ST. LOUIS - Minneapolis Federal Reserve Bank President Narayana Kocherlakota Tuesday evening said that there are strict limits to how much the Fed can do to reduce unemployment.
Kocherlakota said monetary policy can help reduce joblessness but only with the help of non-monetary policies to stimulate demand for labor.
He said the Fed has largely succeeded in its goal of keeping inflation around 2% by counteracting weakness in product demand, but acknowledged that it has fallen short of its maximum employment goal because it has much less ability to offset reductions in labor demand.
"Employment is much lower than four years ago," he said, because of factors such as the increased difficulty in starting a business and business uncertainty about future taxes and regulations.
Government policies to encourage hiring are needed in conjunction with easy monetary policy, Kocherlakota said in a lecture at the Washington University School of Law.
Kocherlakota's implication was that it would be relatively ineffective for the Fed to adopt additional monetary easing measures.
Kocherlakota was one of three Federal Reserve Bank presidents who dissented against easing measures adopted by the Fed's policymaking Federal Open Market Committee last August and September.
The Fed's statutory "dual mandate" is to provide both price stability and maximum employment, but Kocherlakota said that mandate has run up against two kinds of "shocks" since the Great Recession began: "product demand shocks" and "labor demand shocks."
Drawing from an econometric model on which his lecture was based, Kocherlakota said the Fed can, by lowering the real interest rate, influence demand for goods and services and indirectly help reduce unemployment in that way. But it has much less impact on demand for labor.
"The first implication of the model is that monetary policy can offset the impact of the product demand shocks on employment, but it cannot offset the employment loss due to the fall in labor demand and any associated slow real wage adjustment," he said, summarizing his findings in prepared remarks. "As a result, the level of 'maximum employment' achievable through monetary policy is less than the 'full employment' of labor resources."
He said a second implication of his model is that "non-monetary policies specifically designed to stimulate the demand for workers (such as government subsidies for hiring) can offset some of the employment loss due to the labor demand shocks, but only if accompanied by monetary easing."
"That is, monetary and non-monetary policy must work in concert to reduce the impact of a decline in labor demand; neither can do it alone," he added.
Kocherlakota concluded that "the Federal Reserve is performing about as well as it can on both mandates."
"The Federal Reserve's accommodative policy has offset much of the impact of product demand shocks and so has kept inflation near target," he said. "However, this policy has been unable to offset the large adverse shocks to labor demand."
"The model implies that, in terms of employment, there are limits to what monetary policy can achieve on its own," he added.
Kocherlakota offered a number of reasons why "firms want to hire fewer workers/hours in 2012 than in 2007." For one thing, he said it is "harder to start up new firms because households have less net worth," and that is important because "young firms are an important source of employment growth."
He said "the recession eliminated many firms" and that there is less competition among remaining firms.
Kocherlakota also cited a host of "uncertainties" facing would-be employers.
"Firms now see adverse financial shocks as being more likely than they did in 2007," he said, adding that firms "learned in 2008 that such shocks can trigger large layoffs," and so "this possibility makes them less willing to hire new workers."
Also, "firms remain concerned about possible increases in taxes and regulations," Kocherlakota said.
Ideally, he said "real wages should fall to clear markets," but "firms may face internal and external impediments to cutting real wages for new hires."
"This gives rise to even lower employment," he said.
Without recommending anything in particular, Kocherlakota said the government could help reduce unemployment by stimulating demand for labor.
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