Since the most recent increase in the target for the federal funds rate last December, the economy has made further progress toward achieving the Federal Reserve’s dual mandate (maximum sustainable employment and stable prices). The labor market continued to improve as the U.S. economy added over 1.4 million jobs so far this year. Given these improvements in labor markets, wages have risen gradually – wage growth is now above the roughly 2 percent level that it seemed stubbornly “stuck” at, earlier. The growth rate of core PCE inflation has risen modestly, to 1.6 percent.
This progress has occurred despite significant headwinds from abroad, including a slowdown in China’s economy, a surprising “Brexit” vote, and continued problems in some European banking organizations.
The economic progress since the last tightening in December might, by itself, be sufficient to justify a further increase in the rate target. However, it is in considering the implications of current policy for the sustainability of the expansion that the case for raising rates has now become even more compelling.
Federal Reserve staff forecasts, like those of the bulk of private forecasters, see the labor market tightening considerably over the next three years – and this is the case even assuming more rate increases than are currently anticipated by market participants and reflected in market rates. By 2019, I expect the unemployment rate to have declined below 4.5 percent. While I have a long track record of advocating for policy that supports robust labor market conditions, that is below the rate that I believe is sustainable in the long run.
Unemployment this low may well have the desirable effect of bringing more workers into the labor force – but, unfortunately, only temporarily. Historical experience suggests it also risks overheating the economy, the effects of which include heightened pressure on inflation and potentially increasing financial-market imbalances. Gently backing the economy away from such imbalances has proven to be very difficult in the past. In fact, such overshoots have in the past always resulted in a recession, rather than a return to the full employment level. Accomplishing a soft landing is difficult, and very rarely achieved. This is true whether reducing the unemployment rate, such as from its recent high of 10 percent, or raising it back to its full employment value from below.
My goal is to achieve a long and durable recovery – a sustainable expansion. For the reasons articulated above, I believe a significant overshoot of the full employment level could shorten, rather than lengthen, the duration of this recovery.
It is important to note that even with a gradual increase in interest rates, monetary policy’s stance would be accommodative and as such would lead to further improvement of labor market conditions. This would allow policymakers to continue testing to find the level of full employment – but gently, not sharply.
As a result I am arguing for modest, gradual tightening now, out of concern that notdoing so today will put the recovery’s duration and sustainability at greater risk, by generating the sorts of significant imbalances that historically have led to a recession.
Eric S. Rosengren
President and CEO, Federal Reserve Bank of Boston
President and CEO, Federal Reserve Bank of Boston
