The president of the Federal Reserve Bank of Minneapolis said Thursday the Fed should keep interest rates extremely low until U.S. unemployment falls to 5.5 percent.
So long as joblessness stays above that level and inflation stays below 2.25 percent, Narayana Kocherlakota said, the Federal Open Market Committee should promise to keep rates low.
"As long as the FOMC satisfies its price stability mandate, it should keep the Fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent," Kocherlakota said in a speech at Gogebic Community College in Ironwood, Mich.
Some observers were surprised by his position, as Kocherlakota earlier this year expressed concern over the potential for rising inflation. Kocherlakota restated Thursday that the central bank should remain vigilant on inflation, but he also called for low interest rates for as long as it takes to bring unemployment down.
His speech builds on the decision last week by the Fed to do a third round of quantitative easing, an effort to further drive down interest rates by purchasing long-term securities from banks. Fed Chairman Ben Bernanke said the central bank will work to keep interest rates low "for a considerable time after the economic recovery strengthens."
That phrase was important to economists and investors, because they interpreted it as an open-ended commitment to low interest rates, which are supposed to encourage lending and stimulate the economy.
Kocherlakota took it a step further Thursday. He said if the public believes the Fed will start raising interest rates when unemployment falls below 7 percent, or even below 6 percent, people will be more reluctant to spend money and the economy will recover more slowly.
"The current economic impact of both forms of accommodation -- low interest rates and asset purchases -- depends on when the public believes that accommodation will be removed," he said.
It was partly a psychological argument: The lower the explicit target for unemployment, the longer the Fed will keep interest rates low, and the more comfortable people will be spending money. That, in turn, should help the economy recover faster, Kocherlakota said.
"The FOMC can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate," he said.
Kocherlakota's "liftoff," in part, reflects the ideas of Chicago Fed president Charles Evans, who has advocated a similar plan.
Kocherlakota does not serve on the FOMC, though, like all Fed bank presidents, he attends the meetings. The Ninth District of the Federal Reserve covers Montana, North and South Dakota, Minnesota, northern Wisconsin, and the Upper Peninsula of Michigan.
Adam Belz • 612-673-4405