Fed official: Commit to low rates until 5.5 percent unemployment

By Peter Schroeder - 09/20/12 03:41 PM ET

One top Federal Reserve official is pressing the central bank to commit to bottom-rung interest rates until the unemployment rate falls to 5.5 percent.

Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, said Thursday that he believed the Fed should take a new approach. Instead of its current approach of predicting how long it will keep interest rates near zero, it rather should tie rate changes to a decline in the unemployment rate.

Kocherlakota's comments carry added weight currently, as he is a voting member of the Fed's Federal Open Market Committee (FOMC), which sets the bank's monetary policy.

"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," he said in a speech delivered in Michigan.

Kocherlakota's comments drew added attention from close Fed watchers because he is thought to be one of the more "hawkish" Fed members, concerned more with controlling inflation than "dovish" members, who are primarily concerned with battling unemployment.

Kocherlakota had previously discussed the need for the Fed to consider how it would begin exiting from the massive bond purchases it had made in previous attempts to boost the economy as early as the end of the year.

Under his "proposed liftoff plan," he contended that providing that level of specificity would help stimulate the economy.

Earlier this month, the Fed announced it was embarking on a third round of stimulus in a further effort to boost the laggard economic recovery. The FOMC announced it was committing to buying $40 billion of bonds per month, in a bid to lower borrowing costs and spur economic activity. The Fed also said it believed economic conditions would merit it keep rates near zero until mid-2015, after previously expecting those rates would last until the end of 2014.

In its prior two attempts at "quantitative easing," the Fed had set a volume cap on how many bonds it would buy. But this time around, the Fed simply said it would buy the bonds and consider further policy action so long as the labor market does not "improve substantially."

Kocherlakota said he believed that rates could stay near zero so long as inflation stayed below a rate of 2.25 percent. However, he added that both the unemployment and inflation targets should be seen as thresholds instead of triggers, giving the Fed the flexibility to retain or adjust policy as it sees fit regardless of those explicit targets.