'The Slow Rate of Labor Market Improvement in 2015 is Not All That Surprising'

Federal Reserve Bank of Minneapolis president Narayana Kocherlakota:

...Why has the rate of labor market improvement slowed so much in 2015 relative to 2014? In thinking about this question, I find the timing of monetary policy changes to be highly suggestive.

In mid-2013, the FOMC announced its intention to taper its ongoing asset purchase program. We can see that this announcement represented a dramatic change in policy from the sharp upward movements in long-term bond yields that it engendered. Personally, I interpret this policy change back in 2013 as the onset of what the Committee currently intends to be a long, gradual tightening cycle. As I noted earlier, we would typically expect that such a change in monetary policy should affect the economy with a lag of about 18 to 24 months. Viewed through this lens, the slow rate of labor market improvement in 2015 is not all that surprising.

I believe the FOMC should take actions to facilitate a resumption of the 2014 improvement in the labor market by adopting a more accommodative policy stance. Remember, inflation is low, and is expected to remain low, relative to the FOMC’s target. In particular, I don’t see raising the target range for the fed funds rate above its current low level in 2015 or 2016 as being consistent with the pursuit of the kind of labor market outcomes that we are charged with delivering. Indeed, I would be open to the possibility of reducing the fed funds target funds range even further, as a way of producing better labor market outcomes.

There is, of course, a risk that inflationary pressures could build up more rapidly than I (or others) currently anticipate. But the solution to this scenario is relatively simple: Raise interest rates. Given my current outlook, I believe that it would be appropriate to wait until 2017 to initiate liftoff and then raise the fed funds rate at about 2 percentage points per year. My preferred pace of tightening mirrors the pace of tightening from 2004 to 2006—a pace of tightening that is often seen as gradual. (In fact, some would argue, with the benefit of hindsight, that it was overly gradual.) In response to unanticipated inflationary pressures, the FOMC could simply react as it did in 1994, and raise the fed funds rate more rapidly than this gradual pace.

Conclusions

... The lesson of 2014 is clear: We can do better. Given 2014, and given how low inflation is expected to be over the next few years, I see no reason why the Committee should not aim to facilitate continued improvement in labor market conditions. Indeed, I currently see no reason why we should not aim for the kind of strong labor market conditions that prevailed at the end of 2006.

But we will get there only if we make the right choices. The FOMC can achieve its congressionally mandated price and employment goals only by being extraordinarily patient in reducing the level of monetary accommodation. Indeed, to best fulfill its congressional mandates, the Committee should be considering reducing the target range for the fed funds rate, not increasing it. ...