Federal Reserve Chairman Jerome Powell doesn’t claim to have all the answers, but when it comes to where unemployment can settle in the long run, he and his colleagues are especially stumped.
“No one really knows with certainty what the level of the natural rate of unemployment is,” Powell told reporters Wednesday after raising interest rates for the second time this year.
Later, pressed about whether the Fed’s long-run estimate, now at 4.5 percent, could come down, he indicated that it’s possible. “We can’t be too attached to these unobservable variables.”
It’s a crucial uncertainty because the natural jobless rate is a linchpin of Fed policy. It’s a signal of how hot Fed officials think the job market is running, which in turn tells them how much inflation is brewing relative to their 2 percent target and how aggressively they need to raise rates to maintain an even keel.
Unemployment estimates have been a question mark for some time — the U.S. central bank has lowered the long-run estimate by about a percentage point over the past five years — but the stakes are now higher.
The Fed gradually is raising rates and soon will reach what officials think is the neutral level, the policy setting that neither stokes nor slows growth.
If they push past that and the job market isn’t overheating, it could needlessly choke off growth and tamp down inflation.
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If, on the other hand, the labor market is galloping past potential, their slow pace might risk inflation taking off.
“The fact that we live in that uncertainty is why we’ve been gradually raising rates,” Powell said Wednesday. “We’re not waiting for inflation to show up ... we’re going ahead and moving gradually and trying to navigate between two risks really.”
Unemployment was 3.8 percent in May, and the Fed sees it falling to 3.6 percent by the end of the year and dipping to 3.5 percent in 2019 and 2020. That would be the lowest level since the 1960s.
Officials left their estimate of the longer-run natural rate at 4.5 percent on Wednesday, suggesting that they see a job market that’s running warm.
Despite that, wages have been moving up gradually — not taking off — and inflation has been close to or below the Fed’s 2 percent goal. The Fed seems to think price pressures will remain contained: They forecast a small overshoot on inflation, but they don’t see it climbing above 2.1 percent over the next three years, according to their median estimates.