Deciphering the Fed: Guideposts for progress on jobs

October 24, 2012

The Federal Reserve’s open-ended bond-buying stimulus announced last month was coupled with a promise to continue purchasing assets “if the outlook for the labor market does not improve substantially.” Central bank officials are expected to continue discussing what parameters they will take into account to define such progress, but are not expected to come to any hard and fast decisions just yet.

In a research note entitled “What the Fed didn’t say: Payrolls at 160K,” Torsten Slok, economist at Deutsche Bank, offers a few guideposts:

In terms of what the Fed will be looking at, we reckon that employment growth will be first among equals – in particular nonfarm payrolls. We estimate that the FOMC’s economic and policy projections are consistent with payrolls averaging gains of around 160,000 per month through mid-2015, when they have told us they expect the exit process to begin to get under way. There is a range of uncertainty around this estimate. But if the numbers are coming in well below that rate for a number of months (100k or less), look for the Committee to extend the mid-2015 date and possibly step up its QE purchases, and expect just the opposite if they are coming in well above that rate (200k or more).

The employment-to-population ratio (E/POP) will be a more important guide than the unemployment rate with respect to assessing progress that is being made in removing slack and moving the labor market back to more normal levels.  This is because swings in labor force participation, which directly affect unemployment but not E/POP, are likely to continue to be unpredictable.  Indeed, further declines in participation rates are possible in the near term, and we look for a significant reversal of recent substantial declines at some point further out.

We find that E/POP does a significantly better job than the unemployment rate in tracking the recent and projected course of policy interest rates in standard policy rules.  When E/POP is substituted for unemployment in the Taylor Rule, the apparent recent increase in the FOMC’s sensitivity to labor market developments is much reduced.

The U.S. unemployment rate fell to 7.8 percent in September, the lowest in nearly four years. But employers added just 114,000 new jobs, still a relatively tepid pace of employment creation.


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