The economists forecast the strong labor market should put the Federal Reserve on track to raise interest rates once a quarter, even if inflation remains below the Fed’s 2 percent target.
Missing in the recovery has been a steady rise in inflation, signs of which are also missing in the labor market, in wage acceleration. The markets have doubted the Fed will be able to raise rates because of the lack of inflation, but Goldman economists disagree.
Looking at such measures as the long-term unemployment rate, job openings and quits, and reports of skill shortages, “the labor market is about as tight as in the full-employment years 2006 and 1989, though not yet as overheated as in 2000. And while the recent hard wage data have mostly disappointed, surveys of wage growth among employers and households signal a wage acceleration to around 3 percent by the end of 2017,” they wrote. Wage growth in July was 2.5 percent on an annual basis.
The economists said broader growth measures also look firm, and third-quarter GDP is tracking at about the same as the 2.6 percent reported for the second quarter. However, the rebound in productivity growth is fading. They forecast second quarter was a weak 0.6 percent.
The economy needs to grow at a rate of 1 percent to stabilize the unemployment rate in the short term, a pace below their longer-term potential growth forecast of 1.75 percent, they noted.
“We have made a sizable downward revision to our forecast for the unemployment rate by the end of 2018, 3.8 percent from 4.1 percent previously. Our new forecast is 0.4 pp below the FOMC’s median projection as of June and would match the generational trough reached in early 2000,” the economists wrote. The last time unemployment dipped below 4 percent was in 2000.