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Why Narayana Kocherlakota says the FOMC is underperforming

Surbhi Jain

Must-know policy overview: The doves of the FOMC (Part 6 of 10)

(Continued from Part 5)

Narayana Kocherlakota

Dr. Narayana Kocherlakota is the president of the Federal Reserve Bank of Minneapolis and has been since October 2009. He has a dovish stance on the FOMCs monetary policy.

Views regarding monetary stimulus

Narayana Kocherlakota has three key points to make regarding the monetary stimulus the Fed is providing to the U.S. economy to help recover it from its 2008–2009 recessionary abysses.

  1. When the FOMC changes the level of stimulus, it tends to push inflation and employment in the same direction. Raising (or lowering) the level of stimulus puts upward (or downward) pressure on both inflation and employment.
  2. The FOMC’s actions affect inflation and employment with a lag, usually thought to be about one and a half to two years.
  3. Over the long run, monetary policy is the prime determinant of the overall rate of inflation in the economy, but many factors beyond monetary policy affect the level of employment.

The FOMC is undershooting its price stability goal

While the FOMC expects inflation to turn back toward 2% near-term, Kocherlakota expects the return to 2% to take a long time—probably on the order of four years. He supports his stance by the fact that the Congressional Budget Office had also predicted that inflation won’t reach 2% until 2019.

Moreover, Kocherlakota believes the low inflation in the United States tells us that resources, notably human resources, are being wasted. He argued in front of his audience that the low inflation rate is a signal that the FOMC is underperforming with respect to its maximum employment objective.

Kocherlakota takes a dovish stance

According to Kocherlakota, the current unemployment statistics tend to overstate the degree of improvement in the U.S. labor market. He believes that most of the declines in the unemployment rate since October 2009 have occurred because the fraction of people who are looking for work has fallen. Even among those who have a job, there are signs that the economy is significantly under-employing its human resources.

The FOMC’s undershooting its target

Kocherlakota’s stance on the FOMC achieving its monetary policy objectives stays put. The FOMC has been undershooting its price stability objective, as inflation has been running well below the goal of 2% and is expected to remain that low for several years. This undershooting suggests that the American economy is wasting available resources, especially its human resources. This is enough evidence of underuse in the performance of key labor market metrics. So the FOMC is also underperforming with respect to its maximum employment objective.

Inflation is one of the major causes for interest rate fluctuations in the economy. Certain exchange-traded funds (or ETFs), like the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which has its major holdings in companies like Citigroup Inc. (C) and JP Morgan Chase & Co. (JPM), the SPDR Barclays Capital TIPS ETF (IPE), and the PowerShares Senior Loan Fund (BKLN), are designed to protect investors against the interest rate risk caused by inflation.

To read more about Narayana Kocherlakota’s views about the U.S. economy and monetary policy, read our Market Realist series  Is the FOMC achieving its goals? Narayana Kocherlakota weighs in .

The next part of this series shares the views of Chicago Fed President Charles L. Evans, another dovish member of the FOMC who gives due importance to the maximum employment objective of the FOMC.

Continue to Part 7

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