The FOMC’s failure to deliver on its first step towards normalization of monetary policy surprised many market participants and other observers. Despite improving GDP growth prospects and improvements in labor market conditions, the Committee chose to delay acting. Chair Yellen provided some clarity at the ensuing press conference to the Committee’s reasoning by emphasizing what she had been saying all along: that the Committee wants to see additional improvement in labor market conditions and more progress towards its inflation objective.
But here is where it got confusing. She noted the impacts that the appreciation of the dollar and slowdown in economies abroad were having, but she declined to indicate how important those factors were in tipping the committee towards inaction. At the same time, she emphasized that the Committee’s projections were not significantly different from last June’s, and she tended to discount the recent pullback in inflation numbers as being transitory. Chair Yellen pointed to the Committee’s expectation that inflation next year will move significantly back towards its two percent objective. So if little has changed and the inflation projections are on track, what more does the Committee need to see? On this point, she fell back on the need to see more improvement in labor market conditions, pointing specifically to the desire to see a further drop in the U-6 measure of unemployment and reversal of the recent decline in the participation rate. On this latter point she did make a slip that no one in the press conference picked up on. She said the participation rate had fallen below its recent trend. Well, as the chart below shows, the participation rate has been declining ever since it peaked in 2000 at 67.3%. So it is not clear what trend line Chair Yellen was referencing.
Furthermore, we don’t even know what a reasonable participation rate target should be. The chart obviously gives no clue as to what the equilibrium rate should be, and there is no guidance from other countries. Additionally, while the Great Recession clearly had an impact on the participation rate, other demographic factors are now coming into play to push it down, such as the aging of the US population and changing preferences for leisure vs. work in the population.
Additional confusion has now been introduced by the September “Summary of Economic Projections.” As Chair Yellen indicated, there has been a slight downtick in the median projections for GDP growth in 2016 and 2017, some further improvement expected in unemployment from 2015 through 2017 (to a rate below the Committee’s long-run estimate), and a slight downward revision in projected inflation. All of these differences are at most one to two tenths of a percentage point. At the same time, confidence in the forecasts has declined, as evidenced by a general widening of both the measure of the central tendency and the forecast range.