The Dual Mandate

The Federal Open Market Committee (FOMC) is the Federal Reserve’s monetary policy-making body. Congress has demanded that the FOMC implement policies that would satisfy the so-called dual mandate, which requires the FOMC to strive to maintain both maximum employment and price stability.

Full Employment Goal:  A Shifting Target

The FOMC has struggled to define exactly how the goal of full employment should be measured, but does not think it is appropriate to specify a fixed goal for unemployment. In a recent policy announcement, the FOMC provided some insight as to how it views the employment goal.

“The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee’s policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision.”

The Congressional Budget Office (CBO) believes that full employment can be best understood by observing the so-called natural rate of unemployment. The CBO defines the natural rate as ”the unemployment rate that arises from all sources other than fluctuations in demand associated with business cycles. The natural rate is determined by the rate at which jobs are simultaneously created and destroyed, the rate of turnover in particular jobs, and how quickly unemployed workers are matched with vacant positions. Those factors in turn depend on the characteristics of jobs and of workers and on the efficiency of the labor market’s matching process”

The natural rate has declined over the past two decades. Why? Demographically, we have seen a major shift in the age composition of the labor force. Also, the natural rate has declined in part because of an improved match process between workers and jobs. In other words, the unemployment rate that represents full employment is lower today than in the past. The CBO pegs the current 2017 natural rate at 4.74 percent. Surprisingly, the official unemployment rate for July 2017 is 4.3 percent.