Brainard´s “New Normal” is Old

Lael Brainard´s speech on the Fed´s new “longer-run goals and strategies makes reference to a “New Normal”: [I only highlight her references to the labor market]

“The new statement on goals and strategy responds to these features of the new normal in a compelling and pragmatic way by making four important changes.

First, the statement defines the statutory maximum level of employment as a broad-based and inclusive goal and eliminates the reference to a numerical estimate of the longer-run normal unemployment rate.6 The longstanding presumption that accommodation should be reduced preemptively when the unemployment rate nears the neutral rate in anticipation of high inflation that is unlikely to materialize risks an unwarranted loss of opportunity for many Americans.

Third, the statement highlights an important change in the Committee’s reaction function. Whereas previously it sought to mitigate deviations of employment and inflation from their targets in either direction, the Committee will now seek “to mitigate shortfalls of employment from the Committee’s assessment of its maximum level and deviations of inflation from its longer-run goal.” This change implies that the Committee effectively will set monetary policy to minimize the welfare costs of shortfalls of employment from its maximum and not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence and inflation that is correspondingly much less likely to materialize.

… Beyond that, had the changes to monetary policy goals and strategy we made in the new statement been in place several years ago, it is likely that accommodation would have been withdrawn later, and the gains would have been greater.”

What she really shows is that the post Greenspan FOMC has continuously misinterpreted the economy.

The panel below clearly illustrate that during the 1990s and early 2000s (before the Great Recession), a stable growth rate for nominal spending (NGDP) was what was required to keep the rate of unemployment on a downward trend while inflation either fell or remained low & stable.

The same remains true for the post GR period.

When the Fed makes a big monetary policy mistake and allows nominal spending to tank, the consequences are also big. This was the case in the monetary-led Great Recession. NGDP tanks while unemployment balloons. Inflation dropped by 50% (from 2% to 1%).

Four years ago (Sept 16) Lael Brainard made a speech with the title: “The New Normal and what it means for Monetary Policy”. One of the key features of the New Normal was:

  1. Labor Market Slack Has Been Greater than Anticipated
    Second, and related, although we have seen important progress on employment, this improvement has been accompanied by evidence of greater slack than previously anticipated. This uncertainty about the true state of the economy suggests we should be open to the possibility of material further progress in the labor market. Indeed, with payroll employment growth averaging 180,000 per month this year, many observers would have expected the unemployment rate to drop noticeably rather than moving sideways, as it has done.

The next chart zooms in on 2016 to indicate the “cause” of the sideways move in unemployment. You easily see it was due to the excessive drop in NGDP growth from the 4% average that prevailed in the 2010 – 2019 period. The same happened 20 years before. The Fed should have picked on this “pattern” some time ago! As seen in the previous charts, once NGDP growth picks up again, unemployment resumes the down trend.

So, using new words for the “target” – AIT – and new words for the “reaction function” – shortfalls – will likely change very little.

The usefulness of underlying, or core, rates

It is the case, instead, of not missing the trees for the forest. The case for core inflation, for example, is well established, but not always understood. The charts below show that sometimes the qualitative information given by “trees & forests” or core and headline rates is the same, but at other times, “trees & forests” look very different.  In 2007-08, the Fed took drastic and wrong actions because it only looked at the “forest” and missed the “health of the trees”.

The next chart shows the effect of the “sudden drop shock” brought on by Covid19. With economic activity “dumped”, temporary lay-offs skyrocketed.

Temporary lay-offs have since decreased, bringing headline unemployment down. Should we be “thrilled” by the falling headline unemployment, or are we missing the more durable effects of the wild swings in temporary lay-offs? In effect, these lay-offs may increase again following the pick-up in infections since the last data collection period for the employment report.

In order to have a better understanding of what´s happening to the trend in unemployment, we have to strip-out this highly (and distorting) volatile element. Our measure of core unemployment includes those called marginally attached (which are not in the labor force but want to work) and excludes those defined as on temporary lay-offs. In practice, it defines core unemployment by subtracting temporary lay-offs from the U-5 definition of unemployment.

The chart below shows that for most of the time, headline & core unemployment gave out the same information about unemployment.

