Fed's Updated Model of Economy Suggests It's Time to Raise Rates

Updated on
  • `Output gap appears closed,' Barclays economist Gapen says
  • Data may give clues to why Fed highlighted December option

The Federal Reserve Board released an updated version of its large-scale model on the U.S. economy that may hold clues into why policy makers pivoted at their meeting earlier this week toward a December interest-rate increase.

The revised inputs and calculations on Friday suggest the economy will use up resource slack by the first quarter of 2016, according to an analysis by Barclays Plc, and that also indicates Fed staff lowered their near-term estimate for how fast the economy can grow without producing inflation -- a concept known as potential growth.

“The output gap appears closed,” said Michael Gapen, chief U.S. economist at Barclays’s investment-banking unit in New York. “This means further progress would lead to resource scarcity and potential upward pressure on inflation in the medium term.”

Gapen said that may explain why U.S. central bankers signaled this week that they will consider the first interest-rate increase since 2006 at their next meeting, on Dec. 15-16.

The model assumes that the Federal Open Market Committee raises the benchmark lending rate in late 2015. However, immediate liftoff has “been a feature” of the model since late 2014, Barclays noted.

Fed spokesman David Skidmore declined to comment.

2% Growth

In the current model, “the long-run growth rate is two-tenths lower” at 2 percent, Barclays said. FOMC participants forecast the economy’s long-run growth rate at 2 percent in September.

The unemployment rate stood at 5.1 percent in September, and the Fed model assumes little change from that level, dipping to a low of 4.8 percent in a forecast horizon that extends to 2020, according to Barclays. FOMC officials estimated full employment -- or the level of the unemployment rate consistent with stable prices -- at 4.9 percent last month.

“This view is quite different than ours,” said Gapen, who formerly worked at the Fed. “We forecast ongoing declines in the unemployment rate and see it reaching 4.3 percent by end-2016.”

The model, known as FRB/US and updated periodically, is a series of calculations put together by Fed staff that sketch out how broad measures of the economy would change based on a set of defined parameters. The staff also constructs a bottom-up forecast for policy makers before each FOMC meeting. U.S. central bankers use the models and forecasts as reference points, not sole determinants of their decision-making.

— With assistance by Alexandre Tanzi

(Updates with Fed spokesman in sixth paragraph.)
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