- - Wednesday, January 16, 2019

Federal Reserve Chairman Powell faces the tough challenge of engineering a soft landing for the economy. The task is made terribly more complicated by economic conditions abroad and new technologies that have broken traditional relationships among growth, employment, inflation and interest rates.

The nearly three percent growth accomplished in 2018—despite chronic skilled labor shortages—was no accident of nature. Trump tax cuts and a February 2018 budget deal that lifted federal appropriations caps boosted consumer and government spending.

Lower corporate taxes permitted businesses to invest in labor saving robots, artificial intelligence and workforce training. Trump Administration deregulation slashed private sector compliance costs, and together those boosted labor productivity.

More demand, more supply and the economy zoomed ahead at a pace defying naysayers in the left-leaning media.

In 2019, consumers are getting an additional lift from falling gas prices but the benefits from more government spending and personal tax cuts have largely run their course. Businesses should continue to invest but conditions in Europe and China are troubling.

Brexit, the yellow vest riots in France and the emergence of a populist government in Italy were nominally caused by unchecked immigration, higher taxes on gasoline and reforms that tighten belts for workers and pensioners and a left-right coalition agreement to spend more than EU national debt limits permit. In reality, the onerous regulations imposed by the EU bureaucracy and mercantilist policies in Germany and a few other northern European economies that impose perennial trade deficits and austerity elsewhere are pulling the EU apart.

The rump of it is Europe can’t grow—and it’s America’s most important export market.

China has run the string on credit driven growth, and Republicans and Democrats alike are tired of Beijing’s protectionism imposing a whopping $365 billion trade imbalance and exporting unemployment and social problems here.

Donald Trump’s trade war is criticized only because Hillary Clinton, who campaigned on a similar policy, did not win the election. The Fed would have to deal with the uncertainty created by a trade war no matter who occupied the Oval Office.

A decade of low interest rates boosted real estate and stock values in the United States and permitted struggling corporations and foreign governments to avoid reforms that would make them competitive and less corrupt. Now just about anything the Fed does has feedback effects on asset prices, corporate and foreign government finances and ultimately U.S. exports and growth.

Finally, tools the Fed uses to navigate are broken. The Philips Curve, which charts the tradeoff between inflation and unemployment, is flashing red but the hard economic data say otherwise. Even with unemployment at 3.9 percent, wage increases of 3.2 pose few inflationary pressures with stronger productivity growth to pay for those.

The Yield Curve—the difference between the short and long-term interest rates on Treasuries— has been flattening. Historically, that has proven a pretty good indicator of a recession in the next year or so. Theoretically, it is supposed to indicate businesses that buy equipment and hire don’t believe that prospective sales growth justifies borrowing long-term to finance expansion.

The problem is that since the 2000s U.S. long rates have been suppressed by foreign investors. Europeans stuck in a lethargic economy, and Latin Americans and Asians fearful that their corrupt governments will ignite inflation to solve their debt problems, have been buying up U.S. real estate and long bonds.

Similarly, the dollar has increasingly become the preferred currency for all global trade further increasing the demand for U.S. bonds.

Those unhinge the relationships between business expectations and interest rates. For example, the yield curve has been sending warning signals since late 2017 but the economy sped up instead of slowing.

Lacking the Philips Curve and Yield Curve as tools, Mr. Powell is flying without an altimeter and air speed indicator. Not being an economist he hasn’t been to pilot school either.

With all this, turbulence in stock prices is understandable and can’t be ignored. Along with the hostile press coverage President Trump gets no matter his spending or trade policy proposals, falling stock prices could pull the economy into, rather than follow, a recession.

The best thing Mr. Powell can do for now is pull back on the stick and announce he is not planning any more interest rate increases until at least this summer.

• Peter Morici is an economist and business professor at the University of Maryland, and a national columnist.

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