Are We There Yet?
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.
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....MORE
