(What’s Left of) Our Economy: Has the Fed Gotten Savings Incentives Completely Wrong?

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Baby Boomers, banks, consumers, debt, deposit rates, federal funds rate, Federal Reserve, finance, Financial Crisis, housing, incomes, interest rates, recession, retirees, savings, savings rate, seniors, spending, The Economist, zero interest rate policy, {What's Left of) Our Economy

As many of you may know, the Federal Reserve yesterday raised the interest rate it directly controls above an effective zero level for the first time in seven years. So it’s especially interesting and important that a post from The Economist just before the rate hike made a strong case that one of the main rationales for keeping interest rates so low has backfired big-time on ordinary Americans and on the consumer spending still driving most U.S. economic activity.

Just after the height of the financial crisis, the Fed lowered its so-called funds rate to zero (actually, it was a range of zero to 0.25 percent) in part to make sure that the carnage that was spreading from housing to Wall Street and increasingly to the rest of the economy wouldn’t scare households into closing their wallets,and therefore choke off even more growth. The federal funds rate doesn’t directly set consumer borrowing rates – it’s the rate offered by the central bank to the country’s biggest banks. But the Fed was hoping that super-easy money would have twin stimulative effects.

First, when these banks’ borrowing costs fall, they can offer cheaper loans to both consumer and business borrowers and stay just as profitable. And the more affordable credit becomes, the more borrowers were expected to use. Second, the Fed was hoping that super-low rates would penalize saving. A rock-bottom federal funds rate would drive way down the returns on such popular consumer savings vehicles as money market funds and certificates of deposit and savings bonds, and convince Americans that they were better off spending existing savings and incoming income rather than receive literally no reward for thriftiness.

The Economist, though, has argued that the Fed’s penalize-savings strategy was misbegotten. And it looks like it should have been obvious even then. As the magazine points out, the biggest reason Americans save is to ensure a comfortable retirement. For any retirees or those nearing that age who already have substantial savings, even very low-yielding assets can together spin off enough income to ensure the golden years living standards they want.

But then ask yourselves how many Americans were in this situation when the financial crisis and recession struck. Inflation-adjusted incomes for the typical household had been stagnating. Thrift became a forgotten virtue; in part because of those stagnant incomes and in part because perpetually rising home values were hyped as an acceptable substitute, the nation’s personal savings rate hit historic lows and in fact briefly fell below zero. Then, of course, home values began cratering and the stock market went into free fall. So safe but low-yielding assets looked like the only viable savings game in town.

Unfortunately, the lower the return, the bigger the pot needed to guarantee that comfortable retirement. As a result, more and more of the aging American population has felt greater and greater pressure to salt away any new income not needed to cover ongoing living expenses.

Nor do you need to take The Economist‘s analysis on faith. For nothing has been clearer during this weak economic recovery than the continued consumer caution so responsible for holding it back. Many analysts attribute this behavior to a simple – possibly excessive – “once burned-twice shy” fear. But The Economist‘s treatment at least points to another important factor: For Americans with stagnant incomes and meager liquid savings – along with continuing debt – returning to pre-crisis and recession-level spending simply hasn’t been an option. In fact, evidence is accumulating that growing numbers of seniors, including recently retired baby boomers, are feeling these pressures, too – especially on the debt front.

Not that the Fed’s quarter-point rate hike will change matters much. In fact, signs haven’t even appeared yet that it’s a step in the right direction, as those banks that have raised the rates they’re charging for borrowers haven’t raised those that they’re paying to depositors. Until rates rise high enough to reward savings significantly again, most Americans will have ample reason to view recent Fed policies as lose-lose propositions.

(What’s Left of) Our Economy: Wage Inflation Claims Looking Dumber (or More Self-Interested?) Than Ever

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banks, benefits, compensation, ECI, Employment Cost Index, Federal Reserve, inflation, inflation hawks, inflation-adjusted wages, interest rates, manufacturing, real wages, recovery, wages, workers, {What's Left of) Our Economy

You’ve heard the expression that something has just moved from the sublime to the ridiculous? With the new Labor Department report on employment costs, claims that U.S. wage inflation is finally taking off have moved from the ridiculous to whatever comes afterwards – and that may mean “conflicted.”  

The Employment Cost Index (ECI) has recently become the principle basis for the wage inflation case because, six years into a dreary economic recovery, it’s the only measure indicating that compensation might not be continuing its decades-long stagnation. Therefore, it’s become a mainstay for monetary policy hawks who insist that American labor markets crippled by the Great Recession really have healed, and that it’s high time for the Federal Reserve to raise its key interest rate from its current near-zero level. Never mind, by the way, that none of the ECI’s readings adjusts for inflation, and that its headline includes benefits (which include lots of one-time rewards handed out to workers recently by nervous employers seeking more control over and flexibility with their payrolls).

It’s not my intention to comment today on the interest rate debate. But nothing could be clearer than that this morning’s ECI reading means that the wage inflation vigilantes need to change their tune, or they need to find some new evidence that American workers aren’t still receiving the short end of the stick.

The always provocative – and often on-target – ZeroHedge.com site has pointed out that on a sequential basis (these reports come out quarterly), the new ECI headline change was the worst since the series began in 1982. More revealing, though, are the year-on-year changes released this morning.

According to the Labor Department, the increase in total compensation costs for civilian workers – including wages, salaries, and non-wage benefits – was two percent. And even with inflation running well below that level, this means that employees are barely staying ahead of living costs. The comparable figure for the previous year? The same two percent, with the same implications.

Over the last year, wages and salaries rose 2.1 percent in pre-inflation terms – slightly better than the previous year’s 1.8 percent. But despite the excitement among economists and pundits over benefits, their year-on-year increase of 1.8 percent was well below 2013-2014’s 2.5 percent.

But the bad news for inflation hawks (and for the nation’s workforce) doesn’t stop there. For even these crummy numbers were propped up by compensation for government workers. Their wages, salaries, and benefits aren’t set by market forces, which means that they tell us nothing about the state of labor markets. Instead, government wages etc are set by government decisions.

Take out compensation determined solely by politicians’ whims, and the headline ECI figure rose by only 1.9 percent from June, 2014 to June, 2015. That’s less than the previous year’s anemic two percent even. Wage and salary increases picked up some during this period – from 1.9 percent to a still lousy 2.2 percent. But benefits really tanked – from a 2.4 percent rise from June, 2013-June, 2014 to 1.4 percent. That’s barely ahead of inflation.

Today’s ECI did contain one mild surprise: The June year-on-year increase for overall manufacturing compensation (2.5 percent) topped that for private industry as a whole, and was also faster than the previous year’s rise (2.1 percent). At the same time, before the recession hit, total manufacturing pay often registered much bigger annual gains.

I’m not big on conspiracy theories, and by no means do I believe that the economic argument for Fed rate hikes is nonsensical. Far from it. But given these results, going forward, it’s going to be important to keep in mind one other big source of fuel for any continuation of wage inflation claims – higher interest rates, all else equal, would mean much bigger profits for America’s banks. And many other finance companies have based their hopes for bigger profits on expectations of rate hikes. So when you start hearing again about wage inflation claims, which you surely will whatever the data say, it will be more important than ever to consider the source.