Author: WSJ.com: Real Time Economics

The Federal Reserve had its biggest bottom line ever in 2009, generating record profits as its holdings of Treasury, mortgaged-backed securities and agency debt grew.

The Fed last year generated a net income of $52.1 billion, of which it paid $46.1 billion to the U.S. Treasury, the Fed said Tuesday. The windfall came as the Fed’s balance sheet ballooned to more than $2.2 trillion and the Fed acquired billions in securities through unusual asset-purchase programs aimed at spurring economic growth.

The Fed last year purchased $300 billion in US government debt and is on track to buy $1.25 trillion in mortgage-backed securities plus $175 billion in debt from government-backed mortgage agencies. The larger holdings more than offset the historically low interest rates that bring the Fed its income.

The Fed’s 2009 earnings were up 47% from 2008 when it generated a net income of $35.5 billion and transferred $31.7 billion to the Treasury.

The 2009 earnings reflect an estimated $3.7 billion in losses on holdings the Fed acquired when it helped J.P. Morgan Chase & Co. buy Bear Stearns and when it rescued American International Group.

Of the 2009 earnings, $46.1 billion was generated through open market operations and $5.5 billion was generated by companies it created as part of the Bear Stearns, AIG and other rescue operations. The Fed earned $2.9 billion in 2009 on interest on loans it made to banks and other institutions.

Small business owners aren’t optimistic yet, the latest monthly survey by the National Federation of Independent Business found. The NFIB index fell 0.3 points in December to 88. That’s up from the lows of March 2009, but has been below 90 for 15 months. “Optimism has clearly stalled in spite of the improvements in the economy,” the NFIB said.

NFIB Chief Economist William Dunkelberg added, “Continued weak sales and threatening domestic policies from Washington, have left small business owners with little to be optimistic about in the coming year.”

Highlights:

• Jobs: 10% of the owners increased employment (the highest reading of 2009), but 22% reduced employment (seasonally adjusted). Over the next three months, 15% plan to reduce employment (down two points), and 8% plan to create new jobs (up one point), yielding a seasonally adjusted net-negative 2% of owners planning to create new jobs, a one-point improvement from November.

• Credit: Regular borrowers (accessing capital markets at least once a quarter) continued to report difficulties in arranging credit at the highest frequency since 1983. A net 15% reported loans harder to get than in their last attempt, unchanged from November. Although “that is not nearly as severe as the financial distress reported in the pre-1983 period, 24 months of recession have sapped the financial strength of many small firms,” Dunkelberg said. Eight percent of all owners reported that their borrowing needs were not satisfied, down two points from November. The remaining 92% of all owners either obtained the credit they wanted or were not interested in borrowing.  Only 4% of the owners reported finance as their number one business problem (down one point).

• Profits: 54% reported lower earnings compared to the previous three months. Of those, 65% cited weaker sales, 4% each blamed rising labor costs, higher materials costs and higher insurance costs, while 6% blamed lower selling prices. Poor real sales and price cuts are responsible for much of the weakness in profits.

• Prices: 10% of the owners reported raising average selling prices, but 33% reported price reductions yielding a net-negative 22% (seasonally adjusted) of owners who cut prices in December. Plans to raise prices fell one point to a seasonally adjusted net 3% of owners, 35 points below the July 2008 reading. “The weak economy continued to put downward pressure on prices,” said Dunkelberg. “Widespread price cutting contributed to the reports of lower nominal sales.”

• Costs: On the cost side, the percent of owners citing inflation as their number one problem (e.g. costs coming in the “back door” of the business) fell two points to 2%, and only 3% cited the cost of labor.

The household borrowing binge that preceded the housing bust wasn’t just a U.S. phenomenon, a new paper by the Federal Reserve Bank of San Francisco shows.

Reuven Glick and Kevin Lansing show household debt as a percentage of disposable income grew to especially high levels in places like Ireland, Denmark and Norway between 1997 and 2007. Not surprisingly, those countries have been going through their own consumption busts as households try to bring their debt levels back down to manageable levels.

This picture shows household debt as a percentage of disposable income:

This shows countries with the biggest decline in consumer spending:

The authors conclude: “The efforts of households in many countries to reduce their elevated debt loads via increased saving could result in sluggish recoveries of consumer spending. Higher saving rates and correspondingly lower rates of domestic consumption growth would mean that a larger share of GDP growth would need to come from business investment, net exports, or government spending. Debt reduction might also be accomplished via various forms of default, such as real estate short sales, foreclosures, and bankruptcies.”

A roundup of economic news from around the Web.

