Monetary Policy / Why it matters whether the fed targets inflation or unemployment

Today, more than four full years since analysts at the National Bureau of Economic Research declared the last recession officially over, unemployment, at 7.3 percent, remains elevated. The jobless rate still exceeds the 2001 recession peak and stands not far below the higher peak from the 1990-91 downturn. Incomes, whether measured in the aggregate by Gross Domestic Product or on the individual level for those who are employed, have fallen far below levels that were reasonably expected prior to the financial crisis. In the meantime, with its federal funds target still up against its zero lower bound, the Federal Reserve seems incapable of providing much further monetary stimulus through additional interest rate changes.

How should Federal Reserve policymakers respond to this continuing crisis? And what new procedures might they put in place to ensure that nothing like it ever happens again? These questions are addressed in two studies released by top economists from the Federal Reserve Board, presented at a high-profile conference sponsored by the International Monetary Fund, and discussed widely in the popular press, including a recent article from the Wall Street Journal.  William English, David Lopez-Salido, and Robert J. Tetlow argue that even when the current short-term interest rate is constrained by the zero lower bound, monetary policy can still provide additional support for a weak economic recovery if policymakers promise to keep that interest rate low for a prolonged period of time through a form of so-called “state-dependent forward guidance.” Their analysis suggests that in the United States today, it might be appropriate for interest rates to remain low until unemployment crosses a “threshold” as low as 5.5 percent.  Dave Reifschneider, William Wascher, and David Wilcox propose a more permanent change to monetary policy. Going forward, they argue, the Fed should respond more vigorously to rising unemployment in the early stages of an economic downturn to prevent anything like a replay of what we experienced during 2008 and 2009.

Both sets of authors are careful to point out that these views are their own, and not necessarily those of the Federal Open Market Committee. Furthermore, the authors of both studies write in a thoughtful, academic style that we very much admire. Circulating the results of internal research in the form of discussion papers such as these is essential for maintaining transparency about the thinking of Fed advisors, and so we applaud these authors’ willingness to share their views publically.

Chosen excerpts by Job Market Monitor. Read the whole story at 

via Why It Matters Whether the Fed Targets Inflation or Unemployment | e21 – Economic Policies for the 21st Century.

Related Posts

The New Fed Unemployment Target: The story behind

The decision was a testament to what former colleagues call Evans’s ability to build consensus. It also shows how one of the Fed’s 12 regional bank presidents can influence policy that is usually made by the central bank’s Washington-based board of governors, led by Bernanke. “Through the power of his ideas and his powers of … Continue reading »