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Federal Reserve Chairman Jerome Powell is testing the economy’s room to run. It’s a strategy that contains both big benefits and risks for ordinary Americans and is causing excitement, tinged with caution, inside the central bank.

Take Fed treatment of one of its bedrock conceptual benchmarks, a rate of unemployment that keeps inflation stable. In June, they estimated that level at 4.5 percent. Unemployment in May was 3.8 percent. Yet with no sign of price pressures, policy makers plan to let the labor market run even hotter, with the jobless rate projected at 3.5 percent over the next two years.

Powell, a Trump administration appointee, shares his predecessor Janet Yellen’s appreciation that labor-market slack may be greater than estimated. He’s combined that with a sense that the range of uncertainty around guidepost estimates that govern monetary policy are highly uncertain tools.

For Powell, the first non-economist to hold the job in more than three decades, conceptual benchmarks can’t fully describe the complexity of the U.S. economy. So in this first five months, he’s brought a subtle but important change to the chairmanship at a key juncture in the business cycle: trust evidence as much as economic models.

“Let’s be guided by what’s going on and what the real economy’s telling us,” Powell said on the sidelines of a June 20 central bank conference in Sintra, Portugal, at which he also repeated the case for gradual interest-rate increases. “And let’s also admit that our understanding of what the location” of full employment is must be “informed by reality and what’s actually happening.”

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A hot labor market has tremendous benefits for U.S. workers, millions of whom were locked out of jobs during the post-crisis recovery because of age or racial...

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