Since the Covid19 “sudden drop shock”, however, they diverge “majestically”.

The underlying or core unemployment trend trend reversed direction in July. Hopefully this reversal will be confirmed with the data for August.

When low unemployment was meaningful

From the BLS today: 38K Payroll and 4.7% unemployment!

Will the Parrots at the FOMC continue to think the labor market is “overstretched”? Or will they revise their views to contemplate that their monetary policy is totally inadequate?

They could learn something from a historical comparison. In the “good days”, this same low rate of unemployment went hand in hand with about the same low rate of inflation. However, the growth rate of real output was in a very different league!

Those were the days

Update: And the Fed knows why!

Those were the days_1

The Fed & the Unemployment Rate

Yellen on labor market (Sept 2015):

As I said, although we’re close to many participants and the median estimate of the longer-run normal rate of unemployment, at least my own judgment – and this has been true for a long time – is that there are additional margins of slack, particularly relating to very high levels of part-time involuntary employment, and labor force participation that suggests that at least to some extent the standard unemployment rate understates the degree of slack in the labor market.

“But we are getting closer. The labor market has improved. And as I’ve said in the past we don’t want to wait until we’ve fully met both of our objectives to begin the process of tightening policy given the lags in the operation of monetary policy.”

In fact, she´s a long way from meeting both objectives! No one has any doubt about the distance we are from the 2% inflation target. On the other hand, with unemployment down to 4.9%, many could assume that we´re even “overstepped” it!

The best way to look at the unemployment rate is to analyze it from the perspective of its two constituents: The employment population ratio (EPR) and the labor force participation rate (LFPR).

That´s because the unemployment rate (UR) is, by definition, equal to [1-(EPR/LFPR)]*100. Therefore, a rise in the EPR, normally associated with a robust economy, will reduce the unemployment rate. On the other hand, a rise in the LFPR, something also usually associated with a growing economy (controlling for demographic factors, that change slowly), will increase the unemployment rate.

From this perspective, even in a strong economy the rate of unemployment could be rising (a little at least) if the rise in LFPR is higher than the rise in the EPR.

The charts below make the importance of looking at the rate of unemployment together with its determinants clear.

In the “Golden 60s” and in the “roaring 90s”, we see the unemployment rate falling with rising EPR and LFPR, with the EPR rising faster than the LFPR.



Over the last 10 years, and especially since 2008, we see unemployment first jumping from the steep drop in the EPR and then monotonically falling with the fall in the LFPR together with a reasonably level EPR.


The suddenness of the fall in the EPR and coincident falling trend of the LFPR is difficult to ascribe to sudden and big demographic changes. But they are consistent with the initially gradual and then sudden drop in NGDP growth, which even turned significantly negative (a rare event indeed).


It doesn’t look like that the labor market has in some sense, improved. What is more likely is that the perverse monetary policy of the last several years has changed its nature, maybe through hysteresis effects.

That has been the outcome of the Fed´s policy framework, which Kocherlakota aptly named “gradual normalization”. That policy framework has been instrumental in providing monetary policy tightening!

To undo the hysteresis effect on the labor market the Fed has to change the policy framework. The best alternative, and one that would do the most to reverse those effects, is for the Fed to establish a higher nominal spending target. To reach it, nominal spending growth (NGDP) would be temporarily higher, providing the right incentives for an increase in both the EPR and LFPR.

The Fed is getting exactly what it wants…

…And they must be pretty dumb if they think otherwise! They talk about “normalizing” monetary policy as if there could be any other understanding that they want to put rates up. What does the market do? It pushes longer rates down!

For more than one year, ever since “the time is coming talk” began, the economy has been weakening. In that sense, the “TT” (“Tightening Tune”) strategy is working.

This is another example showing that the level of the FF rate does NOT define the stance of monetary policy. As seen in the chart, NGDP growth has been trending down for more than one year, which defines the stance of monetary policy much more precisely.

Converging on 3

So I find it surprising that people who should know better feel baffled:

Chairperson Yellen’s remarks on September 24 mentions again that they could (expect to?) raise rates by the end of the year:

Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter. But if the economy surprises us, our judgments about appropriate monetary policy will change.