• Financial Reform: Writing for the Journal, Alan Blinder says that greed isn’t always good, and that financial regulation reform is lagging. “I’m worried. The financial services industry, once so frightened that it scurried under the government’s protective skirts, is now rediscovering the virtues of laissez faire and the joys of mammoth pay checks. Wall Street has mounted ferocious lobbying campaigns against virtually every meaningful aspect of reform, and their efforts seem to be paying off. Yes, the House passed a good bill. Yet it would have been even better but for several changes Financial Services Committee Chairman Barney Frank (D., Mass.) had to make to get it through the House. Though the populist political pot was boiling, lobbyists earned their keep.”
• Regional Fed: On the Atlanta Fed’s macroblog, David Altig explains the importance of the regional bank model for the Fed. ” In 2009, the Atlanta Fed president, first vice president, and Research staff members made more than 400 speeches to an aggregate audience approaching 30,000 citizens in the six states that we cover. We made this effort in the service of two objectives: First, to give the Federal Reserve System a personal face and to explain, as best we could, the hows and whys of Fed actions to a justifiably concerned public. Second, to collect intelligence and feedback, in real time, from the people making real Main Street–level decisions—to give, in President Lockhart’s words, “voice to people” in the monetary policy process. The district bank configuration of the Federal Reserve is the democratic footprint of the U.S. central bank. If ill-conceived legislation concentrates more power in Washington, that footprint will surely fade. And central bank accountability will not be strengthened. It will be diminished.”
• Financial Rescues: International Monetay Fund First Deputy Managing Director John Lipsky explains how the IMF will prepare a report on how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions. ” At its heart, our analysis will address how to fund the direct financial sector support that could be required in a potential financial crisis. Assessing this need will require analysis of the spillover effects—that is, externalities—that financial sector activities pose for the rest of the economy. At an analytical level, the burdens resulting from financial crises can be addressed through taxation, or regulation, or a mix of the two. Thus, a key question that our analysis will have to confront is the appropriate balance between these two basic policy options.”

Compiled by Phil Izzo

European Central Bank watchers are buzzing in their latest research notes over a recent ECB paper that explored the legal feasibility of withdrawal from the European Monetary Union.

The paper, with the tantalizing headline “Withdrawal and Expulsion from the EU and EMU: Some Reflections” was released over the holidays and cited in a recent Journal article on Europe’s debt crisis.

Written by the ECB’s legal counsel, it notes that “recent developments have, perhaps, increased the risk of secession (however modestly), as well as the urgency of addressing it as a possible scenario.”

It concludes that unilaterally withdrawing from the European Union “would not, as a matter of public international law, be inconceivable, although there can be serious principled objections to it; and that withdrawal from EMU without a parallel withdrawal from the EU would be legally impossible.”

As for expulsion, “the conclusion is that while this may be possible in practical terms — even if only indirectly, in the absence of an explicit Treaty mechanism — expulsion from either the EU or EMU would be so challenging, conceptually, legally and practically, that its likelihood is close to zero.”

Though the odds of withdrawal or expulsion are very remote, the budget crisis in Greece has put the issue on the table, since its double-digit budget gap as a share of GDP is significantly above the limits set by EU budget rules.

Still, as Deutsche Bank notes in a research report Monday, there is “no reason to expect member states to exit EMU.”

Economists are increasingly dividing the euro zone into “core” economies like Germany, France, Italy, Belgium and The Netherlands — those that have emerged from recession — and “peripheral” countries like Ireland, Greece, Spain and Portugal that were the region’s main growth engines last decade but now face painful adjustments in terms of prices, state finances and labor markets.

That divergence poses a dilemma for the ECB. As Deutsche Bank economists note, once the ECB starts raising interest rates — probably in late 2010 – there’s an argument to be made that it “will be disproportionately detrimental to peripherals which will probably not enjoy the same pace of recovery as the core countries.” Tighter policy could even trigger a “double dip” in some of those countries, Deutsche Bank said.

So while expulsion is good for shock value, the likelier — and almost as worrying — scenario may just be slow growth in Europe for an extended time with its growth engines sidelined.

“The euro area will have to learn to live with a lasting drag from the adjusting peripherals,” Deutsche Bank said.

Senate Banking Committee Chairman Chris Dodd said today that Ben Bernanke cannot remain as chairman of the Federal Reserve if the Senate does not confirm him by January 31 when his four-year term expires. In an interview on CNBC, Dodd said Fed Vice Chairman Donald Kohn would take over as chairman. Sen. Judd Gregg (R., N.H.) made the same point. The comments generated some confusion on Wall Street, but the situation isn’t clear-cut.

This much is clear: A Fed chairman cannot automatically stay in his position after his four-year term as chairman expires. Members of the Fed board, in contrast, can remain in office as governors until their expired term has been filled. The Federal Reserve Act says that the Fed vice chairman acts as chair in the “absence” of the chairman. But “absence” is not defined.

The Fed has twice faced circumstances in which a chairman has not been confirmed by the Senate by the time his term expired. But in both those cases, the Fed did not have a vice chairman in place so the members of the Federal Reserve Board elected the chairman as chairman pro tempore. In 1948, Marriner Eccles served as chairman pro tempore from February 3 until April 15, when Thomas McCabe was sworn in as chairman. And in 1996, Alan Greenspan served as chairman pro tempore from March 3 to June 20, when he was confirmed by the Senate for a third term as chairman.

