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The Limits of Fed Policy, Per Its Chairman

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Although the Federal Reserve expects the U.S. economy will continue to expand along with a strong labor market and moderate inflation, the economy faces several long-term issues that are beyond the Fed’s scope or ability to address, according to its chairman, Jerome Powell.

Speaking before the congressional Joint Economic Committee in a prepared statement and question and answer period, Powell said labor force participation, which lags most other developed economies, and slowing productivity gains are key economic concerns but not necessarily ones the Fed can address.

“Think of the economy’s ability to grow as consisting of two things: how fast the labor force is growing and how much output per hour is growing,” said Powell. He added that trend growth of the labor force now is very slow — 0.5%, down sharply from 2.5% in the 1960s — and immigration accounts for about half of current growth rate.

“Immigration is a key input into our longer term growth rate,” added Powell. “If you look to population growth as a way to support higher growth in the U.S. then immigration would need to be in your thinking, but it’s something we don’t comment too much on.”

Neither is labor force growth or the growth of government debt — both matters for fiscal policy.

“The debt is growing faster than the economy … in nominal terms,” said Powell. “That is by definition unsustainable … Even with lower rates and with decent growth there is still going to be a need to reduce these deficits … over time.”

On monetary policy, which the Fed does control, Powell said the Federal Open Market Committee, which sets policy, sees “the current stance of monetary policy as likely to remain appropriate” so long as incoming economic information “remains broadly consistent” with the Fed’s outlook of moderate growth, a strong labor market, and inflation near its 2% target.

If there are developments that cause the Fed to reassess its outlook, however, the Fed will respond, said Powell. “Policy is not on a present course,” he said, repeating a statement he has made many times before.

The central bank has lowered the federal funds rate three times this year to a current range of 1.5%-1.75%. Its policymakers meet one more time this year, on Dec. 10 and 11, but no change in rates is expected. The CME FedWatch tool is currently showing less than 4% odds of another Fed rate cut.

When asked by Rep. Don Beyer, D-Va., if the Fed has enough room to cut rates during the next recession, Powell said there was “less room to cut in the new normal of lower rates and lower inflation,” which is an issue for many central banks around the world. Fed rate cuts during recessions since World War II typically total 5%, Powell said.

Asked about the prospects of negative rates in U.S, Powell said that would not be appropriate in the current U.S. economic environment and tends to be adopted in larger economies when “growth is quite low and inflation quite low. It’s just not the case here.”

The limited ability of the Fed to cut rates in the next recession was the impetus for its current external review of monetary policy. “We’re looking for ways to make sure that we have the tools to do what we’re assigned to do … achieve maximum employment and stable prices even during downturns,” said Powell.

He said the Fed expects to finish the review by the middle of next year and noted that monetary policy is not the only response to an economic slowdown. “Fiscal policy is often a big part of the answer when there’s a severe downturn.”

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