Economists appear to be of two minds about the Federal Reserve.
They agree with the Fed that the job market still isn’t healthy. Yet the latest Associated Press survey of economists finds that most fear the Fed will wait too long to raise interest rates and thereby risk stoking inflation or creating asset bubbles.
The duality of their views underscores the perils of the Fed’s policymaking. Most economists accept that there’s still “significant” slack in the job market. By that, they mean that millions of people — the unemployed as well as part-time workers and people who’ve stopped looking for work and aren’t counted as unemployed — would likely take jobs or work more hours if they could.
Still, they’re concerned that Janet Yellen’s Fed won’t raise rates soon enough.
“I agree with her diagnosis; I even like what she has in mind,” said Mark Zandi, chief economist at Moody’s Analytics. “But I’m skeptical that she’ll be able to pull it off.”
The AP surveyed three dozen private, corporate and academic economists from Aug. 13 to 19. In follow-up interviews, several said they feared that by waiting too long to raise rates, the Fed could ignite inflation or may already be feeding speculative bubbles in assets such as stocks or high-yield bonds.
“Yellen’s much more concerned about the Fed’s employment mandate than inflation,” said David Shulman, an economist at UCLA’s Anderson School of Management, referring to the Fed’s drive to lower unemployment. “They’ll risk financial bubbles.”
Lynn Reaser, a professor at Point Loma Nazarene University, agrees with Yellen that if the economy were nearing full health, workers’ pay would be rising faster, fewer people would be unemployed for more than six months and many part-timers who want full-time jobs would manage to find them.
But “by the time we hit that situation, there may already be pressures on the inflation front or significant bubbles in various asset markets,” Reaser said. “To play catch-up at that point may require large increases in interest rates, which could be very damaging to the economy.”
Strikingly, while the economists worry that the Fed won’t get out of the way of the strengthening U.S. recovery soon enough, they fear the opposite about Europe: that its economy may have entered a “lost decade” similar to Japan’s long-standing stagnation.
Some, like Allen Sinai, chief global economist at Decision Economics, think the European Central Bank has been too cautious and should launch a bond-buying program akin to what the Fed has done. The idea would be to keep rates low, boost stock prices and shrink the euro’s value, which would make European exports more affordable.
“The sooner they do that, the better the chance that Europe can get out of the lost decade before it turns into two decades,” Sinai said.
ECB President Mario Draghi hinted last week that the central bank could take such a move in coming months.
Among the economists’ other consensus views:
— The Fed’s low-rate policies have already inflated a bubble in at least one asset group. Most of the economists who see a bubble think one exists in high-yield corporate bonds, often called “junk” bonds, and in emerging-market debt. Others detect bubbles in small social-media or biotechnology companies or in the stock market as a whole. On Monday, the leading stock-market averages set record highs.
— Inflation will remain generally below the Fed’s long-term target rate of 2 percent this year, but will consistently exceed that rate next year. Only if inflation were to reach or top 3 percent do the economists think the Fed should immediately raise rates regardless of how the economy was faring.
— Sluggish wage growth is slowing the U.S. economy. The most commonly cited factor is that too many people still lack jobs — including many who aren’t being counted as unemployed because they’ve stopped looking for work. And pay growth won’t start to significantly exceed inflation until next year at the earliest. Flat wages are “a limiting factor for consumer-spending growth and a major restraint for the housing recovery,” said Scott Brown, chief economist at financial-services firm Raymond James.
Zandi said his concerns about the Fed’s interest-rate policy stem in part from the Fed’s own outlook. The Fed forecasts that the unemployment rate will fall to between 5.1 percent and 5.5 percent by the end of 2016, from the current 6.2 percent. The Fed thinks unemployment at that level would likely enable workers to demand higher pay and therefore lift inflation above the Fed’s long-range target. Yet Fed officials expect the interest rate it controls to remain below historical norms until a year later.
That suggests that Yellen is willing to risk letting inflation run above the Fed’s 2 percent target to try to boost growth and hiring, Zandi said.
Though inflation won’t likely get out of hand, Zandi said, the approach carries risks. If bond investors concluded that inflation would remain above the Fed’s target for an extended period, they would likely demand higher interest rates. That would raise borrowing costs throughout the economy, including for mortgages and auto and business loans.
In a speech Friday at the Fed’s annual conference in Jackson Hole, Wyoming, Yellen stressed that the Great Recession upended traditional measures of the job market, such as the unemployment rate and wage gains. Policymakers must now consider a wider variety of gauges to determine when to raise rates, she said.
That complexity also makes economists nervous. Many noted that the Fed has kept its short-term benchmark rate near zero for six years and has bought trillions in Treasurys to lower longer-term rates. Neither action had ever before been taken by the Fed. And it’s not clear when the Fed will start to unwind all that stimulus.
“It was uncharted waters on the way in; it’s going to be uncharted waters on the way out,” said Richard Moody, chief economist at Regions Financial.