Evaluating Monetary Policy: Are We Having The Optimal Discussion?

“The Federal Reserve, notwithstanding that not everybody likes it — I think it’s good — has a dual mandate.”  –U.S. Federal Reserve Chairman Ben Bernanke

This past Wednesday, Fed Chairman Bernanke spoke to the National Bureau of Economic Research following the release of the most recent Fed minutes.  He answered questions after his speech which led to some intrigue in the markets because of his responses as to the current state of the economy and what that might mean for Fed policy.

As I discussed recently, the Fed’s dual mandate of focusing on both unemployment and inflation may not be optimal.  Unemployment is a challenging and important issue, especially during the current lack of increased employment commensurate with the recent stock market recovery following its fall during 2008-09:

Chart forS&P 500 (^GSPC)

“The dual mandate is to pursue maximum employment and price stability. Currently, we have an unemployment rate of 7.6 percent, which I think, if anything, overstates the health of our labor markets given participation rates and many other indicators of underemployment and long-term unemployment. So we’re not there, obviously, on the maximum employment part of the mandate.”  –Chairman Bernanke

FRED Graph

 “I think you can only conclude that highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.”  –Chairman Bernanke

However, perhaps a more important question than whether monetary policy should be “highly accommodative” in order to help with the unemployment issue is whether monetary policy can sufficiently help with the unemployment problem, especially under current circumstances.  I recently addressed this issue in light of former Chairman Paul Volcker’s discussion of this issue:

“Asked to do too much, for instance to accommodate misguided fiscal policies, to deal with structural imbalances, to square continuously the hypothetical circles of stability, growth and full employment, then it will inevitably fall short,” Volcker said. Those efforts cause it to lose “sight of its basic responsibility for price stability, a matter that is within the range of its influence.”

One issue I have discussed in the past regarding monetary policy’s role in helping with the unemployment problem is how it might affect Congress’ questioning of the Chairman during his semi-annual testimony to the legislative branch.

I encourage folks to listen to the Chairman this week when he testifies before Congress regarding monetary policy, particularly as to how he focuses on the unemployment aspect of the mandate.

Because unemployment is such a crucial issue, the Chairman will likely often raise this issue as to why the Fed will remain highly accommodative for the foreseeable future.  While this is surely an important issue to raise, perhaps the discussion as to whether inflation is truly as low as the Fed believes is also an important issue to explore in greater detail.

“On price stability, inflation is now about 1 percent, which is below our 2 percent objective”  –Chairman Bernanke

By focusing on the unemployment issue though, the discussion regarding whether inflation is truly as low as the Chairman believes may tend to get relatively lost in the shuffle.  Obviously, the balance between fiscal and monetary policy in helping ensure an optimal backdrop for maximum sustainable employment is an important one, as often discussed by the Chairman more recently:

“Moreover, the other portion of macroeconomic policy — fiscal policy is now actually quite restrictive.”  –Chairman Bernanke

Accordingly, perhaps fiscal policy should be the focus of the discussion regarding unemployment.  Please note that I am not suggesting that current monetary policy would necessarily change based upon re-evaluating the Fed’s mandate:

“So both sides of our mandate — both the employment side and the inflation side, are saying that we need to be more accommodating”  –Chairman Bernanke

I definitely believe optimal Fed policy should consider unemployment in its policy decisions, but whether the Fed is correctly evaluating consumer price inflation might not be currently discussed as thoroughly as it should be.

FOMC Inflation

Consumer price inflation may be a regressive tax on those who consume but may not have the financial assets that have appreciated since ’09 in order to pay for any increase in consumer prices.  On the other hand, as you can see from the charts above, perhaps consumer price inflation is not an issue with which to be concerned.

But, when it comes to evaluating monetary policy, maybe that’s a discussion worth exploring in greater detail…