(Revised) Fed Drops Unemployment Target

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.

In recent news, the Fed’s minutes released three weeks after the March 18-19 meeting resolved the discrepancy that I addressed in the above paragraph. Reserve officials were concerned at the March meeting that they might have accidentally communicated to the public that they plan to raise interest rates in the near future. While referencing graphs of the Fed officials’ projections, some commented that “this component of the projections could be misconstrued as indicating a move by the committee to a less accommodative reaction function”. In other words, the Fed officials were concerned that a rise in interest rate would lead to a less stimulated economy during a time where exactly the opposite is needed in order to fully recover from the recent recession. “The minutes underscore that Fed officials had not become more impatient to raise rates, a message Ms. Yellen and other members of the Fed’s policy committee have reinforced in public remarks since the meeting.” The Fed’s minutes were well-received. After they were released, many investors experienced stock gains and bond prices increased as well. The minutes also showed that Ms. Yellen had an extra meeting on March 4th to discuss whether and how the Fed should alter the tapering. Meetings like these are unusual, compared to those of her predecessor, Ben Bernanke. Bernanke only held meetings like these during the financial crisis. However, holding meetings like these while not in a recession is beneficial because it shows great leadership and prudence. It proves that Janet Yellen is committed to translating the directions of the Fed very clearly to the public.

2 thoughts on “(Revised) Fed Drops Unemployment Target

  1. sekoch

    I think the Fed made a good decision to stop basing decisions on the unemployment rate. The statistic in itself has really shown its problems in the past couple of years, as high dropout rates have pushed it down to levels which don’t accurately represent the state of the work force. I think Chairwoman Yellen will do a great job by evaluating other factors in order to determine when it is time to raise interest rates.

  2. haozhao

    Good post. The unemployment rate can not be used as the only index that reflect the labor market. I think the Fed already realized that and adjusted their unemployment anticipation. More indexes should be used to check whether the market is health. And this is essential before the Fed decided to raise to interest rate.

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