More on the Fed, QE, and the full employment unemployment rate.

October 20th, 2014 at 5:46 pm

Just a quick follow up on this morning’s meanderings about the Fed, QE (quantitative easing, or the Fed’s asset purchasing program, currently winding down), inequality, and that sort of stuff.

I mentioned the President of Boston Fed, Eric Rosengren, and here he is again saying very cool things in my hometown paper. For example, this is much the same point I made this AM about how you’d want to think about the net impact of QE:

There’s no disputing the fact that asset prices have gone up as a result of what we’re doing,” Rosengren acknowledged, and that “disproportionately helps somebody who has enough wealth that they have, for example, stocks.” But “on balance” he “thinks the net benefits outweigh the net costs in terms of income inequality” for a simple reason: “the one thing that really contributes to income inequality is to have no income at all.”

Better yet, on the unemployment rate consistent with full employment (my bold):

“we’re at 5.9 percent unemployment now, and there’s not much wage pressure.” Indeed, “if anything,” he went on, “I would expect inflation maybe drifting down over the next two quarters, because not only are wages not going up, but oil prices and other commodities are going down [don’t forget the strengthening dollar…JB]. So it may be that when we get to 5.25 percent unemployment, if we’re not having any inflationary pressure, I’d be willing to probe further.”

That’s because full employment is “not a theoretical concept, it’s really an empirical observation: at what point is there enough tightness in the labor market that we start seeing wages and prices going up consistent with a 2 percent inflation target.” And the answer is: it depends. Since there are still so many people working part-time for economic reasons, “it may be that when we hit 5.25 percent unemployment, there’s actually more slack, which would mean we’d be comfortable waiting a little longer before we should fully tighten up monetary policy.”

Finally, Rosengren holds forth a bit on the possible need for a higher inflation target. Here’s the logic, and I think it’s sound. The current recovery is getting a bit long in the tooth and hopefully the liftoff of the Fed Funds Rate (FFR) is a ways off and, when it occurs, will be very gradual.

Now, when you hit a downturn, you want your FFR to be at a high enough perch such that it can be lowered to create the necessary monetary stimulus without hitting its lower bound of zero, at which point it can’t go lower even if negative real rates are what it would take to help get us out of the next ditch (this problem, btw, is at the heart of the “secular stagnation” hypothesis).

As Larry Ball has emphasized, and Rosengren give a hat-tip to this type of thinking, a higher inflation target acts as insurance against this possibility (since the real interest rate is the nominal rate minus inflation, at the ZLB, the real interest rate is the negative of the inflation rate).

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4 comments in reply to "More on the Fed, QE, and the full employment unemployment rate."

  1. Smith says:

    2% is looking less and less sensible. From 1990 to 2014 the inflation rate distribution was:
    Yr Rate | Count
    <0 | 1
    1 to <2 | 5 4 of the 6 years below 2% from the past 5 years 2009-20014
    2 to <2.5 | 4 start a campaign to target 2.75%
    2.5 to <3 | 6
    3 to <4 | 7
    4 to =5 | 1

    A better analysis would look at monthly annual rates (the annual rate of the past 12 months recorded each month)

    • smith says:

      The 2% target needs to be demolished.
      1) First off, it’s being misused as a ceiling.
      2) The causes of inflation are not being distinguished, core, commodities (and subcategory of short term like crop failure or cold winter raising heating oil vs. long term like long term drought or oil field destruction), wage pressure, bubbles in housing, healthcare, monopolistic or oligopoly power pricing, spirals.
      3) Standard deviations (permissible range above and below) are not considered
      4) Similar but distinct from 3), variation during business cycle not accounted for
      5) Historically 2% doesn’t make sense unless the economy goes back to the 1950s
      6) No time periods are given, 5% could be tolerated months, but years is another story.

      2% is rarely the the correct target no matter what conditions prevail
      The concept of a target is useless and damaging since it depends on conditions
      Even the optimal ceiling can change depending on circumstances ( 4 to 5%?) which is totally different from targets and averages.

      • smith says:

        I should clarify, the concept of a single target is useless and damaging. Fed officials should have at the ready all the targets they need for the prevailing and anticipated conditions. The 2% seems simplistic to put in the most mild blog friendly terms.

  2. urban legend says:

    You cannot use the U-3 for this purpose anymore because it has lost its close connection to real unemployment — as expressed by Americans themselves rather than economists applying an artificial construct with an arbitrary cut-off point. A U-6 of almost 12% is nowhere remotely close to full employment. We won’t even be approaching full employment until the U-6 drops below 8%, and arguably well below that. Component measures such as involuntary part-time employment will, of course, track closely with the U-6.

    When there is such pain having been inflicted on tens of millions of people for so long, there is something nearly obscene about suggesting we should think about cutting off efforts to get to genuine full employment while wringing hands over possible inflation that might occur someday, somehow, somewhere, with nothing more than a theoretical relationship arguably existing in a very different time 40 years ago, and with no plausible mechanism under current economic structures that can be described. The ethics of such suggestions — considering the balance of the harms that need to be addressed as well as the weak theoretical support — is hard to discern, to say the least.