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SCHILLER: The Fed’s taper trigger
It may be further off than we think
Back in December, he said the Fed would continue its bond-purchase program until the national unemployment rate fell to 6.5 percent. That was a historic shift not only in Fed policy (which had heretofore set inflation triggers, but not unemployment triggers), but also in the transparency of Fed policy. (Would Alan Greenspan ever have been so explicit?) Yet, Wall Street continues to behave like it either didn’t hear the Fed commitment or doesn’t believe it. Pundits respond to every economic report with prognostications about the impact on the timing of Fed tapering. Last week’s belated employment report unleashed another torrent of taper speculation.
The monthly employment reports are, in fact, the key to the Fed’s tapering decision. However, Wall Street hasn’t done the math required to pinpoint the onset of tapering.
The employment report pegged the national unemployment rate at 7.2 percent. The Fed trigger for tapering is 6.5 percent, so, we are 0.7 percentage points away from the Fed trigger. With a current labor force of 155 million people, that “excess” unemployment implies a job shortage of 1.1 million jobs. In other words, the economy must create 1.1 million more jobs before the Fed pulls the taper trigger. Last month 148,00 jobs were created. At that rate, the Fed seemingly could start tapering in seven months — May 2014.
That forecast, though, is way off the mark. The current 1.1 million job shortfall is a very low benchmark for projecting Fed tapering. The population (including immigration) continues to grow every month, bringing more labor force entrants. Then there are the 2 million-plus nonparticipants sitting on the labor-market sidelines. They have become too discouraged or marginalized to actively look for a job and are, thus, not being counted as “unemployed” in the government’s employment reports. Yet if economic growth does accelerate, these sidelined workers will re-enter the labor market in droves. To push the unemployment rate down to 6.5 percent, we’ll have to find jobs for this persistent stream of returning entrants as well as those now counted as unemployed. Accommodating this stream of re-entrants will require at least another 2 million net new jobs per year.
This dynamic perspective pushes the Fed’s taper decision a lot further into the future. The timing of that decision depends on the rate of monthly job creation. The math is easy: We simply ask how many jobs have to be created each month to bring the unemployment rate down to 6.5 percent by a specific future date. Suppose we think the Fed might start tapering a little more than a year from now, in November 2014. In this 12-month period, we’d need to cover the current 1.1 million job shortage plus another 2 million jobs for the labor-force re-entrants. That works out to an average of 260,000 jobs created each month. Does anyone want to bet on that happening? We haven’t seen that kind of job growth since 2007. This means we probably won’t witness Fed tapering next year, especially with the Obama administration’s insistence on thwarting economic growth with higher taxes, increased payroll costs and burdensome regulations.
So when will tapering begin? The accompanying table relates the rate of monthly job creation to the Fed’s taper trigger. If we generate 200,000 new jobs every month, tapering starts in November 2016. If we see an average of only 148,000 new jobs each month, we won’t ever see Fed tapering.
If the Fed sticks to its guns, tapering is still a long way off. Wall Street should focus on the monthly employment reports if it really wants to predict when that taper trigger will be pulled.
Brad Schiller is emeritus professor of economics at American University and the author of “The Economy Today,” McGraw-Hill, 2012).
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