Guest Contribution: “Unemployment and Unnecessary U-turns in Forward Guidance”

Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99.

Friday’s jobs report showed the US unemployment rate falling to 6.6% in January. This is within a whisker of the 6 ½ % threshold that the Fed had announced at the end of 2012: It had said that it planned on keeping monetary policy easy at least until the unemployment rate had fallen below that level. But the central bank is nowhere near ready to raise interest rates, and so has had to back away from that particular “forward guidance.” The FOMC said on December 18 that it now expects to keep interest rates low well past the time that the 6 ½ % mark is reached.

Even though the Fed had always said that the unemployment threshold was a necessary but not sufficient condition for tightening, some critics believe that this shift in emphasis is a policy “U-turn” that has confused the financial markets. If so, it was avoidable.

The Bank of England has undergone a parallel sequence of events. In mid-2013 it gave similar forward guidance, with a threshold figure for UK unemployment of 7%. But Governor Mark Carney at Davos at the end of January signaled that he is now moving away from that guidance. The reason: the British labor market is now “in a different place” from what was expected: The Bank of England’s original forecast had been that the 7% number would not be reached until mid-2016; yet British unemployment, unexpectedly fell to 7.1% in the autumn and thus is poised imminently to cross its threshold as well. And yet, with the economy still weak and inflation still low, the monetary authorities appropriately do not want to raise interest rates anytime soon.

Janet Yellen is now at the helm of the Fed. She will have to re-think forward guidance and use information other than the unemployment rate. (And other than the inflation rate, which has been part of the guidance all along.)

The reason for the change in policy is again clear. The Fed hadn’t expected to reach the threshold for tightening in 2014 or even 2015. But unemployment has fallen unexpectedly quickly — not because of unexpectedly rapid growth in the economy which might call for earlier tightening (good news), but, in large part, because discouraged workers have left the labor force altogether (bad news). (To be sure, a big part of the four-year decline in the unemployment rate has indeed been due to a growing economy; and even part of the decline in the labor force participation rate is due to the benign long-term trend of baby-boom retirement. Nevertheless unexpected exit from the labor force is probably the biggest component of the unexpectedly rapid recent decline in the unemployment rate.)

Both the Fed and the Bank of England are accordingly now subject to much criticism for having delivered forward guidance that they were subsequently unable to stick to. Some of these attacks are unfair. No one should want the central bank to slavishly follow statements made in the past if circumstances have changed in an unexpected way. Any fair critic must acknowledge that the ubiquitous demand for transparency with respect to the central bank’s plans (phrased simply) inevitably conflicts with the reality that the future is unpredictable, in particular with respect to such developments as unexpected fluctuations in the labor force participation rate. This uncertainty is why the monetary authorities have always hedged their foreign guidance. Nobody is now violating a past promise. Are the critics then being entirely unfair?

Not entirely. There was another way. A year or two ago, many of us were suggesting that the monetary authorities could announce a target or threshold for Nominal GDP, instead of for inflation, real income, unemployment, or other alternatives. Some of us explicitly warned that a threshold phrased in terms of the unemployment rate would be vulnerable to extraneous fluctuations such as a decline in labor force participation, and argued that a nominal GDP threshold would be more robust with respect to such unforecastable developments.
Just over a year ago, for example, I wrote in favor of “a commitment to keep monetary policy easy so long as nominal GDP falls short of the target. It would thus serve a purpose similar to the Fed’s December 12, 2012, announcement that it would keep interest rates low so long as the unemployment rate remains above 6.5% – but it would not suffer the imperfections of the unemployment number (particularly its inverse relationship with the labor force participation rate…).” [Central Banks Can Phase in Nominal GDP Targets without Losing the Inflation Anchor blog, December 25th, 2012.] Other NGDP proponents issued similar warnings.

This is yet another instance of a long-standing point: if central banks are to focus attention on a single variable, the choice of Nominal GDP is more robust than the leading alternatives. A target or threshold is a far more useful way of communicating plans if one is unlikely to have to violate it or explain it away when things change later.

This post written by Jeffrey Frankel.

17 thoughts on “Guest Contribution: “Unemployment and Unnecessary U-turns in Forward Guidance”

  1. Ricardo

    Acutally the FED should have contacted those who understood Obama reelection campaign. My friends were signaling in 2010 that the unemployment rate would be down to near 7% before the election of 2012 even if the whole country was thrown out of work. The Obama reelection campaign needed unemployment to be down significantly so in 2012 they began increasing the adjustment for the participation rate. The FED got caught in the reelection trap just as many voters did.

    In truth the FED has never intended to use the unemployment rate to guide their actions. Currently the FED has only one objective and that is to keep Treasury interest rates down. If the interest rates on Treasury debt was to return to a normal level interest on the debt would be greater than the Defense Budget.

