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
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    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
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    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
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    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
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    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
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    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.

  • rate this
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    Comment number 98.

    95. Up2snuff ~ It was a googlie and bowled by Eric the banana. :)

    The markets measure national debt and ability to service debt. Business in spades, everyone and there mother as well, avoid taxes to ensure that government finances falter under stress. Politicians need to sort out the taxation and ALL economic crap vanishes.

    Those wishing to prosper must run balanced or surplus trade. $imples

  • rate this
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    Comment number 97.

    Derived finance is neutral over its term. Black Scholes identifies the point at which benefit transfers between counter~parties. That was the innovation which will sink a thousand economies unless that short is regulated and monitored.

    It is lucrative business but risk applied is a joke, there is none besides cost of default. All things equal losses are normal, but derived finance shorts value.

  • rate this
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    Comment number 96.

    "Despite destroying liquidity in its housing market, the US protected its banking system"

    Ahhhh? 2005-07 FM & FM bought $1 trillion in subprime/ low-qual mortgages (most floating rate). Evntually most bec unaffordable when rates rose,. So FM & FM supported by Gov removed mkt risk from S&Ls.

    So Fed was supposed to keep rates low forever?

  • rate this
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    Comment number 95.

    @92purple
    Oh no, lad, a bit more than that! Money supply, persl & corp indebtedness, business invest, employment levels (as well) & future structuring via Govt spend.

    All come into view or should. That's another reason why its gone all pear-shaped for us. Those who should not have, took their eye off ball with feet in the wrong position just as they were facing a fast, in-swinging yorker.

  • rate this
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    Comment number 94.

    The practices of finance were deregulated since Big Bang, innovated by Black Scholes Merton, endorsed by Nobel Prize, overseen by light touch from regulators which was adamantly lobbied; altered and enabled by accounting changes to take profits from the future because of contractual obligations of underlying assets.

    Finance today is a huge arbitrage courtesy of Black Scholes.

  • rate this
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    Comment number 93.

    @88 purple
    Exactly so hence my reply to J but derivatives, esp. third order ones, could also be said to be underpinner of UK econ.

    And all that was yet another cause of 'the crisis': esp when you mention 'accounting practice' but not 'agreed audit standards' & proper auditing to test that value ...

    Not enough purple crayon ticks on the audit schedules, I think! ;-)

  • rate this
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    Comment number 92.

    90. Up2snuff ~ Risk or down side Central Banks address is liquidity, a problem of rights to liquidate (ie Lehman's, AIG, ARS)

    Despite destroying liquidity in its housing market, the US protected its banking system. The Central Banks do not wish to be dragged into the politics of economics and its politics. They protect the banking systems' liquidity and it is daft to aim at them for what goes on.

  • rate this
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    Comment number 91.

    All things being equal in the land of the free and the brave, let's here it for Sitting Bull, those disposessed of their properties should seek redress from lenders who broke the trust inherent to loan arrangements.

    Lenders hold a lien over property, they do not own the property. It belongs to the borrower, value ensured by contractual obligation of insurance. Ask Ken Clark :) ~ interesting law.

  • rate this
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    Comment number 90.

    @51&62
    With interest rates you have to ask yourself (if a reasonable moderator - unlike M.King) 'are low/med/high rates at any time working or causing harm or good'?

    Bernanke ought to realise from the lack of critical thinking going on on this side of the Atlantic what a millstone he is creating for himself, the Fed & the White House.

  • rate this
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    Comment number 89.

    86 Bubble in asset prices / housing wasn't independent though. Prices of consumer goods etc were held by boom in prod of cheap goods out of Asia. This hugely inflated pp of incomes. Monetary expansion thus feed through into asset prices. In 2005 M" incr almost 15% yet CBs did nothing. Inflation was beaten; the just ignored reality.

  • rate this
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    Comment number 88.

    86 The bubbles are divorced from reality in what is a casino or frenzy for the next big thing. Que the Weather Girls.

    The imbalances are an odd beast to grapple with until it is realised they function forward into time. The underlying asset is a termed contract. Derived assets however, are subject to accounting practice which marks to current market. Trading derived assets shorts the underlying.

  • rate this
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    Comment number 87.

    Greed has and always will be the way 'forward' (What I call the "I want more" syndrome"). That's why we will ALWAYS have inflation. Steph you can do just what every banker, politician etc. all the way to the 'man on the street' does ... TALK (The only cheap thing left. That's WHY there is so much of it) about numbers; AND all prices just keep going one way! UP! I HAVE NO MONEY SO NO MONEY WORRIES!

  • rate this
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    Comment number 86.

    @47 J_f_H
    Bubbles can operate quite independently of the economy in which they are situated.

    House price bubble was only one of many factors in sub-prime crisis, credit crunch & bank crash.

    Quite possible that we could recover from trouble in a few years with avge house prices not shifting a further jot down. Could be we remain mired in recession w/avge h/price steadily falling.

  • rate this
    +1

    Comment number 85.

    84. You're joking. It migth have been polcitically expidient for the democratic party but economic suicide. Clinton's 95 strat & Community Reinvestment Act 98 lead to vast nos of people with no credit raing, without jobs etc get mortgages which once change in circumstances they had not hope of meeting repayments. Lenders were happy to front up with cash since FM & FM carried default risk. Nuts.

  • rate this
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    Comment number 84.

    83. fallingTP ~ Clinton's housing strategy was flawed genius. Create a broader base of wealth by extending property ownership. Increasing liquidity attracted vampire squids and there was no regulation of proper monetary supervision. Greenspan forgot about greed and that undid the enterprise.

 

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