Lunchtime Must-Read: Sven Jari Stehn and Jan Hatzius: Fed Should Target Wage Growth – Business Insider

Sven Jari Stehn and Jan Hatzius: Fed Should Target Wage Growth: “Low inflation should be indicative of the size of the employment gap.

This approach, however, relies on a tight link between slack and price inflation. And the experience of the last couple of years suggests that price inflation is not very responsive to the employment gap at low levels of inflation and seems to fluctuate quite randomly when we are in the neighborhood of price stability. The behavior of core PCE inflation between 2011 and 2013 is a good example: core inflation rose by a full percentage point during 2011 and then dropped by the same amount in 2013, without any compelling macroeconomic explanation….

While such a [wage-targeting] policy is not perfect — because the wage inflation process, too, is subject to uncertainty — the error band around the paths for the funds rate and unemployment rate is lowered significantly and more so than in the case of increased focus on price inflation. The intuition is simple: because the wage inflation process is more stable than the price inflation process in our estimated model, the former provides a better cross check of labor market slack and thus there is a stronger case for Fed officials to focus on it.