The immediate decision facing the Federal Reserve when it meets in Washington isn’t that momentous. The nation’s central bank will likely continue scaling back its support for the economy by reducing the long-term bonds it is buying by another $10 billion, following a path laid out more than six months ago.
But the bigger question is what’s at the end of that road. In the days leading up to the end of the meeting and Fed Chair Yellen’s press conference on Wednesday, we’ll take a look at the debates that are shaping the central bank’s final destination.
When will the economy hit the 6% magic number?
Since the recession ended, the Fed has been criticized for consistently predicting that stronger economic growth was just around the corner, only to have the recovery consistently disappoint. But there’s another forecast the central bank has repeatedly gotten wrong: the unemployment rate. And that miscalculation could throw a wrench into its carefully laid plans.
While the Fed has been overly optimistic about America’s growth prospects, it has been too pessimistic about the unemployment rate. Standing at 6.3 percent, the unemployment rate has already reached the high end of the Fed’s forecast for the year. Officials will almost certainly be marking down their projections during their meeting this week -- as they’ve done over and over again.
For example, when the Fed announced in September 2012 that it would try to jumpstart the recovery with another round of bond-buying -- also known as quantitative easing -- the unemployment rate was about 8 percent. Officials predicted then it would gradually inch down over the next year to between 7.6 to to 7.9 percent. Instead, it plunged to 7 percent. This chart from Regions Bank Chief Economist Richard Moody shows the steady drift downward in the Fed’s expectations for the jobless rate.
This is problematic for the Fed because it has tied its stimulus program so closely to the unemployment rate. And its penchant for overestimating the strength of the recovery and underestimating employment suggests they could soon be caught in a conundrum: what if economic growth does not take off as they expect, but the jobless rate continues its rapid descent? The former is a reason not to remove the punchbowl of monetary stimulus, while the latter suggests that the Fed may already be too late ward off inflation. It’s entirely plausible that the unemployment rate could even fall below 6 percent -- hitting the benchmark that some Fed officials believe is the economy’s natural rate of joblessness -- before the central bank wraps up its bond-buying program this fall.
Officials have tried to anticipate this issue by pointing out that the unemployment is not the only measure of slack in the labor market, even though it is the number watched most closely. Fed Chair Yellen has cited the high numbers of long-term unemployed, the swollen ranks of involuntary part-time workers and the low level of churn in the job market as other signs that weakness. (Check out the Brookings Institution for a handy dashboard to help gauge where we stand.)
Still, an unemployment rate below 6 percent will be difficult to dismiss. Officials would be remiss if they didn't at least broach the possibility during their meeting this week. After all, the Fed may not have much longer to debate its options -- no matter what their projections say.