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Fed holding course on QE2. Even amid this news flow, the FOMC gave no indication in Tuesday’s policy statement that it is considering scaling back the $600 billion, eight-month expansion of its securities portfolio announced last month (QE2). Why such focus on the unemployment rate? The Fed’s willingness to stay the course with QE2 is based on (1) its view that “the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate” to foster “maximum employment and price stability,” and, (2) its observation that, “the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.” 1 In light of the Fed’s statutory mandate, reducing the unemployment rate from its current elevated level is an appropriate policy objective in its own right, and because it would help to stabilize inflation at levels more consistent with the Fed’s long-term objectives. Does the Fed have an unemployment rate target? In theory, the Fed would sanction a decline in the unemployment rate to the level consistent with “maximum sustainable employment” – below which inflation would tend to accelerate. The FOMC expresses a view on this non-accelerating-inflation rate of unemployment (NAIRU): the central tendency of members’ estimates of the longer run unemployment rate is 5.0%-6.0%. Yet estimates of the NAIRU are subject to considerable uncertainty, and should not be a rigid policy objective. 2 A structurally higher NAIRU? Indeed, in the aftermath of a deep recession and a financial crisis, there seems to be broad agreement that structural dislocations 3 have lifted the NAIRU from its putative 5.0%-5.5% pre-recession range. Yet most analysts would likely agree that the NAIRU is percentage points below the current 9.8% unemployment rate, and that inflation is likely to remain below the Fed’s long-term objectives unless the unemployment rate falls closer to the NAIRU. What is the growth threshold to bring down unemployment? In this context, Fed officials likely welcome the coming injection of additional fiscal stimulus (even as they harbor concern, which we share, about the longer-term trajectory of federal debt). FOMC members estimate longer-run growth (the threshold for reducing unemployment) in a 2.5%-2.8% range, and carried a 3.0%-3.6% real GDP growth forecast for 2011 into their November 2-3 meeting, with the unemployment rate falling to roughly 9% at the end of next year. Is a Monetary Policy Re-Think in Order? The tax relief package enacted today should boost 4 policy makers’ 2011 growth expectations. We are watching for evidence that it has engendered second thoughts at the Fed regarding the wisdom of QE2, but we believe that the threshold is high for tempering or suspending this tranche of asset purchases. The extent to which temporary tax relief prompts increased spending remains to be seen, and substantial uncertainties remain, particularly regarding the path of house prices and the depth of state and local government fiscal retrenchment. Policy makers do not want to respond prematurely to a growth pickup that turns out to be transitory. However, if the expansion gains traction and the unemployment rate begins to trend lower, as we expect, the Fed’s attention will broaden beyond the elevated (relative to the NAIRU) level of the unemployment rate to include the rate at which it is declining as well. Even from relatively high levels, the rate at which resource slack declines influences cost and price pressures. Moreover, if the Fed’s intention is to be at a neutral policy setting when the unemployment rate reaches its “full employment” level, then a more rapid decline in the unemployment rate would call for an earlier start to the removal of accommodation than policy makers currently have in mind. 1 “ Press Release,” Federal Open Market Committee, December 14, 2010. 