In a research note today, Goldman economist Sven Jari Stehn takes a deeper look into the supply side effects of lowering the Fed’s unemployment threshold.
The Fed has said that it will not raise rates until unemployment hits 6.5% or inflation rises to 2.5% (the Evan’s rule).
Two weeks ago, the Fed economists released two studies about the effects of lowering that unemployment threshold to 6.0%.
In the wake of those papers, Goldman’s top economist, Jan Hatzius, predicted that the Fed will do just that along with tapering in March.
In today’s note, Stehn examines the supply-side effects of lowering the unemployment threshold.
Here are the findings:
In each of the four graphs, the three curves show the current 6.5%/2.5% threshold, a lower 6.0% unemployment threshold and a new curve that represents the Fed using the total employment gap rule. The total employment gap is made up of the unemployment gap (current unemployment minus structural) and the participation gap (current participation minus trend) to offer a full understanding of slack in the labour market. This includes supply-side effects.
Under this new rule, the Fed would not raise the Federal Funds rate until mid-2016 when unemployment hits around 5.5%, though there is no exact threshold. The rule also allows inflation to rise at a quicker pace than either the 6.5%/2.5% or 6.0%/2.5% thresholds allow.
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