In 2008 when the US was in the wake of the Great Recession, the FED launched the Quantitative Easing (QE) – a relatively and unconventional new program – to stimulate the economy due to the failure of the traditional approach (reducing overnight interest rate). QE consists of creating new money to buy securities (e.g., government bonds) from financial institutions to decrease interest rates. Hence, firms can borrow at a cheaper rate allowing them to increase investment and so creating new jobs to boost the economy. Since the program started, the FED had introduced $3.7 trillion. However, inflation remains at record low levels.
The first culprits appear to be cheap oil and a strong dollar although they are not. Cheap oil cannot be the main source of low inflation because it would reduce costs and thus prices in some service industries. Nonetheless, if we exclude transportation, the relationship between an industry’s use of fuel and recent price moderation it is not clear at all. On the other hand, a strong dollar cannot be the main cause of low prices either. If the dollar appreciates, goods would hike more than services (which cannot be imported) but in reality it is the other way around, whereas services inflation is above 2%, goods are getting cheaper (in order to check the graphs out, click here)
Then the main cause has to be something that affects all industries equally such as labor cost, i.e. wages are not growing enough to boost inflation. The main reason of that is the high level of unemployment, although the rate commonly analysed (called U3 Unemployment rate) does not show it. Instead, we have to analyse the U6 unemployment rate that provides a broad picture of underutilization of labor (See Graph 1 and 2). This way of measuring unemployment follows the next formula: total unemployed plus all persons marginally attached to the labor force plus total employed part time for economic reasons divided by total civilian labor force and all persons marginally attached to the labor force together. If the common unemployment rate is so low is because participation rate has decreased since the Great Recession due to an increase of discouraged workers and the sharp increase of part-time jobs. The fact that more people is working in part-time jobs forces them to seek for another job to gain more money, as a result labor supply increase putting downward pressure on wages.
As we can see, low inflation is not due to low oil price or a strong dollar instead it is a sign of structural problems in the labor market that U3 unemployment rate hints. For this sort of problems QE is not the proper solution so policymakers should try to reform labor market to curb its structural problems. On the other hand, the FED has done well starting to raise interest rates to avoid the problems that may derive from this policy (e.g. bubbles) and so putting further pressure on policymakers to start its reformist agenda.
ʽExplaining low inflation: the lowdownʼ (2015) 417(8958). The Economist, 42-43 (Print)
Mathur, Aparna. ʽLabor Market Woes Remainʼ (December 4th 2014). US News (2015) Online: http://www.usnews.com/opinion/economic-intelligence/2014/12/04/job-growth-rises-but-labor-market-woes-remain
ʽThe Economist explains: What is quantitative easingʼ (March 9th 2015). The Economist (2015) Online: http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5
Gabriel Bracons Font, student of 4th year of the degree in Economics in the UPF and colaborator in Pompeunomics