Minneapolis Fed Chief Has A Killer Explanation Of How The Fed Could Provide Even More Stimulus

Now he's among the more dovish.

And in a speech today he provides an answer of how the Fed could provide even more stimulus.

Basically, the Fed could say that it won't stop easing until unemployment hits 5.5%, rather than the current 6.5% target.

Here's what he said in a speech today. Understanding this is crucial to understanding the Fed's current thinking:

Based on my outlook for the next two years, I’ve concluded that the FOMC would better fulfill both of its congressional mandates by adding more monetary policy accommodation. But how best to do so? In its current forward guidance, the FOMC has stated that it expects the fed funds rate to remain extraordinarily low at least until the unemployment rate falls below 6.5 percent. In my view, it would be appropriate for the FOMC to provide more needed stimulus by lowering the threshold unemployment rate from 6.5 percent to 5.5 percent.

To see why I say so, consider two possible scenarios. In the first, the public believes that the FOMC will begin raising the fed funds rate once the unemployment rate hits 6.5 percent. (To be clear: This belief is consistent with, but not necessarily implied by, the FOMC’s current forward guidance.) In the second, the public believes that the FOMC will defer the initial increase in the fed funds rate until the unemployment rate hits 5.5 percent. The higher unemployment rate in the first scenario means that monetary policy will be tightened sooner, which, in turn, will lead to the unemployment rate being higher for longer. Foreseeing that, people will save more in the first scenario than in the second, to protect themselves against these higher unemployment risks. Because they save more, they spend less, and there is less economic activity.1

Thus, lowering the unemployment rate threshold to 5.5 percent would increase the demand for goods and thereby push upward on both employment and prices. Would this extra monetary stimulus result in an undue amount of inflation at some point in the future? Here, I find the recent historical evidence to be comforting. The following chart documents that the medium-term inflation outlook has not risen above 2¼ percent in the past 15 years, even though the unemployment rate was at times below 5 percent.2 To me, this historical evidence suggests that, as long as the unemployment rate remains above 5.5 percent, the medium-term inflation outlook will stay close to 2 percent.

Crucial concept.