Fed Search for Policy Thresholds Hindered by Volatility
An unexpected drop in the jobless rate last month illustrates the hurdles faced by Federal Reserve officials seeking to link monetary policy to specific economic indicators.
Unemployment fell to 7.8 percent in September, the lowest since January 2009, from 8.1 percent in August, according to a Labor Department report released last week in Washington. The rate was lower than the most optimistic forecast in a Bloomberg News survey of economists. At the same time, monthly payrolls growth slowed to 114,000 from 142,000.
That report “gives you an indication of how potentially dangerous it could be” to tie policy to an indicator such as the jobless rate, said Michael Hanson, senior U.S. economist at Bank of America Corp. in New York who formerly worked for the Fed board. “You had a big fall in the unemployment rate, but you had pretty modest growth in payrolls. This is a very volatile series.”
Since August 2011, the Federal Open Market Committee has said it was likely to keep interest rates low for a specified period of time, currently mid-2015. At last month’s meeting, “many participants” said it would be better to replace the date with language describing the “economic factors” that would prompt them to raise rates, according to minutes of the gathering released last week. The minutes didn’t specify how many policy makers supported that approach.
Officials said such an approach would provide “greater clarity” about their intentions, and would allow market expectations to “adjust automatically” as fresh data on the economy becomes available.
“You want policy to be conditional in a very explicit way that signals to the markets what you’re looking to achieve, as opposed to the calendar date that says how long we’re going to hang around and wait,” Hanson said.
Some policy makers also said extending the time period for low rates might be misinterpreted as a downgrade of their economic outlook, according to the minutes. Still, Fed officials also said it would be “challenging” to agree on specific thresholds, given a diversity of views.
Charles Evans, the president of the Chicago Fed, has said the central bank should promise to keep rates low until the unemployment rate falls to 7 percent, so long as inflation does not breach 3 percent. Minneapolis Fed President Narayana Kocherlakota has said interest rates should stay low until unemployment falls below 5.5 percent, so long as the outlook for inflation does not breach 2.25 percent.
“If they’re able to agree on a 7 percent threshold, by the time they’re able to agree, we may be there anyway,” said Dean Maki, chief U.S. economist at Barclays Plc in New York and formerly an economist at the Fed board. Maki says the unemployment rate could fall more quickly than central bank predicts.
The Fed has kept its benchmark interest rate near zero since December 2008 and has relied on three rounds of large- scale asset purchases to push down borrowing costs and spur growth and employment. Until September, the jobless rate had been stuck above 8 percent for 43 straight months, the longest such stretch in monthly records dating to 1948.
The Fed’s record easing has pushed stocks higher. The Standard & Poor’s 500 Index has more than doubled since reaching a 12-year low on March 9, 2009. Strategists at Bank of America Corp. project it will climb to 1,600 by the end of 2013, surpassing its record high of 1,565.15 reached in October 2007.
The gap between two-and five-year Treasury yields, which shrinks when traders expect the benchmark rate to remain low, is now about one-third of what it was three years ago.
The world economy will grow 3.3 percent this year, the slowest since the 2009 recession, and 3.6 percent next year, the IMF said today, compared with July predictions of 3.5 percent in 2012 and 3.9 percent in 2013. The Washington-based lender now sees “alarmingly high” risks of a steeper slowdown.
Among other economic data today, confidence among U.S. small businesses cooled in September as fewer companies said they planned to hire or invest in new equipment, a survey found.
In Australia, business confidence recovered in September as the prospect of interest-rate reductions overshadowed weaker sentiment among miners and manufacturers, a private survey showed. Japan reported a larger-than-estimated 454.7 billion yen ($5.8 billion) current-account surplus.
Reports in the U.K. showed manufacturing fell more than economists forecast in August and the trade gap widened, indicating the economy may struggle to regain strength.
In September, before the U.S. jobs figures were announced, the FOMC extended its time horizon for low rates at least through the middle of 2015 from late 2014. It also announced its third round of so-called quantitative easing, with monthly purchases of $40 billion of mortgage-backed securities.
Most officials said that numerical thresholds “could be useful to provide more clarity” even as they “thought that further work would be needed to address the related communications challenges,” minutes of the meeting showed.
Among the challenges: choosing among various measures of labor-market health.
A broader gauge of unemployment was unchanged last month at 14.7 percent. That figure includes those who have given up looking for a job and those who work part-time because they can’t find full-time work.
And the percentage of the population that is in the labor force, known as the participation rate, remains near a 30-year low of 63.6 percent. The ratio was at a post-recession low of 63.5 percent in August.
“Any sort of a threshold that is simple enough to be understood by the public is probably too simple to be good policy,” Bank of America’s Hanson said.
In its Sept. 13 statement, the FOMC said it would maintain accommodative policy for “a considerable time after the economic recovery strengthens” yet included no specific thresholds.
“We want to see the unemployment rate come down, but that’s not the only indicator, obviously, of labor market conditions,” Fed Chairman Ben S. Bernanke said in a press conference following the statement’s release. “So we, at least to this point, have decided to define it qualitatively.”
Some Fed officials have raised concerns that policy thresholds would limit the Fed’s flexibility.
In a Box
Since pushing rates almost to zero, the Fed has increasingly relied on shaping public expectations for interest rates as one of its monetary-policy tools.
In March 2009, the central bank began saying it would keep rates low “for an extended period.” Seeking to lower longer- term borrowing costs further, policy makers tied their commitment to a date -- mid-2013 -- for the first time in August 2011. They extended that time frame to late 2014 in January and to mid-2015 last month.
Robert Eisenbeis, chief monetary economist at Sarasota, Florida-based Cumberland Advisors, says the Fed is “asking for trouble” by relying so heavily on its communications strategy.
“If you put together the substantial evidence that the Fed can’t control the real rate of unemployment or real growth in the economy, then pinning your policy on something you can’t control or influence doesn’t make a lot of sense,” said Eisenbeis, a former research director at the Atlanta Fed.
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