The noisy debate: so far there is little reason for the Federal Reserve to raise interest rates.

• Author: Berry, John M.

As the nation's jobless rate fell below 6 percent this fall, the good news intensified an already noisy public debate among some Federal Reserve officials over when to begin raising interest rates to keep inflation from jumping past the central bank's 2 percent target. After all, the central bank's policymaking group, the Federal Open Market Committee, said a year ago, when the jobless rate was 7.2 percent, that it would keep its overnight interest rate target close to zero "at least as long as the unemployment rate remains above 6.5 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well-anchored."

The two inflation metrics are still being met, but the falling unemployment rate has encouraged the band of inflation hawks on the FOMC to argue their points more vociferously than ever and to give a more moderate group some pause.

All the seventeen FOMC participants agree that eventually the Fed will need to tighten policy to withdraw the stimulus that has helped fuel the economic recovery. They have different opinions on when that should happen, and once it does, how fast interest rates should be increased and what might be their eventual top level. However, in September, fourteen of the seventeen said that by the end of next year the target should be roughly between 1 percent and 2 percent. At the extremes, two said rates should not be raised at all next year and one said the target should be close to 3 percent.

Most of these rate projections actually show an aggressive path for rates that is not likely to be justified by developments in either the U.S. or the world economy. To get overnight rates to 2 percent by the end of 2015, the FOMC would have to start that process with a quarter-point increase at its late January meeting and do the same at its other seven sessions during the rest of the year. Alternatively, if the first move were to come in midyear, as a number of officials have suggested, getting to 2 percent would take four consecutive half-point steps.

Again, based on their September appropriate policy projections, a majority of the committee said the rate target should be close to 1.5 percent or higher by next year's end. Thus, they want at least quarter-point increases beginning in the spring.

FOMC statements and numerous public comments by Fed Chair Janet L. Yellen have stressed that decisions on withdrawing stimulus are "data dependent." So far, data on inflation and other indicators that might be considered precursors of inflation, such as increases in wages, certainly do not support such rapid rate hikes.

The reason for using the jobless rate as an important indicator in setting interest rate policy is the concept of the natural rate of unemployment, and the related measure known as the NAIRU--the non-accelerating inflation rate of unemployment. That is, there is a jobless rate at which inflation would be neither increasing nor falling. Some therefore regard it as, effectively, a measure of sustainable full employment. If the unemployment rate falls below this natural rate, employers will find it necessary to boost workers' pay more rapidly in order to fill vacancies and increase the production of goods and services-- and in the process generate more inflation.

Unfortunately, the natural rate can't be measured directly, it changes over time, and it's hard even to estimate, certainly with any precision. A couple of decades ago at one of the Kansas City Federal Reserve Bank's annual seminars in Jackson Hole, Wyoming, economist Edmund S. Phelps of Columbia University, later a Nobel Prize winner, announced that his research showed...