U.S. Federal Reserve changes unemployment targets
by Christopher S. Rugaber, The Associated Press
The move implies that rates will rise more slowly than many had assumed
WASHINGTON—The Federal Reserve was in a tough spot: The February U.S. unemployment rate of 5.5 per cent is right where the Fed had been saying inflation would likely start to accelerate. Yet inflation remains even lower than the Fed wants it to be.
So on March 18, the Fed simply moved the goalposts.
It now says unemployment could fall as low as 5 per cent to 5.2 per cent before inflation pressures would probably start to build. That’s down from its previous range of 5.2 per cent to 5.5 per cent.
That shift is a big reason many analysts think the Fed has in effect postponed the date when it will start raising the short-term interest rate it controls. Many now expect it to start raising rates in September or even later after having previously predicted June.
Investors welcomed the possibility of lower rates for longer, sending the Dow Jones industrial average up 227 points.
“With the stroke of a pen, rather than being at the top end of full employment … we’re farther away,” said Allen Sinai, chief economist at Decision Economics.
As the unemployment rate falls, it typically reaches a level at which employers must raise pay to find qualified workers to hire. Those employers then raise prices to offset the higher wages they’re paying, which usually accelerates inflation. The unemployment rate that triggers higher prices is generally considered “full employment.”
Chair Janet Yellen said the Fed’s new lower range for acceptable unemployment “suggests that (Fed officials) are seeing more slack in the economy now than they previously did.”
That, in turn, implies that rates will rise more slowly than many had assumed. Separate forecasts by Fed officials show they now expect the Fed’s short-term interest rate to be much lower at the end of this year and next than they thought in December.
The Fed had little choice but to make the change to acknowledge economic reality, analysts said. Paychecks for most Americans have barely kept up with inflation since the recession officially ended 5 1/2 years ago.
“If we were even close to full employment, we would be seeing more pressure on hourly earnings by now,” said Richard Moody, chief economist at Regions Financial. “They are just adjusting to that reality.”
The Fed had lowered the upper end of its full-employment range as recently as June 2014. But the lower end had stood at 5.2 per cent since April 2011, according to Michael Gapen, an economist at Barclays.
There are no clear guidelines for what the full employment rate is. In the late 1990s, the Fed chose not to raise rates even as the unemployment rate fell. It eventually touched 3.9 per cent without igniting inflation.
It “does move around a bit and is unobservable,” said Paul Ashworth, chief U.S. economist at Capital Economics. “It is a genuine puzzle.”
The Fed made other changes to its forecasts Wednesday after its latest policy meeting ended. It now predicts:
_ Growth will be much slower through 2017 than it predicted in December. It now foresees growth of roughly 2.5 per cent this year and next, down from 2.8 per cent and 2.75 per cent, respectively. Growth will then slow to about 2.2 per cent in 2017, down from 2.4 per cent, it predicts.
_ Even with slower growth, unemployment will keep falling. The Fed now forecasts that the unemployment rate will be about 5.1 per cent at year’s end, down from its previous estimate of 5.25 per cent. Next year, it will drop to 5 per cent and in 2017 to 4.95 per cent, it predicts.
_ Inflation will be even lower this year, between 0.6 per cent and 0.8 per cent, down from the 1 per cent to 1.6 per cent it forecast in December. But Fed policymakers didn’t cut their outlook as much in later years: They still project that inflation will be near their 2 per cent target in 2016 and 2017.
