The Federal Reserve today announced a new approach to monetary policy, announcing that it would keep interest rates low until unemployment hits 6.5 percent (or inflation exceeds 2.5 percent). This is the first time the Fed has explicitly laid out an unemployment target.
During a press conference today, Federal Reserve Chairman Ben Bernanke explained that the Fed took its latest step due to the “enormous waste of human and economic potential” that is resulting from persistently high unemployment:
It’s been about three and a half years since the economic recovery began. The economy continues to expand at a moderate pace. Unfortunately, however, unemployment remains high. About 5 million people, more than 40 percent of the unemployed, have been without a job for six months or more and millions more who said they would like full-time work have been able to find only part time employment or have stopped looking entirely. The conditions now prevailing in the job market represent an enormous waste of human and economic potential.
A return to broad-based prosperity will require sustained improvement in the job market which in turn requires stronger economic growth. Meanwhile, apart from some temporarily fluctuations, largely reflected swings in energy prices, inflation has remained tame and appears likely to run at or below the Federal Market Committee’s 2 percent objective in coming quarters and over the longer term. Against a macro economic backdrop that includes both high unemployment and subdued inflation, the FOMC will maintain its highly accommodative policy.
As Tim Duy explained at Fed Watch, “The Fed delivered an early Christmas present to the economy by acting above expectations with not only a one-for-one conversion of Operation Twist to outright asset purchases, more than doubling the pace of balance sheet expansion, but also shifting the communications strategy to thresholds. The latter ties policy explicitly to outcomes rather than dates, which I think is the appropriate direction for policy.” Several members of the Federal Reserve board have been pushing for the central bank to adopt an explicit unemployment target.
Bernanke is also right to worry about the plight of the long-term unemployed. Due to an expiration of extended federal unemployment insurance, only one-quarter of the nation’s unemployed will have access to unemployment benefits come January.