Will policy finally be concerned with Levels?

I was surprised to read such an explicit opening remark by Bernanke:

Importantly, despite the recent improvement, the job market remains far from normal; for example, the number of people working and total hours worked are still significantly below pre-crisis peaks, while the unemployment rate remains well above what most economists judge to be its long-run sustainable level.  Of particular concern is the large number of people who have been unemployed for more than six months.  Long-term unemployment is particularly costly to those directly affected, of course.  But in addition, because of its negative effects on workers’ skills and attachment to the labor force, long-term unemployment may ultimately reduce the productive capacity of our economy.  The debate about how best to address long-term unemployment raises another important question:  Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand, or of structural changes, such as a worsening mismatch between workers’ skills and employers’ requirements?  If cyclical factors predominate, then policies that support a broader economic recovery should be effective in addressing long-term unemployment as well; if the causes are structural, then other policy tools will be needed.  I will argue today that, while both cyclical and structural forces have doubtless contributed to the increase in long-term unemployment, the continued weakness in aggregate demand is likely the predominant factor.  Consequently, the Federal Reserve’s accommodative monetary policies, by providing support for demand and for the recovery, should help, over time, to reduce long-term unemployment as well.

This is how Karl Smith interpreted it:

Rates are improving, but “conditions remain far from normal” in the level.

This links well with “economic conditions are likely to warrant an exceptionally low level for the Federal Funds rate”

We are beginning to see a strong implicit recognition that the relevant economic conditions are not the growth rates of real variables but the level of those variables, particularly employment.

That´s interesting. According to this Bloomberg piece:

Federal Reserve Chairman Ben S. Bernanke may be hesitating to extol the improving economy — in part to preserve the central bank’s own reputation.

While Fed policy makers upgraded their assessment of the outlook at their March 13 meeting after the most-robust six- month period of job growth since 2006, they reiterated their plan to keep interest rates near zero until at least late 2014, citing still “elevated” unemployment and “significant downside risks.” Bernanke said today that continued accommodative policy will be needed to make further progress.

Which I interpret as saying that the change in language – from growth to levels – is just a ruse to defend it´s reputation.

Nevertheless, in the same Bloomberg piece we read:

“The market focuses on direction and growth rates” of the economy, while “the Fed focuses on levels,” such as unemployment, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Year in and year out, that’s one of the most fundamental sources of miscommunication. The Fed cares about the gap.

I don´t think Lou Crandall´s observation is consistent with the prevailing reality, at least until now. So much so that some months ago (and not for the first time) I wrote:

One problem is that everyone likes to talk in terms of rates, be it growth, inflation or unemployment, but LEVELS are terribly important. With that in mind, I´ll examine the unemployment/employment situation illustrating with a set of figures.

I just hope, since the Fed is a “trendsetter”, that market participants will learn to at least look at LEVELS. At a minimum that will change the definition of an “improving” economy. It´s not just one that is growing (even if slowly) but one that´s closing the “gap”.

For example: An “improving” economy would be one travelling along path A. If the economy remains in path B it will just be “struggling”.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.