Better Data, but Not Enough for the Fed

Phillip Swagel is a professor at the School of Public Policy at the University of Maryland and was assistant secretary for economic policy at the Treasury Department from 2006 to 2009.

As I wrote four weeks ago, the Federal Reserve is trying to figure out when the recovery has become firm enough to reduce its purchases of Treasury bonds and government-backed mortgages made under the quantitative easing program known as QE3.  This “taper” would be the first step in what is likely to be a lengthy process of moving back to a normal monetary policy after five years of extraordinary measures in the wake of the financial crisis and Great Recession.

Data released Wednesday provided a hopeful indication of strengthening economic growth, with gross domestic product increasing at an annualized rate of 1.7 percent in the second quarter of this year, against expectations of only 0.5 to 1.0 percent.  This is still below the 3 to 3.5 percent that economists saw as the potential growth rate of the economy before the crisis, but constitutes acceleration from economic growth that newly revised data show to have averaged just 1.4 percent in the previous four quarters.

The Federal Reserve stated on Wednesday afternoon that it would tighten monetary policy if inflation became a problem, but otherwise would continue with its expansionary policy “until the outlook for the labor market has improved substantially.”  This largely mirrors previous language from the Fed’s decision-making Federal Open Market Committee. The data on gross domestic product are important for assessing the Fed’s intentions, since the pace of growth has a strong influence on job creation, just as consumer spending growth is likewise driven by G.D.P. growth (as explained Wednesday by Casey Mulligan).

Many Fed watchers have concluded that there has been enough improvement for the Fed to act already, with both strengthening G.D.P. growth and job gains of more than 200,000 per month on average in the first six months of 2013 (employment data for July will be released Friday morning).  Under this view, the taper would be announced on Sept. 18, when Ben S. Bernanke, the Fed chairman, is set to hold a news conference after the next meeting of the policy committee. The Fed is now buying $85 billion a month of long-term securities. It could dial this back to $60 billion a month and still provide an expansionary monetary policy, even if less so than at present.

Some details of G.D.P. growth for the second quarter support the view that the taper is at hand, notably the modest impact of tighter federal spending on the economy. Mr. Bernanke in recent Congressional testimony expressed the concern that “tight federal fiscal policy will restrain economic growth.” So far at least, economic drag from the higher taxes and lower spending that took hold at the start of 2013 appear to have been offset by other factors, including a housing market recovery and a rebound in business spending.  It is possible that Congress and President Obama could find themselves at loggerheads over the debt ceiling and federal budget in the fall, and that the resulting game of fiscal chicken could have a negative impact on business and consumer confidence.  For now, however, one of Mr. Bernanke’s chief worries seems to have been assuaged.

Even so, I am still not so sure that the Fed is ready to dial back its monetary stimulus.  The figures for second-quarter G.D.P. were better than expected, but a growth rate below 2 percent is still too modest to lift job creation beyond the 200,000 recent pace or to hasten the painfully slow downward progression of the still-elevated unemployment rate. There is a sense in which seeing the G.D.P. data as good news only highlights the sadly diminished vigor of the economy since the crisis. After all, G.D.P. grew by better than 3 percent over the 15 years before 2008, and the unemployment rate remains uncomfortably high at 7.6 percent, with millions of Americans still out of work for extended periods.

Indeed, continued growth would draw back into the job market people who gave up looking for work over the past years and allow the Fed to maintain its expansionary monetary policy stance. A reversal of the decline in the labor force participation rate would be welcome because it would indicate that the recovery has finally reached those driven onto the sidelines by the recession. But renewed job seekers would keep the unemployment rate higher than otherwise â€" a person is counted as unemployed only if looking for work. And this continued high unemployment in turn would stave off inflationary pressures that might arise from a heating-up labor market, in that way giving the Fed more room to keep the monetary throttle open.

Moreover, it is possible that the second quarter was not actually as good as the data now indicate. The G.D.P. data released Wednesday will be revised on Aug. 29 and again on Sept. 26, incorporating additional information not yet available (the New York Fed provides a calendar with economic data releases).  In particular, the first estimate of G.D.P. released Wednesday is based on figures for inventories and international trade (imports and exports) that are essentially guesses by the Bureau of Economic Analysis, the government agency that constructs the G.D.P. data. The bureau does a good job, and would do an even better one with additional budgetary resources â€" economic statistics are a vital function for the government. But its figures for inventories and exports were notably better than expected, meaning that downward revisions would not be especially surprising.  Indeed, the bureau on Page 18 of its G.D.P. release indicates that the average revision of the data is 0.6 percentage points between the first estimate and the third, though this includes revisions both up and down.

The improvement in economic growth in the second quarter augurs well for continued job market gains. But the question for the Fed is whether a good-but-not-great quarter and a string of months with moderate job gains is either good enough or perhaps simply the best that can be gotten from monetary policy. With growth still modest and its future prospects uncertain, the unemployment rate high, and inflation not visible, the Fed could reasonably decide to wait several months to be sure that the recovery continues to strengthen. All eyes then will be on Friday morning’s release of jobs data for July.