Bernanke’s 14-year term as a governor — one of seven positions on the Federal Reserve Board — runs through 2020. What would stop the Fed board from electing Bernanke as chairman pro tempore if he’s not confirmed by February 1?  That’s not clear.

The Fed and Sen. Dodd hope the confirmation vote will come soon after the Senate reconvenes on January 19. But at least four senators have placed holds on the nomination, forcing Senate Majority Leader Harry Reid to schedule a floor debate about Bernanke, invoke cloture on the nomination and prepare for an up-or-down vote. At the moment Bernanke seems to have the 60 votes he’d need to be confirmed. But if the Senate delays a full vote past January 31, the Fed’s Board could be forced to make a decision to avert worry on Wall Street.

UPDATE: Former Fed governor Larry Meyer of Macroeconomic Advisers points out that even if Bernanke had to step aside for Kohn as chairman of the Fed board, he could remain as chairman of the central bank’s Federal Open Market Committee. The chairman of the FOMC, which sets interest rates, is elected to a one-year term by the committee’s members at the group’s first regular meeting of the year (January 26-27). When nominations are taken at that meeting, the chairman of the board by custom is the only one nominated.  So Bernanke could remain as FOMC chairman even if Kohn had to be nominated as chairman of the Federal Reserve Board. (This wouldn’t eliminate investors’ concerns entirely, but could limit some worries about the direction of interest-rate policy in the event of a bureaucratic delay.)

Thanks to Fed Chairman Ben Bernanke, economists are abuzz these days about the Taylor Rule, a simple formula that uses measures of inflation and economic slack to show where the fed funds rate should be.

Mr. Bernanke spoke at length about the Taylor Rule last week in comments at the American Economic Association. Critics have used the Taylor Rule to show that monetary policy was too easy last decade. Mr. Bernanke set out to knock that idea down. In doing so, he laid out his own preferences for how the Taylor Rule should be used.

Let’s set aside for a moment whether Bernanke’s defense of monetary policy in the 2000s stands up to scrutiny. Lots of people don’t think it did, but that’s a subject for another day.

At issue today: Did Mr. Bernanke’s speech last week send a subtly hawkish signal to the markets? His charts for how the Taylor Rule should be used showed the fed funds rate being slightly positive. Macroeconomic Advisers Vice Chairman Laurence Meyer, in a note to clients this past weekend, said that hint of hawkishness has caused a mess for markets.

Our own take: Mr. Bernanke made clear that he’s wary of putting too much weight on the rule, which is very sensitive to the numbers you punch in and the assumptions you make. If anything, it probably showed policy is in the right neighborhood right now.

To understand the hubbub, you need to understand how the Taylor Rule works. The rule holds that if inflation moves below the Fed’s target, or if the economy’s actual output moves below its long-run potential output, then the Fed should reduce the interest rate by some prescribed amount. If inflation goes above the target, or actual output goes above potential output, then the Fed should raise the fed funds rate.

(Bernanke gives a very lucid explanation of how it works in his speech, which is worth reading if you want to learn more about the mechanics of the rule.)

There are several problems with the Taylor Rule, which Bernanke lays out to show why it wasn’t a good guidepost last decade.

One problem is that it is very sensitive to the numbers that you plug in for inflation and for the deviation of output from its potential (which is known as the output gap.) Mr. Bernanke prefers to use forecasts for inflation. Mr. Taylor uses actual inflation measures. You can get much different results depending on which numbers you use. (Right now, using forecasts rather than real-time data yields a slightly higher fed funds rate because the output gap is projected to narrow in the months ahead as economic growth resumes.)

The formula is also especially sensitive to how much weight you give the output gap and inflation. If you give extra weight to the output gap, something Mr. Meyer and others prefer to do, you can get a much lower fed funds rate.

The charts in Mr. Bernanke’s speech (table 4) showed his preferred Taylor rule spitting out a slightly positive fed funds rate. You might infer some hawkishness in that. But in fact the fed funds rate is slightly positive right now, with the Fed’s target for the rate between zero and .25 percent.

We plugged in our own numbers to a spreadsheet using a an average of the Federal Open Market Committee’s own forecast for inflation (1.45% for 2010), the Congressional Budget Office’s forecast for the output gap (a 5.5% shortfall of output from the economy’s potential) and Mr. Taylor’s original 0.5 weightings for inflation and the output gap in his formula. That spits out a 0.55% fed funds rate. Tweak the weightings a little bit, and the fed funds rate quickly goes negative. The sensitivity shows why Fed officials are wary of relying too much on the rule.

As an aside, what we found most striking about this exercise was the grim outlook for the output gap. If the CBO is right about the outlook for economic growth and for the economy’s potential output, then the economy is going to be operating below its potential for most of the rest of the decade. That’s bad news for unemployment and for the budget outlook.

