King Consumer: Tightening labor markets lead to better pay, stronger household spending and higher demand that will gradually push inflation up toward the Fed’s 2 percent target. Consumption has averaged 2.3 percent in this expansion compared to 3.1 percent in the five years before the recession.

Productivity: Output per hour is a critical component in estimates of how fast the economy can grow. Lately it has slumped, averaging just 0.5 percent over the past four quarters on a year-over-year measure. That compares with average labor productivity growth of 2.3 percent a year in the 20 years before the 2007-2009 recession, according to JPMorgan Chase.

Low rates of productivity are one reason why unemployment will continue to fall, according to some forecasters. But eventually they see it moving higher. Michael Feroli, JP Morgan’s chief U.S. economist, sees labor productivity accelerating to 1.3 percent in 2016, contributing to the firm’s 1.75 percent estimate for potential growth. “Some reversion toward longer-run averages seems likely,” Feroli said in a note to clients.


The 2 Percent Or Lower Case


Shocks: One possible explanation for low market rates now is that investors are pricing in the risk of a recession or some other shock that slows growth.

“We expect to see growth slow and financial conditions tighten more than the Fed anticipates,” said Laura Rosner, U.S. economist at BNP Paribas in New York, who expects the fed funds rate to crest at 2.25 percent in March 2018.

Stagnation: Productivity continues to slump, unemployed people of working age don’t reenter the labor force, and both consumers and businesses remain cautious, curbing spending and investment.

“If you think productivity is going to stay at half a percent, you are looking at real rates of growth of 1 percent to 1.5 percent,” said Priya Misra, head of global rates strategy at TD Securities LLC in New York, who estimates that the fed funds rate will peak at around 2 percent in this cycle. “That is a pretty negative state of affairs.”

Inflation: U.S. central bankers have been under their 2 percent target for more than three years.

Guy LeBas, a managing director at Janney Montgomery Scott LLC in Philadelphia, said inflation performance will become central to future rate decisions. If the economy has fundamentally disconnected from that target in some way, there is little reason for the benchmark lending rate to go above 3 percent.