    But the FED is spitting into the wind. Ultimately they will not longer be able to manipulate the rate and the citizens of the country will pay a high price.

    So this particular debate is one only economists could love. How may angels can dance on the head of a pin?

    1. Jeffrey Frankel

      Thank you for your comment.
      You believe that the Obama Administration “began increasing the adjustment for the participation rate.” I am not sure what adjustment you are talking about. But the employment figures are compiled by a small number of career professionals at the Bureau of Labor Statistics who are well-insulated from political influence. (Reportedly Richard Nixon tried to intimidate them once, but even he did not succeed.) As it has long done, the BLS reports statistics for those who are counted as out of the labor force because they have given up looking for jobs. These numbers are not secret.
      You are not entirely alone in your belief that the US government manipulates economic statistics. Those of us who know better from firsthand experience usually don’t bother to reply to such blog postings, dismissing them as wild paranoid conspiracy theories. But I figure that if we don’t at least state the case, the general public will have no way of knowing.

      Jeff Frankel

      1. Hugo André

        Mr Frankel

        Please don’t feed the trolls. Conspiracy theorists like Ricardo here have no interest in evidence and most of the time aren’t even very coherent. For this reason, arguing with them is futile and may only encourage them to keep on posting this drivel.
        I believe the general public is clever enough to understand this.

      2. 2slugbaits

        Prof. Frankel,

        Menzie probably should have alerted you to our friend Ricardo. He’s kind of our resident crazy-uncle-in-the-attic, but we still love him. And he does provide a valuable public service. Afterall, someone has to read zerohedge and the site so we don’t have to. But then based on Ricardo’s comment about our Zimbabwe style inflation you no doubt figured out that he also follows shadowstats.

      3. mike

        Bravo Jeff Frankel!

        I realize it is thankless, but I do think there is value in politely responding to posts like Ricardo’s, as you have done so eloquently. It does seem delusional. But I don’t think it’s surprising that a lot of people believe what he believes. There are many voices on talk radio and television, in addition to blogs, that implicitly or explicitly feed these delusions. For many people this is what they are typically exposed to, and what the people they know are exposed to. We cannot begin to bridge the divide without engaging constructively to dispel these delusions.

        Best regards,

  2. Hugo André

    Another alternative is to target wage growth, as the goldman sachs chief economist recently suggested. The advantage of this is that a tightening job market will cause rising wages but may not cause an increase in the CPI. The unemployment rate is of course a poor indicator of the amount of slack in the economy, as pointed out in the article.

    The advantage with this kind of approach compared to a nominal gdp target is that it more directly shows at what point the economy has returned to full employment. As the chief economist writes, the connection between the unemployment gap and inflation is not very strong at low levels of inflation. See for example the full 1% increase in inflation for 2012, a year when the economy most certainly was was below capacity.

  3. JBH

    There can be no substitute for sound money. We are living through an episode of the unsoundest money in all history. Nominal GDP is not the thing to target. Just the latest in a long string of neoclassical economics morphings as it flails about trying to remedy its latest failure (the long credit boom that led to the current stealth depression). Frankel in a link proposes 4 to 4½% for the nominal target. Suppose real GDP growth goes to 1½%. I and many others (like Robert Gorden at Northwestern) argue that’s where it is going. Even the CBO has it flatlining at 2% in the out years. With a target of 4½% nominal that means 3% inflation. So in a single generation’s time, you lose 50% of the value of your fiat holdings. Not sound money! And inimical to the crucial initial variable in the causal chain – savings to investment to capital to productivity. And then, Frankel suggests an eventual target of 5½%. So that the value of your fiat money would halve even faster.

    There is to my knowledge no scientific proof that modest inflation is any better than modest deflation. In fact, modest deflation favors savers. Abstracting from the War of 1812 and the Civil War inflations, the 1800s was a century of mild 1% deflation. And real growth was manifestly better than in the century of inflation wrought by the Fed since 1913.

    In lieu of gold – the quintessential sound money – which will make a comeback after the next truly major global crisis in a world now awash in debt, an augmented Taylor rule with target inflation at zero, and an added asset price variable (mainly if not exclusively home prices), would be the next best alternative. For those of you who do not understand gold, you might read Antal E. Fekete’s Pillars of Sound Money. (…”the essence of the gold standard is not to be found in its ability to stabilize prices (that is neither desirable nor possible). It is to be found in its ability to stabilize the interest-rate structure at the lowest level compatible with economic conditions, and thereby to keep debt within limits.”)

    If you have not figured out by now that excessive debt is the most important problem of the modern economy, you may want to suspend your current beliefs and look into it. Amongst the most prominent offshoots of mainstream macroeconomics are: Keen, Minsky, Kalecki, Geanapolous, Reinhart Rogoff, and Koo. What do they have in common? You guessed it.

