Rock-Bottom Interest Rates May Be Here to Stay

Federal Reserve officials were running a huge experiment with America’s job market before coronavirus lockdowns gripped the American economy, one that could inform how officials think about unemployment — and the path for interest rates — in the pandemic’s aftermath.

The Fed came into 2020 planning to allow unemployment to sit at 50-year lows without trying to cool off the labor market by raising rates. Wages and inflation are usually expected to shoot higher when the job market is tight, but that relationship had remained muted even a decade after the 2008 financial crisis.

America will never know how many people might have gotten jobs had the trial run its course. The labor market was enjoying a slowly increasing employment-to-population ratio, stronger wages, and record-low minority unemployment rates when the pandemic abruptly closed businesses and kicked tens of millions out of their jobs.

But central bankers have learned a lesson over the past decade that could inform how they respond when economies reopen, the recovery picks up steam and unemployment falls. Instead of trying to offset very-low unemployment with higher interest rates, as they did between 2015 and 2018, they may simply remain patient when the job market begins to heal, humbled by the realization that the old inflationary rules seem to no longer apply.

That could leave interest rates, which have been set at near-zero since officials abruptly slashed them at a series of emergency meetings in March, at rock-bottom for years as the labor market mends.

“We’ve learned something very fundamental about our ability to associate levels of unemployment with inflation, or indeed, other imbalances,” Jerome H. Powell, the Fed chair, said in a Peterson Institute for International Economics interview last week. “That is a lesson we’ll be carrying forward.”

For workers like Kathleen Dennis, a strong labor market recovery will be crucial. Ms. Dennis, 29, has typically held relatively low-wage jobs, working in restaurants for years. But after earning a certificate, she got a job as an administrative assistant at a behavioral health clinic in 2019, where she was making $14 per hour. She loved the work, and it allowed her and her son to get off government assistance programs.

Her story of labor market progress is just one example of what happened broadly over the long 2009 to 2020 expansion as the Fed moved rates only slowly, allowing the labor market to strengthen: Lower-wage workers transitioned into better jobs and began to earn a little more.

Now, the single mother is watching her recent progress evaporate. She was sent home with a cough from her job on March 13, and was furloughed before she could go back. She has applied for unemployment insurance and pandemic relief, but aside from a one-time payment, has struggled to qualify. Her savings account is down to $50 from $5,000, and though she usually lives with her parents, both have coronavirus, so she and her 2-year-old are staying with her boyfriend.

Ms. Dennis, who lives in Montgomeryville, Pa., is desperate to get back to work. Her company has not given her a return date, so she spends three to five hours each morning searching for new jobs. She has yet to receive a response to any of the four applications she has submitted since April.

“I’m panicking,” she said, explaining that she had to once again apply for food stamps and other government programs. “I’ve worked so hard to get off assistance, and now I’m right back on it.”

There is muted hope that the labor market will rebound quickly as lockdowns lift, pulling people like Ms. Dennis back onto payrolls. Most workers who have been fired since the crisis began have lost their jobs on a temporary basis, meaning they may be promptly called back: In a recent Fed survey, nine in 10 newly unemployed people said that their employers told them they would eventually return to work.

But if businesses begin to close, it could turn many temporary layoffs permanent — and at the Fed and among labor economists, that is seen as the most likely scenario.

The Congressional Budget Office estimates that by the end of 2021, the unemployment rate will be more than 5 percentage points higher than it was headed into the pandemic. Economists in a Bloomberg survey expect the unemployment rate to remain at 6.8 percent in 2022, about double its pre-crisis level of around 3.5 percent.

That is where the Fed could make a big difference, helping the labor market to stage another robust run by leaving rates at rock-bottom far into the future, boosting economic activity and generating more hiring. Already, officials have said the central bank has no intention of raising rates until “it is confident that the economy has weathered recent events” and is on track to achieve its targets.

Congress has given the Fed two goals: It aims for maximum sustainable employment and low but steady inflation, betting that if workers can take home paychecks that are not eroded by big price increases, the country can achieve sustainable prosperity.

Fed policy helped the economy to achieve its record-long stretch of growth and labor market progress after the last financial crisis. Officials waited years before raising rates, starting to do so only in late 2015.

Starting under Janet L. Yellen’s watch, and continuing after Mr. Powell took over as chair in early 2018, the Fed raised rates nine times as joblessness dropped, expecting price increases to accelerate as employers paid up to attract workers and charged more to cover their costs. It was the slowest set of rate increases in Fed history, and many warned that it risked breakaway inflation.

Instead, price gains remained tepid, and the Fed stopped moving rates up after December 2018. Critics since have questioned whether all of those moves were necessary.

The weak inflation took central bankers by surprise, so much so that after officials cut rates three times to cushion the economy amid President Trump’s trade war in 2019, they signaled that they would leave borrowing costs lower even as the risks abated.

The Fed seems inclined to allow the job market to run hotter for longer again.

“We are going to redouble our efforts to do everything we can to restore maximum employment,” Fed Vice Chair Richard Clarida said in a question-and-answer session Thursday.

The question is what policymakers think “full employment” means in the post-pandemic era. After the financial crisis, many believed that the labor market had shifted in a way that left structural unemployment — the rate that occurs even in an economy running at full speed — permanently higher. They increased their longer-run unemployment estimates, then steadily marked them back down as the labor market blew past their wildest expectations.

Mr. Powell has suggested that he’s not adjusting the goal posts this time around.

“We were able to move down to 3.5 percent and be there without really any reaction from inflation, or other imbalances in the economy,” Mr. Powell said of the unemployment rate in his Peterson remarks, calling that a great outcome and saying that while it will take time, “I have every reason to think we can get back there.”

While he is the Fed’s most powerful policymaker, though, Mr. Powell’s is not the final word. He holds just one vote of 12 on the rate-setting Federal Open Market Committee, and his term as leader ends in early 2022. He may be reappointed, but that will depend on who is in the White House and how that person feels about him. President Trump once called Mr. Powell his “enemy,” but has more recently called him his “most improved player” or “MIP.”

Fed officials will probably debate what full employment means once again, even if Mr. Powell remains in charge.

“One of the challenges to interpreting where full employment is after this shock is to think about how much structural change” is shifting structural unemployment, Eric Rosengren, president of the Federal Reserve Bank of Boston and a proponent of higher rates in recent years, said in an interview.

“Very few restaurants can make it on just takeout,” he said, as an example. “All of these structural changes may mean that we don’t need as many people doing service work, waiters and waitresses.”

America could get a first glimpse of what officials expect longer-run joblessness to look like in June, when Fed officials are scheduled to release their first economic projections of 2020, having scrapped the usually quarterly forecast in March.

Economists expect that the central bank will approach its full employment estimates — and the policy decisions they drive — with greater caution this time around.

“There’s going to be squawking about it, as always,” said Adam Posen, head of the Peterson Institute. “But this group has learned a lesson to always see whether unemployment can go lower.”

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