Economists challenge the Fed’s jobs target

By Caroline Salas
Bloomberg News / June 2, 2010

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NEW YORK — Federal Reserve policy makers say full employment means a long-term jobless rate between 5 and 5.3 percent. Some of the most influential economists say they are wrong.

Dean Maki at Barclays Capital, 2006 Nobel Prize-winner Edmund Phelps, and Bank of America-Merrill Lynch’s Ethan Harris estimate the worst financial crisis since the Great Depression has pushed the so-called natural rate of unemployment to between 6.3 and 7.5 percent. Unless the Fed accepts that more Americans will be permanently out of work, the central bank may spur inflation by waiting too long to raise its benchmark rate from a record low, said Maki, Barclays’ chief US economist and the most accurate forecaster in a December 2009 Bloomberg News survey.

Investors “must worry that if the natural unemployment rate is up to 7 percent, then there’s the danger that the Fed will keep piling on more stimulus money as if they didn’t have to worry’’ about joblessness, Phelps, 76, a professor at Columbia University in New York, said in an interview.

On a “cheerful day,’’ Phelps said, he estimates the rate has climbed to between 6.5 and 7 percent. On a “gloomy day,’’ he pegs it from 7 to 7.5 percent.

“If you knew for sure that the natural rate was 5 percent, then it might make sense for the unemployment rate to hit 7 or 7.5 percent before you start tightening at all,’’ Maki, 45, said from his New York office.

“That becomes a very risky strategy when the natural rate has risen, because you could be sitting at a zero percent Fed funds rate at full employment and not realize it.’’

Joblessness has stalled above 9 percent since May 2009 as about 8 million positions evaporated during the economic slump that began in December 2007, and companies from General Motors to home builder Tousa Inc. declared bankruptcy.

Maki said the natural rate — the level that neither accelerates nor decelerates inflation — will remain high because there’s a mismatch between available jobs and the skills of the unemployed. People whose homes are worth less than their mortgages also may be reluctant to move for work, and the extension of unemployment benefits deters some people from accepting employment with lower pay because a portion of their lost income has been replaced, Maki said.

The Labor Department on Friday is expected to report the jobless rate fell to 9.8 percent in May from 9.9 percent in April, according to the median forecasts of economists surveyed by Bloomberg News.