Krugman Blog: Unemployment late next year (2010) only marginally lower than it is now

Paul Krugman is on a roll this week on the need for the Fed to keep rates at essentially zero for years to come, and the terrible danger of Fed inflation hawks killing any recovery.

Interest rate stuff aside, there are disquieting political (and human) implications in the predictions and assumptions about the likelihood of any sort of employment recovery before 2010, or even to a lesser degree 2012. The employment figures are not HIS work, these are uncontroversial conventional vanilla baseline estimates he is using to plug-in employment assumptions in his own work on interest rates.

(Such projections factor in available data... these projections already include the large outlays from the 2009 stimulus bill that will hit in 2010.)

In my view, a transparent and direct jobs program may be needed. (As opposed to systemic infusions that are calculated to create or save jobs in aggregate but have little political impact.)

Either that or direct demand-side (consumer) stimulus. (I still think federal refinancing of credit card debt at 8% would be the best demand stimulus for the buck but it's too outside-the-box.)

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Target fed funds rate = 2.07 + 1.28 x inflation - 1.95 x excess unemployment where inflation is measured by the four-quarter change in the core PCE deflator, and excess unemployment is the difference between the actual unemployment rate and the CBO estimate of the NAIRU, which is currently 4.8 percent. This rule describes past Fed policy quite well.

Applied to current data, the rule says that the Fed funds rate should be — drum roll — minus 5.6 percent. You can’t do that, of course, so we’re very hard up against the zero lower bound. And if you think the Taylor rule was a good guide to policy in the past, the Fed shouldn’t start to raise rates until the rule starts, you know, yielding a positive number.

So when will that happen? Will it happen any time soon? Not if you believe conventional forecasts. Predictions from the Survey of Professional Forecasters, say that unemployment late next year (2010) will still be only marginally lower than it is now, and core inflation will have fallen; the implied target rate for fourth quarter 2010 is around minus 5.5, barely changed from the current situation.

By late 2011 the forecast calls for modest reductions in unemployment — but I still get a target Fed funds rate well below zero.


http://krugman.blogs.nytimes.com/2009/10/10/the-madness-of-the-monetary-hawks-wonkish/


...Suppose that core inflation stays at 1.6% (although in fact it’s almost sure to go lower.) Then we can back out the unemployment rate at which the target would cross zero, suggesting that tightening should begin: it’s an excess unemployment rate of 2.2, implying an actual rate of 7 percent. That’s a long way from here. If inflation drops to, say, 1 percent, the Fed shouldn’t tighten until unemployment drops to 6.25%.

What would it take to get to that range of unemployment? Okun’s Law suggests that it takes 2 points of GDP growth in excess of potential to reduce unemployment by 1 point. Potential growth is probably around 2.5. So say we have 5 percent growth for the next 2 years — which would be hailed as a stunning boom. Even so, unemployment should fall only 2.5 points, to 7.3. In other words, even with a really strong recovery (which almost nobody expects), the Fed should keep rates on hold for at least two years.

Bear in mind that I’m using entirely standard, conventional analysis here. It’s the people saying that the Fed should start tightening in the near future who are inventing some kind of new, unspecified framework to justify their views.

http://krugman.blogs.nytimes.com/2009/10/11/when-should-the-fed-raise-rates-even-more-wonkish/