The seven-percent solution to U.S. unemployment
As policymakers debate how to bring down an unemployment rate stubbornly stuck above 9 percent, Chicago Federal Reserve Bank President Charles Evans and Boston Fed President Eric Rosengren are embracing what might be called “the seven-percent solution.”
It works like this: the Fed pledges to keep rates near zero for as long as it takes to get some real improvement in the labor market – an unemployment rate, say, of 7 percent – as long as inflation doesn’t get out of hand. That way, every time some good economic news comes out, markets don’t immediately start pricing in a rate hike, undoing the very easy policy that the Fed sees as necessary to pull the moribund jobs market from its deep hole. Don’t you worry about a little bit of inflation here or there, the Fed could say – it’s steady as she goes until unemployment dips below 7 percent.
What, though, is so special about 7 percent? Certainly, it’s much better than the current 9.1 percent. But it still would leave millions unemployed, and Evans himself has said he believes that unemployment normally runs at less than 6 percent. Why settle for a bigger number?
A bit of sleuthing into recent Chicago Fed research suggests one possible answer. In a paper published as part of its “Economic Perspectives” publication, Chicago Fed senior economist Gadi Barlevy takes a deep dive into the data on job vacancy rates, which rose sharply in the early part of the recovery even though unemployment was also climbing. Some researchers say this trend suggests that firms want to hire but simply cannot find the right kind of workers – a structural fault in the economy that easy monetary policy cannot possibly cure.
Drawing on the work of Nobel Prize winners Dale Mortensen and Christopher Pissardes, Barlevy argues that only half, if that, of the increase in unemployment from the Great Recession can be attributed to mismatches between employers’ needs and employees’ skills. The rest, he says, “must be because firms find hiring less profitable.” He goes on:
While there is little monetary policy can do if firms find it more difficult to find suitable workers, there may be scope for monetary policy when firms find it less profitable to hire workers than during normal times….if jobs are less valuable because of insufficient aggregate demand on account of some market friction, there may be a role for monetary policy to stimulate demand.
Still, Barlevy says his research shows that part of the increase in unemployment does indeed come from a labor market shock that monetary policy cannot offset: “This type of shock by itself would lead to an unemployment rate of 7.1 percent.”
Will Fed policy go the Swedish route?
The Federal Reserve’s long-quiet doves are becoming increasingly louder about championing more aggressive forms of monetary easing, including possibly setting employment and inflation targets and/or engaging in another round of bond purchases. Most prominent among these have been Charles Evans, the Chicago Fed president who openly favors more transparent policy guidance and Eric Rosengren, who told CNBC on Wednesday a third round of monetary easing could be in store:
If the economy were to be weaker than most people are forecasting, that would certainly be cause for doing additional monetary policy.
Rosengren also said he favors more explicit policy targets, which could take a rather controversial form known as price-level targeting. Under this arrangement, the Fed would temporarily shoot for higher inflation to make up for the almost deflationary readings seen late last year, in an effort to boost investment, spending and hiring.
Looking for precedents, Goldman Sachs offers up the interesting example of Sweden — in the 1930s. Citing the findings of Claes Berg and Lars Jonung in a 1999 edition of the Journal of Monetary Economics, Goldman economists determine that the program was successful because it was relatively simple and also temporary:
Sweden’s experience highlights a number of issues involved in adopting a price level targeting framework.
Definition of price stability: The authorities decided to stabilize the price level at the price level of the third quarter of 1931, to take place at once. Despite various requests, policymakers decided not to attempt to return the price level to pre-crisis levels and did not allow for a drift in the price level over time. Also, the Riksbank was not given any other goals, such as output or employment stabilization.
Temporary vs. permanent: The introduction of the price level target was intended and announced as a temporary step by the government. Once the conditions were at hand, a return to gold was planned for.
Choice of price index: The Riksbank primarily targeted the CPI, and started publishing consumer prices on a weekly basis to allow for better monitoring. However, it did not tie its policy solely to stabilizing consumer prices and announced that “other price indices besides the Riksbank’s own index of consumer prices will also be taken into consideration.” For example, the Riksbank also paid attention to wholesale prices.
Treatment of special factors: Policymakers stressed the need to disregard temporary factors like indirect taxes, customs duties and seasonal effects influencing inflation.
Implementation: Changes in the discount rate and operations in the foreign exchange market were the most important instruments. Immediately after leaving the gold standard, the Riksbank did not intervene in the foreign exchange market and allowed the krona to float freely. But from July 1933 the Riksbank established a successful peg of the krona to the British pound that lasted until World War II.
Corporations have shipped all of the jobs overseas. They are not coming back. Get over it.