In this article we reiterate our case for industrial policy during periods when structural unemployment is high as now.
We had published a seminal technical paper in these pages on April 12, 2012 arguing that monetary theory suggests that both unemployment and inflation be targeted and ex ante specified by the central bank. The Federal Reserve appears to have taken heed.
Beginning with its December 12, 2012 Federal Open Market Committee (FOMC) Statement, the central bank of the United States began communicating its policy actions in line with its mandate by explicitly specifying both unemployment and inflation targets.
The Fed has the choice between supplying money to the financial markets with no strings attached (unemployment and inflation targets if at all are weak conditions with strong consequences for not meeting them) and letting the economy muddle along the process of structural change at its own pace or directing that process by placing conditions on the markets in its bond buying program. It has opted for the former.
The Federal Reserve appears to be content with the pace of employment creation in its projections expecting the weak global economic conditions to contain domestic headline inflation. However, such conditions will not last forever. Recovery elsewhere will ultimately pressure the United States to find ways of containing domestic inflation while remaining on target for growth and employment. The way out is industrial policy by means of monetary policy beginning now because setting the new non-inflationary structural determinants in place takes time. Doing so will be the biggest bang for the cheap buck and the consequent valuation of financial assets rooted in the real non-financial sector.
Targeting unemployment during periods of high structural unemployment as now entails industrial policy by means of monetary policy. While inflation targeting signals higher interest rates beyond a level of inflation, unemployment targeting signals lower interest rates above the desired level of unemployment. This implies financial markets have the incentive not to lower unemployment provided inflation is to the satisfaction of the central bank.
It must be noted here that in the current economic environment, in practice the Fed will not be able to tighten monetary policy should inflation projections show a persistent 2.5 per cent consumer price index (CPI) reading. Therefore, targeting unemployment by central banks during periods of high structural unemployment of necessity requires industrial policy using the instruments of monetary policy to ensure an economic structure where job creation is non-inflationary, meaning, more jobs and accompanying wages must produce goods and services which place little or no upward pressure on food and energy prices and on prices in general.
Economic winners will be those who can create an economic structure post-crisis for both low inflation and low structural unemployment and the People’s Republic of China is on course to winning the game.