Charles Evans, president of the Federal Reserve Bank of Chicago, joined the chorus of central bank officials acknowledging that the employment picture has improved faster than forecast, but he added he doesn’t want to embrace interest rate increases until he is sure inflation is at 2% and will stay near there.
“It is fair to say that the labor market has improved more quickly than many of us expected,” Mr. Evans said Wednesday in an interview with The Wall Street Journal. The jobless rate, at 6.1%, “is a much lower rate than I had in my previous forecasts for quite some time. So that is good. The signal from that is that the economy is most likely to pick up.”
Some Fed officials are arguing that the improving job market means the Fed should start considering increased short-term interest rates. Mr. Evans said an improving job market does imply an earlier liftoff for interest rates, but only if inflation rises closer to the Fed’s 2% target as well.
He said it likely would be appropriate for the Fed to keep short-term rates near zero “well into” 2015 or even until early 2016.
“We’re undershooting our inflation objective and we really need to get up to that,” he said.
Below are key passages from the interview:
WSJ: How has the decline in the jobless rate in the last few months, and the pickup in payroll growth, affected your thinking on interest rates?
EVANS: The labor market improvement has been real and very welcome. The reduction in the unemployment rate has been good, and a little complicated with the reductions in labor force [participation] for much of that. The expected trend reductions in labor force participation make it difficult to see exactly how much of that is purely the strength of the economy and how much of it is the [labor force] trend. Looking through that it looks like things are improving nicely in the [monthly job gains] number; 288,000 in June and averaging 230,000 over the last six months or so. That’s very good. As I mentioned the other day when we started the ‘QE3′ asset purchases I pointed out that 200,000 for monthly payrolls was a hurdle that we ought to be able to get to pretty easily. It took a long time but we’re clearly doing well. I think it’s been real and that’s consistent with the type of economic improvement that we needed to see in order to get closer to liftoff. It has supported the tapering decision each and every meeting.
WSJ: Fed Chairwoman Janet Yellen mentioned in her statement in the press conference and again yesterday that the timing for liftoff is contingent on how the economy performs. It looks like the labor market is converging toward the Fed’s goals more quickly than expected. What does that mean for you?
EVANS: It is fair to say that the labor market has improved more quickly than many of us expected; 6.1% is a much lower rate than I had in my previous forecasts, for quite some time. So that is good. The signal from that is that the economy is most likely to pick up. My own outlook is for 3% [annualized rate of gross domestic product growth] over the next 18 months. That is not superlative, but it’s good and very meaningful for continued labor market improvement. It is the kind of outlook that we need to start talking about policy normalization. But the other aspect of this is the inflation environment. It is not only the case that we have more unemployed than is consistent with full employment. We also have lower underlying inflation than our 2% target. It is more likely that inflation is going to be under 2% than over 2% for at least the next three years and perhaps a little bit longer than that. We need to see good evidence that inflation is moving up to 2%. Another aspect of that is wages. Wage growth, at 2% to 2.25%, has been somewhat tepid relative to what it ought to be at a fully growing economy. It should be closer to 3.5%. Average productivity growth plus 2% inflation would get you to 3.5%. We still have a ways to go there. That would support sustained inflation at our target.
WSJ: It sounds like you’re not prepared to embrace this idea that the labor market improvement calls for an earlier liftoff.
EVANS: I’m still in the camp that thinks that it has been our appropriate monetary policy that has helped set the table for businesses to take advantage of the opportunities in front of them and hire more workers and the consumer to do better. I think that is going to continue to be appropriate well into 2015. I have said publicly that in the [Fed's] Summary of Economic Projections I still think that the most appropriate monetary policy is liftoff delayed until early 2016. More improvement in the labor market, getting unemployment down closer to sustainable rates, does that accelerate when I would think it would be appropriate to raise rates? Absolutely. That is what economic conditionality is all about. That plus it being consistent with inflation being much, much closer to the 2% target. At 2% is really a good goal there. I wouldn’t be surprised, in my opinion, if appropriate monetary policy liftoff could be delayed until we get to 2% inflation unless there was really, really strong evidence that we had in train strong overshooting inconsistent with our goals. The likelihood of that is not high.
