I guess the big news from its press release yesterday was that the Federal Reserve is getting closer to liftoff. That is, it has held the main interest rate it controls at about zero since late 2009 and as the economy improves, each month brings us closer to the meeting when it announces a (probably small) rate hike. To make sure everyone knew that day is getting closer, the Fed committee took the word “patient” out of Wednesday’s statement, but Chairwoman Janet Yellen was quick to remind Fed watchers that “just because we removed the word patient from the statement doesn’t mean we’re going to be impatient.”
This is all expected…biz as usual, and pretty much what the Fed has been signaling.
But there was something else that I’d argue was really new and important in the report: the Fed lowered its long-run unemployment rate.
Why is that such a big deal? Because it means that a majority of Fed governors believe the unemployment rate can fall further than they previously thought, and it can do so without generating inflationary pressures. Even while the shift looks small — the Fed only lowered it from 5.35 percent to 5.1 percent –in this world, that’s a big deal and as such, it’s a positive development for people who depend on paychecks.
I wrote about these dynamics a few months ago on this page, and I referred to this long-run unemployment rate as the FEUR (full-employment-unemployment-rate): the lowest jobless rate consistent with stable inflation. Thus, you’d expect as the unemployment rate approached the FEUR, price and wage growth would begin to accelerate. My point in the earlier post was that, in fact, neither prices nor wages were speeding up as the actual rate of unemployment fell to the Fed’s FEUR.
I thus concluded: “the Fed needs to either update its FEUR to match reality or clarify why these variables are not behaving the way they should be if their FEUR is correct.”
And so the Fed has updated. The figure above shows the unemployment rate, last seen at 5.5 percent, the core inflation rate (without volatile food and energy prices), average wage growth, and the Fed’s old and new FEUR’s drawn in as well.
As noted, there’s not a huge difference between them, and we’ll need to keep a close eye on the extent to which the tightening job market shows up in wages and prices, especially given that much of the Fed’s commentary from Wednesday was actually pretty dovish. That is, it noted U.S. growth has “moderated somewhat,” the strong dollar is both holding back inflation and widening the trade deficit, and slow growth abroad remains a constraint.
If you find all of this hard to wrap your head around, I feel you, as the kids say. It’s confusing in the sense that part of the message is growth is speeding up such that we’ll need to hit the brakes soon, and the other part is…um…maybe not so much. The Fed is less patient in terms of keeping rates highly accommodative, but not impatient to raise. Based on the observed lack of wage or price pressures, it has lowered its FEUR, also suggesting a later liftoff.
You may also well wonder why we need a FEUR at all. It’s a pretty problematic number in that it’s a) very hard to nail down with any degree of accuracy, and yet b) there’s a lot riding on it. Thankfully, the Yellen Fed appears to be watching wage and price growth more closely than unemployment, but the FEUR is still highly influential, more so than it should be given our uncertainty about it.
Yet with all of these caveats, this is good news. The fact that the Fed marked down the FEUR a bit suggests it is less anxious to fight what is still the phantom menace of rising inflation and in so doing, risk prematurely slowing a recovery in the labor market that finally appears to be gaining traction.