Why Fed policies influence inflation but not employment long-term

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Loretta Mester’s take on the impact of the Fed’s monetary policy

Dr. Loretta Mester spoke about monetary policy and inflation at the Cleveland Fed’s inaugural conference on inflation on May 30. In her speech titled “Inflation and Monetary Policy: Six Research Questions,” Mester focused on the economic importance of price stability and how different measures of inflation can reveal varying price trends. In this part of the series, we’ll discuss Mester’s views on how monetary policy decisions impact the Fed’s dual mandate of ensuring price stability—targeting inflation at the 2% level along with full employment in the U.S. economy. We’ll also see how Mester’s views are likely to impact stock (VOO) and bond (BND) investments.

Part 2

Monetary policy influences inflation more than employment

Mester emphasized that inflation and employment were complementary goals and that while monetary policy was the “chief determinant of inflation over the long-run,” employment was largely determined by factors that weren’t influenced by monetary policy.

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In her speech, she also commented, “The maximum level of employment is largely determined by demographics, production technology, and other factors that change over time and are not influenced by monetary policy. While the FOMC can choose the value of inflation it seeks to achieve over the longer run, it does not have the ability to achieve just any long-run objective for employment.” This statement may imply that Mester believes targeting inflation is the more important goal for the Fed. The Fed’s employment goals may follow if its inflation targeting is successful.

Mester also discussed the differences in various inflation measures the Fed and other policy makers use, posing six research questions to the audience that would help predict inflationary trends in the economy.

Fostering price stability is one of the Fed’s most important goals. Stable prices promote confidence in the debt markets, including Treasuries (TLT), investment-grade (LQD) bonds, and high-yield bonds (HYG). Inflation and inflation expectations also influence the operating environment for businesses—including companies in the S&P 500 Index (VOO). This is because a stable price environment fosters business confidence in the economy. Firms are more prone to hire when they’re confident of the business environment. So well-anchored inflation expectations help in fulfilling the Fed’s second mandate of full employment.

In the next part of this series, we’ll discuss the various inflation measures policy makers use.

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