I wonder if the rate gap shrinking between u and u_star can have any predictive power in terms of hitting a recession in the medium term. This month we saw a 0.07 closure in the gap - given economic inertia is this too fast, too slow or just right, (or is looking at this rate not informative actually)?
The concept of recession is not helpful to think about optimal stabilization policy. What matters is whether the economy is inefficiently tight, in which case monetary and fiscal policy should be tightening, or the economy is inefficiently slack, in which case monetary and fiscal policy should be loosening. In that context, clearly, the continual shrinking of the unemployment gap is meaningful and predictive of future policy changes. But, to answer your question specifically, the relevant statistic is the unemployment gap, not the rate of change of the gap. The rate of change only tells us the time it might take for the economy to reach full employment and from there a slack position.
Does the analysis suggest that FIAT is the wrong target? The target should be full employment as defined? What ARE the implications for monetary policy? And although we do not have handy ways to measure them, could not a lot of goods and services markets be "too hot" by this concept and what are the policy implications of that?
I am not sure what FIAT stands for. But for the Fed's employment mandate, the only target should be the full-employment rate of unemployment (FERU), which we argue is given by u* = √uv. The implication for monetary policy is that the Fed should always strive to bring the unemployment rate closer to the FERU. Of course sometimes there is a tradeoff, since the Fed also has a price mandate. But currently there is no such tradeoff: inflation is above target and unemployment is below the FERU. So the Fed should continue tightening—or at least wait that its past tightening takes full effect.
Indeed the concept of inefficient tightness and slack could apply to any market. To act on it, however, would require to have one policy instrument per market—to be able to influence the tightness in each market and bring it closer to its efficient level. The Fed only has one policy instrument (the fed funds rate) so it can only influence aggregate tightness. But fiscal policy is much more versatile and could influence tightness at the market level (for instance by directing government hiring or government spending to specific markets).
[FAIT = Flexible Average Inflation Tightening. I take it that the Fed thinks that PCE inflation that averages 2%, in the absence of extraordinary shocks is the optimal inflation rate and is compatible with its employment mandate (whatever that is :)). "Flexible" only implies that it may be greater than 2% during the time it takes to adjust to a shock.]
Do I understand your criterion correctly that any level of unemployment is optimal if v is equal to it? There is no unique optimum for FERU?
That is correct. Any level of unemployment can be efficient if v is equal to it. Which level of unemployment is efficient depends on the location of the Beveridge curve.
For a given Beveridge curve, there is a unique FERU, given by the point on the curve where u = v. The FERU is the point at the intersection of the Beveridge curve and pink line in the Beveridge figure above. But any different Beveridge curve produces a different FERU. Beveridge curves that are further out have higher FERUs, while Beveridge curves that are further in have lower FERUs.
The FERU is determined by the location of the Beveridge curve. Since the location of the curve varies when the structure of the labor market changes, it is not unique, and neither is the FERU.
So how do we move the Beverage curve to a higher real income position? What if we could tax vacancies, so firms would search less and just settle. That could get V/U = 1 but does not seem to be an improvement. :)
Tightening monetary policy is a way to move from here to a better spot on the Beveridge curve. We propose a mechanism and review the evidence in this paper: https://pascalmichaillat.org/7/.
This allocation maximizes real output, not real income. In fact, since the economy is too tight, it raises real output by raising real profits more than it reduces real labor income. So if workers own firms, their total income will increase. But if not, lump-sum taxes must be used to redistribute the extra income from firm owners to workers.
I wonder if the rate gap shrinking between u and u_star can have any predictive power in terms of hitting a recession in the medium term. This month we saw a 0.07 closure in the gap - given economic inertia is this too fast, too slow or just right, (or is looking at this rate not informative actually)?
Correction the, gap shrunk by 0.2 - misread that.
The concept of recession is not helpful to think about optimal stabilization policy. What matters is whether the economy is inefficiently tight, in which case monetary and fiscal policy should be tightening, or the economy is inefficiently slack, in which case monetary and fiscal policy should be loosening. In that context, clearly, the continual shrinking of the unemployment gap is meaningful and predictive of future policy changes. But, to answer your question specifically, the relevant statistic is the unemployment gap, not the rate of change of the gap. The rate of change only tells us the time it might take for the economy to reach full employment and from there a slack position.
Does the analysis suggest that FIAT is the wrong target? The target should be full employment as defined? What ARE the implications for monetary policy? And although we do not have handy ways to measure them, could not a lot of goods and services markets be "too hot" by this concept and what are the policy implications of that?
I am not sure what FIAT stands for. But for the Fed's employment mandate, the only target should be the full-employment rate of unemployment (FERU), which we argue is given by u* = √uv. The implication for monetary policy is that the Fed should always strive to bring the unemployment rate closer to the FERU. Of course sometimes there is a tradeoff, since the Fed also has a price mandate. But currently there is no such tradeoff: inflation is above target and unemployment is below the FERU. So the Fed should continue tightening—or at least wait that its past tightening takes full effect.
Indeed the concept of inefficient tightness and slack could apply to any market. To act on it, however, would require to have one policy instrument per market—to be able to influence the tightness in each market and bring it closer to its efficient level. The Fed only has one policy instrument (the fed funds rate) so it can only influence aggregate tightness. But fiscal policy is much more versatile and could influence tightness at the market level (for instance by directing government hiring or government spending to specific markets).
Thanks for your view.
[FAIT = Flexible Average Inflation Tightening. I take it that the Fed thinks that PCE inflation that averages 2%, in the absence of extraordinary shocks is the optimal inflation rate and is compatible with its employment mandate (whatever that is :)). "Flexible" only implies that it may be greater than 2% during the time it takes to adjust to a shock.]
Do I understand your criterion correctly that any level of unemployment is optimal if v is equal to it? There is no unique optimum for FERU?
That is correct. Any level of unemployment can be efficient if v is equal to it. Which level of unemployment is efficient depends on the location of the Beveridge curve.
For a given Beveridge curve, there is a unique FERU, given by the point on the curve where u = v. The FERU is the point at the intersection of the Beveridge curve and pink line in the Beveridge figure above. But any different Beveridge curve produces a different FERU. Beveridge curves that are further out have higher FERUs, while Beveridge curves that are further in have lower FERUs.
The FERU is determined by the location of the Beveridge curve. Since the location of the curve varies when the structure of the labor market changes, it is not unique, and neither is the FERU.
So how do we move the Beverage curve to a higher real income position? What if we could tax vacancies, so firms would search less and just settle. That could get V/U = 1 but does not seem to be an improvement. :)
Tightening monetary policy is a way to move from here to a better spot on the Beveridge curve. We propose a mechanism and review the evidence in this paper: https://pascalmichaillat.org/7/.
This allocation maximizes real output, not real income. In fact, since the economy is too tight, it raises real output by raising real profits more than it reduces real labor income. So if workers own firms, their total income will increase. But if not, lump-sum taxes must be used to redistribute the extra income from firm owners to workers.