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Feds Base Interest Rates on 'Natural' Unemployment

By James Risen
Los Angeles Times

With little public debate, the Federal Reserve Board is increasingly basing interest rate decisions on the controversial assumption that the nation's unemployment rate cannot be reduced much below 6 percent without igniting inflation.

At an annual Federal Reserve conference on economic and labor policy held this weekend in Jackson Hole, Wyo., Fed officials privately acknowledged that they have come to rely on the 6 percent jobless figure as a key benchmark for setting interest rates.

The nation's central bank already has raised interest rates five times this year in an effort to curb the threat of rising prices that often accompany rapid economic growth. While Fed officials concede there has been little evidence so far of surging prices, they argue that the relatively fast pace of growth this year would ultimately fuel inflation if they failed to intervene.

In public and private alike, Fed officials insist that their long-term goal is not to force the country into a recession for the sake of low inflation, but to keep the economy on an even keel, growing at a rate that can be sustained without rapid price increases.

"Monetary policy actions geared to promoting price stability will enhance real growth over time," argued Jerry Jordan, president of the Federal Reserve Bank of Cleveland and one of the participants in the weekend conference.

Yet increasingly, Fed officials tend to gauge whether the economy is overheating partly by referring to what they call the "natural rate of unemployment." That is defined by economists as the lowest level of unemployment that can be sustained without putting inflationary pressures on the economy .

In the 1970s, economists used a benchmark called "full employment," and it was generally agreed to mean an unemployment rate of about 4 percent. But today, Fed officials and many economists believe that the economy cannot long sustain an unemployment rate below about 6 percent without causing wages and prices to begin to spiral upward.

Fed officials here acknowledged there is still considerable debate about the precise level of "natural" unemployment; some conservatives believe that it could be as high as 6.5 percent, while others believe it could be slightly under 6 percent. But there is general agreement inside the central bank that U.S. unemployment, which drifted down from 6.9 percent in mid-1993 to 6 percent in June of this year, is very close to the natural rate. That, in turn, helps explain why the Fed has moved repeatedly in recent months to boost interest rates. Fed officials stress that they use many other economic barometers as well but the natural rate of unemployment is clearly one of the most controversial at the central bank's disposal.