    As for the unintended and undesirable consequences of QE, where is the post on this? Some of these consequences been visible for quite a while to those who have given this thought and looked. The latest is the unraveling of emerging market economies with adverse feedback to the US stock market bubble. In all likelihood, this feedback will become more pronounced as the year progresses.

    1. 2slugbaits


      We are living through an episode of the unsoundest money in all history.

      I’m not a big fan of this “sound money” argument, but most people who use the phrase generally equate “sound money” with low inflation. I think most people would say that inflation is very low right now, so I guess I don’t know what you mean when you say we’re living in “an episode of the unsoundest money in history.”

      Just the latest in a long string of neoclassical economics morphings

      I don’t think Prof. Frankel could be described as a “neoclassical” economist. Do you know what the term “neoclassical” means? If Prof. Frankel is a neoclassical, then what pray tell is Prof. Lucas?

      With a target of 4½% nominal that means 3% inflation. So in a single generation’s time, you lose 50% of the value of your fiat holdings.

      Ah. Well, that answers my question Prof. Lucas. Clearly you’ve never heard of him or something called the “Lucas critique.”

      no scientific proof that modest inflation is any better than modest deflation

      Well, actually there is. Search the literature.

      modest deflation favors savers.

      Why should monetary policy favor savers? I’ll get back to this later.

      real growth was manifestly better than in the century of inflation wrought by the Fed since 1913

      Actually, this is manifestly untrue. Most economic growth in the 19th century was due to the huge expansion in the labor force. Per capita growth was relatively anemic.

      If you have not figured out by now that excessive debt is the most important problem of the modern economy, you may want to suspend your current beliefs and look into it.

      Apparently you haven’t figured out that for every dollar saved there must be a dollar borrowed by somebody. Since the private sector is reluctant to borrow and still deleveraging, that means some other entity must do the borrowing if the private sector is to save. This is just an accounting identity. If everyone tries to save and no one will borrow, then “neoclassical” economics tells us that income must fall in order to equilibrate savings with borrowing. That’s called a demand shock recession. And this leads me back to your comment about deflation favoring savers. I’ve read enough of your posts to know that much of what you write is better understood as a morality play rather than economics. Savers are good, upright citizens who worry about the future. They tell their children the story about the grasshopper and the ant. Borrowers are “those kinds” of people who are shiftless, lazy, undisciplined and unworthy of going to heaven. I strongly recommend that you read an old classic, Norman O. Brown’s Life Against Death. You might recognize yourself as the “perpetual postponement of pleasure” guy. (Note: Brown was a literature guy who like alliteration). Brown has a lot of interesting things to say about Keynes. And if you read Brown, you might as well go the whole Monty and start off with Marcuse’s (non-Marxist) Eros and Civilization. Brown’s book was a response to Marcuse’s book. Hopefully you’ll come away recognizing that economics is not a morality play where the good guys save and the bad guys spend.

    2. baffling

      how long have you been peddling this argument? it never comes to fruition, but is always going to occur “in the years to come”. people like you have been wrong for many years, perhaps its time to step back and reassess your economic paradigm? perhaps to one which matches the reality on the ground?

  4. anon and lazy

    Speaking of unemployment and U-turns, could we do a U-turn on Obamacare and reduce unemployment some way other than low-wage workers less or exiting the labor force in order to live at the expense of others? (Maybe Cutler could weigh in too.)

    1. baffling

      anon and lazy,
      actually you are going to find it is NOT the low wage folks who will leave the work force-they still need cash to survive and at $7.50 an hour they don’t make enough to work lower hours. It will be wealthier folks with substantial asset accounts-enough to live off of comfortably. they will be the ones who back away from work hours, since they will lose “subsidy” money if they work more. so just to be clear, the lazy folks who cut back on work will most certainly come from a traditionally higher income bracket-they will be the ones with the subsidized beach vacation in the Caribbean. you will not see any minimum wage workers basking on the beach. you really need a warped mind to actually believe that propaganda!

  5. Ricardo


    Thank you for taking the time to responsd to my post. I understand your irritation having to reply to such a post but, whether you believe it is political manipulation or not, if you consider how government statistics have changed over the years a statistic today is significantly different from what it has been in the past.

    There are many who live by government statistics. If they were to admit that the statistics are political they would have to admit that their calculations are manipulated.

    CBO has just back-tracked on their latest forecast because of political heat. This is not unique with the CBO and the Obama administration. They have done this before with other administrations. They know who writes their checks.

