Much to the dismay of the Tea Party crowd, the doves remain firmly in control of U.S. monetary policy. The Federal Reserve made that crystal-clear Wednesday when it announced that it will keep interest rates effectively at zero and boost its aggressive purchases of bonds and mortgage securities until unemployment falls below 6.5 per cent.
It’s the first time the Fed has set a specific jobless target, rather than a time frame, for a particular policy move – a reflection of its struggle to meet its oft-criticized mandate of promoting maximum employment. Economists quickly named this the Evans rule, after its leading proponent, Chicago Fed president Charles Evans, who came up with the 6.5 per cent figure. The current jobless rate stands at 7.7 per cent, a four-year low. It’s hard to see how further monetary easing – or a continuation of zero rates – will have much impact on the number, particularly if demand remains weak and businesses and consumers are still focused on shedding debt.
Conservatives argue that fixing the U.S. fiscal mess and providing clarity on corporate taxes would do far more to boost economic and job prospects than anything in the Fed’s limited arsenal. And it’s hard to disagree with that, provided Washington stays away from the austerity trap that has sunk Europe.
Monetary policy is already about as accommodative as it should be, Mr. Evans, a monetary economist, acknowledged in a recent chat with The Globe and Mail. But he said what was lacking was an explanation of what the Fed means by “maximum employment,” particularly as the number is bound to change, depending on everything from demand and deleveraging to productivity gains and demographic shifts. Providing a specific target provides the clarity the markets crave, not to mention the assurance that rates aren’t going anywhere for a considerable period of time. Give the stalled vehicle enough of a push, and the economic engine ought to be able to get to the desired rate of 6 per cent or less unemployment without further meddling by Fed mechanics.
Essentially, as Mr. Evans explained, the goal of further monetary easing is now plainly “substantial improvement in labour market outcomes.” His own estimate is that this could take up to a year. But that’s without figuring in the damage if the U.S. falls off the “fiscal cliff,” which Fed chief Ben Bernanke, who coined the expression, has already warned would derail the weak recovery.
The dramatic change in policy shows that Mr. Bernanke, Mr. Evans, influential Fed vice-chair Janet Yellen and other key dovish policy makers reject the view of some economists that higher U.S. unemployment rates are becoming a permanent feature of the landscape, rather than a temporary result of the severe recession and tepid recovery that will respond to monetary tinkering.
There is not a lot of anecdotal evidence to support the view that the jobless rate is going to be stuck at or near 8 per cent because of structural changes in the economy and the work force, such as a mismatch of skills, Mr. Evans said. Studies have even dismissed the notion that labour mobility has been seriously eroded by an inability of workers to get rid of houses in depressed markets.
As for the other part of the Fed’s job, maintaining price stability, Mr. Evans argues that continued strenuous efforts by Americans to shed debt means policy makers can keep pressing on the monetary gas pedal without triggering a serious return of inflation.
The central bank said Wednesday that rates will stay at rock-bottom in pursuit of that elusive jobless target, provided inflation one to two years down the road is forecast to be no more than half a percentage point above its 2 per cent target and that expectations about longer-term inflation remain well anchored.
Ms. Yellen’s analysis shows inflation rising to a peak of 2.3 per cent and then coming back down. Mr. Evans considers 2.5 per cent “an adequate cushion,” as long as policy makers keep a close eye on the inflation trend. He first proposed a 3 per cent inflation limit and a 7 per cent jobless target in August, when unemployment was at 9 per cent. If he adjusted his formula to win over some of the hawks, it appears to have worked. Only one member of the policy-setting Federal Open Market Committee, the Richmond Fed’s Jeffrey Lacker, opposed the latest moves, down from three in August, when the Fed launched its current asset-buying plan.
Mr. Lacker objects to more easing and the new unemployment goal-setting by an activist Fed. He will not be alone in his anger. The problem, though, is with the Fed’s unworkable mandate, not the new target.