The Federal Reserve held short-term interest rates steady this month amidst low inflation and slow productivity on a national scale. Typically, the Fed looks at the relationship between unemployment and inflation in order to determine monetary policy that dictates money supply. As unemployment goes down, inflation traditionally rises, leading to increases in interest rates. Although unemployment currently sits at 4.7 percent, below the 5 percent trigger mark the Fed uses, inflation has continued to remain slow with projections remaining at a conservative 2 percent annual rate.
More than likely this effect is due in part to stagnant wages and increasing levels of underemployment. In an economy that is based on household spending, like the U.S., stagnant wages can and do have a meaningful impact on the vibrancy of an economy. According to the U.S. Bureau of Labor Statistics, wages haven’t changed much over the past 35 years after adjusting for inflation, thus U.S. households have not experienced any growth in their overall purchasing power for over three decades.
Weak growth in productivity is also impacting the Federal Reserve’s economic outlook. Labor productivity increased by only .6 percent per annum on average in the past five years. This is less than the 1.9 percent growth per year experienced between 2004 and 2010, and substantially less than the 2.8 percent labor productivity growth rate seen between 1994 and 2003.
The impact of the aforementioned variables spell one thing, the U.S. economy is facing new challenges, ones which will require innovative approaches to monetary policy in order to maintain momentum in the national economy and adjust to the nuances of current economic conditions. And with recent events in the European Union, the U.S. is likely to see interest rates remain low for quite a while.
Alexandria M. Wright is director of the Yavapai College Regional Economic Development Center, which provides analysis and services that facilitate economic development throughout Yavapai County and build wealth in our local communities.