The Fed’s Great Optimism

The Federal Reserve barely cuts its forecast for GDP growth in this year and next. The agency estimated the economy will expand 2.7 percent to 2.9 percent this year, down from a forecast of 3.1 to 3.3 percent made in April. The Fed also said it sees 2012 growth between 3.3 percent to 3.7 percent, lower than its previous forecast. Unemployment will be above the “normal” levels of a recovery even in 2013. That means the jobless rate is likely to be above 8% for another two years.

The Federal Reserve must believe that there is such a thing as a “jobless recover”y. And, that recovery will also be accompanied by inflation which is now moving quickly higher because of oil and commodities prices

Barely a day passes when some large company says its earnings have been hurt by margin compressions brought on by increases in the cost of goods.  For example, cotton prices could raise retail prices for nearly every clothing retailer in the country.

Drops in profits which sometimes lead to losses are almost always trigger layoffs. The last recession showed that, if it showed anything. The economy lost several hundred thousand jobs a month for over two quarters. And, even now, businesses are reluctant to add jobs, as the May unemployment numbers showed. The economy could very easily move into a period in which it sheds jobs again. Inflation, one of the great enemies of both consumer and business spending, will be a major trigger.

The Fed’s mathematics are problematic for another reason. Low GDP growth means that the six million Americans who have been unemployed for over half a year (that number grows by tens of thousands each month) will for the most part stay unemployed. Their inability to spend is another drag on consumer spending. And, just as important, it is a drag on both the crumbling housing market and the resources that governments, churches, and other support groups must muster to keep many Americans from becoming destitute.

The Fed’s projections are still too optimistic because the case for a “jobless recovery” has already been disproved.

Douglas A. McIntyre