[The Editors' Verdict] The Core of the Tapering Debate: Employment

Kim Kyung-soo, Professor Emeritus at Sungkyunkwan University

The Financial Stability Report published by the U.S. Federal Reserve (Fed) in early May did not explicitly state it, but it warned of a ‘bubble’ in the asset market. Even considering the low Treasury yields, a significant portion of asset values are overvalued, and there is concern that adjustments may occur when preferences for risky assets change in the future. The report mentions the term “meme stocks” (stocks overvalued not because of the company’s value but because they are widely talked about among people) no less than three times. Additionally, it warned of the possibility that the global financial system could be at risk due to financial authorities’ inability to properly grasp leverage conditions, as seen in the Archegos incident.

However, there is some question as to why the monetary authorities, who are responsible for liquidity, would deliberately warn about bubbles in the asset market. About four and a half decades ago, then-Fed Chairman Alan Greenspan once said that a bubble can only be recognized as such when it bursts (later revealed as the dot-com bubble). However, after his retirement, he admitted that the Fed bore some responsibility for the global financial crisis. Even an extreme market believer acknowledged that central banks should not stand by and watch asset market overheating.

Prices are rising across the board, from international commodities to services. If this is due to pent-up retaliatory consumption, the inflation could be seen as a temporary phenomenon. However, the continuously rising producer prices suggest that consumer price trends will eventually be affected. Moreover, the pattern of significant increases in producer prices in both South Korea and the U.S. over the past six months is sufficient to suggest a common factor in the global economy.

Concerns about inflation stem from zero interest rates, the Fed’s asset purchases amounting to $120 billion per month, and the Biden administration’s unprecedented economic stimulus measures. Unlike during the financial crisis, various monetary indicators have surged beyond their limits during the pandemic crisis.

Concerns about inflation have led experts to predict that the Fed’s tapering (reduction of asset purchases), which is planned to continue until 2023, may begin earlier than expected. However, the Fed maintains the position that there is still a long way to go to achieve full employment and the average 2% inflation target. It diagnoses that employment is still 8.4 million short of pre-pandemic levels and that inflation is temporary.

Employment is currently the most important monetary policy goal the Fed is grappling with. This is because the longer the unemployment duration, the more likely the unemployed become discouraged workers, i.e., move into the non-economic activity population. Even if the economy recovers from recession and the unemployment rate (number of unemployed / economically active population) decreases, the employment rate (number of employed / working-age population) does not easily recover because the recession affects not only those who lost jobs but also increases their average unemployment duration.

Despite the longest economic expansion in the U.S. starting from the second half of 2009, it took more than ten years for the employment rate to recover to pre-recession levels. In April 2021, the average unemployment duration exceeded 28 weeks, longer than any previous recession period. Although wage pressures are rising due to current labor shortages, it remains uncertain when employment will recover to pre-pandemic levels.

In June last year, Fed Chair Jerome Powell said he “did not even think about” raising interest rates. However, according to the publicly released April FOMC minutes, some participants stated that if economic expansion continues, it might be appropriate to begin discussions on tapering. This shows that the direction of monetary policy is path-dependent. The core issues are employment and inflation. If employment does not clearly improve despite high inflationary pressures, the Fed will face a dilemma. The market will face the same dilemma.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

This content was produced with the assistance of AI translation services.