Rising Labor Force Participation Means “More Room to Grow”

Neither the prepared remarks nor the Q&A for the first day of the semiannual monetary policy testimony changed on our views on the outlook for monetary policy—our baseline continues to be no rate moves this year. 

Powell reiterated that, as a result of muted inflation, the Committee is able to be “patient” and therefore is in a “wait and see” posture while it looks to see if downside risks are realized. There was no unfavorable reaction from U.S. senators today on the plan to be patient and “wait and see” before proceeding with any further rate hikes. Powell even made sure to reiterate the “patience” message one last time before the testimony concluded. Some policymakers have moved away from describing the FOMC’s current stance as a pause before further rate hikes, instead preferring to talk about future moves in more symmetric terms. That change in messaging in line is in line with our interpretation of the change to the forward guidance in the January statement. The guidance now refers to “adjustments” in the fund’s rate—which we interpret as “up or down” 

—as opposed to the previous language about gradual “increases” in the funds rate. 

His comments on the economic outlook were in line with his most recent remarks: First, he described “current  economic conditions as healthy and the economic outlook as favorable.” The latter (“favorable”) represents slightly less enthusiasm than “strong,” the word he regularly used to describe the outlook earlier this year.  He described the job market as remaining “strong.” Second, he drew attention to downside risks: “Over the  past few months we have seen some crosscurrents and conflicting signals.” These are the downside risks he has emphasized. 

Labor market issues were a point of emphasis both in Powell’s prepared remarks and in the Q&A. Powell put  particular emphasis on the strong labor market bringing people into the labor force: “the ample availability of  job opportunities appears to have encouraged some people to join the workforce and some who otherwise  might have left to remain in it.” He indicated that this is an area where his views have evolved in recent  quarters: “We have learned this year that there’s more slack in the labor market because people are coming  back in.” Despite the progress already made on this front, he suggested that there’s room for further 

improvement in labor force participation: “that tells us that there is more room to grow, and that certainly  has implications for monetary policy.” If there is more slack, there is less upward pressure on inflation, so the economy can continue to grow faster than the trend without inflation rising as much. He also said that the unemployment rate would be lower if the labor force participation rate had not edged up, implying that the increase in the participation rate had contributed to muted inflation. Despite the strength of the labor market,  there was virtually no concern about the possibility of overheating. When discussing the pick-up in wages,  Powell emphasized that he saw this as welcome and not inflationary: Wages “have now started to move up  in a way that’s more consistent with past history and with inflation and productivity.” 

This was Powell’s first testimony since the FOMC announced at the January meeting that it intended to stay in the current regime of abundant reserves. Senators didn’t contest that decision, though they asked questions relating to it. The gentle questioning regarding the Fed’s decision to maintain a large balance sheet was quite a contrast to the strong opposition in previous years. Powell did mention that there are public estimates of the minimum quantity of reserves necessary to operate in this regime, roughly $1 trillion-plus a buffer. He  

saw these estimates as “a reasonable starting point, an estimate of where we might wind up.” He added that  reserves demand is “very substantially higher than it was before the crisis and will not go back to those  levels.”  

It was also Powell’s first testimony since the Fed announced its policy review taking place this year and indicated it would consider changes to its policy framework. On this front, there were some concerns. One senator noted that one option that has been discussed is price-level targeting, and he questioned whether aiming for above-target inflation for some time because of a previous shortfall would be consistent with the price stability mandate. The tone was fairly conciliatory, but it’s still early in the review process and this served as an initial preview of pushback the FOMC might receive on its interpretations of and approaches to meeting the dual mandate. (See our commentary on Clarida’s speech for more details on the review.) For his part, Powell handled that pushback well. He explained the motivation for the Fed’s review, namely the problems associated with the effective lower bound, and said that the Fed owed it to the public to undertake a comprehensive analysis of how it might best meet its mandated objectives. He underscored that “inflation  expectations are the most important driver of actual inflation.” He acknowledged there might be drawbacks to various approaches, but wouldn’t rule out anything before the review. 

Of course, as is always the case for the Chair’s monetary policy testimony, Powell faced questions on a very wide range of topics. Powell warned that the debt ceiling negotiations could have adverse consequences:  “The idea that the United States would not honor its obligations and pay them when due is not something  we can consider,” adding that it was a “bright line.” Powell also revealed a bit more on his views on topics less directly related to monetary policy, such as health care costs, the interaction between labor force participation and public policies, and low-income programs. Indeed, he went as far as espousing maximizing  labor force participation as a worthy policy goal: “We ought to have policies that reward and support labor 

force participation.” But he was tight-lipped on the effects of U.S. trade policy, except for a peculiar comment  that “over time, we’d like to see balance both in savings and investment and in the trade balance.” When asked about deficits, he pushed back strongly against the idea that the U.S. debt ratios are inconsequential or that the Fed would directly fund specific programs: “The idea that deficits don’t matter for countries that can borrow in their own currencies I think is just wrong…We’re going to have to either spend less or raise  more revenue.” He also declined to answer a question about the communication between the Trump White  House and the Fed on interest rate policy. 

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