Cleveland Fed Researchers on Evolution of U.S. Monetary Policy; Labor Market Recovery

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The sluggishness in U.S. labor markets is a result of cyclical factors.

Cleveland, OH (PRWEB) February 08, 2013

The evolution of the Federal Reserve's framework for conducting monetary policy over the past decade has been influenced by developments in economic theory, lessons from the Great Depression, and ongoing economic challenges in Japan, says Mark Sniderman, chief policy officer at the Federal Reserve Bank of Cleveland.

Sniderman says rational expectations theory has transformed central banking. Recognizing that businesses and consumers make decisions based partly on their expectations of how the central bank will behave, the Federal Reserve has become more transparent and more explicit about its objectives.

Academic research on monetary policy's role in contributing to the Great Depression, and Japan's efforts to combat deflation have also provided insights into how central banks can offset recessionary and deflationary pressures when short-term interest rates approach zero, says Sniderman, who discusses the emergence of large-scale asset purchases as part of the Fed's strategy to address the most recent recession.

Read Monetary Policy: From There to Here to Where?

Sweden suffered a financial crisis 20 years ago that brought unemployment to an all-time high. Some have looked to Sweden for clues as to how long it will take for the U.S. labor market to fully recover. But Sweden's experience is not relevant to the U.S., says Federal Reserve Bank of Cleveland economist Emre Ergungor. The researcher says Sweden's labor market problems were structural in nature, while the sluggishness in U.S. labor markets is a result of cyclical factors.

Ergungor says actions taken to address instability in Sweden's economic system included the privatization of large publicly-owned employers, which resulted in a steep decline in public sector employment.

Ergungor says there has not been such a structural shift in U.S. labor markets. Instead, he sees two culprits behind slow U.S. employment growth. The first is reduced consumption due to the shock to households’ balance sheets. Ergungor says people consume less when they get poorer, and people got poorer when home prices crashed, especially when one considers households' high debt loads. So some auto workers, for example, may remain unemployed not because their skills are stale but because the demand for autos has declined.

The second culprit, says Ergungor, is that the dynamism of the US labor market--the rate at which people quit their jobs and find new ones--has been slowing down for many decades. Even if research determines that there is a structural reason behind the slowing job flows (an aging population, for example), Ergungor says this long-term process is unrelated to the upheaval created by the financial crisis.

Read Are We Like Sweden? Recovery in the Labor Market.

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