I would say that most of the [tightening] conditions that were laid out in the minutes as of right now seem to be . . . on the verge of broadly being met.I think the Federal Reserve minutes were pretty clear that a number of conditions would be necessary but if those conditions were met it would be appropriate to raise rates. One of the conditions was economic growth picking up in the second quarter. Given that real GDP was only a half a per cent in the first quarter that is a relatively low threshold. If you look at how the data has actually been coming in I was a little surprised that there was not more of a market reaction to the very strong retail sales for April. If you look at the economic forecasters in the private sector most of them have raised their consumption forecasts for the second quarter to be in the range of 3 per cent to 3.5 per cent. When consumption is roughly two-thirds of GDP, a number that high for that major a component means that it is likely we will see growth around 2 per cent.
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The second condition was labour markets continuing to strengthen. While the payrolls number was a little lower than market expectations it is still consistent with a gradually tightening labour market. 160,000 jobs is well above what we are going to need in order to take into account new workers coming into the labour force. If we were to continue to get 160,000 jobs [a month] it is less than what we were getting in the first quarter of a little bit above 200,000, but it is well above what we need to have a gradual tightening of labour markets.
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We are still a month away from the actual meeting. We are going to get another employment rate in early June. We are going to get a second retail sales report. So I want to be sensitive to how the data comes in, but I would say that most of the conditions that were laid out in the minutes as of right now seem to be . . . on the verge of broadly being met. We have more data to observe before we actually go into the meeting. If we were to get a lot of weak data between now and when the meeting occurs that would obviously influence how I was seeing the economy. Just focused so far on what we have seen to date since the last FOMC meeting, and broadly all that data has been pretty supportive of the criteria that were laid out in the minutes.

An interesting implication of this demographic shift is that the unemployment rate should perhaps be lower at so-called “full employment.” Younger workers tend to have higher unemployment rates, since they are only beginning to acquire the skills needed by employers. Older workers tend to have very low unemployment rates if they remain in the workforce. As a result, the estimates of the unemployment rate at full employment need to consider whether changes in the demographic composition of the workforce have an impact. This is one reason why I personally have lowered my estimate of the natural rate of unemployment to 5 percent, and I believe it may need to be adjusted even lower if inflation continues to undershoot our forecasts.

The economist John Maynard Keynes said that in the long run, we are all dead. If he were around today he might say that, in the long run, we are all on Social Security and Medicare.

I especially want to highlight my unease with using the term “imbalances” to characterize the current situation. That term almost begs for a policy response—how can policymakers allow imbalances to persist? Unfortunately, policy responses could well involve damaging protectionist measures. I will argue that, to a large extent, the current situation is not fundamentally an imbalance but rather a condition that is conducive to coping with the major demographic changes that are occurring throughout the world.

When a population can be characterized as middle aged, then the economy should tend to have a higher saving rate than when it can be characterized as elderly. Thus, as the population of a country moves from middle aged to elderly, it is reasonable to expect a country’s saving rate to decrease. Unless the country’s investment rate moves identically, foreign capital flows and current account balances will be affected. Exactly how depends on the change in investment.

In this country, we have become accustomed to (net) increases in employment of at least 150,000-160,000 workers per month on average, roughly equal to the average monthly addition to the labor force. But labor force growth is projected to slow appreciably over the next ten years as the baby boom generation retires; depending on which reputable set of projections you select, we should probably expect monthly increments to the labor force of 110,000 on the low end to 150,000 on the high side. Increases in employment will adjust down similarly, other things equal, since people who are not available cannot be hired. Moreover, to the extent that labor force participation rates level off or decline—and this is widely anticipated in part because of the end of the run-up of participation rates of women—increases in the labor force will be even smaller than the estimates I just cited, probably by several tens of thousands per month.

A rise in saving can achieve that shift because the extra savings would be used to increase the nation’s stock of capital and increase our net holdings of foreign assets.  Increasing the amount of productive assets owned by Americans increases the amount of consumption that future generations will be able to enjoy.  Determining the best way to distribute the burden associated with the aging of the population should be high on society’s list of priorities. 

