Consensus is growing at the Federal Reserve that the central bank should declare that it wants to reduce unemployment to a specific level before withdrawing the unprecedented stimulus it has injected into the economy over the past few years.
On Thursday, an unlikely voice, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, proposed that the Fed publicly state that it will continue to stimulate the economy until the unemployment rate reaches 5.5 percent or inflation rises higher than 2.25 percent.
The proposal was somewhat surprising because Kocherlakota has been part of a posse of Fed officials who have been skeptical about additional actions to reduce unemployment and have been more concerned about the threat of inflation.
The proposals come as the Fed is seeking to better balance its two legal mandates: keeping prices stable and unemployment low. For much of the past few years, inflation has remained at or below the Fed’s target of 2 percent while unemployment has been far above the target of 5.5 to 6 percent.
At its meeting last week, the Fed took a series of major actions to bolster economic growth and try to lower unemployment.
The Fed announced it would keep interest rates near zero percent until mid-2015 and continue to boost the economy even when the recovery strengthens. It also announced it would purchase $40 billion in mortgage bonds every month through the rest of the year and continue purchases afterward until the economy doesn’t need the support any more.
The open-ended nature of the commitment sent a signal to investors, consumers and businesses that the Fed plans to continue to add fuel to the economy for a long time to come, a move the Fed hopes gives people confidence that they can borrow and spend.
The Kocherlakota plan is somewhat similar to a proposal made by Charles Evans, president of the Federal Reserve Bank of Chicago. Evans has proposed that the Fed declare it will continue to stimulate the economy until unemployment reaches 7 percent or inflation rises above 3 percent.
The proposals seek to solve a problem: Even as the Fed continues to boost the economy, no one is sure when the central bank will withdraw. As a result, consumers and businesses may hold back on borrowing and spending.
By being clearer about its plans to stimulate until unemployment is low, the central bank can ease those concerns.
“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,” Kocherlakota said in a speech at Gogebic Community College in Ironwood, Mich.
By no means is Kocherlakota abandoning his desire to keep inflation at bay. He is leaving little room for inflation to rise above 2 percent a year, which the Fed considers the appropriate rate over the long run.
Still, it shows that even one of the Fed’s “inflation hawks” believes the unemployment problem is big enough that the Fed should push the economy to grow until inflation shows any real sign of creeping up.
The unemployment rate is 8.1 percent, though that number somewhat understates the depths of the nation’s unemployment problem.
Fed officials, including Chairman Ben S. Bernanke, generally like the idea of declaring an unemployment target. But they aren’t ready to embrace one yet, concerned that no plan yet has anticipated all the problems. For example, they question why the Evans plan would find a 7 percent unemployment target acceptable when most economists judge the natural rate of unemployment to be 5.5 to 6 percent.