Higher Growth Rate Could Be New Fed Target
Policy + Politics

Higher Growth Rate Could Be New Fed Target

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In the wake of last month’s disappointing employment report, Federal Reserve Board chairman Ben Bernanke has his eyes firmly fixed on the nation’s lagging job market.

In testimony before a joint committee of Congress on Thursday, the head of the nation’s central bank said higher growth rates will be necessary for millions of out-of-work Americans to find jobs. He even set a benchmark for measuring the economy’s job-creation potential: 2.5 percent. If growth is at or below that level, he said, “the improvement in the unemployment rate going forward might be quite limited.”

Economists at the Fed are working on a new set of economic projections for the policy-setting committee meeting that takes place later this month. Its latest survey of economic conditions across the country noted some improvements, but found much of the country was still struggling to emerge from another sluggish growth patch.

Moreover, the latest slowdown in hiring probably reflected an end to post-recession catch-up hiring. When sales drop sharply – as they did in the depths of the Great Recession – companies tend to lay off more workers than necessary. When sales growth resumes, they squeeze more productivity out of their existing workforce rather than rehire out of fear the bad times will return quickly.

Eventually companies have to add new workers, which probably accounted for a healthier job market last fall and winter than economic conditions warranted. But now, with the catch-up period over, only growth “higher than trend” can lead to robust job growth, Bernanke said. “The key question is will growth be sufficient to improve the labor market.”

The Fed chief does see some encouraging trends, especially in the housing market where construction has picked up reflecting an improvement in homebuilders sentiment and a stabilization in prices. But federal spending policies – the first of the 10-year, $1 trillion in cuts from last summer’s Budget Control Act are now starting to take full effect – have become a significant drag on economic growth, he said.

And, of course, the evolving situation in Europe continues to worry central bankers across the world. The Fed is prepared to pump liquidity into the global banking system “if the financial stress escalates,” he said.

What steps could the Fed take if the job market doesn’t rebound to a level where it can create 200,000 jobs a month or more, which is necessary to substantially lower the unemployment rate?  Bernanke offered few clues other than to say the Fed still had plenty of options.

He also gave a spirited defense of the Fed’s earlier efforts at lowering long-term interest rates through quantitative easing, where the central bank buys government or agency bonds. “They lowered interest rates,” he said. “It raised stock prices, which increased wealth effects for consumers. . . We continue to believe that potentially these sorts of measures could still add some additional accommodation, additional support to the economy.”