Federal Reserve Unemployment Target May Be Key to Strategy

(Bloomberg View) -- There’s tension at the Federal Reserve that won’t be resolved at next week’s meeting of officials to set interest rates.

How that tension is resolved may hold the key to whether inflation can finally stabilize around, or possibly exceed, the Fed’s 2 percent target. It may also determine the length of the economic expansion, now among the longest, and be the arbiter of whether Americans actually feel like they are getting a raise.

The strain is over what to do about the central bank’s forecast of an unemployment rate of 3.6 percent for next year and 2020. The number was contained in the Summary of Economic Projections released after the March 20-21 Federal Open Market Committee meeting, the first under Chairman Jerome Powell.  

The new estimate of 3.6 percent is a big reduction from the prior projections of 3.9 percent in 2019 and 4.0 percent in 2020. (This is one of the few instances when a cut in a forecast is a good thing!) It’s even more startling when you consider that the same Fed document also puts the longer-run sustainable number at 4.5 percent.

For all the significance of that change, the Fed’s famous, and sometimes derided, dot plot didn’t evolve as much. Median projections showed officials anticipated three rate increases this year and three next year. A growing minority favored four this year, but given a forecast of such low unemployment, one might have expected a broad shift in favor of faster rate increases.

Powell was quizzed at length about the dots at his inaugural press conference after the FOMC meeting and didn’t give much away. He wanted people to focus on the quarter-point increase in the benchmark rate and little else. A lot of commentary noted Powell’s style and what he had to say about trade and tax cuts.  So the jobs number, and its disconnect from projections for interest rates, was under-discussed. It did get attention during a panel at last week’s meeting of the Institute of International Finance in Washington. Jason Cummins, chief economist at Brevan Howard Inc., called the 3.6 percent unemployment forecast “pretty remarkable.”

The implication is that -- in the absence of a significant change to the interest-rate landscape -- the Powell Fed might be quietly preparing to let the economy run hotter. If inflation exceeds the 2 percent target for a while, so be it. It sure would solve the problem of failing to reach it.

Here’s the catch: It’s hard for the Fed to explicitly say it wants more inflation and is prepared to let it rip. That is an awfully tough sell in Congress, to which the Fed ultimately answers. Even if one of the outcomes of that policy would be meaningful pay raises that people can touch and feel. Better for the Fed to be discreet and avoid the confrontation.

Speaking of discretion, one explanation for Powell’s insistence during his press conference on just the interest rate decision: He may be trying to fly below the tweet radar of you-know-who. So far Donald Trump has largely left the Fed alone. Powell surely wants to keep it that way. Next week the Fed will probably keep rates unchanged, but don’t be misled. It has already tipped its hand with that employment forecast, and corresponding rate increases are likely to follow.

Daniel Moss writes and edits articles on economics for Bloomberg View. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.

To contact the author of this story: Daniel Moss at dmoss@bloomberg.net.

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