FOMC Minutes Don’t Add Up

The Fed released the notes of the Federal Open Market Committee and Board of the Governors of the Federal Reserve joint meeting on June 23rd and 24th. The two major conclusions from this meeting are contradictory to one another, unless the reader believes that unemployment can go to frighteningly high levels and still be considered a lagging economic indicator of the economy.

The Fed has a wonderful habit of publishing its top line forecasts based on what it calls “central tendency” which takes the projections of all of the members and then throws out the highest and lowest three figures for each projection. The Fed says that next year’s GDP will improve in a range of 2.1% to 3.3%. One member, whose vote was not counted as equal to those in the central tendency, believes that growth will only be .8%. The same odd way of looking at projections shows up for unemployment figures. The spread for 2010 is 9.5% to 9.8%, which is up from the Fed’s projections in April. One member of the committee believes that 2010 unemployment will be 10.6%, and the most pessimistic forecast for 2011 is 9.2%. Joblessness would need to be above 10% for more than one quarter for the most negative numbers to be true.

The theory that employment lags GDP is a sound one. Businesses need to see some recovery in sales before they will begin hiring again. Businesses need ready access to capital. But, there is a point when unemployment is so high that it compromises commercial activity enough to create a drag that keeps GDP from getting airborne again. That number may well be in the 10% range, particularly because this figure leaves out people who are forced to work part-time or those who have stopped looking for jobs altogether. It has been written many times and in many places that the effective unemployment rate in America is moving quickly toward 15% or 16%.

The Fed’s view of GDP recovery may be flawed due to a reason that is nearly as significant as employment. CIT (CIT) said yesterday that it could not come to terms with the government on a bailout. The small-business lender will probably file for bankruptcy. Customers and clients of CIT will not lose their money; the government will see to that. But, the process of getting access to capital at CIT will almost certainly be disrupted. This happens at a time when banks are already leery of lending money to firms that have modest revenues.  Some of CIT’s customers may face temporary cash squeezes that could cause business closures and job cuts. Unemployment and access to credit have to be factored in before there is a complete and accurate portrait of the long-awaited recovery.

The FOMC notes show that the Fed would still like to have the benefit of being an accurate arbiter of reasonable forecasts about unemployment while doing what it can to be a quietly enthusiastic cheerleader for the recovery. The Fed is surely careful about its role because if it is the government’s leading pessimist the credit and financial markets would almost certainly be demolished.

The safest thing for the FOMC to do is disconnect unemployment from GDP recovery, at least as much as it reasonably can, and hope for the miracle of a jobless recovery which would have no equal.

Douglas A. McIntyre