macroblog

About


The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


« Getting There? | Main | Are You Sure We're Not There Yet? »

August 12, 2014


Are We There Yet?

Editor’s note: This macroblog post was published yesterday with some content inadvertently omitted. Below is the complete post. We apologize for the error.

Anyone who has undertaken a long road trip with children will be familiar with the frequent “are we there yet?” chorus from the back seat. So, too, it might seem on the long post-2007 monetary policy road trip. When will the economy finally look like it is satisfying the Federal Open Market Committee’s (FOMC) dual mandate of price stability and full employment? The answer varies somewhat across the FOMC participants. The difference in perspectives on the distance still to travel is implicit in the range of implied liftoff dates for the FOMC’s short-term interest-rate tool in the Summary of Economic Projections (SEP).

So how might we go about assessing how close the economy truly is to meeting the FOMC’s objectives of price stability and full employment? In a speech on July 17, President James Bullard of the St. Louis Fed laid out a straightforward approach, as outlined in a press release accompanying the speech:

To measure the distance of the economy from the FOMC’s goals, Bullard used a simple function that depends on the distance of inflation from the FOMC’s long-run target and on the distance of the unemployment rate from its long-run average. This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard explained.

We think that President Bullard’s quadratic-loss-function approach is a reasonable one. Chart 1 shows what you get using this approach, assuming a goal of year-over-year personal consumption expenditure inflation at 2 percent, and the headline U-3 measure of the unemployment rate at 5.4 percent. (As the U.S. Bureau of Labor Statistics defines unemployment, U-3 measures the total unemployed as a percent of the labor force.) This rate is about the midpoint of the central tendency of the FOMC’s longer-run estimate for unemployment from the June SEP.

Chart 1: Progress toward Objectives: U-3 Gap

Notice that the policy objective gap increased dramatically during the recession, but is currently at a low value that’s close to precrisis levels. On this basis, the economy has been on a long, uncomfortable trip but is getting pretty close to home. But other drivers of the monetary policy minivan may be assessing how far there is still to travel using an alternate road map to chart 1. For example, Atlanta Fed President Dennis Lockhart has highlighted the role of involuntary part-time work as a signal of slack that is not captured in the U-3 unemployment rate measure. Indeed, the last FOMC statement noted that

Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.

So, although acknowledging the decline in U-3, the Committee is also suggesting that other labor market indicators may suggest somewhat greater residual slack in the labor market. For example, suppose we used the broader U-6 measure to compute the distance left to travel based on President Bullard’s formula. The U-6 unemployment measure counts individuals who are marginally attached to the labor force as unemployed and, importantly, also counts involuntarily part-time workers as unemployed. One simple way to incorporate the U-6 gap is to compute the average difference between U-6 and U-3 prior to 2007 (excluding the 2001 recession), which was 3.9 percent, and add that to the U-3 longer-run estimate of 5.4 percent, to give an estimate of the longer-run U-6 rate of 9.3 percent. Chart 2 shows what you get if you run the numbers through President Bullard’s formula using this U-6 adjustment (scaling the U-6 gap by the ratio of the U-3 and U-6 steady-state estimates to put it on a U-3 basis).

Chart 2: Progress toward Objectives: U-3 Gap versus U-6 Gap

What the chart says is that, up until about four years ago, it didn’t really matter at all what your preferred measure of labor market slack was; they told a similar story because they tracked each other pretty closely. But currently, your view of how close monetary policy is to its goals depends quite a bit on whether you are a fan of U-3 or of U-6—or of something in between. I think you can put the Atlanta Fed’s current position as being in that “in-between” camp, or at least not yet willing to tell the kids that home is just around the corner.

In an interview last week with the Wall Street Journal, President Lockhart effectively put some distance between his own view and those who see the economy as being close to full employment. The Journal’s Real Time Economics blog quoted Lockhart:

“I’m not ruling out” the idea the Fed may need to raise short-term interest rates earlier than many now expect, Mr. Lockhart said in an interview with The Wall Street Journal. But, at the same time, “I’m a little bit cautious” about the policy outlook, and still expect that when the first interest rate hike comes, it will likely happen somewhere in the second half of next year.

“I remain one who is looking for further validation that we are on a track that is going to make the path to our mandate objectives pretty irreversible,” Mr. Lockhart said. “It’s premature, even with the good numbers that have come in ... to draw the conclusion that we are clearly on that positive path,” he said.

Mr. Lockhart said the current unemployment rate of 6.2% will likely continue to decline and tick under 6% by the end of the year. But, he said, there remains evidence of underlying softness in the job sector, and, he also said, while inflation shows signs of firming, it remains under the Fed’s official 2% target.

Our view is that the current monetary policy journey has made considerable progress toward its objectives. But the trip is not yet complete, and the road ahead remains potentially bumpy. In the meantime, I recommend these road-trip sing-along selections.

Photo of John RobertsonBy John Robertson, a vice president and senior economist in the Atlanta Fed’s research department


August 12, 2014 in Economics, Employment, Federal Reserve and Monetary Policy, Inflation, Labor Markets, Monetary Policy, Pricing, Unemployment | Permalink

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c834f53ef01a3fd455f7a970b

Listed below are links to blogs that reference Are We There Yet?:

Comments

Major problems with U6 include the fact that someone working 34 hours but wants to work 35 or more is considered unemployed (not partially unemployed) -- a very loose definition of an unemployed person. Also, some policymakers conflate marginally attached with discouraged workers. Only one-third of the marginally attached are discouraged about job prospects (the other two-thirds didn't look for work because of illness, school, etc. -- i.e., for reasons monetary policy cannot address). So there are very good reasons for President Bullard's objective function to be based on U3 rather than U6. Additionally, what policymakers should consider, to follow through with your analogy, is when you arrive at your destination should you still have the accelerator pressed to the floor? Or does it not make sense to let off of the gas a bit as you approach your destination (to avoid driving the minivan right through your home).

Posted by: Conrad DeQuadros | August 14, 2014 at 12:57 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

Google Search



Recent Posts


December 2014


Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31      

Archives


Categories


Powered by TypePad