The hiring of temporary workers is a leading indicator of future job growth, and new employment numbers suggest the U.S. economy may be on the road to recovery.

Last month, temporary employment rose 2.5%, seasonally adjusted, according to the Labor Department’s employment report. “As employers feel more secure, they bring back furloughed workers, lengthen the hours for existing workers and then bring on temporary staffers,” says Richard Wahlquist, president and chief executive officer of the Alexandria, Va.-based American Staffing Association. “These are the classic early stage of recovery.” Interim job creation typically precedes standard job growth by three to six months, says Mr. Wahlquist.

It’s also common for employers to convert temporary hires into staff employees, says Brett Good, district president of Robert Half International, a staffing company based in Menlo Park, Calif.

“Six to nine months ago, the jobs available were truly temporary,” Mr. Good says. “Now people are being brought in on a project basis, and employers are indicating that these positions will be rolled over into permanent payroll once the economy stabilizes.”

After cutting so deeply into infrastructure during the recession, companies are at a breaking point, adds Mr. Good. They simply can’t increase productivity without adding to the head count, he says.

Growing sectors include financial services, manufacturing and information technology, says William Grubbs, executive vice president and chief operating officer of Spherion, a staffing firm based in Fort Lauderdale, Fl. “Moving forward, we’re also going to see even more growth in the more high-end professional sectors,” he adds.

Meanwhile, with 15 million people out of work, competition for even temporary positions will be stiff, warns Mr. Wahlquist. “Companies will see talent pools as deep and rich as they’ve ever been,” he says. “But the job market will continue to seem brutal.”

Friday’s disappointing jobs numbers might have been good news for corporate profits.

Demand rebounded in the fourth quarter even as firms held the line on hiring more workers or adding much to their hours. That adds up to another barn-burning quarter of labor productivity growth, which likely supported corporate profit growth. Something to keep in mind as corporate earnings reporting season kicks in.

Chris Varvares, economist at Macroeconomic Advisers LLC, estimates U.S. gross domestic product grew at a 5.4% annual rate in the fourth quarter and that output-per-hour of non-farm workers (i.e. labor productivity) grew at a 6.5% annual rate. In normal times, 2.5% productivity growth is considered really good.

Of course, these aren’t normal times. While labor is suffering, productivity is booming. It grew at an 8.1% annualized rate in the third quarter and a 6.9% annualized rate in the second quarter. That averages out to a growth rate of more than 7% during the past nine months, much faster than anything registered during the tech boom.

The last time productivity grew at such a fast rate, in the early 1960s, corporate profits took off. Mr. Varvares says it should eventually lead to an upturn in job growth as well.

On a day marked by otherwise disappointing news about the health of the labor market, Alliance Bernstein’s Joseph Carson has a strikingly upbeat assessment of the economy in his weekly economic commentary today.

He says the manufacturing sector is in the midst of staging its starkest turnaround in a quarter century.

Mr. Carson tallied up manufacturing shipments from Census Bureau data and changes in manufacturing inventories. The combination of rising shipments and the end of massive inventory cuts means manufacturing output grew at a 20% annualized rate in the fourth quarter, he says. That would be the biggest quarterly increase since 1983, when the U.S. was bouncing back from another deep recession.

He also notes that data from the Institute for Supply Management’s monthly survey of supply managers suggests that new order growth is outstripping inventory growth, meaning there are “plenty of production gains in the pipeline,” he says.

“The U.S. economy has plenty of hurdles to jump in order to return to sustainable growth in 2010,” he concludes. “With bad debts mounting at banks, high unemployment and a record pipeline of mortgage foreclosures, it’s hardly surprising that most analysts expect a relatively modest economic recovery, echoing the weak rebound that followed the recessions of 1990/91 and 2001. However, we believe the rapid pace of recovery in the manufacturing sector is starting to increase the chances of a speedy recovery.”

It’s not a great day for economic news. First there was the grim jobs report. And now a much worse than expected drop in total outstanding consumer credit. It fell by $17.5 billion, or at an 8.5% seasonally adjusted annual rate, the Fed said Friday.

The sharp decline surprised economists, who expected about a $5 billion decline.

“This was a shockingly weak report, as it suggests that the deleveraging process taking place among U.S. households continued unabated,” Millan L. B. Mulraine of TD Securities wrote in a note to clients. “The continued decline in credit remains the most serious risk for the economic recovery.”

To be sure, consumers had to deleverage after overextending themselves but there’s still no sign of relief. With consumer spending responsible for 70% of demand in the economy, a continuing drop in Americans’ access to and affinity for credit is a bad sign for growth.

Revolving credit fell at an 18.5% annual rate as consumers shied away from their credit cards or found credit was no longer available. More than a third of banks in the Fed’s October Senior Loan Officer Survey said they were decreasing lines of credit to existing credit card customers. None of the banks said they were increasing lines of credit.

