Three Hidden Words From Fed Insiders Point to Much Higher Rates

The Federal Reserve’s influential staff judges that under the surface the US economy is running even hotter than they thought, helping to explain why inflation remains at a 40-year high and providing reason to expect even more interest-rate hikes.

Tucked within 12 dense pages describing the Fed’s September policy meeting last week was a statement concerning a seemingly innocuous yet vital estimate that the staff use as a building block for internal economic forecasts.

Their gauge of US potential output was “revised down significantly,” the minutes showed, due to disappointing productivity growth and slow gains in labor force participation.

Potential gross domestic product is essentially an estimate of how fast the economy can run without breaking a sweat in the form of tightening resources and higher inflation. The new estimate was not disclosed -- nor was the prior one.

Even so, “the policy implication is significant,” said Anna Wong, chief US economist at Bloomberg Economics. “Lower potential growth means the economy has been more overheated last year and this year than realized, and it will take more rate hikes or a longer period of below-trend growth to close the output gap,” said Wong, a former Fed economist.