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Boston Fed Research Paper: The Key Variable for Monetary Policy Is . . .

Posted by Larry Doyle on June 26, 2013 7:47 AM |

Are we supposed to really think that Ben Bernanke believes our economy — and especially our employment situation — is markedly improving?

If we were to gather our news from USA Today or similar outlets, I guess we could just think just that.

Let’s dig a little deeper.

What are many in and around the Federal Reserve likely reviewing in an attempt to gauge the real health of our employment situation?

I thank one of the single best individuals with whom I ever worked on Wall Street for sharing a paper released recently by the Federal Reserve Bank of Boston addressing the fact that the 35-year low in the labor force participation rateand not the unemployment rate — is truly the key variable in setting Fed policy. Is that right? Indeed it is.

We have not heard this take from Big Ben himself or other officials as they clearly subscribe to the “you can’t handle the truth” approach in dealing with the American public.

The authors provide:

. . . compelling evidence that cyclical factors account for the bulk of the post-2007 decline in the U.S. labor force participation rate. We then proceed to formulate a stylized New Keynesian model in which labor force participation is essentially acyclical (i.e moves independent of the economy) during “normal times” (that is, in response to small or transitory shocks) but drops markedly in the wake of a large and persistent aggregate demand shock.

Finally, we show that these considerations can have potentially crucial implications for the design of monetary policy, especially under circumstances in which adjustments to the short-term interest rate are constrained by the zero lower bound.

The paper gets very technical in its delivery, but from what I have been told it has attracted the attention of many within the Federal Reserve system. What do the authors conclude?

Overall, we view our paper as pointing out how labor market slack arising in the wake of deep recessions may not be well summarized by the unemployment rate (given the substantial lag in the response of participation), and consequentially, that monetary rules developed for the Great Moderation period may have to be adapted to account for broader measures of slack.

That is, they maintain that proper Fed policy is to stay exceptionally accommodative for a protracted period and run the risk of greater inflation to counteract the current underlying disinflationary trends within our economy.

So what are we to make of Bernanke’s comments last week and last month? I personally believe Ben is stretching the truth when he comments about an improving economy. I think he was — and still is — concerned with inflated asset valuations and wanted to let some air out of many of the market segments that had clearly bubbled.

For those who care to read and review this paper, I thank my friend for sharing Labor Force Participation and Monetary Policy in the Wake of the Great Recession

Navigate accordingly.

Larry Doyle

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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • LD

    Speaking of economic growth or the lack thereof…

    The U.S. economy grew at a slower pace than previously estimated in the first quarter as consumer spending and business investment were revised sharply downward, amid signs the pace of growth is likely to have slowed in recent months.

    The nation’s gross domestic product, the broadest measure of all goods and services produced in the economy, grew at a 1.8% annual rate from January through March, the Commerce Department said Wednesday. That was less than earlier readings and below the 2.4% gain estimated by Dow Jones Newswires.

    The economy has grown for 15 consecutive quarters, but the pace of those gains—about 2%—is among the weakest for recoveries since World War II. In the fourth quarter of 2012, economic output expanded only 0.4%.

    First Quarter GDP Growth Revised Down to 1.8%

  • larry Levin

    Hi Larry Doyle

    I thought the fed wanted to inflate asset prices to generate a wealth effect I think I even remember Greenspan testifying about this during some hearings on the hill.


    • LD


      There comes a point when “inflate” becomes “bubblicious” and the wealth effect runs the risk of becoming destructive as the market goes over a cliff.

      I think Ben was trying to send a warning siren and “break the inevitable fall.”

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