WASHINGTON – Federal Reserve officials have long said that a key condition for raising interest rates is a return to peak employment. The evolution of their views on how much job growth it will entail could lead them to reduce support for the economy earlier than expected.
Policymakers are likely to discuss when and how to start cutting monthly bond purchases, a prelude to eventually raising rates, at a meeting on Tuesday and Wednesday. They have said since December that to justify the reduction in bond purchases, the economy needed to make “further substantial progress” toward maximum employment and sustained 2% inflation.
The Fed has never put a number on its full employment target. Still, central bankers for months have compared current employment to the number of jobs in February 2020, before the pandemic hit the US economy, to illustrate the ground that needed to rebound. President Jerome Powell said earlier this year that the gap was “a way of counting it.” In May, the deficit stood at 7.6 million jobs.
But in recent weeks, policy makers have become less confident that the economy can regain all the jobs lost amid the pandemic without stimulating inflation. Employers added less payroll than expected in April and May, even as the economy grew rapidly, wages rose and other indicators pointed to a worker shortage. The unemployment rate also continued to fall, to a pandemic low of 5.8%. In part, this is because fewer people are returning to the workforce looking for work. The number of people who are working or want to work is still 3.5 million below February 2020, and the labor force participation rate of 61.6% is lower than 63.3% then.
The Fed believes that many factors holding back the workforce are linked to the pandemic and will disappear by the end of this year.
But one might not: the 2.6 million people who have retired since February 2020, according to estimates by the Dallas Fed. The steady aging of the American population suggests limited scope to reverse that trend, some economists say.
“The number of people who left the workforce to retire was higher during this pandemic recession recovery than in previous recession recoveries,” Cleveland Fed President Loretta Mester said June 4 on CNBC. “Normally when people retire, they don’t go back into the workforce.”
Treasury Secretary Janet Yellen, an economist who led the Fed from 2014 to 2018, said on June 5 that while employment remains more than 7 million jobs below pre-pandemic levels, rising pensions could mean that “we do not need to recover so many to return to full employment”.
While current Fed officials have been less explicit in their public comments, they have signaled a similar openness. “Whatever … the top unemployment rate is, it’s something that varies over time for structural reasons,” Fed Vice Chairman Richard Clarida said last month. “Labor force participation evolves for a number of reasons, so I think going forward, speaking for myself, we have to be very in tune and watch to see how the post-pandemic job market clears up.”
Due to the wave of retirements, Ms. Mester said she is focusing more closely on the workforce participation of people in their best working years, ages 25 to 54.
Progress towards maximum employment is one of the Fed’s main criteria for withdrawing the easy money policies implemented during the pandemic. If officials are convinced that the economy is destined to operate with lower labor force participation rates than before, they could start tightening policy earlier than expected.
Since last year, the Fed has been buying $ 120 billion in Treasuries and mortgage bonds each month and has kept overnight interest rates close to zero. Many economists expect the Fed to begin reducing bond purchases later this year or early next.
The Fed has said it will refrain from raising interest rates until inflation reaches 2% and it is likely to rise and maximum employment is achieved. When they last released the projections in March, most Fed officials expected the first rate hike in 2024 or later.
But since then, surprisingly strong inflation in April and May and the rethinking of maximum employment suggest those conditions could be met sooner. That could be reflected in updated rate projections from Fed officials to be released on Wednesday.
Central bankers expect that by the fall, when improved unemployment programs expire, schools will reopen and more people are vaccinated, hiring will accelerate and some recent retirees could return to the workforce.
During the last business cycle, Fed officials were pleasantly surprised to see unemployment hit 50-year lows without stirring up inflation. That happened in part because a tight job market consistently drew people who hadn’t been looking for work into the workforce.
If this pattern repeats itself in the coming months, it would ease concerns that the worker shortage could result in a more persistent rise in inflation.
“The rise in pensions may moderate in a stronger economy, as we saw in the year or two before the pandemic,” Fed Vice President of Supervision Randal Quarles said May 26. But, he added, “we may need more public communications on the conditions that constitute further substantial progress since December toward our broad and inclusive definition of maximum employment.”
Write to Paul Kiernan at [email protected]
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