A third of banks also said demand off all types of consumer loans was weaker. Just 9.4% of banks said they’d see a stronger demand for such loans. Nonrevolving credit — loans for things like vacations, boats and vehicles — also declined at a 2.9% annual rate.

Friday’s jobs report damped expectations in financial markets that the Federal Reserve will raise its benchmark federal funds rate by midyear. By the close of trading Friday, futures contracts implied there was just a 22% chance of a rate hike by June.

Fed officials are expecting a recovery that produces spotty job growth in its early stages. The latest report is in keeping with that view and is likely to leave Fed officials committed to their pledge that interest rates will stay low for “an extended period” as they prepare for a policy meeting later this month.

“The employment picture overall has improved, and the outlook is certainly much brighter than one year ago,” Eric Rosengren, president of the Federal Reserve Bank of Boston said in a speech Friday. But he warned that while layoffs are abating, “many firms are not yet ready to do new permanent hiring.” Spotty job growth means downward pressure on wages and inflation and gives the Fed room to keep monetary policy very easy.

Economists and others weigh in on the drop in nonfarm payrolls amid a steady unemployment rate.

• That we took a step back in employment in December should not be a shock as this tends to happen. Despite the negative reading in December, we are almost assuredly at the very end of the current cycle of firing and we repeat our belief that the number of people that lose their job from here on out is irrelevant. With over 8 million jobs shed in this recession, another 85,000 or 25,000 has no bearing. The only thing that matters is how quickly these people find a new job. –Dan Greenhaus, Miller Tabak



• The 85,000 decline in non-farm payrolls in December, which follows a revised 4,000 increase the month before (previously an 11,000 fall), is not a sign that the economic recovery has already stalled. November’s gain undoubtedly over-stated the strength of the labour market, while December’s decline probably under-states it. Monthly changes in payrolls are notoriously volatile and the underlying trend of improvement, which began in the first half of last year, still appears intact. –Paul Ashworth, Capital Economics
• The fact that positive job creation occurred in November 2009 is a very important fact, one that should not be ignored despite the disappointing headline print in December. While the worst of the recession is likely over, the fact that the duration of unemployment remains rigid is a concern, though a silver lining is that we are likely to see net job creation assisted by census hiring in the first quarter of 2010. –Ian Pollick, TD Securities
• There was some important weather-related downside in the December labor market report. This factor, together with the recent sharp improvement in jobless claims, a pullback in layoff announcements and a couple of other technical factors, all point to a much stronger employment report next month. –David Greenlaw, Morgan Stanley
• The labor market is not out of the woods yet. The December report was generally weak… The unemployment rate would have been higher if it weren’t for the fact that 661,000 people dropped out of the labor force. The underemployment rate rose again to 17.3% from 17.2% in November. The long-term unemployed, those out of work for 27 weeks or longer, continued to rise. In December, 4 out of 10 unemployed were long-term. Despite the disappointing report, the labor market is in the process of stabilizing. –Sung Won Sohn, Smith School of Business and Economics
• Perhaps more concerning than the weak nonfarm payrolls figures were results from the household survey. Household employment (an alternative measure of employment derived from surveys of households rather than firms) fell by 589k. We had expected a decline in this series after a large gain in November, but the drop was far in excess of our expectations. On a six-month moving average basis, the rate of decline in the household employment series has shown little improvement since July. –Zach Pandl, Nomura Global Economics
• The lack of hiring might reflect greater caution on the part of small companies or an outright inability to respond to rising sales because of financing constraints. The number of persons unemployed for 27 weeks or longer increased by 229,000 in December to 6.1 million, or 4% of the labor force. Both the average and median duration of unemployment rose in December. The good news is that labor markets are always weakest at cyclical upturns and that the foundation for job creation and business spending gains is in place. – Aaron Smith and Ryan Sweet, Moody’s Economy.com
• Despite the disappointment over the headline payroll decline, the improvement in the three-month trend is not violated by this report and, given the further decline in initial jobless claims since the December payroll survey week, we still believe we are on the verge of the emergence of modest payroll growth. –RDQ Economics
• November payrolls looked too good to be true relative to ADP and other indicators so this is a correction; the underlying trend undoubtedly continues to improve and payrolls will be positive by February, not least because Census hiring will start to rise. But the core is improving too; manuf just -27,000 in December and trending towards stability; services down just 4,000 after a 62,000 gain in November; temp hiring soaring, up by 47,000 in December. Unemployment will be slow to fall though because people will come back into the labor force, and wages will keep slowing. –Ian Shepherdson, High Frequency Economics
• Overall the December employment report was a disappointment and potentially highlights the difficulties making the transition from the end of firing to actual hiring. –Julia Coronado, BNP Paribas
• The jobs situation had been improving since summer on the back of reduced layoffs but in December the run to recovery slammed into the hard reality that no one is hiring… Although the pace of layoffs is far less than it was in the spring, the lack of hiring means that those out of work continue to stay that way for a long time. The average duration of unemployment extended out in December to 28.5 weeks compared with 26.9 weeks in November. Among those unemployed a post-war record 38.3% have been looking for work 27 weeks or longer. When the employment data are stacked up with consumer activity and the like the total picture is of an economy that has stopped falling but has yet to start improving in earnest. –Steven Blitz, Majestic Research

Compiled by Phil Izzo

The U.S. jobless rate was unchanged at 10% in December, following a decline the previous month, but the government’s broader measure of unemployment ticked up 0.1 percentage point to 17.3%.

