From Deviations to Shortfalls: The Effects of the FOMC’s New Employment Objective
Abstract: The Federal Open Market Committee (FOMC) recently revised its interpretation of its maximum employment mandate. In this paper, we analyze the possible effects of this policy change using a theoretical model with frictional labor markets and nominal rigidities. A monetary policy that stabilizes employment “shortfalls” rather than “deviations” of employment from its maximum level leads to higher inflation and more hiring at all times due to firms’ expectations of more accommodative future policy. Thus, offsetting only shortfalls of employment results in higher inflation, employment, and nominal policy rates on average and also produces better outcomes during a zero lower bound episode. Our model suggests that the FOMC’s reinterpretation of its employment mandate could alter the business cycle and longer-run properties of the economy and result in a steeper reduced-form Phillips curve.
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Provider: Federal Reserve Bank of Kansas City
Part of Series: Research Working Paper
Publication Date: 2021-07-16
Number: RWP 21-04