As you undoubtedly know, since 1977 the Federal Reserve has operated under a dual mandate from Congress:
“promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”
and you also know, at least if you took an Intro to Econ course when I did, that those two mandates are, shall we say, in tension if not outright contradiction. In his Washington Post column Jared Bernstein remarks on a very interesting new study:
According to their work, that path courts danger, specifically, under certain conditions — like unforeseen shocks to the system — the jobless rate could fall too far and trigger so much inflation or other distortions, like bubbles in financial markets, that the Fed would have to slam the growth brakes at great cost to economic growth.
The Fed 5 humbly submit that our knowledge of the key parameters in play in this inflation/unemployment drama are poorly understood. The level of one of the most important — u* (that’s “u-star,†the lowest unemployment rate consistent with stable prices) — has long eluded economists. We don’t enough about what’s driving inflation, why its correlation with unemployment is so low, and whether it could come back to life in a truly full-capacity economy.
That’s led many of us to conclude that our “best move is … to admit the uncertainty . . . and follow the data, particularly inflation.â€
But — and here’s the paradox — the Fed 5 argue that even amid the uncertainty, we’re still better off targeting u*, even though the Fed’s guesstimate of it — 4.5 percent — seems clearly too high, as unemployment has long been below that rate and their key inflation gauge has hardly accelerated. The Fed’s own forecasts have unemployment falling a point below their u* and inflation still remaining tame!
He concludes:
In fact, given the recent relative gains of minorities, the steady job growth, and the need for faster real wage gains among middle-wage workers, it’s more important than ever to sustain our favorable labor market conditions for as long as possible. We shouldn’t ignore the macroeconomic risks of very low unemployment. But until those risks are clearer and better understood, the bar to sacrificing even a smidgen of the benefits of full employment should be extremely high.
The Fed has nearly always ignored the unemployment component of its mandate in favor of controlling inflation and some economists (notably Scott Sumner) think they’ve been far too aggressive in controlling inflation and instead should be targeting nominal growth (something the Federal Reserve is not empowered to do). In my view if its mandate is to be adjusted at all, it should be that the Fed should do its job of regulating its member banks much more vigorously, the neglect of which was one of the causes of the financial crisis.
