March 29, 2023

Economic View: Fed Monetary Policy Drives Best at Higher Speeds

First, what has the Fed done recently? Until September, its bond-buying program was explicitly limited in size and duration. Fed policy makers then replaced it with an open-ended program, whose pace was to be determined by progress in healing the labor market. And they adopted simpler, more positive explanations for their actions — jettisoning the gloomy, expectations-killing language that cited wretched economic prospects to justify every expansionary move.

Then, in December, the Fed surprised markets by replacing its somewhat confusing predictions for interest rates with numerical guidelines. It said it would keep the rate it controls — the federal funds rate — near zero at least until the unemployment rate fell below 6.5 percent or inflation rose above 2.5 percent.

Under the circumstances, it was significant that the policy makers took these actions at all. The economic data that came out before the September meeting were actually better than expected. And, based on forecasts released after the meeting, members of the Fed’s policy-making committee were slightly more optimistic about prospects for employment and output growth than they had been three months before. That they nevertheless adopted a more expansionary policy can be read as an admission that they hadn’t been doing enough earlier.

The pledge to keep rates low, even if inflation edged above 2 percent, is particularly consequential. For the last several years, the Fed has acted as if 2 percent were not just a target but a ceiling that should never be breached. But coming out of a terrible recession, with unemployment excruciatingly high, a period of very rapid growth is needed to repair the damage — and it wouldn’t be surprising for such growth to push inflation a bit over 2 percent. A Fed acknowledgment that 2.5 percent inflation would be tolerable for a short while isn’t a sign that it has lost its commitment to price stability. Instead, it’s a strong statement that it is committed to ensuring a faster recovery.

The more positive language, along with the “we’ll do whatever it takes” approach to bond buying, seems designed to reassure Americans that conditions will improve. This, too, is important. With short-term rates close to zero, the Fed’s main tool is expectations management. If it can persuade people to expect more growth — and yes, a little more inflation — it may help encourage companies to stop sitting on cash and start investing again.

The new policies are improvements, but I don’t want to oversell them. As I suggested in a previous column, a more definitive policy shift — like adopting a new target for monetary policy — would likely have a greater impact on expectations and in stimulating the recovery.

And the new policy’s numerical parameters are too conservative. According to the Fed’s own assessments, normal unemployment over the longer run is well below 6.5 percent. If inflation remains low and unemployment gets down to 6.5 percent, there’s no reason to rush to raise interest rates.

The most pressing problem, though, is that the Fed’s commitment to its new policies appears shaky. Soon after the December meeting, some members of the policy-making committee spoke out against the action — killing some of the positive buzz created by the policy statement and by a spirited news conference by the Fed chairman, Ben S. Bernanke. Also, the minutes of the December meeting showed that some who had voted for the new guidance on the fed funds rate were skeptical about the complementary action on bond-buying.

No one of the Fed’s recent actions is particularly powerful on its own, but together they create a sense of aggressive expansion and commitment to recovery. If the Fed now stops some of them, giving the public a mixed message, the positive effect on expectations could easily evaporate.

So why has the Fed moved slowly, and why are some policy makers threatening to undo the recent actions? In a recent paper, Prof. David Romer of the University of California, Berkeley (my husband), and I found that pessimistic views about the effectiveness and costs of expansionary actions have played a major role in limiting Fed moves over the last few years. Policy makers worry that such actions will do little good and that they could cause inflation, distortions in financial markets and losses on the Fed’s portfolio.

I can’t say for sure that those views are wrong today. We just don’t have enough experience with situations like the current one to have conclusive evidence one way or the other.

But our paper shows that in two periods when the Fed made terrible errors, the same kinds of pessimistic views were present. Faced with the Great Depression of the early 1930s and the high inflation of the early and late 1970s, monetary policy makers did little because they were convinced that action would be ineffective.

Subsequent events proved both decisions wrong. In the 1930s, a propitious gold inflow allowed the administration of Franklin D. Roosevelt to conduct monetary expansion without the Fed. Real interest rates plummeted, expectations improved and investment spending and consumer purchases of durable goods took off — jump-starting the recovery. At the end of the 1970s, a new Fed chairman, Paul A. Volcker, concluded that monetary policy absolutely could reduce inflation, and he led the Fed to raise interest rates to historic highs. The recession that followed was painful, but inflation did come down — and it has been low ever since.

WHEN monetary policy makers meet again at the end of this month, they should keep these historical lessons in mind. At the very least, the Cassandras on the committee might want to reread the policy record from the 1930s. The degree to which some of them sound like their Depression-era counterparts might shock them — and give them pause.

The Fed’s new more aggressive policy shows every sign of being helpful, and there are no indications that the feared costs are materializing. So rather than trimming the policy before it can bear fruit, why not give it a chance?

Even better, why not give it some extra oomph? Rather than just continuing the bond-buying program, accelerate it somewhat. Instead of just reiterating the numerical guidelines on the funds rate, policy makers could follow the suggestion of Narayana Kocherlakota, the president of the Federal Reserve Bank of Minneapolis, that they lower to 5.5 percent the unemployment level at which the Fed starts to consider raising interest rates. And if Mr. Bernanke wanted to be truly aggressive, he could broach the idea that in a weak economy, a strong dollar isn’t necessarily desirable.

The important thing is that hypothetical fears shouldn’t stop the Fed’s evolution. History is on the side of doing more, not standing on the sidelines.

Christina D. Romer is an economics professor at the University of California, Berkeley, and was the chairwoman of President Obama’s Council of Economic Advisers.

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Economix Blog: Longer Unemployment, Fewer Interviews



Dollars to doughnuts.

