Question

1. The Fed’s maximum employment mandate is generally interpreted as an attempt to achieve an unemployment rate that is as close as possible to the natural rate and inflation that is close to its 2% goal for personal consumption expenditure price inflation. Go to the St. Louis Federal Reserve FRED database and find data on the personal consumption expenditure price index (PCECTPI), the unemployment rate (UNRATE), and a measure of the natural rate of unemployment (NROU).

For the price index, adjust the units setting to “Percent Change From Year Ago” to convert the data to the inflation rate; for the unemployment rate, change the frequency setting to “Quarterly.” Download the data into a spreadsheet.

Calculate the unemployment gap and inflation gap for each quarter. Then, using the inflation gap, create an average inflation gap measure by taking the average of the current inflation gap and the gaps for the previous three quarters.

Now apply the following (admittedly arbitrary and ad hoc) test to the data from 2000:Q1 through the most recent data available: If the unemployment gap is larger than 1.0 for two or more consecutive quarters, and/ or the average inflation gap is larger in absolute value than 0.5 for two or more consecutive quarters, consider the mandate “violated.”

a. Based on this ad hoc test, in which quarters has the Fed “violated” the price stability portion of its mandate? In which quarters has the Fed “violated” the maximum employment mandate?

b. Is the Fed currently “in violation” of its mandate?

c. Interpret your results. What do your response to part (a) and the data imply about the challenge that monetary policymakers face in achieving the Fed’s mandate perfectly at all times?

Answer 1

Answers:

a) The Fed violated the price stability mandate according to this ad hoc test five times since 2000.

2002(Q2) – 2002(Q4), 2005(Q1) – 2007(Q1), 2007(Q4) –2008(Q4), 2009(Q2) – 2010(Q2) and 2013(Q2) – 2014(Q1).

The Fed violated the employment mandate twice since 2000. 2003(Q2) – 2003(Q4) and 2008(Q3) –2014(Q1).

https://fred.stlouisfed.org/series/NROU

b) According to this test, the Fed currently is violating its mandate. The unemployment rate is 1.2% points above the natural rate, and the averageinflation measure indicates inflation is 0.9% points below the 2% target. The Fed had violated the employment mandate since 2008(Q3) and has been violating t the price stability mandate since 2013(Q2).

c) Since the FED failed the employment test, it is difficult to fulfil its objectives. However, other violations are noted somewhat minor and will not last for long.