Should the Fed Worry About Unemployment?

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Should the Fed Focus on Unemployment or Inflation?One of the things most people don't realize when they watch the Federal Reserve move the levers of U.S. monetary policy is that its leaders actually wear two hats. The Fed's marching orders from Congress are to "promote effectively the goals of maximum employment and stable prices." One of the hottest debates among economists right now is whether the Fed should try to do both jobs – what's known as the Fed's dual mandate -- or just focus on prices, i.e., inflation.

Criticism of the dual mandate is often loudest from the political right, as exemplified by Mark A. Calabria, director of financial regulation at the Cato Institute. Calabria and his colleagues at the libertarian think tank maintain that there is no connection between keeping inflation low and reducing unemployment.

"The consensus among economists is that the Fed can't do anything about employment in the long run, and the debate is even whether they can do something in the short run," Calabria says.

He points to the fact that the Federal funds rate, the key benchmark interest rate in the country, has been at close to zero for two years, yet the unemployment rate has not come down significantly.

Fed's Efforts Have Kept Things From Being Worse


Karen Dynan, vice president and co-director of the economic studies program at the nonpartisan Brookings Institution in Washington, D.C., disagrees wholeheartedly with that assessment.

"There is a strong case that the Fed's efforts thus far have made the recovery stronger than it would otherwise be," Dynan says. "There is increasing evidence out there that the Fed did help to ease financial conditions, and a large body of evidence suggesting that easing financial conditions helps boost spending and demand."

Dynan says that given the current economic circumstances, the Fed at the moment "can certainly do both jobs."

But Calabria says the Fed has basically stopped worrying about price stability for political reasons, and has become "obsessed" with the unemployment rate to the exclusion of other, more important, economic worries. "I don't think they care about price stability at all," he says.

Of course, the Fed might not be focusing on prices now because they aren't a pressing issue: The U.S. inflation rate reported this week, 1.2%, is the lowest since records began being kept.

Calabria, though, says the core consumer price index used by the Fed to measure prices doesn't capture all the inflation in the economy, and that inflation expectations have been edging up while the Fed is focused on bringing down unemployment through its program of buying government bonds, a process of loosing the money supply known as quantitative easing.

Which 'Mistake' Is Bigger?


Dynan says that it would be a mistake to believe the Fed has magical powers to turn the economy around, but that its policies can help lessen the pain of unemployment when you have millions out of work. "I don't think the two goals are inconsistent much of the time," she says.

The real issue will come when the results of quantitative easing program start to overheat the economy. Will the Fed raise interest rates even if there is still high unemployment? Dynan believes they will.

Calabria, by contrast, says it's a mistake to give central bank officials so much discretion to choose which policy they favor. Instead, he would like to see clear rules drawn up about when the Fed should focus on containing prices.

He notes that other central banks, including the European Central Bank, have only one policy objective: price stability.

"I think the ECB has a better track record than the Fed on price stability," he says.

However, inflation in the U.S. at the moment is running well below the 1.9% rate being experienced by the EU. Dynan says that's why the Fed should be more worried about deflation, the spiraling down of prices that reduces consumer demand and wages, and leads rapidly to recession. Deflationary spirals are exceptionally difficult to end with government policy measures.

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chev66427

is this true? I just heard a disturbing fact that illegals work here 6 months, collect and then purposely leave country and go back home, yet their checks are forwarded to their home country? NICE...

November 22 2010 at 1:18 PM Report abuse +3 rate up rate down Reply
chev66427

is this true? I just heard a disturbing fact that illegals work here 6 months, collect and then purposely leave country and go back home, yet their checks are forwarded to their home country? NICE...

November 22 2010 at 1:18 PM Report abuse +3 rate up rate down Reply
chev66427

I

November 22 2010 at 1:16 PM Report abuse rate up rate down Reply
Robert & Lisa

With commodity prices having surged over 50% in the past year and unemployment at almost 10%, we obviously have a deep recession with inflation just like the Jimmy Carter years. Ronald Reagan's policies pulled us our of the abyss then, who will do it now? Obama and thugs seem hell bent on keeping us in the abyss.

November 22 2010 at 10:52 AM Report abuse +1 rate up rate down Reply
joaquinabco

FRIENDS OF MADOFF SAY WHAT?

November 22 2010 at 4:02 AM Report abuse +1 rate up rate down Reply
dsnrntrng

The government's idea of spend, spend, spend doesn't work and their idea of giving home loans to unqualified buyers is what got us here in the first place. They don't know what they're doing or they are intentionally trying to bring us down. Which one is it?

November 21 2010 at 12:27 PM Report abuse +2 rate up rate down Reply
vdema26408

The silence from our elected representatives about the major problems facing us is simple,they have no answers. Both parties with their corruption have led our once great country down to possible bankruptcy.The USA is broke,a large number of states are broke. Counties are broke and some cities are ready to file.The Fed.can only print money or borrow it.At some point the lenders will require much more interest which will be paid via printed money.This Ponzi game may be coming to an end. Please ask your elected officials what plan 2 is.

November 21 2010 at 12:20 PM Report abuse +1 rate up rate down Reply
freemen76

bring back the glass/stegal act repeal the 1913 fed res act

November 21 2010 at 11:38 AM Report abuse +6 rate up rate down Reply
kenneth

I believe that it is far past time for the Congress to reign in the Federal Reserve. They (the Fed) have entirely too much sway over the economy, largely unchecked by any branch of Government. This is in contradiction of the intent of the founders, as expressed in the Constitution--that is, that the three branches should act as a check (restraint) and balance of the other two. Congress should immediately re-define the role of the Fed and strictly limit its authority to providing a stable supply of money which would accommodate the orderly growth of the money supply, consistent with the increase in population.

November 21 2010 at 11:23 AM Report abuse +6 rate up rate down Reply
gmydogbud

If Requireing people to come to this country Legally,is unfair, wrong WRONG, why were my Grandparents and one parents Required to do so? If it is not fair to require people who come to this country along with their off-spring Legally, then why are American Citizens Required to follow the laws. Why can't we decide which laws we want to respect? Why isn't the Congress fighting for American Citizens to be able to Break the Laws! Suppose American Citizens want to engage in Insider Trading, as the Congress allows it's self and it's Staff do, why can't we do it? Rangel who wrote the laws can't even follow them, why should the average Joe or Jane be held responsible, for not following them?

November 21 2010 at 11:22 AM Report abuse +8 rate up rate down Reply