What’s wrong with the Fed?

LET’S put a slightly finer point on the argument in the previous post. The Fed technically has a three-part mandate: “maximum employment, stable prices, and moderate long-term interest rates”. In January of 2012, the Fed basically defined what it thought its real mandate is as: 2% annual inflation (as measured by the price index for personal consumption expenditures) and as close to maximum employment (which it is free to define for itself) as it can get.

Since the Fed made this declaration, PCE inflation has been below target roughly 90% of the time. It was just 0.9% in the most recent data release, and markets believe inflation will remain below target for the foreseeable future.

Since the Fed made this declaration, the gap between the unemployment rate and the Fed’s estimate of “maximum employment” has shrunk from a range of 2.2-3.0 percentage points to a range of 1.1-1.5 percentage points. The Fed still anticipates that the gap will not be closed entirely until 2016, at which point the Fed would have failed to provide maximum employment for eight full years.

This is an extraordinary period of time during which the Fed has failed to meet even the rather lax definition of the mandate it has set for itself by a rather substantial margin. How can we explain this? Some…Continue reading

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