Randall Kroszner has seen his share of political power shifts — both as a Washington policy insider and as a Chicago School economic wonk. Interspersed with his time as a professor of economics at the University of Chicago — a post he has held on and off since 1990 — Kroszner served as a governor of the U.S. Federal Reserve System from 2006 to 2009 and as a member of then-president George W. Bush’s Council of Economic Advisers from 2001 to 2003. You don’t have to be a Ph.D. in economics, however, to know that there have been plenty of economic ups and downs during the 16 Congresses since he first became a professor. The 2014 midterm Congressional elections saw a GOP sweep, with Republicans gaining at least seven seats to take control of the Senate and expanding their majority in the House of Representatives. A change in partisan control often signals voter discontent with the state of economic affairs. During the 2014 iteration, the U.S. economy continues to plod along its upward trajectory despite ultralow wage inflation and, in Kroszner’s view, unemployment numbers that, while oft-touted in the press and by policymakers, don’t quite give an accurate diagnosis of the U.S. economy’s convalescence. Kroszner spoke with Institutional Investor about his predictions for the markets in the lead-up to and during the 114th Congress. In his view the private sector may see near-term positive repercussions, although he cautions that badly needed long-term reform may remain politically untenable for now. On a global level, as the quantitative easing baton passes from the Federal Reserve to central banks in Europe and Asia, the U.S. is faring better than other developed markets — though it’s not time to party just yet, Kroszner warns.
Institutional Investor: How do you see the U.S. economic situation developing overall?
Kroszner: The U.S. appears to be on a stronger growth path than the rest of the world: Emerging markets are mixed, the euro zone is facing the threat of deflation, and China appears to be slowing, with downside risks in the real estate market. This does not mean, however, that the U.S. is going gangbusters and we should be popping champagne corks. Many discouraged workers would still like jobs but have dropped out of the labor force. In addition, many people are in part-time jobs but want to work full-time. When we take these groups into account, the broad U-6 unemployment rate is nearly 12 percent, far above the traditionally measured unemployment rate of 5.9 percent. Put simply, job market recovery is slower than we would like, as is wage growth.
Last week the Federal Reserve announced the anticipated endgame for its asset purchase facility. What steps do you see as next for policymakers at the bank?
Kroszner: A major communication challenge faces the Federal Reserve in telegraphing the timing of its first interest rate increase. Last week the Fed continued to use the phrase “considerable time” to describe how long it would be before they begin to raise rates. Since inflation and inflation expectations are below their 2 percent goal, they are in no rush to raise rates. At the next meeting in December — or certainly by early next year — the Fed will have to adopt new language. The key challenge will be to convey their intentions to the market without causing premature tightening in fixed-income markets — no easy task.
Is there any reason to think that extraordinary policy actions taken by central banks abroad such as the Bank of Japan and the European Central Bank could present a threat to the momentum of the U.S. economy?
Kroszner: The euro zone is facing a serious threat of deflation. Over the past couple of years, the ECB allowed its balance sheet to contract by roughly €1 trillion [$1.25 trillion], much like the Bank of Japan let its balance sheet shrink significantly in the early to mid-2000s, leading to Japan falling back into deflation. The Bank of Japan reversed the deflation with a rapid increase in its balance sheet and just announced an even more aggressive asset purchase program. Extraordinary actions by both the ECB and the Bank of Japan are needed to avoid the contractionary effects of deflation on these important U.S. trading partners.
How much of an impact will the Republican victory in this week’s legislative elections have on the momentum of the economy?
Kroszner: Policy uncertainty weighs heavily on business. Some of my colleagues here at the University of Chicago have done research arguing that fiscal and regulatory uncertainty in particular has slowed recovery in investment and hiring. If the Republican Congress and President Barack Obama can find points of agreement, even if narrow ones, related to tax reform, energy policy and trade, I think that will help to improve the business climate. Long-term fiscal issues still loom large, but, unfortunately, I don’t think that they will be resolved before the 2016 presidential election.
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