With a pretty solid recovery now under way and the unemployment rate way down from its recession-era peak, the Federal Reserve is wondering when to start raising interest rates. It has said it will be “patient” – which investors have taken to mean “not before the middle of this year.” That might not be patient enough.
The timing of the first increase depends – or ought to – on the outlook for inflation. The Fed’s calculation unavoidably involves guesswork, but here’s one way to look at it: The Fed can choose to err on the side of a bit too much inflation, or a bit too much unemployment. In current circumstances, the first error is preferable.
Once the recovery has taken up all the slack in the labor market, continued monetary stimulus will push wages higher, and inflationary pressure will build. So the question is, how much slack remains?
With unemployment at 5.7 percent, the answer might seem to be “not much.” Most economists think that, in the U.S., an unemployment rate of roughly 5 percent is full employment. But the recent recession was unusually severe, and the labor market was stretched out of shape. The figures may not give an accurate reading of slack – not good enough, anyway, to trigger higher rates without other signs of inflation.
The main problem is that the headline rate of unemployment excludes other measures of underemployment – in effect, hidden labor-market slack. These worsened during the recession. At the end of last year, almost 9 million people were unemployed. Excluded from that number were 2.3 million more who wanted a job but hadn’t “actively” looked for one in the previous month; also excluded were 6.8 million part-time workers who would have preferred to be working full time.
Patience is a virtue. And there’s never been a better time for the Fed to be virtuous.