The last sentence in the Yellen quote once again provides an out for the Fed not to do anything.

The bigger question is whether the economy is in a sustained recovery or have we hit a rocky spot giving the Fed further pause? That said, a return to normal monetary policy that begins to eliminate some of the distortions caused by several years of zero interest rates would seem to be beneficial and it is surprising that the FOMC did not see it that way.

Man, what do you mean by “not doing  anything”? As I just argued, the Fed is in “tightening mode”. By actually raising rates they will be in “economy strangulation mode”!

Scott Sumner says:

Get ready for the new normal—3.0% NGDP growth—it’s coming soon.

As the chart above shows, we may be there already! Worse, if the Fed continues with the “TT” Strategy, it will bring it even lower.

PS Remember, in the “limit”, if there´s no labor force, there´s 0% unemployment!

Good-bye, so long, farewell?

In a recent post Scott Sumner muses:

For the past few years I’ve been suggesting that the labor force participation rate is not going to bounce back.  Commenters have insisted that the workers were just “discouraged”, and that they’d come back in and start looking for jobs when the labor market got somewhat better.

Today the unemployment rate fell to 5.1%.  If that’s not the natural rate, it’s pretty close. Close enough so that if you really wanted a job you should at least be looking by now.  And yet the Labor force participation rate is 62.6%, the lowest level since the 1970s. No, I’m afraid the discouraged workers are gone for good.  Indeed the Fed wants to tighten now to prevent the job market from overheating!

In the next post he asks:

What is the total number of months during the Ford, Carter, Reagan and Bush I administrations, plus the first term of Clinton, when the unemployment rate was lower than today?

Answer:  1

(March 1989, when it was 5.0%)

Come on discouraged workers, get out there and start looking!

Nevertheless, taking a longer view, below several instances (many more in the 60s and 90s) of unemployment below 5.1% and the corresponding YoY core pce inflation:

Nov/66: 3.6% – 3.1%

Nov/73: 4.8% – 4.8%

Mar/89: 5.0% – 4.5%

Apr/00: 3.8% – 1.7%

May/07: 4.4% – 2.0%

Now: 5.1% – 1.2%

However, it is disturbing to see, as shown in the chart below, that monetary policy failures (letting NGDP growth drop significantly, or even tank) has permanent real effects, in this case causing a permanent drop in the labor force participation rate (even considering only prime-age workers). And the Fed Borgs think more “tightening” is needed!

So long Farewell_1

Therefore, saying that 5.1% unemployment is indicative of a “tight” labor market is nonsense! What is “tight” and remains “tight” is monetary policy.

The following chart indicates that higher employment growth could be forthcoming with higher nominal spending growth. Unfortunately, the Borgs don´t seem willing to experiment!

So long Farewell_2

Title Song


The unemployment controversy

Five years ago, Kocherlakota dismissed the power of monetary policy to bolster employment:

Kocherlakota in August 2010

What does this change in the relationship between job openings and unemployment connote? In a word, mismatch. Firms have jobs, but can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs. There are many possible sources of mismatch—geography, skills, demography—and they are probably all at work. Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

Three years later (September 2013) his view changed completely:

First, I will show you data that depict the painfully slow pace of recovery in the U.S. labor market. Second, I will show you data that demonstrate that there is considerable monetary policy capacity with which to address this problem.

Now, New York Fed William Dudley parrots Kocherlakota in 2010:

The New York Fed president was in western New York for a routine district visit, his third to Rochester in the past five years. In remarks kicking off his one-day tour, Mr. Dudley highlighted structural imbalances in the labor market, saying they can’t be resolved with monetary policy alone.

He said there is a growing mismatch between employers’ needs and job seekers’ skills or locations, and that monetary policy couldn’t substitute for the workplace development programs that are needed to fix them.

 “Monetary policy can help labor markets recover by providing incentives for firms to invest and grow,” Mr. Dudley said. “However, monetary policy cannot by itself solve skill mismatches that may exist in the economy. These frictions must be addressed in other ways.”

The point that Kocherlakota grasped two years ago is that monetary policy, by “capping aggregate spendinghas not been providing incentives for firms to invest and grow.