The comprehensive gauge of labor underutilization, known as the “U-6″ for its data classification by the Labor Department, accounts for people who have stopped looking for work or who can’t find full-time jobs. Though the rate is still 0.1 percentage point below its high of 17.4% in October, its continuing divergence from the official number (the “U-3″ unemployment measure) indicates the job market has a long way to go before growth in the economy translates into relief for workers.

The 10% unemployment rate is calculated based on people who are without jobs, who are available to work and who have actively sought work in the prior four weeks. The “actively looking for work” definition is fairly broad, including people who contacted an employer, employment agency, job center or friends; sent out resumes or filled out applications; or answered or placed ads, among other things.

The U-6 figure includes everyone in the official rate plus “marginally attached workers” — those who are neither working nor looking for work, but say they want a job and have looked for work recently; and people who are employed part-time for economic reasons, meaning they want full-time work but took a part-time schedule instead because that’s all they could find.

In the coming months, the U-6 measure may be an important signal for the labor market. The official jobless rate is likely to hold steady or rise through the first half of the year as more people return to the job market. That means Americans who now fall into the U-6 category, for stopping their job searches due to discouragement, will eventually fall into the U-3 category as they restart their job hunt.

A U-6 figure that converges toward the official rate (even an official rate that’s above 10%) could indicate improving confidence in the labor market and the overall economy. This month pushes convergence even further away.

On a day where the government released more bad news on hiring, a Federal Reserve official said Friday that unemployment will take a long time to come down, which means the central bank will keep its stimulative policy stance for some time.

Rosengren

While employment has “improved” relative to the past, “it appears that this recovery will likely experience only a slow improvement in the employment picture, and that the unemployment rate will remain quite elevated during the early phases of the recovery,” Federal Reserve Bank of Boston President Eric Rosengren said.

He said he believes economic output gains will be “strong enough to produce some employment growth, but that rate of employment expansion will not likely be rapid enough to put a large dent in the unemployment rate.”

That comes with serious implications for what the Fed does with interest rates and its other programs of support.

“With significant capacity in labor markets, wages and salaries and the ability of businesses to increase prices are all likely to be restrained, resulting in little immediate inflationary pressures,” Rosengren said in the prepared text of his remarks. “This should allow for accommodative monetary policy to continue to support the economy until the underlying demand of consumers and businesses becomes self-sustaining,” he said.

Rosengren, who was addressing the Connecticut Business and Industry Association, in Hartford, Conn., will hold a voting slot at this year’s Federal Open Market Committee meetings.

His speech, which was prepared in advance of the December jobs data’s release, was given after the report was made public. The jobs report was a bit of a setback for the economy, with the pace of job losses speeding up and falling by 85,000 in the final month of the year, after a revised 4,000 gain the month before. The unemployment rate held steady at a high 10%.

The report reaffirmed that even as the economy is recovering, it will be a long slow process to undue all the economic damage wrought by the financial crisis. As long as hiring remains moribund, most believe the Fed will face little pressure to tighten monetary policy, be it by lifting interest rates or via other avenues.

Rosengren’s worries about hiring extended to his economic outlook as well, with the official saying “I expect a rather slow recovery in output.” He noted that he expects fourth quarter 2009 growth to be “stronger” than what was seen in the third quarter, although recent gains are largely tied to benefits from businesses cutting inventories.

The central banker counted financial markets, consumer caution and slow job growth as the three primary headwinds the economy faces on its path to recovery.

“Financial markets are in a much better state than they were a year ago” although “while the banking crisis has passed, banking problems remain,” Rosengren said. Meanwhile, “consumers and businesses will likely remain cautious,” and a reluctance to hire will mean a “slow recovery” in employment.

The headline decline of 84,000 jobs in the December employment report was worse than expected, but a key culprit may be the weather.

Temperatures in the U.S. were running above normal from October through late November, but turned sharply lower last month right around the time that the Labor Department calculates its jobs numbers. The household survey of the jobs report showed that the people “not at work for weather reasons” hit 283,000, the highest reading since 2005. Those people are still counted as employed, but the elevated level suggests the extent of weather-related effects in December.

The cold snap may have triggered seasonal layoffs in outdoor areas of employment, especially construction. Indeed, the construction category of the December report noted a drop of 53,000 jobs.

