Economic Letter

The Federal Reserve has started the process of raising interest rates, in line with ongoing improvement in U.S. economic conditions. The path for subsequent interest rate increases, however, is likely to be shallow compared with past tightening cycles. This reflects in part growing evidence that the new normal for interest rates is lower than in the past. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the California Bankers Association in Santa Barbara, California, on January 8.

Setting a higher minimum wage seems like a natural way to help lift families out of poverty. However, minimum wages target individual workers with low wages, rather than families with low incomes. As a result, a large share of the higher income from minimum wages flows to higher-income families. Other policies that directly address low family income, such as the earned income tax credit, are more effective at reducing poverty.

The minimum wage has gained momentum among policymakers as a way to alleviate rising wage and income inequality. Much of the debate over this policy centers on whether raising the minimum wage causes job loss, as well as the potential magnitude of those losses. Recent research shows conflicting evidence on both sides of the issue. In general, the evidence suggests that it is appropriate to weigh the cost of potential job losses from a higher minimum wage against the benefits of wage increases for other workers.

The U.S. economy is on the cusp of full health, supported by highly accommodative monetary policy in recent years. The labor market is nearing maximum employment. Inflation remains too low, but measures of its underlying trend suggest that it is not far from the Fed’s 2% target. With real progress toward these goals, the conversation has turned to normalizing policy. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to community leaders in Portland, OR, on December 2.

After peaking in 2006, the median U.S. house price fell about 30%, finally hitting bottom in late 2011. Since then, house prices have rebounded strongly and are nearly back to the pre-recession peak. However, conditions in the latest boom appear far less precarious than those in the previous episode. The current run-up exhibits a less-pronounced increase in the house price-to-rent ratio and an outright decline in the household mortgage debt-to-income ratio—a pattern that is not suggestive of a credit-fueled bubble.

Labor costs constitute a substantial share of business expenses, and it is natural to expect wages to be an important determinant of prices. However, research suggests that wages do not contain much useful information for forecasting price inflation that is not available from other indicators. Therefore, one should not infer too much from recent wage data regarding the future path of inflation.

Short-term interest rates in the United States have been very low since the financial crisis. Projections of the natural rate of interest indicate that a gradual return of short-term interest rates to normal over the next five years is consistent with promoting maximum employment and stable inflation. Uncertainty about the natural rate that is most consistent with an economy at its full potential suggests that the pace of normalization may be even more gradual than implied by these projections.

The recent Federal Open Market Committee decision to hold off on raising interest rates reflected conflicting signals, with favorable U.S. economic conditions offset by downside risks from abroad. However, the economy continues to make progress toward achieving the FOMC’s goals. If developments stay on track, the process of monetary policy normalization is likely to start later this year. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the UCLA Anderson School of Management in Los Angeles on September 28, 2015.