    The level of employment has been virtually unchanged since the end of the Bush administration, but the unemployment rate has declined. That is because those who stop looking for work are not counted as unemployed, but just because your neighbor is no longer looking for work does not change the fact that he is unemployed. Rather than recount all of the ways that government manipulates numbers it would be better to ask if there is any government statistic that has not been changed in the past 20 years.There may be one but I am not aware of it. Granted the government always says it is to better report the statistic but isn’t it strange that the changes always seem to make the statistics look better? I can remember the Soviet Union always seemed to have pretty good statistics too, as does China today.

    I want to release you from responding to me because it would probably serve no purpose, but I would encourage you to be more skeptical about government statistics, not in a destructive way but in a constructive way. When government manipulates numbers it may get them past the next election but it does not change the truth that must be faced at some time in the future.

    1. pete

      I will fill in for Dr Frankle. I did several years in DC as a regulator. We did not publish statistics like this, but the agency was heavily politicized, which was confusing as it went from Bush to Clinton to Bush. However, I did meet with fellow economists in many other agencies, some academic types, and other “lifers.” By and large the lifers were definitely simple technocrats without noticeable political motivations. The senior executives, the political appointees, obviously were slanted, but not always in the way one might think, and more than once the bureaucrats would place facts in front of them and they would have to adjust.

      Bottom line, the spin on the numbers can be biased, but the numbers themselves are probably spot on for what they are worth. Nice article in the weekend WSJ by Zachary Karabell on how the unemployment rate is a silly measure. Thus, it could be accurately measuring what they think it is measuring, but says little about how things are really doing out there.

  6. Ricardo

    Thanks Pete for the thoughtful reply. I do not doubt that the NUMBERS that are reported by the various economists are what they say they are but because they are subject to the political definitions they are constantly changing to support the political agenda. A great example it the CBO reports on TARP. The law itself dictated what estimates CBO should use in certain calculation and even thought the calculations made no sense when applied to TARP the CBO was restrained by law. I believe that the CBO, for example, does monumental work trying to comply with its mandate. My problem is the mandate is political and manipulated. Look at how the Obama administration is using numbers for how many have signed up for nationalized health care. They know what numbers they are using but they report them so that they are misleading.

    Numbers that come from government will always be political because no one pays a price if the numbers support the political agenda. If the numbers were coming from industry or people who see their profit or losse dependent on accuracy it would be different. Business knows that ultimately they will pay a price for bad numbers. Politicians only look to the next election.

    It is the system itself the begats bad numbers from government.

    1. mike


      It would help if you were a little more specific about where you think manipulation is taking place. The standard statistics are being calculated as they always have. The whole world is watching, and if numbers start to look strange, someone will notice and document inconsistencies. The agencies will scramble to figure out whether there is a problem and explain the phenomenon if they can. As someone who once worked in the federal government, I can personally attest that while politics (and sometime error) plays into many things, the statistics are not being manipulated in ways you suggest.

      With regard to the CBO report, I don’t think CBO backtracked. If you go and read the original report, I think you will find that their own original characterization is very much in line with what they are still saying. Manipulation came from the way some media outlets spun some of the results. The media outlets are selling a product too, and salacious stories sell. Sadly, there seems to be a lot more cheap journalism out there, even though we also have more high quality, from-the-source reporting like Professor Frankel’s gracious post here.

      In my experience, politics tends to enter the picture (usually for more obscure matters) by cutting resources from agencies or sub-agencies that report politically uncomfortable realities.

  7. baffling

    what about the propaganda recently regarding obamacare, the cbo and lost work hours? the report states there will be a reduction in hours work-as chosen by the workers themselves. there was no manipulation of the data by cbo. but many self serving pundits and politicians blatantly lied and stated the cbo report says these will be jobs lost due to obamacare-as in people getting fired. the agency work was fine. it was a subgroup of politicians and media pundits who were disingenuous.

    i think your fight against the obamacare enrollment numbers has more to do with the fact as enrollment numbers increase, the success of the program becomes firmer. you simply do not want to believe people are signing up for the program-it goes against your political agenda.

  8. Ricardo


    I thought you might be interested in the following. It is not getting wide circulation but is just another example of how government statistics are manipulated. This was very overt. Most manipulation is covert and very difficult to uncover.

    At the core of all these investigations is solid evidence that at least one surveyor — a guy named Julius Buckmon, working out of the Philadelphia Census office but polling in Washington, DC — submitted fake household surveys that were used in compiling the Labor Department’s unemployment rate.

    Because of the scientific nature of the Labor Department survey, Buckmon’s actions alone would have affected the responses of some 500,000 households.

    But as I’ve been reporting, the scam was allegedly much larger than that and included other surveyors (or enumerators as they are called) over many years. And supervisors at least two levels up are said to have known about — and covered up — the scandal.

    So far Congress has mainly been asking questions about the Buckmon incident and his supervisors’ actions. But the inquiry is likely to get broader, especially if correspondences between people in the Philadelphia office show a conspiracy to make the unemployment rate look better than it really was.

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