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Unemployment rate of 6.5% is no rates 'trigger'

The unemployment rate remains locked at 7.7%, forcing the Federal Reserve to continue its monthly purchase of mortgage-backed securities to spur along housing and employment activity.

Fed Chair Ben Bernanke has made it clear the Federal Open Market Committee remains committed to accommodative monetary policies — like its monthly $40 billion MBS purchases — until the labor market improves.

The magic number is 6.5% unemployment. At that point, the labor market is expected to be strong enough to allow the Fed to ease up on low interest rates and asset purchases. At least that's the belief that some economists hold.

The bigger question is when will the economy get there? 

Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, says the unemployment rate is not a "trigger" for Federal Open Market Committee action.

"Thus, the FOMC may choose not to raise interest rates when the unemployment rate falls below 6.5%," he said. "I see the FOMC’s guidance as providing a great deal of protection against undue inflationary pressures."

The FOMC said March 20 that it would keep the federal funds rate near zero as long as unemployment remains above 6.5% and the outlook for inflation does not exceed 2.5%. 

However, should the central bank’s inflation outlook ever rise above 2.5% "its commitment to keep interest rates extraordinarily low is off the table."

"I’ve said that I see it as unlikely that this inflation threshold would be breached, even if the Committee were to lower the unemployment threshold to 5.5%. Conversely, I would see a breach of this threshold as being a cause for significant concern," Kocherlakota said. 

Additionally, the policymakers haven’t had a medium-term outlook for inflation as high as 2.25% during the past 15 years. In that context, a medium-term outlook of 2.5% or more should be seen as being highly unusual.

"In my view, such an unusually high inflation outlook should lead the FOMC to strongly consider an aggressive response," the Minneapolis Fed president explained.

During Kocherlakota’s speech, he kept his prior forecasts that gross domestic product will expand by 2.5% this year and reach 3% by 2014. Additionally, he projected that unemployment will continue to gradually fall, hitting 7.5% near year’s end and 7% in late 2014 — well above the expected unemployment rate of 6.5% by 2015. 

The takeaway from the Minneapolis Fed president’s speech was that monetary policy is not accommodative enough and, as a result, the Fed should do more to spur economic growth.

Kocherlakota offered various ways to increase monetary policy accommodation, including reducing the public’s level of policy uncertainty by "clarifying the nature of the economic conditions that would lead the Committee to reduce or stop its current asset purchases." 

"Alternatively, the Committee could communicate to the public that, once the removal of monetary accommodation eventually commences, the rate of withdrawal will be slower than is currently anticipated," he suggested. 

cmlynski@housingwire.com

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