2 Indeed, the principal policy error leading to the Great Inflation of the 1970s was an overestimate of the economy’s production capacity (i.e., too low an estimate of the NAIRU). In contrast, FOMC members’ indication that 1.6%-2.0% inflation in the PCE price index represents “price stability” is a more appropriate object of policy commitment: over time, monetary policy’s most consistent influence is on nominal quantities, such as price levels. 3 These structural factors might include the loss of skills due to long unemployment spells, and reduced mobility of under-water homeowners. 4 FOMC members will update their economic projections for the January 26-27, 2011 meeting. The results will be released with the semi-annual Monetary Policy Report to Congress, in mid-February. December 17, 2010 T. Rowe Price U.S. Economic Perspective 2
Offices and Investor Centers of the T. Rowe Price Group of Companies UNITED STATES OFFICES Baltimore 100 East Pratt Street Baltimore, Maryland 21202 410-345-2000 Financial Center 10090 Red Run Boulevard Owings Mills, Maryland 21117 410-345-2000 Corporate Campus 4515 Painters Mill Road Owings Mills, Maryland 21117 410-345-2000 Technology Center 11550 Cronridge Drive Owings Mills, Maryland 21117 410-345-2000 Colorado Springs 2260 Briargate Parkway Colorado Springs, Colorado 80920 719-278-5800 San Francisco 333 Bush Street, Suite 2550 San Francisco, California 94104 415-772-9950 Tampa 4211 West Boy Scout Blvd Tampa, Florida 33607 813-554-4000 Long Beach 4401 Atlantic Avenue, Ste. 200 Long Beach, CA 90807 562-422-8812 INTERNATIONAL OFFICES Netherlands Strawinskylaan 1047 1077 XX Amsterdam The Netherlands 31.(0)20.333.62 00 England 60 Queen Victoria Street London EC4N4TZ England 011-44-20-7651-8200 Japan NBF Hibiya Building – 20 th Floor 1-7, Uchisaiwai-cho 1-chome Chiyoda-ku, Tokyo 100-0011 Japan 011-81-3-3504-1810 Hong Kong Jardine House 21 st Floor 1 Connaught Place Central Hong Kong 011-852-2536-7800 INTERNATIONAL OFFICES (Cont’d.) Singapore No. 290 Orchard Rd. #14-04 Paragon Singapore 238859 011-65-836-0098 Argentina Carlos Pellegrini 1149, piso 12 (1009) Buenos Aires Argentina 011-54-11-4394-4089 Australia Levels 25 & 29 Chifley Tower 2 Chifley Square Sydney NSW 2000 Australia 011-61-2-9293-2894 Denmark Lautrupsgade 7 2100 Copenhagen Denmark 011-45-33-36-05-00 Luxembourg Boulevard Royal 26 2449 Luxembourg Grand Duche de Luxembourg Switzerland Dreikoenigstrasse 31a 8002 Zurich Switzerland 41 44 208 3905 Canada Brookfield Place – TD Canada Trust Tower 161 Bay Street, Suite 2700 Toronto, ON M5J 2S1 Canada 1 416 572 2580 INVESTOR CENTERS Baltimore 105 East Lombard Street Baltimore, Maryland 21202 410-345-5757 Owings Mills 4515 Painters Mill Road Owings Mills, Maryland 21117 410-345-5665 Massachusetts 386 Washington Street Wellesley, Massachusetts 02481 781-263-1200 Colorado Springs 2260 Briargate Parkway Colorado Springs, Colorado 80920 719-278-5700 INVESTOR CENTERS (Cont’d.) Los Angeles 10100 Santa Monica Blvd., Suite 100 Los Angeles, California 90067 310-772-3000 San Francisco 1990 N. California Blvd., Ste. 100 Walnut Creek, California 94596 925-817-1900 Tampa 4211 West Boy Scout Blvd., 8 th Floor Tampa, Florida 33607 813-554-4000 Washington, DC 900 17 th Street, NW Farragut Square Washington, DC 20006 202-466-5000 New Jersey 51 JFK Parkway, 1 st Floor W Short Hills, New Jersey 07078 973-467-6800 Paramus 81 E. Route 4 West, Suite 102 Paramus, New Jersey 07652 201-712-4700 New York 1100 Franklin Ave., Suite 101 Garden City, New York 11530 516-535-6100 Illinois 1900 Spring Road, Suite 104 Oak Brook, Illinois 60523 630-645-9700 Illinois 40 Skokie Blvd., Suite 100 Northbrook, Illinois 60062 847-313-4500 Tysons Corner 1600 Tysons Blvd., Suite 150 McLean, Virginia 22102 703-873-1200 Boca Raton Wachovia Plaza 925 S. Federal Hwy., Suite 175 Boca Raton, Florida 33432 561-338-4300 December 17, 2010 T. Rowe Price U.S. Economic Perspective 3
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