Study: We won’t meet the Fed’s unemployment target for three years

December 17, 2012

Last week's announcement by the Federal Open Markets Committee (FOMC), which makes monetary policy for the Federal Reserve, was a sea change. Fed officials announced that the central bank would keep interest rates low as long as unemployment was above 6.5 percent and inflation below 2.5 percent.

That decision marked the culmination of years of arguments from observers like Bentley's Scott Sumner, the Chicago Fed president Charles Evans and Columbia's Michael Woodford that the Fed should tie policy to explicit, numeric thresholds, rather than on general time spans (e.g., "rates will stay low through 2015").

But if the Fed stays the course, how long will it be until rates rise? Not for a very long time, say the Hamilton Project's Michael Greenstone and Adam Looney. The project has been sounding the alarm about the snail-like pace of the economic recovery for a while now, noting that it will take seven years and a month to get back to pre-recession levels of employment if we maintain the past year's average of 220,000 jobs gained per month.

Greenstone and Looney looked at how long, at that rate, it would take for the country to reach the Fed target of 6.5 percent unemployment. That's still considerably worse than the job growth we had before the recession, but it's a substantial improvement over the current 7.7 percent figure. Still, if we maintain the 220,000 jobs-a-month average, we won't get to 6.5 percent until the middle of 2015:

Given current rates of job growth, this means the 6.5 percent target pretty much matches the Fed's previous commitments to keep rates low until the middle of 2015. But it's worth noting that Federal Reserve Chairman Ben Bernanke stressed in his press conference last week that while the central bank will not raise rates if unemployment is above the 6.5 percent target, he didn't rule out keeping them low even after that target -- or the 2.5 percent inflation target -- is reached. "Reaching one of those thresholds, however, will not automatically trigger immediate reduction in policy accommodation." Bernanke explained.

So, even if we stay the course and get to 6.5 percent unemployment by the middle of 2015, the Fed could keep rates low considerably longer than that, provided the recovery is still proceeding very slowly and the risk of inflation is, as now, basically nonexistent.

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Sarah Kliff | December 17, 2012