Meanwhile, the weather also may depress the length of the average workweek, which was unchanged in the December report at 33.2 hours. Economists look to increases in the length of the workweek as a leading indicator, as companies raise the hours current employees work before reaching out to boost hiring.

“From a weather standpoint, the situation actually looks quite similar to December 2005 when employment registered a well below-trend performance,” said David Greenlaw of Morgan Stanley in a research note ahead of this morning’s report.

If the weather was a significant influence, it suggests that the economy is still on track to start adding jobs soon. “The recent performance of the jobless claims figures and other indicators (such as the Challenger layoff tally) point to the likelihood of a much better employment outcome in January,” said Greenlaw.

One of the main reasons Federal Reserve policy makers have been able to keep monetary policy so stimulative in the face of an economic recovery is their steadfast confidence that inflation is, and will remain, quiescent.

But two new papers from the central bank challenge that outlook. One, published by the Federal Reserve Bank of St. Louis, warns price pressures may rise more quickly than thought in coming years. Another, from the Federal Reserve Bank of Richmond, notes the uncertainty of the Fed’s framework for divining the nation’s inflationary potential.

What happens with inflation is always a key matter for the Fed. But in the current environment, tame price pressures and the expectation they’ll stay that way are even more important.

Low inflation gives the Fed considerable breathing room to keep interest rates low and provide other forms of support in an environment in which economic growth is tepid and halting. If price pressures were to accelerate, the central bank would likely have to respond with a tightening in policy, even if economy was ill-prepared to deal with that action–a choice it would rather not have to make.

The St. Louis Fed paper, written by bank economist Kevin Kliesen, sees inflation risks coming from several sources. One problem spot could be that the Fed misjudges the economy’s ability to create price pressures. It’s possible policy makers will misgauge the so-called output gap, which is the difference between the economy’s potential–its ability to growth without fueling inflation–and actual rates of growth. The wider the gap, the lower the economy’s likely level of inflation.

“The size of the output gap might be smaller than conventional wisdom might believe,” Kliesen wrote. “If so, those who foresee little risk to the near-term inflation outlook because of a large, persistent output gap may be too optimistic.”

He also warns the Fed’s current policy stance–interest rates are effectively set at zero percent, mortgage asset purchases continue until the end of the first quarter–may distort financial markets.

“Although low interest rates are a key part of the FOMC’s strategy to boost economic growth and cement the health of the economic recovery, there might still be a danger of inflating asset prices by encouraging investors and speculators to shift out of low-yield assets like Treasury securities into higher-yielding assets like commodity contracts or other tangible financial assets,” Kliesen noted.

And while it’s not part of the Fed’s portfolio, huge government budget deficits also pose a risk to a stable inflation environment, he wrote.

The St. Louis Fed economist’s anxiety over the output-gap issue is backed up by Thomas Lubik, an economist at the Richmond Fed. In his paper, Lubik warns “uncertainty” over the correct way to measure the gap makes this concept, as central bankers now understand it, “a potentially faulty gauge” for assessing the economic situation and guiding monetary policy. That increases the chance of policy leading to a bad outcome.

Some of the worries shown by the Fed economists extend to the policy-making level. In a speech Thursday, Kansas City Fed chief Thomas Hoenig reclaimed his role as the most aggressive advocate for undoing the current state of policy. He said he’d like to see policy tightened “sooner rather than later” lest the central bank let inflation bloom and allow overly-easy policy to distort financial markets.

For now, however, most of the central bank’s weight rests behind maintaining the status quo of low interest rates. While the economy appears to be recovering, there is even a reappraisal of Fed’s mortgage-buying program now. The program is scheduled to conclude at the end of the first quarter but some officials are now leaning toward keeping the effort alive longer, fearing the critical mortgage market may not yet be able to function properly without Fed support.

A veteran U.S. Federal Reserve official said Thursday the central bank shouldn’t wait long to tighten the stance of monetary policy in order to keep longer-run inflation pressure contained, in what appears to be a recovering economy.

Hoenig

“The process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later,” Federal Reserve Bank of Kansas City President Thomas Hoenig said.

“We cannot afford to be short-sighted,” and “we must more evenly weigh our short-run concerns against the longer-run costs,” the official said. He said the central bank should raise its overnight target rate “to a more normal level, probably between 3.5 and 4.5%, and restore its balance sheet to pre-crisis size and configuration.”

“While I agree that unemployment is unacceptably high and short-term inflation risks are likely small, we must also recognize what monetary policy can and cannot do” in the face of structural shifts in the economy, the policy maker said.

The official, who described himself as holding a “more optimistic” economic outlook than many private-sector economists, warned that keeping rates very low comes with many risks. The Fed’s current overnight target rate is effectively set at zero% and has been at that level for just over a year, amid large scale asset buying that is set to end at the conclusion of the first quarter.

“Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment–not today, perhaps, but in the medium and longer run,” Hoenig warned. He added, “maintaining short-term interest rates near zero could actually impede the recovery process in financial markets.”

