By Steven K. Beckner
(MNI) – Minneapolis Federal Reserve Bank President Narayana
Kocherlakota Thursday said he currently believes it is “appropriate” to
have a “highly accommodative” monetary policy.
However, he cautioned that the Fed will need to be “vigilant” in
watching the size of the gap between the actual unemployment rate and
the so-called “natural” unemployment rate, even while acknowledging that
the latter is difficult to measure.
Kocherlakota, a voting member of the Fed’s policymaking Federal
Open Market Committee, also said he intends to pay “close attention” to
the core inflation rate to determine when it is time for the FOMC to
tighten policy.
Kocherlakota, in remarks prepared for delivery at St. Cloud
University in St. Cloud, Minn., devoted most of his highly academic
presentation to measuring the true degree of slack in labor markets and
its implications for monetary policy.
At the center of his analysis was the “natural” rate of
unemployment — sometimes called the non-accelerating inflation rate of
unemployment (NAIRU).
This has been a source of debate among economists and policymakers
lately, with some contending that various “structural” factors related
to the financial crisis and recession have elevated the NAIRU so that
the Fed putatively might have to tighten policy sooner than it otherwise
would to avoid wage-price pressures.
New York Federal Reserve Bank President William Dudley addressed
the issue on Monday, contending that even if the NAIRU is temporarily
higher by one or two percentage points, it does not pose an inflation
threat.
Dudley conceded NAIRU may be as high as 6-7% due to extended
unemployment benefits and other factors, but said, “this rise should not
create concern about the medium-term inflation outlook.”
“First, even the higher estimate of NAIRU is still far below the
current unemployment rate of 9%,” he said. “Second … much of this rise
is likely to be temporary rather than permanent.”
Taking a slightly different approach, Kocherlakota said the
experience of the 1970s when both unemployment and inflation were high
show that “accommodative monetary policy may not always be an
appropriate response to high unemployment.”
But he said research has shown that “the primary role for monetary
policy is to offset the impact of what economists term nominal
rigidities — that is, the sluggish adjustment of prices and inflation
expectations to shocks.”
Kocherlakota defined the natural rate of unemployment, which he
designated u*, as the unemployment rate “that would prevail in the
absence of any nominal rigidities.”
“To offset nominal rigidities, monetary policy accommodation should
track the gap between the observed unemployment rate and u*,” he said.
The problem for the Fed is that the “natural” unemployment rate or
u* “changes over time and is unobservable.”
In the current environment, he said extended unemployment and
business fears of higher taxes and other costs “may have been
sufficiently large to generate a big increase in u* in the past three
years.”
“However, it is also possible that low job creation is largely
attributable to nominal rigidities that are generating low demand,” he
continued, adding that if so the natural rate may have “changed little”
since December 2007.
Given the uncertainties, Kocherlakota said the “natural”
unemployment rate may range from as low as 5.9% to as high as 8.9%.
But Kocherlakota ended up largely agreeing with Dudley, finding
that low demand for labor is the main reason for high unemployment and
therefore there is no near-term inflation threat.
“I find that business surveys and the current data on inflation
both point to u* being low relative to the current unemployment rate,”
he said.
Kocherlakota concluded that “it is appropriate for monetary policy
to be highly accommodative.”
But Kocherlakota added a caveat: “However, the Federal Open Market
Committee will need to remain vigilant to the possibility of changes in
the gap between the unemployment rate and u*.”
To judge when the FOMC needs to “cut back on accommodation,” he
said he “will be paying close attention to the behavior of core
inflation.”
** Market News International **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]