(Bloomberg) — As the U.S. jobless rate reaches the range that the Federal Reserve defines as full employment, some Fed officials are asking a question: How low can you go?
Their answer: less than the 5.2 percent to 5.5 percent the Fed currently defines as the lowest that can be achieved without heating up inflation. Some Chicago Fed economists say this sweet spot, often called full employment or the natural rate of unemployment, may be as low as 5 percent.
Their boss, Chicago Fed President Charles Evans, is among policy makers who have lowered their estimates for the normal rate. “I now think that it might be something more like 5.0 percent,” Evans said in a speech Wednesday.
He’s not alone. “A few” members of the policy-making Federal Open Market Committee lowered their estimates in light of “continued softness” in inflation, according to minutes of the Jan. 27-28 meeting, which didn’t identify the officials.
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The question is more than academic: It may influence how much longer officials keep interest rates near zero, where they have been since December 2008. Policy makers will next estimate their view of long-run unemployment at the March 17-18 meeting in Washington, and are likely to lower the goal, said JPMorgan Chase & Co. economist Jesse Edgerton in New York.
If officials shift their views, “you would argue to hold rates lower for longer,” said Edgerton, a former Fed economist.
Investors now see the Fed keeping rates low even longer than policy makers themselves do. Futures based on the federal funds rate imply a rate of 0.51 percent in December 2015. Fed officials expect the benchmark funds rate to trade in a range between 1 percent and 1.25 percent by the end of 2015, according to the median estimate of their quarterly forecasts in December.
One reason the long-term unemployment rate may be lower than officials currently estimate: Demographic changes mean the out-of-work population includes fewer hard-to-employ groups such as teenagers and is more dominated by older, better-educated people.
That implies more room for the unemployment rate to fall because those people are more likely to have skills that are in demand. Such changes in the labor force mean the jobless rate representing full employment has dropped as much as 0.6 percentage point since 2000, according to the research by the Chicago economists.
“This is a matter of debate and continuing discussion,” Atlanta Fed President Dennis Lockhart said Feb. 6, adding he is “certainly sympathetic” with the idea of a lower rate.
The Fed’s definition of full employment is taking on added urgency as joblessness has fallen more quickly than policy makers expected. The Labor Department reported Friday that unemployment fell to 5.5 percent in February, the lowest level since May 2008. The jobless rate will be 5.4 percent at the end of the second quarter and 5.3 percent at the end of the third, according to the median estimates of 65 economists surveyed by Bloomberg News Feb. 6 to Feb. 11.
Getting the unemployment target wrong could be a costly mistake. The Fed’s mandates from Congress include price stability, which it defines as 2 percent inflation, and maximum sustained employment.
Declaring full-employment victory while the jobless rate remains too high could leave the central bank with monetary policy that’s too tight and limits job growth. Aiming for a too-low jobless rate might cause the Fed to be late dealing with inflation or asset-price bubbles.