Tricky balancing act for the Federal Reserve


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Bankrate’s recent second-quarter survey of economists found a generally upbeat view of the economy looking out over the next year. Beneath the surface, however, many of the experts also saw a range of factors continuing to restrain the economy. Chief economist Lynn Reaser at Point Loma Nazarene University in San Diego is fairly optimistic about the job market. But the former president of the National Association for Business Economics also has a number of concerns, including excess caution on the part of employers and the risk of burgeoning inflation. In the following interview, Reaser discusses issues facing the economy.

You’re forecasting that the unemployment rate will slip to 6.1 percent over the course of the next year and the economy will add an average of more than 200,000 jobs per month. Can you elaborate?

The case for a robust, sustained rebound is still elusive. Companies still seem to be somewhat cautious in terms of hiring. The costs of health care reform are still very much on their minds. We are still seeing a lack of robust growth overseas, and the dollar’s strength will have some impact on our export potential. Companies are still very concerned about containing costs, and the doormat for robust hiring does not appear to be in place.

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Job growth should be good, at around 200,000. That represents a solid gain, but it does not appear that will be spectacular. At the same time, we should get more growth in the size of the labor force, which will put some brakes on the reduction in the unemployment rate.

Are we still feeling negative effects from the financial crisis?

We are, to some extent, still paying the penalty of the financial crisis. Recoveries following those types of downturns typically are slow, subpar, with relatively disappointing job growth.

This was such a deep and traumatic financial downturn that it may, in fact, take some time. Individuals are certainly attempting to spend more, as they can. But we have experienced the ongoing slow increase in real wages, and the middle class is still not making much headway, which is putting something of a damper on their overall spending.

When we asked in our survey whether the economy is at risk from either too much or too little inflation, you answered, “too much.” But don’t at least some Federal Reserve board members fear the opposite is true?

The current view is very much based on the recent evidence, which has suggested that price increases are indeed subdued. The risk, I believe, comes from the fact that we have a lot of tinder in the fireplace — meaning that there are huge amounts of excess bank reserves that are currently parked at the Federal Reserve. If banks start to put more of those reserves to work, we could see the potential for a rather quick absorption of excess capacity and upward pressure on overall price levels, and the Federal Reserve may be in a situation where it will be hard to play catch-up and contain the inflation risk in time.

Are Federal Reserve policies failing to address that inflation risk?

The Federal Reserve is balancing the risk between unemployment and inflation, and at the present time the risk does seem to be more on the side of a lack of full employment. The view of monetary authorities is that if the switch comes more quickly than they believe, that Fed policymakers could make the necessary adjustments.

People like myself are concerned that the inflation risk might be more evident than the Federal Reserve currently anticipates, and that could be a problem because monetary policy operates with a significant lag. It can be difficult, politically, to raise interest rates very rapidly, and then it takes time before higher rates actually affect the economy.

Are there any economic issues that keep you awake at night?

The financial markets now are very much dependent on the impact of “quantitative easing” (the Fed’s bond-buying program) and the Federal Reserve’s support of a huge and growing balance sheet.

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The stock market already is richly valued, which means that any kind of perceived change in the stance of monetary policy could have huge ripple effects throughout the market, which could be devastating. The wealth effect that the (rising) stock market has engendered has been a significant factor behind increases in consumer spending that we have seen.

Do you think that there’s a risk of a recession in the near term?

Typically, recessions are caused by overheating in the economy and a rapid increase in interest rates. It does not appear that we are at that point in the economic cycle, where we are close to a sizable outbreak of inflation and a Federal Reserve (rate) tightening.

Perhaps the greatest risk that we might face is one of stagflation, where the Federal Reserve is caught between the conflict of its two goals. In other words, it has the very difficult choice to make between raising interest rates, which would be needed to fight inflation, or lower interest rates, which would be needed to sustain the economic recovery and reduce unemployment. Right now, low inflation means that the Fed can focus solely on unemployment, but the picture could rapidly change if its goals are pointing it in different directions.

You expect the economy will be growing at a 3 percent rate a year from now. But it contracted during the first quarter of this year. Why has it been so uneven?

I think it will continue to be volatile, and this is still going to be a recovery that is largely consumer-led. At some point, households will need to save larger amounts of their incomes. We had argued that that was the case before the recession — that Americans needed to save more for retirement. The recession derailed that objective. The recovery started with the message that, yes, we want Americans to save more — but not right now. That continues to be very much the message.