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WASHINGTON (MNI) - The Federal Reserve is set to carefully evaluate a shift
in the balance of risks to its dual mandate amid soaring job growth and sagging
inflation, and with Jay Powell preparing to take the helm from outgoing Chair
Janet Yellen next month.
In light of the continued shortfall in inflation, which has mystified
officials, economists are calling into question the Phillips curve -- a key part
of the Fed's conventional thinking. The unemployment rate is half a percentage
point below the Federal Open Market Committee's estimate of maximum employment,
but so far that has not translated into any significant upward pressure on wages
or prices more broadly.
For several years, economists have estimated the level of monthly payrolls
growth consistent with a stable unemployment rate to be around 80,000 to
120,000. Yet jobs growth has exceeded that level, averaging 171,000 a month in
2017 and pulling the unemployment rate down six-tenths of a point over the
course of the year to a 17-year low of 4.1%. The FOMC projects it will fall
further to 3.9% by the end of this year before beginning to rebound in 2020.
--MANY FOMC BELIEVERS
The minutes of the December FOMC meeting released last week revealed that
many officials expect cyclical pressures to push inflation higher in the future,
though some expressed concern that persistently low inflation could depress
inflation expectations further.
Two regional Fed presidents recently urged patience on further interest
rate hikes out of concern that the central bank might send the wrong signal by
pressing on with normalization while inflation was still weak.
"I view the possibility that the public believes inflation will
persistently fall short of the 2% objective as a risk," Atlanta Fed President
Raphael Bostic said Monday, citing survey responses as well as market-based
estimates of inflation expectations that indicate people may not be "completely
convinced" about the symmetry of the FOMC's inflation objective.
"This possibility is one factor that might argue for being somewhat more
patient in raising rates, even as the inflation rate moves toward the 2%
objective," Bostic said. He supports gradual rate hikes, but the economy may not
need three-to-four a year, he said.
Philadelphia Fed President Patrick Harker on Friday similarly signaled a
dovish turn in his view, calling for two rate increases this year, down from the
three he had predicted for 2018 late last year and which remains the FOMC's
The fact that policymakers are not seeing a significant acceleration of
inflation means "we have some time" to consider the next rate increase, Harker
said. "It would be helpful if we were able to get inflation not just at 2% but
above it for a while."
--WILL WAGES RISE?
If the jobless rate continues to fall, employers could become more reliant
on hiring individuals not actively seeking jobs. The labor force participation
rate for prime age workers, at 81.9% in December, has climbed steadily over the
past two years but remains a full percentage point below its pre-recession
level. That means roughly 3 million fewer men and women between the ages of 25
and 54 are sitting on the sidelines of the labor force compared to in 2007. At
the top of the last expansion in 1999, prime age participation hit a high of
Whether that type of hiring would lead to wage inflation is an open
question in a rapidly evolving economy. Underemployment actually rose a tenth of
a percentage point to 8.1% in December, suggesting among other things that the
gig economy could become a larger portion of the labor market.
--RETHINKING POLICY FRAMEWORK
If the Phillips curve is broken, then policymakers must focus on other ways
to anchor inflation expectations to help meet their 2% objective. Harker last
week joined several other regional Fed presidents, including Chicago's Charles
Evans and John Williams of San Francisco, in urging further study of
alternatives to the current policy framework of targeting 2% inflation.
One option, temporary price level targeting, would let Fed officials make
up for years in which inflation is below 2% by overshooting the goal in other
years until inflation averages 2% over the long run. Another method would target
a nominal GDP level to achieve those consistent with 2% inflation.
The Fed is by no means ready to change its operating framework in the near
future, but as officials grapple with relatively modest gains in average hourly
earnings and muted inflation, they may proceed more cautiously in tightening
policy this year than in 2017.
--MNI Washington Bureau; +1 202-371-2121; email: email@example.com