If Washington surprised everyone and struck an intelligent fiscal bargain in the next fortnight, the US labour market would still take years to regain its pre-recession level. It is thus encouraging that the Fed is looking at how to improve its zero interest rate guidance.
At the moment it forecasts low rates until at least mid-2015 – a somewhat arbitrary date. It would be logical therefore to replace that with a trigger that linked interest rates with unemployment – say a threshold of 6.5 per cent. It would also make sense were lawmakers to do the same for unemployment insurance and the payroll tax holiday, both of which are about to expire. Unfortunately, Congress is not in such an innovative frame of mind.
The case for both steps is strong. Policy makers should not be passive in the face of a sluggish labour market. At the current pace of job creation, it will take until 2025 for the US to return to the 2007 rate while accommodating the growth in the population. If consumers and investors knew that the Fed would keep interest rates low for as long as joblessness remained high, and if they knew the fiscal stimulus would be kept in place as long as the economy was weak, they would have less to fear from a new downturn. If they have less to fear from a downturn, it will be less likely to happen.
Happily the Fed is embracing this logic. To be sure, there are technicalities to iron out before it can change its guidance, most likely in January or March. Any unemployment trigger must include an inflation ceiling above which the Fed would be able to tighten – it must also choose which inflation level to target. It would probably make sense to stick to the headline rate rather than the core rate, which excludes food and petrol prices. Any change must also leave room for flexibility. If there is one lesson from the recent past, it is that central banks need discretion. But this can be addressed in the language.
The opposite applies to Capitol Hill, which treats its fiscal discretion with predictable abandon – as we see with the looming cliff. It is unclear whether Congress is going to renew the payroll holiday and unemployment benefits at the end of the year. In both cases, it should be automatic.
It would be a surprise were Congress to tie its hands by linking the fiscal stabilisers to a numerical target. It would also be a big step forward. Alas, if there is another lesson from recent years it is that Congress cannot be trusted to do the right thing.