In evaluating the current stance of monetary policy, the long-run unemployment rate would appear to be an attractive yardstick, since it provides a sense of where one ultimately would like to be. But for assessing monetary policy on a month-to-month or quarter-to-quarter basis, the long-run unemployment rate can be very misleading. For example, when unemployment is relatively high, it’s unlikely that unemployment can be made to return to the long-run unemployment rate at a very rapid clip — within a quarter or two, say. At such times, the best possible monetary policy will only bring unemployment down gradually over time.  We can debate whether a given pace is faster or slower than optimal. But there is undoubtedly some optimal pace, and it’s unlikely to be virtually instantaneous. While that convergence process is going on, to what unemployment rate should we refer when assessing monetary policy? In other words, while an economy is adjusting to significant economic shocks, what constitutes “maximum employment”? Surely not the long-run rate, because how far we are away from that rate does not, in general, tell us how fast we should be returning...

There is a clear intuition for having the unemployment yardstick for monetary policy vary with economic conditions...From this perspective, some popular empirical practices are of dubious value for evaluating current monetary policy. For example, estimates of an older concept known as the “non-accelerating inflation rate of unemployment,” or “NAIRU,” are aimed at measuring the long-run normal unemployment rate. Estimates of NAIRU invariably impose the assumption that it varies only slowly and does not respond to many transitory shocks...

One broad quantitative measure of mismatch comes from what's called "the Beveridge curve," which refers to the relationship between unemployment and vacancies. Since the recession ended, that curve has departed from its prerecession position. Typically when the number of vacancies is low, unemployment is high, since workers are competing for a limited number of open positions. Conversely, when vacancies tend to be high, unemployment tends to be low. At present, however, both the unemployment and vacancy rates are relatively high, which suggests that unemployed workers are not finding jobs as rapidly as usual, despite the large number of open positions. This apparent outward shift in the Beveridge curve suggests that labor markets have become less effective at matching workers and vacancies. Empirical estimates suggest that this reduced efficiency could account for between 1/2; and 1-1/2 percentage points of unemployment.

Some commentators are urging the Fed to take additional action as long as the unemployment rate remains elevated. But if elevated unemployment reflects largely fundamental factors rather than insufficient spending, such stimulus might have little impact on unemployment and instead just raise the risk of pushing inflation up.

Finally, I do not interpret data suggesting an outward shift in the Beveridge curve as providing much evidence in favor of an increase in structural unemployment...  In my view, a portion of this apparent outward shift in the Beveridge curve reflects increases in the maximum duration of unemployment benefits, which have been important in buffering the effects of the weak labor market on workers and their families. The influence of these benefits will dissipate as they are phased out and the economy recovers. In addition, loop-like movements around the Beveridge curve are common during recoveries. 

With respect to globalization, I agree with Bill that, through its effect on relative prices, globalization has created both tailwinds and headwinds for central banks in their quest for price stability. Such shocks do not, in my view, alter in the least the ability of a central bank to attain its desired inflation objective over the medium term in a flexible exchange rate regime. But they do affect inflation in the short run, and they can make the attainment of a particular inflation goal easier or more painful by impacting NAIRU, at least for a time.

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level.    

And so the challenge for the Fed is always to balance supply and demand, to think about whether or not the level of demand that we're generating with our interest rate policies and with other policies -- government policies for example -- is consistent with the underlying supply. It's not so much that a given level of unemployment is, per se, inflationary, but if the economy is overheating, one might see a temporary dip in unemployment reflecting the extra resource utilization associated with it. So we don't have a magic unemployment rate that we look at and say, "Oh, that's too low or too high."   What we try to do is look at the whole economy, look for sources of price pressure. Are firms finding it easy to raise prices? Are there indications that markets are very tight, both at the labor level and the product level? And we try to make a judgment about the balance of supply and demand.  And that helps to govern our thinking about this.

The labor market -- you mentioned 6 percent -- the labor market changes a lot over time in terms of demographics, in terms of skills and education, in terms of job-finding through the Internet and so on. And so that number is not a fixed number. We always have to think about, you know, how it might be changing over time.

