Dec 7 The Federal Reserve was reminded on Friday
of the challenge of adopting numerical thresholds to guide
expectations for future interest rate hikes, after the November
jobless rate fell due to an unwelcome decline in the country's
labor participation rate.
The U.S. central bank, which meets next week to review
policy, is debating the merits of replacing a current pledge to
hold interest rates near zero until at least mid-2015, with
thresholds for unemployment and inflation.
But some Fed officials have warned that unemployment can
drop for the "wrong" reasons. That argument was vindicated by
data for last month showing unemployment declined to 7.7 percent
after the labor force participation rate dipped to 63.6 percent
as thousands of workers stopped looking for work.
It was a lowest unemployment reading in 4 years. But the
underlying cause for the fall reinforced the message that labor
market conditions remain tepid and well short of the substantial
improvement the Fed wants to see before it starts raising rates.
Economists had not expected the Fed to reach a consensus on
thresholds in time for its policy meeting on Dec. 11 and Dec.
12, which they think will be dominated by a decision to announce
fresh purchases of Treasury bonds.
But they do think policymakers will talk about thresholds
behind closed doors, as they review making a radical change to
their communication strategy that would have major implication
for how the Fed conducts monetary policy for the next several
"I don't think it makes it impossible for them to get there,
but it definitely makes it harder," said Lewis Alexander at
Nomura in New York.
WORK IN PROGRESS
Fed Chairman Ben Bernanke has recently highlighted a number
of things he likes about thresholds, compared with the current
date commitment, and his number two, Janet Yellen, says she is a
stronger supporter of taking this step.
One proposal, put forward by Chicago Fed President Charles
Evans, advocates holding rates low until unemployment reaches
6.5 percent, provided inflation stays under 2.5 percent. The Fed
has a dual legal mandate to pursue both price stability and low
Evans at one point had suggested 7.5 percent as a threshold,
which might have made Friday's number look like a harbinger of
policy tightening if it had been adopted.
But the minutes of the Fed's October meeting spelled out
that although "many" policymakers thought thresholds could help
the central bank communicate, the move remains a work in
St. Louis Fed chief James Bullard, who is a voting member of
the policy committee next year, has specifically noted that
volatility in the participation rate can lead to changes in the
unemployment rate that ought not signal a change in Fed policy.
"I think tying monetary policy explicitly to unemployment is
a mistake. Unemployment tends to be a fickle variable," he told
reporters after delivering a speech in Memphis in October.
"Unemployment fell for wrong reasons... that kind of
unemployment decline isn't going to make people very happy."
Threshold advocates at the Fed are well aware of this
pitfall, and have sought to defuse it.
The Chicago Fed's Evans, an early and vocal proponent of
thresholds, has repeatedly said that a drop in the unemployment
rate is not the only thing the Fed will look at, even if it does
adopt a specific unemployment-rate threshold.
Evans says he would also want to see above-trend GDP growth
and at least 6 months of jobs gains of 200,000 or higher. By
that measure, November's report falls short, with only 146,000
jobs created and the prior two months' totals revised down,
underlining that the labor marker remains tepid.
Also, genuine improvement on the underlying health of the
economy should deliver a pick-up in the participation rate in
the longer run as workers who had become discouraged in their
search for employment re-enter the workforce and find new jobs.
"If you think there is a cyclical decline in the
participation rate, that should reverse itself as the economy
heats up. So over the long run that (participation rate
volatility) should all come out in the wash," said Michael
Feroli at JP Morgan in New York.