The Objective Function of the Federal Reserve Looks Not to Be the Right One: Friday Focus: March 7, 2014

Tim Duy: Unemployment, Wages, Inflation, and Fed Policy: “Historically, the Fed tightens before wages growth accelerates much beyond 2%….

Wage growth tends to accelerate as unemployment approaches 6 percent…. That 6.5% [unemployment] threshold was not pulled out of thin air…. The tightening cycle is usually topping out when wage growth is in the 4.0-4.5% range. One interpretation is that the Fed continues to tighten policy to prevent workers from gaining too much of an upper-hand…. They see it as tightening monetary conditions to hold inflation in check.  Either way, the end is the same. It would represent a very significant departure from past policy if the Fed waited until wage growth was at pre-recession rates before they tightened policy or if they allow conditions to remains sufficiently loose for wage growth to eventually rise above pre-recession rates. If you want the Fed to make such a departure, start laying the groundwork soon….

I believe that Tim Duy is correct: that the overwhelming current on the FOMC today is that the Federal Reserve needs to keep inflation at (or below) its target rate of 2% per year, and needs to raise interest rates in order to keep its expectations of the inflation rate from rising above 2% per year for any substantial period of time. The FOMC, as it is currently constituted, is not focused on balancing its two mandated goals of maximum feasible employment and price stability. It is not interested in recovering any of the downward base drift that the price level has suffered since 2007. It is profoundly uninterested in restoring the track of nominal demand to its pre-2007 trend.

That is a great pity, for either of those alternative goals would, I think, be a very very good thing for America and the world.