Economist points toward link between interest rates and employment

The Federal Reserve raised its Federal Funds interest rate to 3.00 percent on Tuesday, May 3, and three days later the Bureau of Labor Statistics announced that the U.S. economy created 274,000 jobs during April. Mitchell J. Held, an economist and market analyst for Citigroup, encouraged the business group he addressed in Minneapolis on May 3 to pay attention to those two numbers. The Fed will increase the rate of interest rate hikes if it senses the labor market heating up, Held said.

“The most important factor in looking at the Fed Funds rate over the next three or four months will be the unemployment rate,” Held said. “If the unemployment rate drops below 5 percent and stays there, I would not be surprised to see before the end of the year, the pace of rate hikes pick up.”

Despite the healthy growth in job numbers, the unemployment rate remained unchanged at 5.2 percent for April. That’s compared to 5.5 percent in April 2004, and 6.3 percent in June of 2003. After gains of 300,000 jobs in February and 146,000 jobs in March, total employment stands at 133.3 million jobs. The Bureau of Labor Statistics said the April gains came from new hires in construction, mining and service businesses.

Held said that two-thirds of the cost of any product is labor, so if labor costs go up, the Fed begins to worry about inflation. “When you start to get below 5 percent unemployment, that’s when wages start to get bid up,” he said.

Held said he expects the Fed Funds rate to be between 3.5 percent and 4.0 percent at year end, and trend as high as 4.75 percent in 2006. “At that point, we think the Fed will become more neutral in nature." (The neutral rate is the rate at which it neither stimulates nor deters economic growth.)

Held is generally optimistic about the condition of the economy. Although many observers have said the economy is “going through a soft patch,” Held said the country’s foreign exchange policy and fiscal policy, in addition to the Federal Reserve’s interest rate policy, are all encouraging economic growth.

The widening trade deficit, coupled with a perception that European economic growth will be greater than U.S. growth, has put the dollar “under some downward pressure,” Held said. “Downward pressure tends to promote economic growth. Foreign exchange policy is not particularly restrictive at this point.”

Tax collection for the month of April was higher than expected, Held said. Budget deficit estimates are going to be reduced sharply, he said, estimating the 2005 deficit “somewhere south of $350 billion.” Spending, he said, remains a problem. “Unfortunately, people on both sides of the aisle have not forgotten how to spend,” he cautioned. “Nobody is serious about any spending restraint. Fiscal policy itself is not particularly restrictive at this point.”

The core inflation rate is 2.3 percent, creating a real Fed Funds rate of 0.70 percent, Held said. “People would say that is still accommodative. Anything north of a real Fed Funds rate of 2 percent is restrictive.” The Fed has a lot of room to raise rates, given the current inflation situation.

“The three policies are clearly not restrictive and may be even accommodative,” Held summarized. “Until one of those policies becomes restrictive I don’t know how this economy grinds to a halt. There are no policies standing in the way.”