stay ahead of it. Let inflation out of the bag, and you'll supposedly get instant acceleration.

But this argument is seriously out of date. It is of absolute paramount importance that the Fed delay its rate hikes until inflation begins to measurably increase. There are two major reasons why.

The first is simple morals. The vast majority of the country has been absolutely hammered by the Great Recession. Median incomes are down 8 percent since 2007, and long-term unemployment is still extremely high. Waiting to raise rates until the last minute risks a bit of minor inflation, hurting creditors and helping debtors (the disproportionately rich and poor respectively). On the other hand, tightening before there is evidence of inflation risks cutting off the recovery at the knees. If inflation estimates are wrong, then you've stymied job creation for no reason — or worse, created an unnecessary recession!

Therefore, both the possible downside and possible upside both point the same direction: toward stoking the economy as long and as hot as possible. At best, we'll make some inroads into reversing this atrocious trend and help out the vast majority of people in the process. At worst, we'll kick up inflation to 1980s levels.

The second is for the sake of the economic profession. Since the recession started, there has been a ferocious argument over what will happen to inflation as unemployment goes down. Conservatives have been predicting skyrocketing inflation just around the corner since 2009, even though wage growth has remained flat and inflation consistently below target. As Paul Krugman notes, there is only one way to tell for sure when inflation is coming — when it's actually here:

...we really, really don't know how much slack there is. Don't show me your new estimation method and claim that it proves that there is x percent of slack — there are lots of clever people doing clever estimates, they don't agree, and nobody really believes in econometrics anyway unless it tells them what they want to hear. (Sorry, but that's reality.) We really won't know until after the fact, if and when we finally see a notable pickup in inflation, and in particular in wages. [The New York Times]

The moral argument ought to be dispositive by my lights. But waiting until inflation is off the peg would be a critically important piece of data for economists, too. There are serious arguments now that the 1970s have been completely misinterpreted, and that inflation doesn't behave the way standard economic models say it should. And if so, that would be an exceedingly useful thing to know for future policymakers.

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