Kocherlakota’s revelation

This is from Bloomberg:

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank should hold the main interest rate near zero until unemployment falls below 5.5 percent, marking the first time he has linked policy to a specific economic goal.

“As long as the FOMC is continuing to satisfy its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent,” Kocherlakota said today in the text of remarks prepared for a speech in Ironwood, Michigan, referring the policy-setting Federal Open Market Committee.

…Kocherlakota today embraced a proposal by Chicago Fed President Charles Evans to calibrate monetary policy based on specific economic goals. Evans advocates holding to near-zero rates until the jobless rate falls below 7 percent or inflation reaches 3 percent.

“My thinking has been greatly influenced by his,” Kocherlakota said, referring to Evans. “By increasing monetary accommodation, the Committee can better meet its employment mandate while still satisfying its price-stability mandate,” Kocherlakota said to business and community leaders at Gogebic Community College.

…”It’s an appropriate time to start thinking about when to begin the process of reversing the level of accommodation,” Kocherlakota said on May 9. “Six to nine months down the road, we should be thinking about initiating our exit strategy.”

Today, Kocherlakota said, “the FOMC can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate.”

Kocherlakota said today the central bank should give itself leeway by allowing inflation to deviate from its 2 percent target, saying the FOMC could contemplate raising rates if inflation rises above 2.25 percent. History suggests it’s unlikely inflation will rise above that point as long as the jobless rate remains above 5.5 percent, he said.

“The current economic impact of both forms of accommodation — low interest rates and asset purchases — depends on when the public believes that accommodation will be removed,” Kocherlakota said. Confident the Fed will keep the fed funds rate near zero until achieving 5.5 percent unemployment, “people will spend more today, and that will drive up economic activity,” he said.

This is pretty sensational – it seems like Kocherlakota finally understands. And it is it not only Kocherlakota. In fact it seems like there has been a completely transformation of the thinking at the Federal Reserve. I have no clue what happened at the Fed, but something happened. And it is good…

PS Just so it is 100% clear – I don’t think it is a good idea to target real variables like the unemployment rate and that it would make much more sense to introduce a proper NGDP level target, but at least variations of the Evans rules as suggested by Kocherlakota is much better than the status quo.

Update: See the entire speech here and a summary of Kocherlakota’s “liftoff plan”.

Update 2: Scott Sumner also comments on Kocherlakota.

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