Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank should do more to boost hiring by aiming to meet a lower jobless-rate threshold before policy makers raise their main interest rate.
The Fed can “provide more needed stimulus” by reducing the unemployment-rate threshold to 5.5 percent from 6.5 percent, Kocherlakota said in a speech today in Golden Valley, Minnesota. Growth will remain “moderate” and inflation will be below the Fed’s 2 percent target for the next two years under current policy, he said, while estimating unemployment will be above 7 percent.
Four years after cutting interest rates to near zero, the Federal Open Market Committee is turning to communication policies to combat unemployment, which remained at 7.8 percent in December. The FOMC said last month it will keep rates near zero as long as the jobless rate is above 6.5 percent and inflation is forecast to be 2.5 percent or less. They said previously that rates would stay low until at least mid-2015.
“The FOMC could facilitate a faster return of the unemployment rate to its lower long-run level by adopting a more accommodative monetary policy that puts more upward pressure on employment,” said Kocherlakota, who doesn’t vote on the policy-setting committee until next year. “My outlook for unemployment and my outlook for inflation both point to a need for more accommodation.”
Kocherlakota, 49, said that gross domestic product probably will expand by about 2.5 percent this year and 3 percent in 2014. Inflation measured by the personal consumption expenditures index will probably be 1.6 percent this year and 1.9 percent next year, below the Fed’s 2 percent goal, he said.
Evidence suggests that increasing accommodation would not cause an “undue amount of inflation,” the Minneapolis Fed chief said. The “medium-term” outlook for price increases hasn’t exceeded 2.25 percent for the past 15 years, even as the jobless rate during that period fell below 5 percent, he said.
While inflation above 2.5 percent “would be a cause for concern,” reducing the unemployment rate threshold to 5.5 percent would not cause inflation expectations to escalate, Kocherlakota told reporters after his speech concluded.
“It doesn’t set you up for overheating,” he said.
Fed officials are constantly evaluating whether the unemployment rate is at risk of becoming permanently elevated and what the implications of that would be for price increases, Kocherlakota told reporters. The longer unemployment remains elevated, the higher the probability it will become structural, he said. The Fed’s 2.5 percent inflation threshold means the policy has a built-in guard against price increases, he said.
“The thresholds that we have in place provide protection to us as we continue to think about this question of structural versus cyclical,” he told reporters. “Where would that manifest itself? It would manifest itself in higher wage pressures for a given level of unemployment and higher inflation.”
The Standard & Poor’s 500 Index declined a third day, retreating 0.1 percent to 1,468.98 as of 12:30 p.m. in New York. The yield on the benchmark 10-year Treasury note also slipped, dropping 0.02 percentage point to 1.83 percent.
The possibility that reducing the jobless-rate threshold to 5.5 percent would ignite inflation is “unlikely,” Kocherlakota said in his speech. Still, if it does happen, policy makers can use forward guidance to provide safeguards, he told the Financial Planning Association of Minnesota.
“Guidance clearly states that the committee’s commitment to a low fed funds rate is off the table if the medium-term inflation outlook ever rises above 2.5 percent,” Kocherlakota said. “I see it as unlikely that this threshold would ever be breached, even if the committee were to lower the unemployment threshold to 5.5 percent.”
Gross domestic product grew at a 3.1 percent annual rate in the third quarter, rebounding after it slowed to 1.3 percent in the second quarter from 2 percent in the first, according to Commerce Department data. Growth this year will be 2 percent, according to the median of 96 economist estimates in a Bloomberg survey.
Fed officials said in their forecast last month they don’t expect to raise the main interest rate until 2015, when they project the jobless rate will fall to between 6 percent and 6.6 percent. GDP growth this year will be 2.3 percent to 3 percent, compared with September’s forecast of 2.5 percent to 3 percent.
Kocherlakota was among the earliest advocates of tying the Fed’s interest-rate policy to economic data, first calling for the change in a speech in September. The FOMC adopted a variation of what the district bank president advocated in the committee’s December meeting.
Kocherlakota was born in Baltimore, grew up in Canada, entered Princeton University in New Jersey at the age of 15 and received a doctorate from the University of Chicago at 23. He was an economics professor at the University of Minnesota before becoming head of the regional bank in October 2009. He was an economist at the bank from 1996 to 1998.