A telling speech | FT Alphaville

A telling speech

This speech by Minneapolis Fed president Narayana Kocherlakota had a couple of insights into the Fed’s thinking that are worth noting.

Here’s an excerpt from the speech discussing the FOMC’s recent decision to re-invest the money from repaid MBS into treasuries:

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.

It’s hard to know exactly what investors are thinking, but surely some of the reaction was based not just on the updated outlook for the economy from Ben Bernanke, but also anticipation of what the Fed would do next.

Kocherlakota appears to be saying that investors can’t really tell anything about the Fed’s next move (or about anything else) by looking at its recent decision, and that they have overreacted.

Second, we’ve written about the large and persistent gap between job openings and the high unemployment rate, which was much higher than would be predicted by the historical relationship between the two.

Many economists and other observers had noticed it and offered possible reasons for the deviation, but nobody was sure they could explain it. Well, Kocherlakota is pretty sure he can explain it:

What does this change in the relationship between job openings and unemployment connote? In a word, mismatch. Firms have jobs, but 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.

Of course, the key question is: How much of the current unemployment rate is really due to mismatch, as opposed to conditions that the Fed can readily ameliorate? The answer seems to be a lot. I mentioned that the relationship between unemployment and job openings was stable from December 2000 through June 2008. Were that stable relationship still in place today, and given the current job opening rate of 2.2 percent, we would have an unemployment rate of closer to 6.5 percent, not 9.5 percent. Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.

As we wrote in our previous post, the “mismatch” was just one of the possible contributors to the gap between high unemployment and job openings cited by economists.

Others included reduced labour mobility, the perceptions of employers towards the long-term unemployed, jobless benefits, and simply the reluctance of employers to hire in the midst of a fragile economic recovery.

But Kocherlakota doesn’t discuss any of these. Instead, he concludes that the mismatch is the main reason, and that structural rather than cyclical issues are mostly responsible for the unemployment problem. And that’s that.

At the risk of reading too much into this, if Kocherlakota’s views are common throughout the Federal Reserve, then the prospect for further big monetary action (QE II or III or whatever) is probably limited.

It’s hard to know anything for sure, but Free Exchange reasonably suggests that the Fed’s unwillingness to take more drastic action to this point could be telling us something. Kocherlakota’s reading of the economy may ultimately prove correct, but for now his conclusions seem premature.

(H/T Calculated Risk)

Related links:
Inside the FOMC – Narayana Kocherlakota
What’s in this Beveridge? – FT Alphaville
Why isn’t the Fed acting? – Free Exchange