Planning for Liftoff - Video Summary
Gogebic Community College
September 20, 2012
In its statement following the Sept. 13, 2012, meeting, the Federal Open Market Committee, or FOMC, stated that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” I argue that the FOMC can provide additional monetary stimulus by making this sentence more precise in the form of what I call a liftoff plan: a description of the economic conditions that would lead the Committee to contemplate the initial increase in the fed funds rate above its currently extraordinarily low level.
I suggest the following specific contingency plan for liftoff:
As long as the FOMC satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent.
By “satisfies its price stability mandate,” I mean that longer-term inflation expectations remain stable, and the medium-term outlook for inflation is within a quarter of a percentage point of the Fed’s long-run target of 2 percent.
The substance of this liftoff plan is that the Committee will not raise the fed funds rate unless the medium-term outlook for the inflation rate exceeds a threshold value of 2 1/4 percent or the unemployment rate falls below a threshold value of 5.5 percent. Most FOMC participants project that the long-run unemployment rate consistent with 2 percent inflation is between 5.2 percent and 6 percent. These estimates, along with the historical evidence from the past 15 years, suggest that the unemployment rate can fall considerably without violating the proposed inflation threshold.
The proposed liftoff plan does not generate stimulus by promising higher inflation. Rather, the proposed plan recommends that the FOMC clearly communicate that it will not begin the process of cooling off the economy by raising rates until it sees much higher levels of economic activity. With that commitment, households can anticipate a lower path for unemployment, and they can save less to guard against the risk of job loss. People will spend more today, and that will drive up economic activity.