Federal Reserve Chairman Jerome Powell may have dropped a clue this week about why he thinks unemployment can fall lower than many economists believe is advisable without triggering a spike in inflation.
Based on a comment he made to lawmakers on Wednesday, Powell may be exploring whether there is a cyclical nature to the concept of full employment, one which lowers that important level, at least temporarily, during a jobs-rich expansion.
David Altig, research director at the Atlanta Fed, is a believer in that idea. At the moment, he said, the job market is still finding available workers from outside the labor force, people who are not counted as unemployed. As long as that flow continues, it may prevent inflation from accelerating even as unemployment falls further.
“What is sustainable in the near term can be different from what is sustainable in the longer term,” Altig said. “Just because we think you can’t sustain 4.5 per cent in the long term, that doesn’t mean 3.5 per cent is a problem for a year or two. ”
To be sure, Powell hasn’t endorsed this theory. And even if he’s leaning that way, he’s not backing away from the Fed’s current path of interest-rate hikes. He repeated that view during both appearances before House and Senate committees this week when he said “for now -- the best way forward is to keep gradually raising” rates.
Still, it would help explain some of his remarks, especially his assertion to lawmakers that the U.S. economy is “close to full employment, maybe not quite there.”
That sentence is striking because unemployment, currently at 4 per cent, is already below every estimate submitted in June by Fed officials, including Powell, for full employment. The range of estimates ran from 4.1 per cent to 4.7 per cent, with the median at 4.5 per cent.
“It’s a little confusing, because they say that the unemployment rate is a half point below their estimate” of full employment, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “If you think you have more slack, either lower your estimate or change what you’re saying -- it’s contradictory.”
To be fair, Powell has said before that the Fed ultimately looks to a number of measures of labor utilization, not just the headline unemployment rate, when it gauges the level of full employment.
But it’s also true that when officials submit their estimates of full employment, it’s expressed as the “longer-run” level of the jobless rate that’s consistent with low and stable inflation.
Economists generally agree this longer-run level is linked to deep, structural factors that tend not to shift with the business cycle. That’s why Eric Rosengren, president of the Boston Fed, hasn’t moved his estimate of full employment much in recent years and why he’s warning his colleagues against dropping their estimates in an attempt to square the circle of low unemployment and low inflation.
Full employment, Rosengren said in April, “should change as the workforce becomes better educated. It should change as demographics change. Those things are slow moving trends.”
But what if there is also a cyclical nature to full employment? Economists recognize that in a severe shock, like the 2007-09 recession, the level moves up as people who are laid off and remain out of work for an extended time find it hard to get hired. The question is whether this can operate in the other direction.
If Powell is, indeed, open to this idea, his comments on full employment make more sense, as does his serene take on price pressures. While he pronounced the risks around inflation to be “roughly balanced,” he admitted to being “slightly more worried about lower inflation.”
Embracing the idea of a lower, shorter-run level for full employment comes with risks, according to William English, a former director of the Fed’s Division of Monetary Affairs and now a professor at Yale University.
“Potentially, you undo some of the damage from the deep and protracted recession,” English said. But if the Fed moves rates up too slowly, and inflation takes off, “then, you have to raise rates too quickly.”
That would not only end the flow of people back into the work force, but send many back out again.