From the Q&A session

For example, the estimates of Staiger, Stock, and Watson (1997a and b) of the 95 percent confidence interval for the NAIRU were as much as 3 percentage points wide.    Thus estimates of the NAIRU, in isolation, provide policymakers with little real-time insight for assessing the effect of labor markets on inflation pressures.

In particular, over the past few decades the natural unemployment rate and the path of potential output have apparently moved around quite substantially. If we do not recognize the potential for such shifts, they can pose serious pitfalls for the conduct of monetary policy...

To be sure, central banks need to form some views about the economy's potential to produce on a sustained basis. After all, as I have already noted, the amount of slack in the economy is a key determinant of inflation. But, rather than focusing on fixed estimates of potential output or the natural rate of unemployment, central banks should take an eclectic approach in assessing the overall balance of economic activity relative to productive capacity. In other words, in pursuing the dual mandate, the central bank should recognize that a wide variety of indicators drawn from labor, product, and financial markets provide information about the overall balance of supply and demand in the economy. In addition, central banks should use information from various price indicators to tell them whether the economy is overheating or running well below productive capacity.

I was not entirely persuaded by the authors’ arguments ... that rely on “new estimates of real-time output gaps,” a bit of an oxymoron given that you cannot really produce a new real-time estimate of a constructed series like the output gap.  Perhaps the gap series produced by the Council of Economic Advisers was viewed skeptically by some contemporary observers, but it was the “official” series published by the Commerce Department, and it was referred to by the Federal Open Market Committee (FOMC) in its policy deliberations.  It does not surprise me that forecasters took several years to catch up to the adverse developments in trend productivity and the demographic factors that boosted the NAIRU; in the 1990s, we took a while to realize the implications of favorable movements in both variables even though we were aware from the experience of the 1970s that such changes were possible.

"To the extent that there is a relationship between economic slack more broadly, and I mean not just labor market conditions, but capital and product market conditions as well, it's become a much weaker relationship. That is, the relationship between slack and slower inflation is clearly lower than it used to be. So that connection is much weaker and there are other factors that seem to play an important role.''

     ``The other problem with using this natural rate concept actively is that a lot of research, some of it at the Federal Reserve Board, has shown that in real time we have a really hard time determining what the natural rate is, if such a thing exists.

     ``And in particular, with demographic changes, changes in the labor market, all kinds of other things, you wouldn't expect a measure of slack to be constant. So what we do at the Federal Reserve is, we really have to be very eclectic.''

     ``We don't rely on any single indicator, on any single measure. We look at a wide variety of indicators.''

     ``The economy is just too complicated now to rely on any single indicator.''

From the audience Q and A session, as reported by Bloomberg News

It's true that the empirical evidence suggests that the link is looser, that there's less responsiveness of inflation to employment conditions than there perhaps may have been in past decades.

My own view is that we should take a very eclectic approach in thinking about inflation.

I look at the state of the economy. I try to assess whether demand is exceeding supply in some sense; whether the financial conditions are promoting growth in demand which is greater than the productive capacity of the economy.  But I also look at a wide variety of indicators, including commodity prices, including financial indicators like bond rates and inflation compensation.

I don't think we can rely on any single indicator, particularly one like the natural rate of unemployment concept. It's very difficult to know. Even if there is such a relationship, it's very difficult to assess in real time where that number might be.

And so we really have no alternative but to look at, you know, many indicators -- including {commodity prices} -- to try to assess where inflation's going.

From the Q&A session

We do not have any fixed speed limit in mind when we think about the economy going forward. We do not have any fixed number for the unemployment rate.

Rather, we are looking at the overall balance of supply and demand, looking at the evolution of inflation, and trying to ensure that there's a reasonable balance between demand and supply so that our economy can continue to grow at a sustainable, moderate pace going forward.

From the Senate Q&A session

"You can get down to 3.6, 3.5'' percent {unemployment} without stirring inflation, Frank said in an interview in Washington last week. ``Wages that rise to the level of productivity are not at all inflationary.''

Bloomberg News interview

We've got a 4.6% unemployment rate.  That's great, if it stays in that region.