Monday, April 21, 2014
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Should Central Banks Target Employment?

WASHINGTON, DC – On December 12, US Federal Reserve Chairman Ben Bernanke announced that the Fed will keep interest rates at close to zero until the unemployment rate falls to 6.5%, provided inflation expectations remain subdued. While the Fed’s governing statutes, unlike those of the European Central Bank, explicitly include a mandate to support employment, the announcement marked the first time that the Fed tied its interest-rate policy to a numerical employment target. It is a welcome breakthrough, and one that should be emulated by others – not least the ECB.

Central banks’ statutes differ in terms of the objectives that they set for monetary policy. All include price stability. Many add a reference to general economic conditions, including growth and employment or financial stability. Some give the central bank the authority to set an inflation target unilaterally; others stipulate coordination with the government in setting the target.

There is no recent example, however, of a major central bank setting a numerical employment target. This should change, as the size of the employment challenge facing the advanced economies becomes more apparent. Weak labor markets, low inflation, and debt overhang suggest that a fundamental re-ordering of priorities is in order. In Japan, Shinzo Abe, the incoming prime minister, is signaling the same set of concerns, although he seems to be proposing a “minimum” inflation target for the Bank of Japan, rather than a link to growth or employment.

The spread of global value-chains that integrate hundreds of millions of developing-country workers into the global economy, as well as new labor-saving technologies, imply little chance of cost-push wage inflation. Likewise, the market for long-term bonds indicates extremely low inflation expectations (of course, interest rates are higher in cases of perceived sovereign default or re-denomination risk, such as in Southern Europe, but that has nothing to do with inflation). Moreover, the deleveraging underway since the 2008 financial implosion could be easier if inflation were moderately higher for a few years, a debate the International Monetary Fund encouraged  a year ago.

Together with these considerations, policymakers should take into account the tremendous human and economic costs of high unemployment, ranging from the millions of shattered lives, skills erosion, and disappearance of opportunities for an entire generation, to the dead-weight loss of idle human resources. Is the failure to ensure that millions of young people acquire the skills required to participate in the economy not as great a liability for a society as a large stock of public debt?

Nowhere is this reordering of priorities more needed than in the eurozone. Yet, strangely, it is the Fed, not the ECB, that has set an unemployment target. The US unemployment rate has declined to around 7.7% and the current-account deficit is close to $500 billion, while eurozone unemployment is at a record high, near 12%, and the current account shows a surplus approaching $100 billion.

If the ECB’s inflation target were 3%, rather than close to but below 2%, and Germany, with the world’s largest current-account surplus, encouraged 6% wage growth and tolerated 4% inflation – implying modest real-wage growth in excess of expected productivity gains – the eurozone adjustment process would become less politically and economically costly. Indeed, the policy calculus in Northern Europe greatly underestimates the economic losses due to the disruptions imposed on the South by excessive austerity and wage deflation. The resulting high levels of youth unemployment, health problems, and idle production capacity also all have a substantial impact on demand for imports from the North.

Contrary to conventional wisdom, the ECB’s legal mandate would allow such a re-ordering of priorities, as, with reference to the ECB, the Treaty on the Functioning of the European Union states that “The primary (emphasis added) objective of the European System of Central Banks…shall be to maintain price stability,” and there is another part of the Treaty dealing with general eurozone economic policies that emphasizes employment. This would seem not to preclude a temporary complementary employment objective for the ECB at a time of exceptional challenge.

Moreover, the ECB has the authority to set the eurozone-wide inflation target, and could set it higher for two or three years, without any treaty violation. The real problem is the current political attitude in Germany. Somehow, the memory of hyperinflation in the early 1920’s seems scarier than that of massive unemployment in the early 1930’s, although it was the latter that fueled the rise of Nazism. Maybe the upcoming German elections will allow progressive forces to clarify what is at stake for Germany and Europe – indeed, the entire world.

In a more global context, none of this is to dismiss the longer-term dangers of inflation. In most countries, at most times, inflation should be kept very low – and central banks should anchor inflation expectations with a stable long-term target, although the alternative of targeting nominal GDP deserves to be discussed.

Moreover, monetary policy cannot be a long-term substitute for structural reforms and sustainable budgets. Long periods of zero real interest rates carry the danger of asset bubbles, misallocation of resources, and unintended effects on income inequality, as recent history – not least in the US and Japan – demonstrates.

For the coming 2-3 years, however, particularly in Europe, the need for deleveraging, the costs of widespread joblessness, and the risk of social collapse make the kind of temporary unemployment target announced by the Fed highly desirable.

Read more from our "New Model Central Banking" Focal Point.