WSJ: Can you summarize what economic conditions you want to see in place at the time of liftoff?
EVANS: I definitely think that the inflation outlook ought to be at 2% or even above. Being above 2% is not a big problem in the environment we’re facing. We’re supposed to be averaging 2% and we’ve been well under 2% for quite some time. I want to have a tremendous amount of confidence that inflation is going to be at our target and not go down below our target once we start raising rates. If we had the expectation that we were going to get to our 2% target and then we started raising rates and then we were disappointed that inflation didn’t increase to our target and we were looking at a forecast of under 2% inflation, that would be a problem. That would suggest there was something else going on in the economy that wasn’t quite as vibrant as we thought. I want to have a lot of confidence that we get to our inflation objective.
WSJ: Do you think there should be some makeup on the inflation because it has run under 2% for so long?
EVANS: I don’t think we have to have makeup per se, but I think we shouldn’t fear going over our 2% in a controlled modest fashion for some period of time in order to ensure that inflation expectations are firmly up to the 2% rate. In a world environment where inflation is coming in under central bank targets and there is a lot of global softness, I want to be sure we get away from the recent period of the zero lower bound and below target inflation. Whatever it takes to make sure and have high confidence that we’re going to continue with inflation at our target in a sustainable fashion is important. I don’t think it requires makeup but I don’t think we should be too concerned about modest overshooting in a controlled fashion.
WSJ: You’ve described yourself as an optimist on the economic outlook. How has your view on the economy’s growth potential changed?
EVANS: We’ve looked at the reductions in the labor force participation rate and the likelihood that growth in the labor input is going to be lower. We’ve seen the more restrained improvement in innovation for whatever reason, productivity growth. We’ve marked down our potential output growth rate for gross domestic product somewhat. We were probably before a little above 2.5% and at the moment we’re closer to 2.3%. We moved it down. Economic theory says that is consistent with the real interest rate moving down too. My assessment of the longer-term nominal fed funds rate has moved down a little bit because of that, but not a lot, not in any way close to something that would be consistent with what some people call the secular stagnation hypothesis. But I’m still an optimist. I think we’re going to be seeing 3% growth over the next 18 months or more, maybe longer. Because it’s above trend output we should be seeing continued labor market improvement. In that sense I’m an optimist. Having said that, we should all be nervous about certain things. The global environment continues to be unsure. Global demand is tepid. Business expansion has not been as strong as you would like. In the housing sector, tremendous improvement has been delayed. Consumers are doing better but the sustainability of a stronger consumer is something that you have to keep in mind and wonder about. There are still a lot of risks for consumers.
WSJ: If the economy has less growth potential it suggests it will get back to capacity quickly but then won’t growth very fast after that. That seems to imply earlier rate hikes, but that rates don’t get very high.
EVANS: I go out and talk all of the time about how we need to be focused on our goals and think about goal-oriented monetary policy. The way to cut through these questions is to say, ‘How is inflation doing relative to our objective? That is fundamentally the responsibility of the central bank. We’ve been below our inflation objective for a number of years. We ought to get up to that objective. That is how we’re telling people how to price all of the financial products. It is OK to go out and borrow at a particular interest rate because inflation will be this amount and that is embedded in your borrowing cost; the same thing for people making loans. If we’re off on either side it is costly to one party. If the secular stagnation hypothesis were to emerge, then we’d have lower growth. If I’m looking at the growth target I might be disappointed and think policy can do better, but in fact it can’t because that is the nature of the economy. Inflation is supposed to tell us what the stance of monetary policy is, especially at this point since there is uncertainty as to what the 6.1% unemployment rate is telling us about just how strong the economy is, and the growth rate and what is trend growth. I can agree with people that there is a lot of uncertainty about that. But what I’m pretty comfortable with is that we’re undershooting our inflation objective and we really need to get up to that.