Since 1977, Congress has instructed the Federal Reserve to control inflation while enabling full employment.
These are the Fed’s two mandates.
However, the Fed may have effectively created itself a third mandate for itself by setting a target for the country’s unemployment rate.
To recap: last week, Fed Chairman Ben Bernanke announced the Fed would keep interest rates close to zero until the U.S. unemployment rate fellow below 6.5% (it is currently 7.7%) and until the inflation rate exceeds 2.5%.
University of Chicago Nobel-winning economics professor Gary Becker says unemployment and full employment are not mirror images of each other, Becker says on his blog:
During business cycles, the employment rate and the unemployment rate do move in opposite directions, but the relation is far from one to one, especially during severe recessions. The reason is that the labour force also changes over the course of a business cycle. Especially during severe recessions, some workers get discouraged about finding jobs and leave the labour force. This would tend artificially to reduce the unemployment rate even when both employment and unemployment did not change.
Becker believes the Fed’s move will further be complicated by fiscal moves to aid the unemployed, subscribing to the belief that unemployment benefits actually prolong jobless periods.
As a result, Becker says there is a strong likelihood inflation could increase even while unemployment doesn’t budge.