Fed Drops Unemployment Target

In recent news, the Fed is still staying on course with the bond buying program. However, some changes have been made to expand the array of indicators used to start raising short-term interest rates, rather than solely focusing on the unemployment rate. Also, Yellen reported at the meeting that the Fed will keep short-term rates lower than usual even after the unemployment and inflation rates return to long-term levels.

In regard to the unemployment rate, the Fed has now decided to drop the connection that it once made to raising the interest rate once the economy has reached the 6.5% unemployment threshold. The Fed plans to use other measures that it believes will represent the situation more accurately, such as the U6 measure (includes marginally attached workers and those working part time but prefer full time work), the share of workers who have been unemployed for six months or more, the rate at which people are quitting jobs, and the share of adults who are holding or seeking jobs.

In terms of interest rates, the Fed plans to keep the short-term rate lower than usual even after the jobless rate and inflation rate return to long term levels. Since the Fed expects a 4% rate as the normal long-run rate, this implies that officials do not expect rates to get back to this level anytime soon. Later actions taken by the Fed were to continue in reduce its bond-buying program to $55 billion. The long-term goal of the program is to hold down long-term interest rates, thus boosting spending, hiring, and growth.

One discrepancy that I noticed in the report was that even though the Fed said it plans to keep rates low well after the Fed returns to the long-run trend, the projections of the actual officials seemed a bit aggressive. More specifically, “Ten of 16 officials saw short-term rates rising to 1% or more by the end of 2015, with four of them right at 1%. Six officials saw rates below 1% by the end of 2015. In December, ten officials saw rates below 1% by the end of 2015. Twelve of 16 officials saw the target fed funds rate rising to 2% or above by the end of 2016, while four officials saw rates staying below 2% by the end of 2016.” In my opinion, I found the projections of these officials in comparison with Yellen’s earlier statements to be contradicting. From Yellen’s report, it seems that the Fed thinks the economy isn’t good enough right now, but will accelerate in the next 12 months- therefore warranting higher interest rates… but the Fed said that it plans to keep rates low “for a considerable time” after the bond buying program ends, given that the program is scheduled to end this fall. However, I anticipate this vagueness has to do with the fact that it depends on the condition of the labor market later this fall. If there were still high unemployment in the labor market and the inflation rate were still running below 2%, this would be good reason to believe that the Fed would hold the interest rate near current levels.

5 thoughts on “Fed Drops Unemployment Target

  1. gkugler

    I completely agree with the point you raise in your last paragraph – that the consensus by Fed officials seems to contradict the Fed’s forward guidance that rates would remain low for a long time. I believe this confusion was a major source of concern for financial markets, which is represented by falling stock prices and rising bond yields.

  2. wyna

    I think what really scared the market is the play on “expectation.” Although you have a very good point that it may actually be more than 6 months like Yellen stated for interest rates to climb, if she had not said that she will drop the UE target at all, it would have been better with the expectation game.

  3. pranavrk

    I completely agree with this. I have been somewhat skeptical about tying interest rate policies to the U3 rate because it can fall for so many different reasons and they are not always good. Historically the U3 and the U6 were fairly close together, differing by about 2.5% on average, if I remember the graph correctly. But there has been such a large disconnect between the two rates over the past couple of years that makes it very difficult to determine whether the labor market is in good health or not.

  4. viczhou

    I think the Fed is more focused on keeping long-term borrowing cost low even after the overall economy shows significant signs of improvements, as Treasuries dropped right after the Fed statement in anticipation that short-term rates are likely to increase sooner rather than later. Also, I do agree that we should adopt the U6 measure rather than the unemployment rate for the evaluation of the health of economy.

  5. sekoch

    While Yellen’s comments about a potential date for a rate increase were likely ill-advised and hurt the markets, her description of what will determine the read for the labor market moving forward is a step in the right direction. For months, people have questioned the accuracy of the number, which disregards those who have dropped out of the labor force. I think this change will help to better choose the right time to start increasing interest rates.

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