I’ve written before about about how the longer you’re unemployed, the less likely you are to find a job. That’s probably because of some combination of several factors: skill deterioration; better workers are more likely to get hired faster, leaving a pool of less qualified workers as the ones who disproportionately make it to long-term unemployment in the first place; and the stigma of unemployment, or at least the assumption by employers that the longer-term unemployed will be lower quality because of the previous two factors.

A new study tries to measure how big a factor that stigma is.

In the fall of 2009, the authors sent out 12,054 fake résumés for 3,040 jobs posted online, with most showing that the (fictional) applicant had been unemployed somewhere from one to 36 months. The résumés were all variations on a few standard templates that the researchers came up with. The duration of unemployment was randomly assigned to candidates of otherwise equal qualifications.

Over all, 4.7 percent of résumés resulted in the candidate’s being invited for an interview. But a candidate’s chances of being called back depended on how long he or she had been looking for work.

Courtesy of Kory Kroft, Fabian Lange and Matthew J. Notowidigdo, Courtesy of Kory Kroft, Fabian Lange and Matthew J. Notowidigdo, “Duration Dependence and Labor Market Conditions: Theory and Evidence from a Field Experiment.” These figures are generated by computing the average callback rate for each 3-4 month bin in the range of unemployment lasting between one and 36 months. The line shows the five-month moving averages computed at each month.

Candidates unemployed for just a month had a 7 percent chance of being invited for an interview. Those chances dropped off sharply with just a few more months of unemployment. After eight months of unemployment, the callback rate was just 4 percent. In other words, the chances of getting an interview fell about 45 percent from Month 1 to Month 8.

At that point, though, the callback rate pretty much flattened out.

Candidates unemployed for 8 months, 12 months and even 36 months all had about a 4 percent chance of getting an interview.

“A lot of this sorting mechanism happens really early on,” said Fabian Lange, an economics professor at McGill University and one of the paper’s authors, along with Kory Kroft at the University of Toronto and Matthew J. Notowidigdo at the University of Chicago Booth School of Business.

He attributed these patterns to the fact that in a normal economy, most people who are unemployed find jobs within the first several month. After someone has been unemployed for more than a few months, the chances that the candidate is a desirable one start to fall rapidly. But after some point — in this case, about eight months — employers believe the difference in duration of unemployment is less informative about a candidate’s likely quality.

The résumés were submitted for three categories of jobs: customer service, clerical and administrative, and sales. The drop-off in callback rates was largest for sales.

“That makes some sense,” Mr. Lange said. “If you’re in sales, you’re supposed to sell something. If you’ve been unemployed for six or seven months, you’re not that good at selling yourself, so why should an employer take a chance on you?”

Interestingly, the study also found that a candidate who is currently employed is actually less likely to be called back for an interview than one who is newly unemployed.

This may be surprising, given that people with jobs have already demonstrated that they are employable; there are even some job postings that specifically require candidates to be currently employed to be considered.

The authors of the study offered a few theories for why the currently employed had a lower callback rate than the recently employed.

First, they learned from personnel professionals that employers were concerned that people who were already employed were not serious candidates. Second, some jobs require workers to start immediately, and someone who already has a job will probably have to give notice before leaving. Third, a person who already has a job has more bargaining power and can ask for a higher wage in a new position. There’s also the question of loyalty.

“If you’re an employer, you might see that this person has a job and is not being very loyal to that current job,” Professor Lange said. “You might think, ‘Maybe if I give him or her a job, and they go through a phase of training, maybe he or she will leave me  within a few months on the basis of what they did to the last employer.’”

The study also found that in areas with higher unemployment rates, callback rates for even the recently unemployed were very low, and there was not as much of an advantage to being recently unemployed compared with long-term unemployment.

Courtesy of Kory Kroft, Fabian Lange and Matthew J. Notowidigdo, Courtesy of Kory Kroft, Fabian Lange and Matthew J. Notowidigdo, “Duration Dependence and Labor Market Conditions: Theory and Evidence from a Field Experiment.” These figures are generated by computing the average callback rate for each 3-4 month bin in the range of unemployment lasting between one and 36 months. The line shows the five-month moving averages computed at each month. “High” and “low” unemployment refer to whether cities had above or below 8.8 percent unemployment, the median for cities in this sample.

In other words, employers are more forgiving of longer durations of unemployment when they know that the job market is really bad: they recognize that length of unemployment is not as good a proxy for quality of a worker when no one is being hired, not even the really good candidates.

The problem, of course, is that duration of unemployment is always going to be an imperfect signal for quality. You still have a lot of good candidates being passed over for interviews because they got unlucky, and that unluckiness develops an inertia.

“It’s the classic lemon problem,” Professor Lange said. “You have a lot of lemons, but still some good cars among then. The problem is to distinguish the good from the bad when you have a high proportion of bad.”

One possible policy response, he speculates, is having the government provide some sort of additional screening mechanism to help employers distinguish the unlucky-but-good long-term unemployed from the long-term unemployed who cannot find jobs because they are unmotivated or unskilled.

For example, there could be “training” programs whose purpose is just to demonstrate that students have the discipline and motivation to attend and complete them, regardless of what skills are actually taught.

“It could be something that involves 40 hours a week, the regular workday length, and starts early in the morning,” he said. “If you find people who are willing to subject themselves to a 40-hour-a-week program and complete that successfully, that might be the signal the labor market needs to determine they’re good job candidates.”

Mr. Lange and his colleagues are also looking into ways to redesign the unemployment benefits system to account for the patterns they found.

He says one idea might be to start benefits at lower levels, to encourage people to take jobs sooner before their chances for getting interviews fall off sharply. And then to make benefits more generous once applicants pass the eight-month mark, when it becomes much more difficult to get interviews and applicants are in need of assistance.

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