Federal Reserve vice chairman Stanley Fischer issued a vote of confidence Wednesday night that inflation will rise in the U.S. if unemployment continues to fall, providing one possible reason for the Fed to raise rates sooner rather than later.
Fischer expressed faith that the Phillips Curve, the historical relationship between falling unemployment and rising prices, will soon reassert itself. That dynamic would be a reason for the Fed to tighten monetary policy even with inflation low.
Fischer’s bet on the link between falling unemployment and inflation is one that other members of the central bank have rejected in recent weeks, saying that the Fed should not raise rates even though the unemployment rate is low.
“I believe that we will see it, the Phillips Curve will come back,” Fischer said in an question-and-answer session at the Embassy of Canada in Washington.
The question is relevant because inflation has been running close to zero even though the unemployment rate has fallen to 5.1 percent, near the rate that Fed officials have estimated is consistent with a fully health economy. The Fed’s inflation target is 2 percent.
Fischer suggested that the reason that inflation remains dormant could be lagging productivity.
With higher productivity, or economic output per worker, wages would be rising faster, Fischer said. He gave wage growth of 3 percent or 3.5 percent as a possible range, rather than the roughly 2 percent annual growth seen in recent months.
“With productivity not growing, there’s not a lot of force today in the economy for real wages to rise,” Fischer said.
Nevertheless, he predicted that the situation would soon change, and that the Phillips Curve would again be relevant.
“There are many things in economics that come late, and you’re always waiting for them and you say, ‘Ugh, this damn thing’s broken down,'” Fischer quipped. “It’ll be back.”
Those remarks run counter to recent public statements from other members of the Fed’s Board of Governors.
In mid-October, Governor Lael Brainard said that, based on recent evidence, “the classic Phillips curve influence of resource utilization on inflation is, at best, very weak at the moment.”
In a recent interview with CNBC, Governor Daniel Tarullo made similar comments, suggesting that rather than rely on historical relationships, the Fed should look for actual data that inflation is rising to the 2 percent target.
Both governors weighed in against the Fed raising rates in 2015, suggesting that the central bank should keep its interest rate target near zero well into 2016 to make sure that it hits its inflation target and keeps the recovery on track.
Fischer, however, along with Fed chair Janet Yellen, has said that a 2015 rate hike is likely. Yellen has said that the Fed must act based on its projections, rather than actual data, because its policies can take a long time to affect the real economy. The Fed’s next monetary policy meeting, and its last of the year, is scheduled for Dec. 15 and 16.
In his comments Wednesday night, Fischer also suggested that inflation is not currently as low as the headlines would indicate.
Setting aside volatile price changes in energy and food, core inflation is 1.3 percent in the metric the Fed favors, he noted.
Once the effects of the recent drop in oil and appreciation of the dollar work their way through the inflation data, “we’re not that far from the 2 percent target,” he said.
