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May 12, 2013

'The Fed Dials the Wrong Unemployment Number'

Gavyn Davies argues the Fed is targeting the wrong thing (unemployment instead of employment):
...the Fed has a headache. Its forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed. ...
The difficulty is that unemployment is declining towards the announced threshold in part because large numbers of people have left the labour force altogether as the recession has dragged on, and this probably means that the official unemployment rate is no longer acting as a consistent measuring rod for the amount of slack in the labour market.
The upshot is that the Fed will probably want to keep short rates at zero until unemployment has dropped a long way below 6.5 per cent...
[I]t is a distortion which the Fed cannot afford to ignore. Its mandate requires that it should aim for “maximum employment”, not “minimum unemployment on the official statistics”, which is what it risks doing under its current forward guidance. ...
If the Fed is going to make a mistake -- ease too long or tighten too soon -- you can probably guess which mistake I think is worse.

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