Benn Steil


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“It’s (Still) the Inflation, Stupid.”

by Benn Steil and Dinah Walker
March 13, 2014


Fed officials have been tripping over themselves and each other trying to explain to the world what the right measure of unemployment is and how it should affect what the Fed does.

Using the headline unemployment rate (“U-3”) in official communications hasn’t worked out so well.  Last June, then-Chairman Ben Bernanke suggested that the taper would end with U-3 around 7%; in fact, taper only started with U-3 below that level, at 6.6%.  The FOMC’s December 2012 forward guidance specified a 6.5% threshold for potential rate rises; yet now, with unemployment barely above this, we have NY Fed President Bill Dudley arguing that the guidance should be discarded entirely, as the number is “not providing a lot of value right now in terms of our communications.”

No kidding.  And that’s because, as we argued in this post, it’s actually not about unemployment right now – whether the “right” measure is U-3, U-4 (adding discouraged workers), U-5 (adding all marginally attached workers), or U-6 (adding all marginally attached and employed-part-time-for-economic-reasons workers).  As the graphic above shows, unemployment today is not much above where it was when the Fed started hiking in ’94.  And the evidence is strong that unemployment is on a downward trend.  (The main debate is over how rapid the decline will be.)  Inflation, however, is way below the Fed’s official long-term target of 2%.  It is also substantially below where it was at the beginning of the Fed’s past four rate hike episodes – ’94, ’97, ’99, and ’04.

This suggests not just that Dudley is right about the Fed dropping the U-3 guidance, but that the Fed should replace it with clarification on inflation.  At what point does the Fed worry about inflation going, or staying, too low?  Is the December 2012 inflation guidance, which said that the Fed would tolerate projected inflation 0.5% above its long-term target of 2% in order to bring unemployment down, still operative?  Or are we back to the plain-old 2% target?  Something else?

It’s on inflation that the Fed appears disconcertingly rudderless at the moment.

New York Fed: Eight Different Faces of the Labor Market
Real Time Economics: The Evolution of the Bank of England’s Rate Guidance
Davies: The Fed’s Next Focus Is on Wages
Free Exchange: The Market Does Not Expect Overshooting


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Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Post a Comment 2 Comments

  • Posted by Eric W

    Your headline CPI point should be 1.1, not 1.6. I think you are using Core CPI in both places.

  • Posted by Benn Steil and Dinah Walker

    Our figures are correct as of the time of posting. When we published the post on March 13, the most recent CPI data available were for January, when headline CPI was 1.6%. CPI data for February, which showed headline inflation at 1.1%, were only released on March 18.

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