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Monday, September 21, 2009

Fed Funds and Unemployment Rate

by Calculated Risk on 9/21/2009 07:04:00 PM

The Real Time Economics blog at the WSJ discusses expectations for the Fed two day meeting that starts tomorrow: Expect Patience From the Fed (note: the statement will be released on Wednesday).

No one expects a rate hike, and the main focus will be on the economic outlook and whether MBS purchases will slow. Last month, the FOMC statement noted "economic activity is leveling out", and the statement this month might be slightly more positive.

The Fed also announced last month: "To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions ..."

And this month the committee might announce a "smooth transition" for the purchases of agency mortgage-backed securities - and extend the deadline a few months into 2010.

As far as "patience", the Fed's mission is to conduct "monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates". So unless inflation picks up significantly (unlikely in the near term with so much slack in the system), it is unlikely that the Fed will increase the Fed's Fund rate until sometime after the unemployment rate peaks.

Fed Funds and Unemployment Click on graph for larger image in new window.

This graph shows the effective Fed Funds rate (Source: Federal Reserve) and the unemployment rate (source: BLS)

In the early '90s, the Fed waited more than a 1 1/2 years after the unemployment rate peaked before raising rates. The unemployment rate had fallen from 7.8% to 6.6% before the Fed raised rates.

Following the peak unemployment rate in 2003 of 6.3%, the Fed waited a year to raise rates. The unemployment rate had fallen to 5.6% in June 2004 before the Fed raised rates.

Although there are other considerations, since the unemployment rate will probably continue to increase into 2010, I don't expect the Fed to raise rates until late in 2010 at the earliest - and more likely sometime in 2011.