NEW YORK – The unemployment rate, and the reasons it is so high, trouble Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, who said the Fed may not be able to resolve the problem.
Inflation is too low, but deflation is unlikely, Kocherlakota told an audience in Marquette, Mich., according to prepared text of his speech, which was released by the Fed. Unemployment, however, is a major concern.
Kocherlakota explained that the relationship between the unemployment rate and the jobs openings rate “began to break down” in June 2008 and “has completely shattered” since. “The job openings rate has risen by about 20% between July 2009 and June 2010. Under this scenario, we would expect unemployment to fall because people find it easier to get jobs. However, the unemployment rate actually went up slightly over this period,” he said.
The statistics indicate a “mismatch,” with jobs available but firms “can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs. There are many possible sources of mismatch—geography, skills, demography—and they are probably all at work. Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.”
Also, it appears that a lot of the current unemployment rate is due to mismatch, he added, as the current job opening rate is 2.2%, the unemployment rate should be closer to 6.5%, not 9.5%, Kocherlakota said.
“Given the structural problems in the labor market, I do not expect unemployment to decline rapidly,” he continued. “My own prediction is that unemployment will remain above 8% into 2012.”
While there may not be a solution, Kocherlakota said “good public policy requires that we help mitigate their losses via a well-designed unemployment insurance program” that offers “constant benefits over the entire duration of an unemployment spell, however long. It should provide incentives only through the level of those benefits, not through their timing.”
Elsewhere in the economy, Kocherlakota said he expects gross domestic product (GDP) growth around 2.5% in the second half of this year and near 3.0% next year. “There is a recovery under way in the United States, and I expect it to continue,” he said, noting it “is more modest than I would have anticipated.”
“We are four quarters into the recovery, and real GDP per person is still about 3.2% below its level in the fourth quarter of 2007 when the recession began. In some sense, this number actually understates the economic problem,” he said. “Typically, real GDP per person grows between 1.5% and 2% per year. If the economy had actually grown at that rate over the past two and a half years, we would have between 7% and 8.2% more output per person than we do right now. My forecast is such that we will not make up that 7%-8.2% lost output anytime soon.”
As for inflation, Kocherlakota sees it near 1% this year and 1.5% to 2% next year.
Translating the Federal Open Market Committee’s statement, Kocherlakota said, rates will stay low to prevent a rise in unemployment, and with little threat of inflation, rates can be kept low.
Speaking of the Fed’s balance sheet, Kocherlakota explained that since “long-term interest rates declined surprisingly fast in the past three months,” homeowners were prepaying their mortgages, so the Fed’s mortgage-backed securities principal balances fell. “In this sense, the Fed’s holdings of long-term assets were shrinking, leaving a larger share of the long-term risk in the economy in the hands of the private sector. This extra risk in private hands could force up the risk premia on long-term bonds and be a drag on the real economy,” he said. “The FOMC decided to arrest the decline in its holdings of long-term assets by re-investing the principal payments from the MBSs into long-term Treasuries.”
However, he said, “The FOMC’s decision has had a larger impact on financial markets than I would have anticipated. My own interpretation is that the FOMC action led investors to believe that the economic situation in the United States was worse than they, the investors, had imagined. In my view, this reaction is unwarranted. The FOMC’s decisions were largely predicated on publicly available data about real GDP, its various components, unemployment, and inflation. I would say that there is no new information about the current state of the economy to be learned from the FOMC’s actions or its statement.”
With inflation near 1% recently, “some observers ... worry about the possibility of a multiyear period of falling prices—that is, persistent deflation,” he said. “I don’t see this possibility as likely. It would require the FOMC to make the surprising mistake of ignoring the long run in its desire to fix the short run.”
