Federal Reserve Governor Jerome Powell said hidden slack in the labor market justifies a gradual approach to monetary policy tightening after an initial interest-rate increase, which he expects later this year.
“The unemployment rate probably understates the amount of slack remaining in the labor market,” Powell said, according to the text of a speech he is scheduled to deliver at the Council on Foreign Relations in New York on Wednesday. “The labor force participation rate continues to be unusually low, suggesting that potential workers may be waiting on the sidelines for further improvements in job opportunities and wages.”
Powell said he saw a greater risk of damaging the economy with a premature rate increase than of triggering inflation by waiting too long. At the same time, the Fed should guard against contributing to “frothy” financial conditions that might undermine market stability.
“I expect that economic conditions will support the first rate increase later this year,” he said. “If the economy continues on its expected path, it will be appropriate for a time to increase rates fairly gradually.”
Powell’s speech aligns him closely with Fed Chair Janet Yellen and New York Fed President William C. Dudley, who have said in recent days they expect the central bank to raise rates gradually in coming years. The federal funds rate has been held near zero for more than six years as the economy recovered from its worst downturn since the Great Depression.
Powell said he expected further progress in lowering unemployment in coming months. He also said inflation would probably move back toward the Fed’s 2 percent target after the temporary impact of lower oil prices and a stronger dollar dissipated.
Unemployment in the U.S. has dropped to 5.5 percent as employers added 269,000 a month on average in the year through February. That string of robust job gains was broken by a weaker-than-expected report for March, which showed 126,000 new jobs created last month.
“Despite slowing in March, job creation has been particularly strong over the past two years,” he said.
While unemployment has dropped, inflation has remained stubbornly low. The Fed’s preferred gauge of prices rose just 0.3 percent in the year through February, marking 34 months it has lingered below the central bank’s target of 2 percent. Excluding food and energy, inflation was 1.4 percent.
Powell, 62, a former partner at Washington-based private equity firm Carlyle Group LP, said economists and policy makers tend to underestimate the impact of severe financial crises on the supply side of an economy, especially the damage to the labor force, capital investment and productivity.
“Many economists now estimate that substantially more than half of the shortfall in gross domestic product relative to its precrisis trend represents a reduction of potential output and not just a shortfall in demand,” he said.