[S]cenarios that project large deficits also project rapid growth in the outstanding government debt.  The higher levels of debt in turn imply increased expenditures on interest payments to bondholders, which exacerbate the deficit problem still further.  Thus, a vicious cycle may develop in which large deficits lead to rapid growth in debt and interest payments, which in turn adds to subsequent deficits.  According to the CBO projection that I have been discussing, interest payments on the government's debt will reach 4-1/2 percent of GDP in 2030, nearly three times their current size relative to national output.  Under this scenario, the ratio of federal debt held by the public to GDP would climb from 37 percent currently to roughly 100 percent in 2030 and would continue to grow exponentially after that.  The only time in U.S. history that the debt-to-GDP ratio has been in the neighborhood of 100 percent was during World War II.  People at that time understood the situation to be temporary and expected deficits and the debt-to-GDP ratio to fall rapidly after the war, as in fact they did.  In contrast, under the scenario I have been discussing, the debt-to-GDP ratio would rise far into the future at an accelerating rate.  Ultimately, this expansion of debt would spark a fiscal crisis, which could be addressed only by very sharp spending cuts or tax increases, or both. 

Because of demographic changes and rising medical costs, federal expenditures for entitlement programs are projected to rise sharply over the next few decades. Dealing with the resulting fiscal strains will pose difficult choices for the Congress, the Administration, and the American people. However, if early and meaningful action is not taken, the U.S. economy could be seriously weakened, with future generations bearing much of the cost. The decisions the Congress will face will not be easy or simple, but the benefits of placing the budget on a path that is both sustainable and meets the nation's long-run needs would be substantial.

The largest challenge facing the United States is not the business cycle but the task of adjusting on many fronts to the retirement of the baby boom generation. Fortunately, U.S. laws and institutions will enable us to face these challenges with a greater deal of optimism than in some other countries that will face the demographic challenge sooner and in larger measure than we will.

Official projections suggest that the unified budget deficit may stabilize or moderate further over the next few years. Unfortunately, we are experiencing what seems likely to be the calm before the storm. In particular, spending on entitlement programs will begin to climb quickly during the next decade. In fiscal 2006, federal spending for Social Security, Medicare, and Medicaid together totaled about 40 percent of federal expenditures, or roughly 8-1/2 percent of GDP.² In the most recent long-term projections prepared by the Congressional Budget Office (CBO), these outlays are projected to increase to 10-1/2 percent of GDP by 2015, an increase of about 2 percentage points of GDP in less than a decade. By 2030, according to the CBO, they will reach about 15 percent of GDP.

In the mid- to late-1990s, when I had been at the Chicago Fed for only a short time, one of the big questions was whether inflation would increase given the tightening labor market. The unemployment rate had fallen from 7-3/4 percent in 1992 to 5-1/2 percent in early 1995. Conventional thinking at the time was that the natural rate of unemployment was around six percent. So when unemployment went below that six percent level, a number of people worried that accelerating inflation was just around the corner...  Most analysts have since revised their estimates of the natural unemployment rate, putting it in the range of five percent.

...Demographic changes also are a factor in the decline in the natural rate of unemployment. As the baby boom generation acquired more working experience, their ability to find jobs improved. It happens to every generation. Experienced workers have more employable skills, know more about what jobs match their skills, and have built a broader network to help them conduct a job search. Since 1960, the unemployment rate for 25-34 year olds has been about two percentage points higher than the unemployment rate for 45-54 year olds, on average. In the late 1980s, about 15 percent of the labor force was 45-54. This share has since trended up and now appears to be peaking at 23 percent. In turn, the natural rate of unemployment for the entire economy should be lower because of the relatively higher employability of these workers, who now constitute a larger portion of the workforce.

With regard to the labor force, research by the Board's staff highlights the role of demographic factors in determining the number of people available to work in the years just ahead. Most notably, the impending retirement of the baby boomers and the fact that women are no longer increasing their participation in the labor force at the rate they were in the past will tend to restrain the future growth rate of the U.S. labor force. All else being equal, these developments translate into a slower rate of growth of potential output.

[T]he aging of the population is likely to lead to lower average living standards than those that would have been experienced without this demographic change.

Although demographic change will affect many aspects of the government’s budget, the most dramatic effects will be seen in the Social Security and Medicare programs, which provide income support and medical care for retirees and which have until now been funded largely on a pay-as-you-go basis.  Under current law, spending on these two programs alone will increase from about 7 percent of the U.S. gross domestic product (GDP) today to almost 13 percent of GDP by 2030 and to more than 15 percent of the nation’s output by 2050.  The outlook for Medicare is particularly sobering because it reflects not only an increasing number of retirees but also the expectation that Medicare expenditures per beneficiary will continue to rise faster than per capita GDP.  For example, the Medicare trustees’ intermediate projections have Medicare spending growing from about 3 percent of GDP today to about 9 percent in 2050--a larger share of national output than is currently devoted to Social Security and Medicare together.