San Francisco/Washington: Officials at the US Federal Reserve are debating a historic shift in one of its core economic gauges that could lead the central bank to move even more slowly than now thought once it lifts its rates from rock bottom levels.
According to interviews with half a dozen current and former Fed policymakers and staff, the concept that the economy can produce far lower levels of unemployment without stoking inflation is being built into Fed models and becoming increasingly entrenched in the central bank’s views.
That shift may not delay the timing of the Fed’s first rate increase, still expected in mid-year. But it does offer chair Janet Yellen a good reason to move at a snail’s pace from then on to bring as many people as possible back to work and to push inflation back up to the Fed’s 2% target. Fed policymakers’ December projections show most expect the Fed’s benchmark rate to rise to 2.5% or above by the end of 2016 from the 0-0.25% range now.
On Monday, Fed governor Jerome Powell became the latest of policymakers to suggest the “natural" rate of unemployment, also referred to as a level of full employment, had fallen.
“Maybe the natural rate is lower... That it is five (percent) or even lower," Powell said. That would be significantly below current unemployment rate of 5.7% and the 5.2% to 5.5% range Fed officials have recently estimated as the level of unemployment at which inflation is likely to increase.
Atlanta Fed president Dennis Lockhart said the question of the true level of full employment will come into focus when the Fed will have to decide whether to allow unemployment to drift to unusually low levels to push inflation towards its target.
The chiefs of the Boston Fed and the Minneapolis Fed have also said they are considering lowering their estimates, as did several staff at other Fed branches who declined to be quoted, in line with the central bank’s policy for briefing the media. For months, Fed policymakers have been puzzling over how the accelerating economy kept adding jobs but failed to spur wage and price increases that would cement the recovery and allow them to wind-down crisis era policies. Now, there is growing sense that the point where the job market tightens enough to start pushing up wages and prices may be further away than earlier thought.
The US central bank has no official target for full employment—generally expressed as the unemployment rate that is consistent with stable prices. But accurately estimating it is critical for the Fed, given its mandate is to safeguard economic conditions that allow maximum employment consistent with stable prices that the bank defines as 2% inflation.
Beginning in 2013, however, its staff has been marking that rate down, from 5.6% to 5% by late last year. That may lead regional Fed presidents and board members to cut their quarterly estimates due next month. Research at several Fed banks, both published and unpublished, puts the estimate as low as 4.7%.
The possible reasons, according to Fed policymakers and staff, range from a structural downshift in growth, an ageing workforce less likely to job-hop, and the sense that there are many people willing to rejoin the labour force and work for less.
Another explanation is the rise in the number of workers who choose to work part time, which helps lower both labour costs and the unemployment rate.
Many economists now also believe that low inflation expectations are so deeply rooted they act as a cap on wages and prices.
Those policymakers and Fed researchers who estimate a lower “non-accelerating inflation rate of unemployment" believe those and other scars of the 2007-2009 financial crisis have allowed the unemployment rate to slide from 10% without much evidence of a run-up in wages or prices.
Despite an addition of a million jobs between October and December, wages in the 12 months to December rose just 2.2%, a historically slow pace.
“Wage inflation has been well below the level that would be consistent with 2% price inflation," Powell said. Wage growth, he said, would need to accelerate to perhaps 3.5%—the target inflation rate plus the expected increase in productivity—before it nudges up inflation.
Not all Fed policymakers have changed their minds, however. Cleveland Fed president Loretta Mester, for example, said last week she was sticking with her current estimate of 5.5%.
Coming out of the recession, Fed policymakers were jacking up their estimates of the normal jobless rate to account for growing ranks of long-time unemployed who might lack skills sought by employers.
But as unemployment plunged with no sign of wage or price rises, they shifted those down. Reuters