The economy may not need to bounce back all that much from its first-quarter swoon for the Federal Reserve to raise interest rates in September.
A slowdown in the long-run potential growth rate of the economy has lowered the bar that gross domestic product must clear for the central bank to increase rates, according to Fed watchers including Michael Feroli of JPMorgan Chase & Co.
“It may not be that high a hurdle” to a September move, said Feroli, a former Fed researcher who is chief U.S. economist for JPMorgan in New York.
GDP shrank at a 0.7 percent annualized rate in the first quarter, according to Commerce Department figures issued Friday in Washington. Economists surveyed earlier this month by Bloomberg expect the economy to shake off that weakness and expand by 2.7 percent in the second quarter and 3 percent in the third, according to the median forecast.
Lackluster productivity and a slower expansion of the workforce has reduced the underlying growth rate of the economy to 1.75 percent or below, according to Feroli.
The underlying, or potential, growth rate is the pace at which the economy can expand in the long run without generating faster inflation, while keeping unemployment steady. If Feroli is correct, growth above 1.75 percent should be sufficient to keep unemployment falling -- a key Fed requisite for a rate rise.
Feroli said the central bank will boost rates in September if the economy expands at an annual clip of 2 percent to 3 percent over the rest of this year and nonfarm payrolls rise by about 175,000 per month.
Krishna Guha, vice chairman of Evercore ISI in Washington, said GDP growth could average as little as 2.25 percent per year to allow the Fed to go ahead with a September rate increase, provided it was coupled with monthly job increases of around 200,000. Payroll growth so far this year has averaged about 194,000 a month, down from 260,000 last year.
Jan Hatzius, chief economist at Goldman Sachs Group Inc. in New York, said he also sees the economy improving enough to allow the Fed to raise rates in September, though he added it was a close call and the increase could slip into December.
Fed Chair Janet Yellen and her colleagues next meet on June 16 and 17 to plot monetary strategy. At their last gathering in April, many policy makers considered it unlikely they would increase rates in June, according to the minutes of that meeting released by the central bank.
The Fed has said it will raise rates when it sees further labor-market improvement and is “reasonably confident” inflation will rise back to its 2 percent goal over time.
Yellen said in a speech on May 22 that “it will be appropriate at some point this year” to start raising rates if the economy improves as she expects.
The benchmark federal funds rate has been kept near zero since December 2008 as the Federal Open Market Committee battled the worst recession since the Great Depression and then sought to keep the expansion going.
In comments in Israel on May 25, Fed Vice Chairman Stanley Fischer seemed to set a relatively low hurdle for a rate rise. “If the economy is growing very, very slowly we will wait,” he said in a speech at Israel’s IDC Herzliya university.
Fischer also warned about the risk of putting off a rate increase too long, saying this could force the Fed to tighten credit sharply later on to keep the economy from overheating.
Guha said the Fed’s mandate is not the promotion of faster growth per se. Its dual goals are the attainment of price stability and full employment. If those goals can be achieved with a slower expansion of GDP because the economy’s potential is lower, that’s where the Fed’s focus will be, he said.
Former Fed Chairman Ben S. Bernanke made a similar point in a blog posting on April 30 for the Brookings Institution in Washington. While economic growth has been slow during this expansion, that’s been due to sluggish productivity gains, he wrote, adding that there’s little the Fed can do about that.
What the Fed can do is support a return to full employment and there its record “has been reasonably good,” according to Bernanke, who is now a distinguished fellow at Brookings.
Unemployment has fallen from a high of 10 percent in 2009 to 5.4 percent last month, according to data from the Labor Department in Washington. It is now close to the 5 percent to 5.2 percent level that most Fed policy makers reckon is the equivalent of full employment.
Since the recession ended in June 2009, GDP has grown at an average annual pace of 2.2 percent.