Hoenig’s views, which came from the text of speech prepared for delivery before the Central Exchange in Kansas City, Mo., are the most aggressive of any policy maker. They take on added importance because he will hold a voting role on the interest rate-setting Federal Open Market Committee this year. Hoenig’s stance isn’t entirely novel–he gave voice to similar sentiments late last year. Still, they come at a time where policy makers are looking at an improving economy and are weighing what to do with what they all agree is a very stimulative policy stance.

Most economists don’t expect the Fed to change rates until at least mid-2010, if not later. While the buying of mortgage-related securities will end in a few months, some officials are coming to the view the program may need to be kept alive longer, to aid the economic recovery. Policy makers are wrangling with their desire to normalize monetary policy and not kill off a nascent recovery by tightening financial conditions prematurely.

Hoenig noted what lies before the Fed is a “contentious undertaking.” But he also said that “even as the Federal Reserve begins the process of winding down its emergency credit facilities, the extreme amount of policy accommodation means that it will still be some time before monetary policy will return to a more balanced level.”

Hoenig said that monetary policy, along with government stimulus, have both been “instrumental” in engineering a recovery. But much as the Fed will have to tighten relatively soon, so to must the government get its fiscal house in order.

“The ballooning federal deficit must be controlled and reduced,” because if it isn’t, “eventually, there will be pressure put on the Federal Reserve to keep interest rates artificially low as a means of providing the financing,” Hoenig said. And that would be a recipe for hyperinflation, he warned.

The long-serving policy maker was upbeat in his economic views. While “uncertainty remains,” Hoenig said “conditions continue to improve, and we appear to be in the early stages of economic recovery, both in the U.S and internationally.” He added, “economic growth has increased, labor market conditions have begun to stabilize, and housing shows signs of recovery.”

The official reckons the U.S. gross domestic product will likely rise by 3% over the course of 2010. There are “realistic possibilities” stimulus will prove more powerful than now thought, and business could invest more in their activities in the face of a recovering economy, Hoenig said.

But he also said “unemployment will likely remain elevated, and consumers must deal with lower home equity and high debt levels.”

More employers plan to increase college graduate hiring than decrease it for the first time in more than a year.

The National Association of Colleges and Employers‘ index for college hiring rose to 98.2, up from 87.2 in November. The index, based on the organization of career counselors’ survey of 122 employers and released Tuesday, covers employer expectations for January through March.

In the December poll, 33.4% of employers said they plan to increase hiring recent college graduates compared to 26.7% who said they will decrease it. It marks the first time since August 2008 that the fraction of employers who plan to hire more college graduates outpaced the portion who planned to hire fewer.

Similarly, companies are stepping up recruiting to engage more new graduates. The recruiting activity index increased to 95.4 from 89.8 the previous month, though that increase also included a seasonal uptick in recruiting that tends to happen in January.

“While this is a positive sign for colleges that have developed relationships to connect their students with employers, it’s also important to recognize that we’re still not where we were two years ago, in terms of recruiting activity,” Marilyn Mackes, the association’s executive director said in a release.

A roundup of economic news from around the Web.

• Bubbles: The Economist this week looks at bubbles. ” Investors tempted to take comfort from the fact that asset prices are still below their peaks would do well to remember that they may yet fall back a very long way. The Japanese stock market still trades at a quarter of the high it reached 20 years ago. The NASDAQ trades at half the level it reached during dotcom mania. Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give.”
• Damaged Retirement: On the Tax Policy Center’s TaxVox blog, Howard Gleckman looks at the extent of damage the market crash had on retirement security. ” In a new paper, TPC’s Eric Toder, along with the Urban Institute’s Karen Smith and Barbara Butrica, look at how investors would fare under three post-crash market scenarios. And what they found may surprise you a bit. Under one, your portfolio gets back to where it would have been, absent the crash, by 2017. That would take large, but not unprecedented, stock gains over the next decade. If equities merely revert to their historic annual returns from the market’s December 2008 level, you’ll permanently remain far behind where you would have been if there had been no collapse. And if stocks respond as they did in the decade after the 1970s crash—well, you don’t want to know.”
• Housing and Recovery: Dan Gross of Slate says that the economy will recover no matter what happens to the housing market. ” People! Wake up! It may be difficult to imagine, but we’re going to have to have this recovery and expansion without housing. In fact, we already are… We’ve shown that we don’t need housing to produce growth. The U.S. economy has staged an extremely dramatic turnaround, from contracting at an annual rate of 6.4 percent to growing at a 2.2 percent rate in the third quarter. Macroeconomic Advisers says fourth-quarter growth is tracking at a 4.9 percent annual rate. If that proves true, the economy’s growth rate will have risen 11.3 percent in a nine-month period—an astonishing shift. And all this growth has occurred as house prices continued to fall and consumer lending declined. With apologies to Larry Kudlow, it’s the greatest story never told!”

Compiled by Phil Izzo