viernes, 31 de julio de 2015

viernes, julio 31, 2015

Why the Fed Needs to Get Off the Dime

Waiting until the unemployment rate reaches the natural level before beginning to raise interest rates risks inflation.

By Richard W. Nelson

July 24, 2015 6:52 p.m. ET

Federal Reserve chair Janet Yellen at a news conference following the Federal Open Market Committee meeting in June.Federal Reserve chair Janet Yellen at a news conference following the Federal Open Market Committee meeting in June. Photo: Bloomberg News


There is a lot of discussion about what level of unemployment the Federal Reserve should seek to fulfill its mandate to promote maximum employment and stable prices. This key unemployment rate is called either the “natural” rate, or “Nairu”—the non-accelerating inflation rate of unemployment.

Yet there seems to be an assumption among many policy makers, analysts and market participants that the Fed should wait until the natural rate of unemployment is reached before it begins to raise interest rates. That would be a huge mistake, greatly increasing the chances of significant inflation beginning sometime next year.

The problem is that the Fed has to finish normalizing monetary policy by the time unemployment falls to its natural rate—and that may take more than a year once it begins. If the Fed waits until the natural rate of unemployment is reached, there will be many months when interest rates are too low. These low rates can cause the economy to overheat, putting pressure on prices.

According to economic projections by the Federal Open Market Committee (FOMC) at its June 16-17 meeting, 3.5% to 3.75% is the likely level of the federal-funds rate after monetary-policy normalization is completed. Currently the Fed’s target range for this key interest rate is 0% to 0.25%.

The Fed historically has increased the federal-funds rate by 25 basis points (0.25 percentage points) at each of its monthly meetings. All indications are that the Fed would like to move even more slowly this time around, so it can gauge the impact of its actions on economic activity. That implies it could take 14-15 months or more to complete monetary policy normalization.

The Fed has no time to spare. In the FOMC’s March 2015 economic projections, committee members estimated that over the longer run the unemployment rate would settle in the range of 5% to 5.2%.

However, a recent study by Federal Reserve staff suggests that Nairu may have fallen much lower, perhaps to 4.3%, and the FOMC may well modify its views in this direction. But over the past 15 months, employment growth has been strong and unemployment has fallen by 1.3 percentage points, to 5.3% from 6.6%.

If unemployment continues to fall at this pace, the unemployment rate will fall to around 4%—below the Fed staff’s 4.3% estimate of full employment, and well below the current estimate of the FOMC members, before monetary normalization is complete. This analysis suggests that the Fed is risking inflation beyond its 2% target by waiting to begin raising rates, and will face an increasing risk the longer it waits.

It is true that longer-term interest rates are likely to rise quickly as financial markets anticipate the Fed’s next moves. And so higher short-term and longer-term interest rates could impede employment growth and the achievement of full employment. Still, the FOMC could monitor the movements of interest rates and employment monthly, making appropriate adjustments as needed.

On the other hand, the risks of delay—higher and perhaps rising inflation—are not likely to emerge until we are closer to full employment. By then adjustments would likely be too late.

The best course for the Fed is to begin raising rates very soon, if cautiously.


Mr. Nelson, a former chief economist at the Federal Home Loan Bank of San Francisco and manager of banking research at the New York Federal Reserve, is the founder of RWNelson Economics, a consultancy in Orinda, Calif.

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