The next few monthly job reports, including this weekend's, will be watched especially closely to assess the balance in a rather unusual tug of war that has developed in Washington: between a dysfunctional Congress set on creating headwinds to a slowly-recovering US economy, and a central bank willing to roll out one untested measures after the other in its attempt to steer the economy towards higher growth and more robust job creation.
The 'sequestration' is, of course, the latest example of America’s self-made obstacles. This set of blunt budgetary cuts, which automatically went into effect this week due to Congressional inaction, will add another fiscal drag of 0.5 percentage points off gross domestic product in 2013. Coming on top of January’s tax increases and recovering (but still-weak) endogenous growth drivers, this will serve to again limit the annual growth rate of the economy to 2 per cent or less – and do so without involving a rational and durable reform to America’s medium-term fiscal dynamics.
The sequestration also failed to overcome recurrent Congressional dramas over fiscal issues. If anything, it accentuated the already-disruptive polarisation on Capitol Hill. As such, it is just a matter of days before the political parties bicker over the 'continued resolution' required to avoid a government shutdown at the end of this month; and it is just a matter of weeks before yet more brinkmanship emerges over the debt ceiling.
In addition to damaging the momentum for sensible and comprehensive medium-term fiscal reform, this Congressional management by crisis inhibits the US economy from attaining escape velocity, and does so through three channels: it undermines sensible demand management policies in the short-term; it pushes off the legislative agenda other much-needed structural reforms to enhance growth; and it increases the political risk factor that enters the calculations governing private sector investments in new plants, equipment and hiring.
Long ago, the Federal Reserve under its activist chairman, Ben Bernanke, correctly realised that the longer the US spends in this economic 'new normal' – which we specified in May 2009 to include an unusually prolonged period of sluggish growth and persistently high unemployment in advanced economies – the greater the social costs and the bigger the damage to the economy’s long-term potential. As such, the Fed pivoted in 2010 from using unconventional monetary policies to fix market failures to also targeting better macroeconomic outcomes.
This is evident in the Fed’s seemingly-endless series of policy innovations – from previously-unthinkable forward policy guidance and policy rates floored at zero to what market participants have dubbed 'quantitative easing infinity'. Moreover, every serious discussion on 'exit' has fallen to the side as macroeconomic outcomes have fallen short of the Fed’s own expectations. In the meantime, Congress has continued on its merry way of creating new headwinds for the economy.
Lacking sufficient data, we will never know whether the precise extent to which disappointing macroeconomic outcomes are due to unanticipated developments (including heightened Congressional dysfunction) versus imperfect policy tools. What we do know is that the country’s central bankers feel more than just a moral obligation to remain hyperactive in building a bridge until politicians and policy making entities step up to their responsibilities; they are also engaged in countering in real time the adverse effect of recurrent political headwinds.
With the widely-followed unemployment rate sending less than clear-cut signals due to variations in the labour participation rate, we should look to four specific indicators in this Friday’s (and subsequent monthly) jobs report to shed light on whether the Fed is succeeding in assisting the economy’s endogenous growth drivers to overcome Congressional dysfunction:
– An average monthly job growth in excess of 225,000;
– A steady reduction in the share of long-term unemployment;
– Robust average monthly earning gains; and
– A continuing gradual compositional shift to a tradeable sector that creates well-paying jobs faster than in non-tradeables.
Unfortunately, the job reports will not shed light on the most important counterfactual: namely, how fast would the US be growing if Congress had transitioned from being a headwind to providing a tailwind to the country’s gradually-healing economy. This is regrettable given the urgent need to encourage Congress to embark on a more responsible path and, more generally, the importance of established political orders responding properly to the wave of popular dissatisfaction with the status quo that is spreading throughout the west.
The writer is the chief executive and co-chief investment officer of Pimco.
Copyright the Financial Times 2013.