Job Report Should Boost Fed’s Plan to Hike Rates This Year

September 30, 2015 6:42 pm Last Updated: October 5, 2015 5:34 pm

On Friday the U.S. Labor Department is expected to report the economy added 203,000 jobs in September. The data should further support Federal Reserve plans to raise interest rates before the end of this year.

Bouncing back from a harsh winter, GDP grew at a 3.9 percent annual rate in the second quarter. For the balance of this year and next, growth is expected to moderate to 2.5 percent to 2.8 percent, but that is still considerably better than the first six years of the economic recovery.

Despite stock market jitters and manufacturing hard hit by a strong dollar and retrenchment in the oil sector, consumer spending continues to increase at a strong pace.

Overall household balance sheets are in their best shape since the recovery began.

Overall household balance sheets are in their best shape since the recovery began. Stock prices are down but home values are up and ordinary consumers have learned to be more cautious about carrying large credit card balances.

Low interest rates are expected to boost growth by encouraging consumers to purchase new homes, automobiles, and appliances, and businesses to finance new investments in plant and equipment. As the Fed raises the federal funds rate—the overnight bank borrowing rate—the impact on mortgage rates will be minimal and should not derail new home construction. The auto and appliance sectors have largely recovered from the Great Recession and no longer need support from rock bottom rates.

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Business spending on plant and equipment remains weak by the standards of past economic recoveries, but that has more to do with structural shifts in the economy than interest rates. Businesses are learning to more effectively use machines for multiple purposes. For example, a single 3-D printer can be used to create a diverse range of products. Feliance on software to control devices permits engineers to merely reprogram machines rather than replace those as needs change.

Although inflation remains well below the Fed’s 2 percent target, Fed policymakers continue to express optimism that the pace of price increases will accelerate as oil markets tighten and slack industrial capacity is absorbed.

Evidence to the contrary is building: Oil prices remain stubbornly low even as U.S. production declines, and surveys of manufacturers and service providers indicate cost pressures are not building. However, Fed policymakers may feel free to tacitly abandon its 2 percent target and raise interest rates.

For one thing, the Fed adopted 2 percent as a policy objective only in 2012. Accelerating GDP growth in the face of very low inflation indicates 2 percent annual price increases are not needed to push down unemployment.

Job creation has slowed in recent months owing to a surge in productivity, and a weak pace of new business startups.

Job creation has slowed in recent months owing to a surge in productivity, and a weak pace of new business startups. Small enterprises are an important engine of job creation, but higher taxes and tighter regulations hamstring entrepreneurs in ways more easily circumvented by large corporations.

Keeping interest rates low for prolonged periods of time has done little to ameliorate the effects of those trends, but low rates do impose significant distortions on the economy.

For example, those frustrate seniors who depend on certificates of deposit to supplement pensions and Social Security. In turn, more seniors seek part-time employment, and that increases competition for young job seekers and suppresses wages.

Prolonged low mortgage rates pushes up land values in hot markets like Manhattan and the Silicon Valley to levels that may not be easily sustained when interest rates are normalized. Low interest rates subsidize Wall Street private equity and activist investors—bent on quick payouts as opposed to positioning companies to innovate and grow—and that is attracting some of the best young talent to those nonproductive pursuits.

Overall, a Fed interest rate increase won’t harm growth and job creation, and the Fed is likely to begin gradually raising rates at its October or December policymaking meetings.

Peter Morici, professor at the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. He previously served as director of the Office of Economics at the U.S. International Trade Commission. Follow him on Twitter @pmorici1

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