Stephen Foley: Unemployment threat to American economy

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The Independent Online

US Outlook: Chairman Ben Bernanke has finally got his way. The Federal Reserve has set an explicit target for inflation, and yet again the central bank reveals it sees its responsibility for maximum employment as the junior half of its dual mandate.

Disagreement among economists over what constitutes "maximum employment" means it could not set a numerical target for unemployment, it said. That's a shame.

Maximum employment is indeed a moving feast – the current consensus of between 5.2 and 6.0 per cent is higher than it was before the credit crisis – but then so is the Fed's policy framework, which it says it will review annually. It is also true that monetary policy is most easily applied to massage inflation than the labour market, where the flexibility of the economy and the impact of government policy are more keenly felt. But the asymmetry is disappointing and dangerous.

The inflation target of 2 per cent is, in practice, a cap, which could box the Fed into monetary tightening before the unemployment problem has been licked. The US could end up with a permanent underclass of long-term unemployed who – quite aside from the social consequences – act as a perennial drag on the economy.

The last time there was runaway inflation in the US economy, in the Eighties, the Fed under chairman Paul Volcker used tough monetary policy to tame it. We know how to tackle inflation, in the unlikely event it were to rear its head again; there is no risk from switching the Fed's focus to the junior half of its mandate.

By stepping back from setting an unemployment target, the Fed has foreclosed the possibility of innovative research on how to tackle the economic problem of this decade.