Do Economic Thresholds Make Sense to Financial Markets?



The big issue the latest FOMC members debated in today’s minutes was a move to “specific threshold values” for unemployment and inflation. 

Specific targets for these two variables would provide “forward guidance regarding the timing of the initial increase in the Fed Funds rate”.  Currently, the Fed relies solely on a mid-2015 calendar date to communicate when the Fed Funds rate is to move off its zero level.

This new approach would be some version of a plan offered by Chicago Fed President Charles Evans.  He wants the Fed to tell financial markets that it will keep Fed Fund rates low -- until the unemployment rate falls below 7%, and as long as inflation remains below 3%.

FOMC minutes showed three issues needed to be resolved, before officials would use "economic thresholds."

The three issues:

(1) Whether to specify such thresholds in terms of realized or projected values of inflation and the unemployment rate.  And, in either case, what values for those thresholds would best balance the Committee’s objectives of promoting maximum employment and price stability?

(2) Whether to supplement thresholds expressed in terms of the unemployment rate and inflation with additional indicators of economic and financial conditions that might signal a need either to raise the federal funds rate before a threshold is crossed, or to delay until well afterward. 

(3) Whether the statement should also provide forward guidance about the likely path of the federal funds rate after the initial increase.  It was noted that such guidance could have significant effects on financial conditions and the economy. 

At the conclusion of the discussion, Chairman Bernanke asked the staff present to provide additional background material, taking into account the range of participants’ views.

What do you think?

Would using “specific threshold values”, i.e. an unemployment below 7% and inflation below 3%, better communicate an upward change in the Fed Funds rate from zero?

Or would adding these two variables just add confusion?

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