I don’t know whether this is a positive sign about policymakers recognizing the depth of our economic problems, or a negative sign about the depth of our economic problems. But the President of the Minneapolis Federal Reserve, Narayana Kocherlakota, set a target unemployment rate he would like to see before the Fed raises the federal funds rate from its current position at 0%. This is seen as a shift for Kocherlakota, who had a far greater fear about inflation in the past.
“As long as the FOMC is continuing to satisfy its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent,” Kocherlakota said today in a speech in Ironwood, Michigan, referring to the policy-setting Federal Open Market Committee [...]
Kocherlakota embraced a proposal by Chicago Fed President Charles Evans to calibrate monetary policy based on specific economic goals. Evans advocates holding to near-zero rates until the jobless rate falls below 7 percent or inflation reaches 3 percent.
“My thinking has been greatly influenced by his,” Kocherlakota said, referring to Evans. “By increasing monetary accommodation, the Committee can better meet its employment mandate while still satisfying its price-stability mandate,” Kocherlakota said to business and community leaders at Gogebic Community College.
However, there is a difference between Kocherlakota’s conception of the specific goals, and Evans’. Even though it looks as if Kocherlakota wants an even lower unemployment rate as the benchmark, his threshold for inflation is actually much lower than Evans. As Mark Thoma points out, Kocherlakota only allows for 2.25% inflation as an upper bound, barely more than the current target. However, Kocherlakota justified this by focusing on long-term inflation:
As discussed earlier, by “satisfy its price stability mandate,” I mean that longer-term inflation expectations are stable, and the Committee’s outlook is that the annual inflation rate in two years will be within a quarter of a percentage point of the target inflation rate of 2 percent [...]
The proposed liftoff plan does allow the FOMC to contemplate raising the fed funds rate if the Committee’s medium-term inflation outlook rises above 2 1/4 percent. However, the following chart shows that recent historical evidence suggests that this possibility is unlikely to occur. It documents that the medium-term inflation outlook has not risen above 2 1/4 percent in the last 15 years. Thus, this historical evidence suggests that, as long as the unemployment rate remains above 5.5 percent, it seems unlikely that the price stability mandate would be violated.
That appears to suggest that near-term inflation could breach 2.25%, but it’s not clear.
Kocherlakota was a true inflation hawk who didn’t want to do any monetary stimulus at all, and it does suggest a shift among central bankers toward a more accommodative policy, as well as a shift in the direction of providing clear forward guidance for their actions. Kocherlakota also acknowledged, in a deviation from prior thinking, that unemployment is not structural but cyclical, a key admission. This basically means that the problem in the economy is demand rather than mismatched skills. That’s a major step toward dealing with the problem at hand.
But while the thinking behind the action looks solid, the action is more limited. Kocherlakota isn’t currently on the Federal Open Market Committee, but he’s an influential central banker. This suggests that his coterie is barely moving in the direction of conceding the nature of the unemployment crisis and the need to act. That’s good – sometimes these Fed Presidents don’t acknowledge the unemployment part of their mandate – but not quite a breakthrough.