Re-Targeting the Fed

by Yuval Levin

This morning’s jobs report is not just very disappointing but also rather peculiar — as an unusually large difference between the two surveys that make up the report means that while the report suggests that job creation was exceedingly weak in December, the top-line unemployment number declined to the lowest level in the Obama years, 6.7 percent. Some of that has to do with yet more people leaving the workforce, but more of it has to do with the fact that the generally less reliable household survey, from which the jobs-created number is derived, showed more job creation than the generally more reliable establishment (or employer) survey. 

The combination of a lower unemployment rate with worse rather than better news about the labor market makes this report especially challenging for the Federal Reserve, and turns it in fact into an important early test for new Fed chairwoman Janet Yellen. The Fed has signaled that it would consider a 6.5 percent unemployment rate a marker of sufficient economic strength to begin tightening the money supply. But this decline in the unemployment rate toward that trigger point does not actually seem to be a function of a stronger economy. 

The conclusion the Fed should draw from that is that the unemployment rate is not always a very good way to judge the health of the economy, and perhaps even of the labor market. At the very least, the central bank should formally adopt some broader mix of labor-market indicators as a guide for its decisions. But it would do best to go further and use this as an opportunity to move toward a nominal-GDP target for monetary policy — which not only would make more sense in this exceedingly weak recovery but also could enable monetary policy to offer a much better foundation for strong and stable growth in the long term. Scott Sumner ably made the case here a couple of years ago, and that case seems even stronger in light of all we’ve seen since. 

UPDATE: I see now that Patrick Brennan made much the same case below this morning too. Be sure to read his post.

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