Fed gives itself a new target

Ben Bernanke Fed chairman Ben Bernanke said he expects the unemployment rate to fall below 6.5% in 2015

The world's most important central bank has just given itself a new magic number: 6.5%.

That is the level the Federal Reserve now says it wants the US unemployment rate to fall to, before it will consider raising interest rates.

In a sense, this is just a logical continuation of the shift in policy announced in the autumn - which I wrote about at the time. But you have to wonder whether it will also turn out to be another step towards a post-crisis world of monetary policy, where the nominal rate of inflation is no longer the target of choice.

There are caveats to this promise, and it is not independent of what happens to inflation. In its statement yesterday, the Fed said that its forecast for inflation would also need to be below 2.5% for them to think about raising rates.

As it happens, the moment at which the Fed now expects unemployment to go below the magic 6.5% is the middle of 2015, which is more or less when they had previously said they would think about tightening policy. So you can see why the financial market reaction has been pretty muted.

It's also worth mentioning that the Federal Reserve already had an employment target: unlike most central banks, its mandate tells it to pursue not just price stability but full employment as well.

But still, it feels like an interesting moment: dangerous for the Fed, in the short term, perhaps, but also one that could open up new opportunities for other central bankers down the road.

At the Bank of England's Christmas drinks party last night, the reaction of senior officials and economists from inside and outside the Bank was almost universally scathing. They said the Fed had given itself another straitjacket - which it would live to regret.

Unlike inflation, unemployment statistics get revised. They tell you something about the strength of the economy, but they also tell you about the level of labour force participation at any given point in time: immigration, demographics - you name it.

A 6.5% unemployment rate might be consistent with one rate of growth this year - and another growth rate entirely in a few years' time. So, what looks like a good number now may look wrong in 2014.

All of these are reasonable concerns. But I can't help noticing that they are rather like the arguments that Bank and other UK officials have always given, when asked about policies or targets that are different from those currently being followed here in the UK. Other countries' targets are always either too rigid - or too flexible. Or sometimes, both. Ours, by a happy coincidence, seem always to be just right.

In a speech earlier this week, the next governor of the Bank of England, Mark Carney, said that numerical thresholds like the new ones provided by the Fed yesterday "exhaust the guidance options available to a central bank operating under flexible inflation targeting. If yet further stimulus were required, the policy framework itself would likely have to be changed."

At that point, he said, adopting a nominal (or cash) GDP target might then be the right way to go. Many others now agree.

Bank officials have been equally scathing about nominal GDP targeting - which, surprise surprise, turns out to be inferior, in their view, to the inflation target we have now.

I will go into the pros and cons of cash GDP targeting in my next post. But one early new year's prediction I would make is that we are going to hear more about it. And so are people at the Bank, when the new boss arrives.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 103.

    #81 fallingTP

    There is little or no hope of convincing you from such revisionist opinions; rewriting history.

    Glas Steagall separated retail & investment banking. Pecora warned that banks would later try to overturn his recommendations post Great Depression & that legislators should stand firm. Hayek warned against banks having too much credit creating power.

  • rate this

    Comment number 102.

    Starting from January 2013, US will print/create 85 billions dollars per month, or more than a trillion per year, this is more or less than 6,5% of their GDP and if their annual grow in 2013 is officially predicted at 2 to 3%, doesnt it mean that USA are in tecnical recession, unless printing money is an activity of real economy.

  • rate this

    Comment number 101.

    @98 purple
    Oh! I wish! I've been going on about that for yonks, too.

    There could be instantaneous gains for GO & UK in complete re-jig of tax system. I think penny may now be dropping in some circles with LocAuthorities under great pressure. Their CEOs must be saying to GO 'Look cancelling FD incrs is not enough, you've got to cut it.'

  • rate this

    Comment number 100.

    Obama learnt his lessons during his first term and fought through his major planks of policy. He grew into the job and during the next two years will be as formidable a foe as republicans have ever faced. In respect taxation business has been blind sided and face a disaster.

    Romney was to have squashed the 35% tax on repatriated profits of $1.7 tn sloshing about in hedge funds. 600 Billion.. haha

  • rate this

    Comment number 99.

    96 ~ The Fed has stated it will not tighten until unemployment hits -6.5%. It will be Obama who replaces Benanke so believe the Fed. Interest rates will remain low until business and investors decide that it is profitable to invest in the future. That is where the problem lies in the US where the 15~20% of total that is longer term investment, fell off a cliff.

    Inflation will now hurt profits.


Comments 5 of 103


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