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  1. CommentedDheeraj Akula

    Integration of low-cost Global Workforce and labor-saving technologies are factors that are here to stay. To ensure that young people acquire skills required to participate in global economy, we need to point their learning energy towards such sectors that are relatively immune to the above factors (e.g. Medical Research, Fundamental Scientific Research, etc). But such sectors are not yet big employers due to the short-term yield and low-risk inclination of the present post-recession capital markets. We need to nurture such sectors by providing alternate and long term capital through a sector-specific approach. Central Banks have to discover sector specific tools. Central Banks can no longer follow the same thought paradigms as in Early Industrialization Era were all industries/sectors were the same.

  2. CommentedJonathan Lam

    Gamesmith94134: Should Central Banks Target Employment?

    “All include price stability” is the best description and machination for Central Banks in dealing with currencies and investments interact with various economies and nations. Its priority is to enact policies to maintain harmony and balance to all sovereignties. It is all macro-economics.

    Ever since the 80’s, during the breakage of the deficits and hyperinflation, Central Bank has to carry the role of manipulator of the micro-economics that what the politicians failed to do since there was stricter rules on money supply and what the FED can do or how much money is allowed to be printed. Then, all rules are nullified after debt ceiling was created, so is the availability of the deficits and debts.

    At the time, America was the consumer of the world and dollar is reserve of all central bank. Since then, the FED shifted its isolated post to all politics and dissipated its uniqueness to maintain harmony and balance to all sovereignties. Just like our auto industry, Chevrolet ruled after Ford, Ford was crippled after the invasion of Hondas and Mercedes, again the BMW and Lexus rolled in and Toyota won the last tournament. Eventually, Chevrolet went bankrupt over its debts and outdated designs, and fell over the gas prices. Perhaps, it is not a very precise paradigm for FED or ECB; however, in term of the global finance, there is a displacement of market shares that the FED or ECB might overlook how the emerging nations took over and grew prosper; just like American auto industry missed its call.

    Mr. Bernanke is targeting the unemployment and Mr. Abe called to stop deflation. They both may understand now the competitiveness or market shares are making the call. Under performed interest rate kills infrastructure and development that rebuild its economy, and consequently unemployment and deflation signify the recession. We must develop the long term investment to heal the economy, and the twist or quantitative easing is just buying time. Without the long term investment from the foreigner now, we can just playing see saw on the economy. It is the job for the Central banks to set goal and policy to maintain the harmony and balance to all sovereignties and not to buy jobs with credits if we are certain that competitiveness and fairness in trade make a stronger currency policy and long term investment can offer consistency to growth.

    I truly believe correction is justified that Central Banks must do what they should do in macro-economic and let politicians deal with the domestic finance and set better rules on value and price structuring through a new recalculation on currencies and its shares. Monopoly or quantitative Easing intensifies all sovereignties; and the twist is only buy time or wasting time. We can really deleverage the process by let it runs on its natural course. So, let recession come to take off the tensions of the inequality of the domestic and nationals, let deflation rolls in, so foreign investment can fill the long term debts with a reasonable interest rate in return.

    Recently, now the banks reversed FED’s low rate mortgage rose from 2.8% to 3.37% last week. New built housing slowed down, and property taxes go up. How long will the hedge fund manager hold their loots from the defaulters? Is it delusion or Blooming industry? Even the retailer had tried their best cutting profit in promoting the blooming image; and the great Christmas sales went up only0.7%. These are not good signs for recovery, and I see bubble in real estate industry.

    Why targeting unemployment or inflation if we cannot improve on our deficit?

    May the Buddha bless you?

  3. Portrait of Pingfan Hong

    CommentedPingfan Hong

    A central bank can, and should, particularly in the current situation of crisis, set a target of the unemployment rate, but this does not mean excessive monetary easing is an effective policy to promote jobs creation directly. The main purpose of setting a numeric target of the unemployment rate is to prevent the central bank from tightening monetary policy prematurely. The effects of monetary policy on the unemployment rates are asymmetric: a premature and over tightening of monetary policy can curb the recovery of aggregate demand and thus impede the recovery of the employment, but monetary easing alone cannot effectively create jobs. It would be a mistake to believe there is a constant trade-off between inflation rate and the unemployment rate, as a view reflected in this article. A simple Phillips curve has never been proved to exist in any economy.

  4. CommentedShane Beck

    Unless the country is implicitly or explicitly protectionist, the central bank holding interest rates at zero will do little to stimulate jobs growth. Why? Because in a global economy, the cheap money will always follow the cheap labor costs in labor intensive sectors such as manufacturing. Global trade is always zero sum game in jobs even if the national GDP grows.

  5. CommentedDaniel Tanner

    within economy field or process how much weight the 'money' be ? Normally same money with different person or plan will cause distinct results ... They, the money spreader, really think 'money' is the whole reason over others, such as ...

  6. CommentedDanny Cooper

    Central banks should focus on how to make monetary policy more effective. The main problem at present is that the monetary transmission channel is too dependant on the lending decision of banks which renders monetary policy ineffective. A viable solution for central banking would be to bypass the commercial banks and conduct monetary policy directly with the public in a non debt based manner. For a more detailed explanation: