US Monetary Policy – The ‘balanced approach’ to a dual mandate in a figure

The January 2012 statement of long-run monetary policy strategy clearly expresses the FOMC’s policy intentions: It states that the FOMC’s explicit inflation objective is 2 percent for the price index for personal consumption expenditures (PCE) in the long run and that maximum employment is associated with a sustainable unemployment rate that properly reflects structural developments that may alter this rate over time. Our long-run strategy also points to the Committee’s Summary of Economic Projections (SEP) to provide a range of values for the sustainable unemployment rate. Currently, the central tendency for this range is between 5¼ percent and 5¾ percent. Finally, our strategy states that the Committee will use a balanced approach to reduce deviations from our long-run objectives.

This balanced approach implies strongly that our policy loss function can provide what I refer to as “bull’s-eye” accountability. This entire chart is like a simple “corporate scorecard” for our two-dimensional policy objectives in unemployment and inflation outcomes. The circles provide collections of unemployment and inflation rates that are equally uncomfortable for FOMC participants. The chart clearly depicts the unemployment dilemma that the Committee still faced as of September 2011. For example, it tells us how a 9 percent unemployment rate can be depicted in “inflation-loss equivalent units” by showing what inflation rate gives an equivalent loss when unemployment is at its sustainable rate. The answer is 5½ percent inflation! All post-Volcker central bankers would respond to 5½ percent inflation as if their “hair was on fire.” Such a situation would call for strong and decisive monetary action. The bull’s-eye scorecard provides accountability. And indeed, in response to this loss, the FOMC acted. The FOMC had already employed QE2 in the fall of 2010. In August 2011, the FOMC employed a form of forward guidance and followed that up in September 2011 with the Maturity Extension Program, or “Operation Twist.”

Chosen excerpts by Job Market Monitor. Read the whole story at Like It or Not, 90 Percent of a ‘Successful Fed Communications’ Strategy Comes from Simply Pursuing a Goal-oriented Monetary Policy Strategy – Federal Reserve Bank of Chicago.

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