Jerome Powell, chairman of the U.S. Federal Reserve, puts on his glasses during a House Financial Services Committee hearing in Washington, D.C., the U.S. (Photographer: Andrew Harrer/Bloomberg)

Powell Wants ‘Real Economy’ to Guide Fed

(Bloomberg) -- Federal Reserve Chairman Jerome Powell is testing the economy’s room to run. It’s a strategy that contains both big benefits and risks for ordinary Americans and is causing excitement, tinged with caution, inside the central bank.

Take Fed treatment of one of its bedrock conceptual benchmarks, a rate of unemployment that keeps inflation stable. In June, they estimated that level at 4.5 percent. Unemployment in May was 3.8 percent. Yet with no sign of price pressures, policy makers plan to let the labor market run even hotter, with the jobless rate projected at 3.5 percent over the next two years.

Powell, a Trump administration appointee, shares his predecessor Janet Yellen’s appreciation that labor-market slack may be greater than estimated. He’s combined that with a sense that the range of uncertainty around guidepost estimates that govern monetary policy are highly uncertain tools.

For Powell, the first non-economist to hold the job in more than three decades, conceptual benchmarks can’t fully describe the complexity of the U.S. economy. So in this first five months, he’s brought a subtle but important change to the chairmanship at a key juncture in the business cycle: trust evidence as much as economic models.

“Let’s be guided by what’s going on and what the real economy’s telling us,” Powell said on the sidelines of a June 20 central bank conference in Sintra, Portugal, at which he also repeated the case for gradual interest-rate increases. “And let’s also admit that our understanding of what the location” of full employment is must be “informed by reality and what’s actually happening.”

A hot labor market has tremendous benefits for U.S. workers, millions of whom were locked out of jobs during the post-crisis recovery because of age or racial bias, or a lack of skills. Some of these gains are already showing up. Workers are moving off disability rosters, black unemployment fell to 5.9 percent in May, the lowest going to back to 1972, and Hispanic unemployment has matched record lows.

Powell said on June 13, and again in Sintra, that there’s “a lot to like” about low unemployment. He even hinted that it could have lasting benefits.

Julio Joaquin is the sort of person he might have in mind. The 26-year-old from Harlem, New York, got out of prison in 2014 after being convicted of robbery at 18 -- a record that could have been a job-market kiss of death in an earlier era.

At first, Joaquin swung between unemployment insurance, jobs in demolition and handy-man work. But with the help of the Center for Employment Opportunities in Manhattan, he recently landed a job placing reinforcing bars in building projects for $18 an hour.

‘Like a Masterpiece’

“When everything is laid out, it looks like a masterpiece,” he says. He woke up at 4:30 a.m. to clock in at 6:30 and has just got off a nine-hour day -- his shirt flecked with the concrete to prove it -- but he says the job is fulfilling. With experience, he could also earn a much higher wage.

Fed researchers are digging into what low unemployment might mean for wages, inflation and the U.S. economy more broadly. One big idea: A tight labor market could improve labor force attachment and boost productivity. That’s a double win.

“Some of our research suggests if you become employed in a high pressure period, your labor market prospects in terms of attachment and wages are better,” Atlanta Fed research director David Altig said in an interview. On-the-job learning and skill acquisition “feeds into greater productivity.”

For all the enthusiasm, there is also plenty of caution and debate.

Kartik Athreya, the research director at the Richmond Fed, said that for the gains in the current hot labor market to stick and produce more attachment “these people need to be transformed in some way.”

Evidence that such widespread training and skill development happened in past booms, or is underway now, is “tentative at best,” he said.

Bubble Concerns

Some Fed officials also worry that a long period of low interest rates amid scarce resources, including a smaller pool of available workers, could generate bubbles.

“You want to get to a lower level of unemployment without triggering excesses, and imbalances,” said Dallas Fed President Robert Kaplan. “I personally still believe that we should at least be moving gradually toward a neutral monetary policy stance,” he added, referring to a policy rate that neither speeds up nor slows the economy.

Stylistically, Powell’s approach is closer to an earlier Fed chief -- Alan Greenspan -- than his immediate predecessors, Ben Bernanke or Yellen. Greenspan was an expert in “current analysis,” his own, often idiosyncratic, discipline of forecast updating that dove deep into esoteric economic data. It’s a hard act to duplicate.

The strategy requires nimbleness and sometimes sharp changes in policy. A more data-dependent approach can be frustrating for investors who have been spoon-fed guidance by the U.S. central bank much of the past decade, because economic data are often noisy.

Against that backdrop, Powell is stepping up communication and will start holding press conferences after every meeting, starting in January.

Inflation Expectations

Fed strategy hinges on the idea that the central bank’s actions inform inflation expectations.

Remarkably, even as the unemployment rate dipped below 4 percent and some types of compensation moved higher, the public’s inflation outlook has remained low and stable. So have overall price gains, averaging 1.7 percent over the past 16 months, according to the Fed’s preferred benchmark, below the central bank’s 2 percent target.

Still, anchoring expectations was a hard-won victory, and the Fed wants to keep them nailed down. Officials raised rates on June 13 for the second time in 2018 and signaled another two moves this year.

“He is testing the economy’s limits,” said former Fed Governor Laurence Meyer, whose term at the Fed encompassed a dip below 4 percent unemployment. “He’s said as long as we appear to be doing something, that will take inflation in the right direction,” he added. “But we don’t know” how this is going to end.

©2018 Bloomberg L.P.

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