By Jon Hilsenrath


During the past five years, the U.S. unemployment rate has dropped on average by 0.8 percentage points every 12 months. If that pace of decline were to persist, the jobless rate would hit 4.8% by December and 4% by December 2016.

However, Fed officials don’t think it will last.

In forecasts released last week, officials projected the jobless rate would fall to 5.2% or 5.3% by year-end, meaning little additional decline from the 5.5% registered in May or the 5.6% rate registered in December 2014. From there, officials see the rate settling at around 5% in 2016 and 2017. The decline in unemployment, in other words, has already nearly run its course, according to the Fed’s projections.

These projections are fraught with uncertainty, a point Fed Chairwoman Janet Yellen acknowledged in a press conference last week. The Fed has consistently underestimated how fast the jobless rate would fall in this recovery. In December 2013, for example, officials projected it would settle between 5.3% and 5.8% by the end of 2016. Instead it did so by December 2014, two years sooner than anticipated. In December 2012, officials thought the jobless rate would still be well above 6% at this point in the expansion.

Seeking to explain the Fed’s latest forecast, Ms. Yellen said last week that officials expect worker productivity growth to pick up in the months ahead. If that were to happen, firms would face less pressure to hire workers and that could thus slow the absorption of unemployed workers into jobs. Moreover, more individuals could re-enter the labor force, boosting the supply of labor and keeping the jobless rate elevated.

Yet the Fed misjudged the performance of worker productivity and labor force participation earlier in this recovery. Some analysts doubt it is right this time around. “The Fed’s forecasts for unemployment are so cautious as to be scarcely credible,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a recent research note.

What could go wrong with its forecast now and shift the interest rate outlook? This is one area to watch closely. If the jobless rate keeps falling at the pace already established in this expansion, Fed officials might find there is less slack in the job market than they expected, and be forced to raise interest rates more aggressively than planned.

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