Economy will be stuck in a hole all year: Blinder

Government will be a drag on growth as Fed winds down quantitative easing

May 5, 2014 @ 8:13 am

By Jeff Benjamin

A “catastrophically bad” first quarter has put the economy in a hole it will be stuck in for the rest of the year, according to Alan Blinder, professor of economics and public affairs at Princeton University.

Speaking Sunday in Boston at the Investment Management Consultants Association's annual conference, Mr. Blinder did not sugarcoat what he sees as the challenges facing the economy. And at times during his keynote presentation, even his good news sounded like bad news.

“This year, the government will be less of a drag on economic growth than it was last year, but that's a very low bar because the government was a titanically huge drag on economic growth in 2013,” he said. “The government will still be a net negative for the economy in 2014, but it will be less than it was in 2013.”

Even has he detailed the fallout from the winding down of quantitative easing and the looming interest rate hikes, Mr. Blinder pointed to the upside of no more winter weather hurting the economy and the ongoing wealth effect from a rising stock market and real estate prices.

On Federal Reserve policy, Mr. Blinder said the message is clear that the eventual target is for a short-term interest rate in the 4% range, which compares to the current overnight rate of between zero and 0.25%.

The tapering program is on track to end the Fed's bond-purchasing program in October or November. Fed Chairman Janet Yellen has made it clear she would like to start raising the short-term borrowing rate about six months after the conclusion of the quantitative easing program, and that means the Fed could start raising rates by this time next year.

Mr. Blinder believes that is too soon. He thinks the U.S. economy will need closer to a year after the end of QE to be able to absorb higher interest rates.

“Don't hang around with bated breath waiting for the Fed to start raising rates, because it's not happening for a while,” he said.

One thing that could delay the Fed's plans to start raising rates after QE is wrapped up is the real rate of unemployment, he said.

While the official unemployment in April fell to 6.3%, from 6.7%, Mr. Blinder emphasized what other economists have been saying for years, that the reported unemployment rate is skewed downward by a dramatically reduced labor force participation rate.

“The unemployment rate is a very solid number,” he said, “but you have to remember that the number of unemployment people only represents a fraction of the labor force, and not the employment population ratio number.”

The employment population ratio figure, he explained, shows that the overall labor participation rate in this country fell dramatically after the financial crisis in 2008 and has never recovered. The current labor force participation rate has remained virtually unchanged since bottoming in mid-2009.

“The employment participation ratio has not improved at all,” Mr. Blinder said.

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