Ben, Please Drop the Employment Trigger

The forward guidance policy announced last fall was widely seen as a partial victory for the NGDP targeting approach:

• It combined inflation with a variable closely linked to RGDP growth.
• It made policy conditional on the state of the economy.

The basic idea was that the Fed promised they would not raise rates AT LEAST until one of the following two things happened:

• Unemployment fell to 6.5%
• Inflation had risen to 2.5%, on a forward-looking basis.

Dropping the unemployment trigger would make policy more expansionary, and that’s a good thing.

Bernanke already seems to be having doubts about the 6.5% figure, and deep down I’m pretty sure he would agree with this post:

Bernanke said Sept. 18 that “the first increases in short-term rates might not occur until the unemployment rate is considerably below 6.5 percent.”

Why do I favor dropping the unemployment trigger; doesn’t that move us away from NGDP and toward an inflation target?  Not really, because the current policy is extremely weak precisely because there is no real “level targeting” aspect to it.  There’s no catch-up, it’s a let bygones-be-bygones approach.  If we dropped the unemployment mandate, then we’d effectively be moving to an inflation/price level target hybrid.  There would definitely be a little bit of catch-up.  Not much, just a 1/2% or so, but that’s better than nothing. Under current policy it’s quite likely that inflation will still be below 2% when the Fed starts raising rates (roughly when unemployment falls to 6%.)  I.e. there is no catch-up at all for the current policy, which is undershooting their 2% inflation target.

As a practical matter either approach would fall short of the NGDPLT ideal, indeed either approach would fall short of a 5% NGDPLT policy starting from today, with no catch-up, as NGDP growth will likely undershoot 5% either way.  But dropping the unemployment trigger would make policy slightly more expansionary, and oddly enough conservatives/libertarians might like it more, because they hate seeing the Fed target unemployment. (Indeed I seem to recall George Selgin criticizing the employment trigger.)

And best of all, there would be no loss of credibility, as the new promise would be 100% consistent with the previous promise.  A promise not to do X if A occurs, is 100% consistent with an earlier promise not to do X if A and B occurs.