Too Soon for a Rate Increase

Nicole Woo

This week, the Federal Open Market Committee (FOMC) is meeting to review the current state of the economy and decide whether or not to make any changes to monetary policy to promote the Federal Reserve’s goals of “maximum employment, stable prices, and moderate long-term interest rates.”

The main policy tool available to the Fed at this juncture is raising the federal funds interest rate, which has been pegged at essentially zero for over six years. While Fed watchers and other experts don’t expect the FOMC to raise rates at this meeting, they’ll be hanging on every word of the FOMC’s announcement and Federal Reserve Chair Janet Yellen’s press conference afterwards to find out if they plan to raise the rate sooner rather than later this year.

Most of Wall Street appears to be expecting that the FOMC will wait until September or October to raise the rate, but a growing number of voices are predicting that the recent strong jobs report, which reported 280,000 jobs added to the economy in May, could motivate it to raise the rate as early as July. Another reason that is cited to support a rate increase is the fact that the official unemployment rate is currently at 5.5 percent. While that is a healthy drop from the peak of 10 percent in October 2009, many experts point out that in this weak recovery, that rate may not be an accurate measure of “full or maximum employment.” This is because the official unemployment rate fails to account for the significant numbers of part-time workers who’d like more hours, discouraged workers who’ve given up even looking for work, and others who are not counted as part of the labor force.

One way to get around these issues and more directly measure the recovery is to look at the employment to population ratio (EPOP), which basically is the percent of the population that is employed. My colleague at the Center for Economic and Policy Research, Nicholas Buffie, recently did just that.

His analysis shows that, for prime-age (25 to 54 years old) workers, the EPOP was 79.7 percent at the start of the recession in December 2007. During the downturn, the prime-age EPOP hit a low of 74.8 percent, or a drop of 4.9 percentage points. By March 2015, the EPOP has risen to 77.2 percent, or an increase of 2.4 percentage points. In other words, we’re less than halfway back to where we were before the recession.

When you look at different demographic groups, the story is even more telling. For example, the prime-age EPOPs for Asian-Americans has seen just a 15.3 percent recovery. Latino Americans have fared better than other ethnicities, but have only recovered 57 percent of employment lost to the recession. Prime-age African-Americans saw their EPOP drop by 8.1 percentage points, from 74.8 to 66.7 percent, during the recession. By March 2015, African-Americans’ EPOP has risen to 71.0 percent, which means that there are still 4.3 percentage points to go. That means that prime-age African-Americans still need to close an employment gap that’s almost as large as the entire decrease faced by whites during the recession.

It’s also worth noting that before the recession, the 74.8 percent EPOP for African-Americans is equal to the lowest point for whites during the recession. In other words, black Americans were already experiencing the equivalent of a white American recession before the economy crashed at the end of 2007.

So what does this mean for the Federal Reserve? The implications seem obvious: The labor market is still far from fully recovered, so we’re not anywhere near ready to raise interest rates. Prime-age workers’ overall employment is only about halfway back to where it was before the recession, and when you look at different demographic groups, it becomes clear that as African-Americans lost the most during the downturn, they still have the most to gain from the recovery.

Simply put, if the FOMC raises rates too early, then those groups that were harmed the most by the recession will also lose the most by the resulting halt to the recovery.