Federal Reserve officials are moving on to their next big policy debate: defining their “broad and inclusive” maximum-employment goal that they have pledged to reach before raising interest rates.
With Chair Jerome Powell and colleagues paving the way to slowing their massive asset-purchase program this year, attention will turn to when they will hike rates for the first time since 2018.
Seven of 18 policy makers wanted to raise in 2022 and that number could grow when the Fed releases updated economic forecasts next month.
The discussion could be an even more heated argument than discord over scaling back bond purchases. That’s because the Fed’s overhaul of monetary policy last year didn’t spell out a numeric definition for the minority unemployment rates that would meet their new goal.
“It is going to be an issue,” said Derek Tang, an economist at L.H. Meyer Inc. in Washington. “What does broad and inclusive mean? It is going to be a very ugly fight.”
At stake is just how hot officials are willing to let the labor market run before they start to shut off support of cheap money.
Act too soon and the minority and less educated workers Powell now includes in the policy calculus could miss out on jobs and wage gains. Act too late and inflation could accelerate, pushing the Fed to respond with force, harming labor market gains.
August’s employment report isn’t likely to clarify the labor-market picture as the delta variant weighs on consumer sentiment and schools are just starting to reopen.
Jobs data for July, for example, showed a large 1 percentage-point drop in the black unemployment rate. But black labor-force participation also fell nearly a percentage point.
Falling participation as people drop out of the workforce subtracts from the unemployment rate because they aren’t counted in the jobless numbers. It will take months for officials to sort out what the trend participation might be and any conclusion will be tentative.
At the central bank’s annual Jackson Hole conference on Aug. 27, Powell described an optimistic outlook for the labor market “with high levels of employment and participation, broadly shared wage gains, and inflation running close to our price-stability goal.”
But assessing full employment has always been hard for the Fed — it doesn’t define it as fixed target in its annual statement on longer goals in contrast to 2 percent inflation — and what the labor market looks like at that point is already a topic of dispute.
According to the July meeting’s minutes, there were “several participants” who said the pandemic caused “longer-lasting changes in the labor market,” and pre-pandemic conditions “may not be the right benchmark against which the committee should assess the progress toward” maximum employment.”
Officials who saw things that way could argue the employment goal had been met and push for rate hikes sooner than otherwise.
Adding complexity to the outlook is President Joe Biden’s appointments of potentially four new people to the Fed board in coming weeks.
Democratic support to give Powell another four-year term as chair is partly based on confidence that he will stick to the pledge of broad labor-market gains.
If Biden keeps him in the job, Powell will have to broker a committee consensus on labor supply and inflation risks.
That puts the Fed in a politically tricky place, said Adam Posen, president of the Peterson Institute for International Economics.
“For all the masterful work Powell and company did to get unanimity on the framework review, they could not get unanimity on the substance of what full employment and inflation overshooting entails,” Posen said.
“They have not reinforced their commitment to broad and inclusive gains” as more persistent inflation threats emerge, he added. “They could have stuck with it much more than they did. The political blowback is potentially very large.”
When the unemployment rate dipped to 3.5 percent in 2019, inflation remained below 2 percent while black unemployment dropped to record lows. The labor-force participation rate defied its downward trend and started to climb as women rejoined the job market.
It was labormarket nirvana, and the experience informed the central bank’s new framework. But COVID-19 has turned policy risks upside down.
The Fed’s preferred price indicator rose 4.2 percent for the 12-month period ending July. The jobs recovery has picked up, with payroll gains averaging 617,000 a month this year.
“Broad and inclusive measures of maximum employment won’t be back to pre-pandemic levels next year” when inflation could still be running above the 2 percent target, predicts Andrew Levin, a Dartmouth College professor and former Fed board economist.
“The Fed will almost certainly have to renege on its commitment about holding interest rates at zero until the economy has reached maximum employment,” he said.
Indeed, broader measures already show an uneven recovery for some.
The unemployment rate for black men 20 years and older is at 8.4 percent versus 5.7 percent at the start of 2020. The participation rate for Hispanic women is at 58.4 percent, down from 61.9 percent in February 2020.
The consensus among officials to start to taper asset purchases this year is mostly about managing risks around inflation, said Skanda Amarnath, executive director at Employ America, a pro-labor think tank.
“The question is how much of this inflation reflects the labor market,” he said. The recovery in the labor market “is just getting started.” Nevertheless, Dallas Fed President Robert Kaplan and St. Louis’s James Bullard are wary that a chunk of the labor force is gone for good because of a higher pace of retirements during the pandemic.
On the other side of the conversation, Governor Lael Brainard, one of the authors of the “broad and inclusive” language in the new strategy, and Kansas City Fed chief Esther George, a 2022 Fed policy voter, are in the wait-and-see camp, as is Minneapolis’s Neel Kashkari.
Whenever a shock hits the economy, forecasters tend to raise “their estimate of how low the unemployment rate can go without triggering high inflation,” Kashkari told Bloomberg in an Aug. 15 interview.
“What we learned after the ‘08 crisis is all of those stories were wrong. It turns out most Americans want to work,” he said.