In January 2012, the Fed set a formal inflation target of 2% over the long run. Currently, inflation is well below that target. In fact, the 12-month inflation rate as per the Personal Consumption Expenditures (or PCE) index was 1.2%, while the rate for the core PCE index (which excludes volatile food and energy prices) was 1.1%, as per January 2014 estimates. Moreover, the rate of inflation hasn’t shown much movement over several months, and it doesn’t seem to be moving any higher currently. According to Lockhart, the unhealthy low rate of inflation is a by-product of a sustained quicker pace of growth and it justifies continuing monetary stimulus.
Achieving sustainable full employment
Usually, the Fed sets a threshold unemployment rate as a criterion to consider a rate hike, or a liftoff. The committee had earlier set this threshold at 6.5%. However, later, this guidance was updated for the policy rate to remain unchanged well past the 6.5% threshold. There’s been a significant decline in the unemployment rate, which was 10% at its peak and nearly 8% at the beginning of last year. With the current rate of unemployment, at 6.7%, so close to the threshold, investors may want a refreshed explanation from the committee on how unemployment or broader employment conditions will factor into a liftoff decision.
The current official unemployment rate seems to show that the country is rapidly approaching full employment—that is, full use of the nation’s labor resources. However, in reality, this isn’t the case, as the interpretation of falling unemployment has been complicated by a decline in workforce participation. This is explained in detail in the next part of this series.
Lockhart also spoke on the role of financial stability as a related consideration that could influence a liftoff decision along with inflation (or price stability and unemployment). On this stance, he agrees with the views of Governor Dan Tarullo, saying that incorporating financial stability considerations into monetary policy decisions need not imply the creation of an additional mandate for monetary policy. The potentially huge effect on price stability and employment associated with bouts of serious financial instability provides ample justification.
The performances of popular exchange-traded funds (or ETFs) like the SPDR S&P 500 ETF (SPY), the iShares Core S&P 500 ETF (IVV), and the iShares S&P 100 ETF (OEF), which track large-cap equities of companies like Apple Inc. (AAPL) and Exxon Mobil Corp. (XOM), serve as a good indicator of the course the U.S. economy is taking.