After holding the interest rate they control at around zero for exactly seven years, later this week the Federal Reserve is likely to raise its target rate to 0.25 percent. If so, that implies that a majority of the members of the Fed committee believe that we are either at or heading for full employment at a fast enough rate that they need to tap the growth brakes.
I’m not so sure about that, and the stakes of getting this wrong are high.
First, what’s full employment? It’s a tight matchup between the number of jobs and number of job seekers. The Fed currently thinks that corresponds to an unemployment rate of just under 5 percent, but neither the central bank nor anyone else really knows.
In fact, the Fed has a more nuanced definition of full employment: It’s the lowest unemployment rate consistent with stable prices, which to them, means a steady inflation rate around 2 percent (that’s their inflation target).
Here’s where the confusion starts. The annual growth of its preferred inflation gauge has averaged 0.25 percent this year. Clearly, low energy prices are a big factor, but take them (and volatile food prices) out of the mix and that same metric gets you 1.3 percent.
In other words, based on inflation, there’s no rationale to raise. True, the Fed also has to worry about expectations for future inflation, but as the figure below from economist Andy Levin shows, the expectations of professional forecasters have been drifting down, not up. Same for household expectations, btw.
So that leaves their rationale with the 5 percent unemployment rate. I’ve already shown that 5 percent doesn’t match the inflation criterion for full employment, but what about the “tight matchup” criterion? In fact, here, too, it misses; there’s still considerable slack in the job market. The number of involuntary part-timers is still elevated and there remain significant numbers of working-age people out of the workforce and, thus, not counted in the official jobless rate.
For that reason, a better slack metric right now is the underemployment rate, which stands at 9.9 percent. According to my estimates, that’s about a point-and-a-half above where this measure would be at full employment.
In other words, based on labor market slack, there’s little rationale to raise.
But is a small tweak in the target interest rate really that big a deal? Perhaps not, and I understand that Chair Janet Yellen has to fend off the sharp talons of the inflation hawks over there. But if, as some suspect, this is the first in a sequence of rate hikes next year, I fear the Fed will invoke significant downside risk.
Suppose the rate increase has more of a negative impact than I expect. What’s at stake?
Well, there’s the Fed’s credibility, no small matter, as Andy Levin stresses here. But closer to my heart is the economic damage done to those who depend on lasting full employment to lift their bargaining power such that they can finally claim their fair share of the growth they’re helping to generate.
Ben Spielberg and I recently ran some numbers on the impact of lower underemployment on various groups of workers (specifically, on the decline from its peak of 17 percent to its full employment rate of 8.5 percent). If we can stay at full employment, we’d expect the real wages of low-, middle- and high-wage workers to eventually go up by 6, 5 and 2 percent, respectively. Note that this pattern pushes back on wage inequality, as full employment disproportionately helps the least advantaged (see, for example, economist Valerie Wilson’s work on its impact on African-American workers).
I’ve been touting such effects for years now, along with running the Full Employment Project at the Center on Budget and Policy Priorities, designed to identify and elevate policies that will get us to and keep us at full employment. But in the age of Donald Trump, where irrational and dangerous hatred of the “other” has been so viciously released, I’m wondering if I’ve been too narrow in my thinking about the benefits of full employment.
I suspect that the anger that fuels Trump is partially borne of wage stagnation, inequality and the sense of an economy rigged against the working class. There’s certainly historical precedent for a negative correlation between these phenomena and intolerance. Racism is also in play, of course, so I don’t mean to be an economic reductionist. But if I’m even partially right — if there’s a “tolerance for others” elasticity that could be tapped by full employment — then the stakes are particularly high.
So be careful, Fed. Liftoff if you must, but after that, it’s critical that you go back to being data-driven. I get that this is more art than science, and errors will be made. But given the stakes, if you must err, do so on the side of full employment.