Nov. 20 (Bloomberg) -- The Federal Reserve should lower its jobless-rate threshold for raising interest rates to 5.5 percent if it takes both the unemployment and participation rates into account, keeping its main interest rate lower for longer, according to Goldman Sachs Group Inc. research.
The analysis updates a study Goldman Sachs published earlier this month by factoring in the labor force participation rate rather than simply addressing unemployment.
“Taking into account adverse supply side effects -- by aiming to normalize both the unemployment and participation rates -- strengthens the case for lowering the 6.5 percent unemployment threshold,” economists led by Jan Hatzius say in the note written by Sven Jari Stehn and dated Nov. 19. “Our small model suggests that the most desirable unemployment threshold in this case would be around 5.5 percent.”
The study builds on papers presented by Fed officials earlier in November. William English, head of the Division of Monetary Affairs, wrote that the strategy of not raising interest rates if unemployment is above 6.5 percent has provided useful stimulus and suggested an even lower threshold could be effective. David Wilcox, the research and statistics chief, argued for loose policy amid contained inflation expectations and high labor slack, noting that “participation appears to have moved noticeably lower.”
Goldman’s previous analysis, which looked at English’s work, found that a threshold of 6 percent would deliver “the best combination of a stronger recovery and modest inflation.” The update takes into account “the supply side mechanisms of the Wilcox paper,” the economists wrote.
If the Fed tried to address the entire employment picture by taking into account a measure of the so-called participation gap, the Fed’s policy rate would be on hold until mid-2016, they found. In that case, a 5.5 percent jobless rate threshold is best, the Goldman Sachs economists wrote.
“Our analysis suggests that taking into account that weak aggregate demand might have adverse effects on labor supply strengthens the case for lowering the 6.5% unemployment threshold,” they said in the paper.
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