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Reducing US Unemployment Rate: To Members of Federal Open Market Committee

The unemployment rate continued to rise and hit 8.5 % this march from 8.1% in February 2009 according to the statistics released by the US Department of Labor.  When the recession took off in 2007, a whooping 5.1 million Americans have lost their jobs with 3.3 million being lost in past 5 months to March. The Household Survey Data released in April indicate that the total unemployed person rose to 13.2 million.

In March alone unemployed persons rose by 694, 000 culminating into an unemployment rate of 8.5 %. Within the last 12 months, a record 5.3 million people were unemployed with a an average unemployment rate increasing by 3.4% with has occurring in the past 4 months (BLS, 2009)

In March the unemployment rate among  adult men was 8.8%, Hispanics was 11.4%, adult women was 7.0 %, and for whites was 7.9%, blacks was 13.3 % while that for teenagers was 21.7 % (St. Louis Fed Reserve Bank, 2009)

Traditional Macro-Policies for Reducing Unemployment

Expansionary monetary policy should be used together with other reforms in the labor market. An expansionary monetary policy like reducing the federal lending rate will in turn reduce the inter-bank lending rate and boost aggregate demand in the economy. To assist in stimulating demand more funds should be availed meaning more federal funds should be availed to the banks so that they can borrow and lend to others. By increasing the supply of federal reserves in market, market liquidity is enhanced and consequently the funds rate falls. The Federal Reserve should also buy more securities in the market. This will have the resultant effect of raising the banks reserves, increase inter-bank lending regime (the federal funds market) and consequently the federal funds rate will fall remarkably.

The discount rate, the rate at which banks borrow from the Federal bank, should be lowered and be set below the 100 points that it has occasionally been fixed. The federal funds rate had by December 2008 been set between 75 to 100 points (FOMC, 2009)

This should for instance be lowered to 25% to encourage borrowing from commercial banks which will in turn infiltrate the market and reduce the credit crunch. This monetary easing policy will go a long way in availing credit to the affected financial institutions who were severely hit by the economic recessions. Subsequently the effect of unemployment will be lessened and reversed in this poor macro-economic environment.

Interest rate changes have profound effects on the demand within an economy since they can significantly alter the borrowing rates.  The lower the real rates the higher will be the amount the banks will lend to the people which will increase the overall spending in the economy and boost demand for labor.  The low interest rates also increase demands for private bonds and other instruments which consequently raises the stock prices. Individuals with stocks will find it lucrative to sell those equities at the prevailing high prices and make them wealthier. A low interest environment has the effect of reducing the value of the US dollar which increases domestic spending on US manufactured goods and services.  From the foregoing, it follows therefore that a reduction in the interest rate can have great ripple effects on the economy which in turn boosts the potentiality of the economy by increasing output and employment of the factors of production.

However sustained low interest rates will in turn push up the prices and wages in the economy especially in the short run (FOMC, 2009)

Unemployment Requires a New Approach to Monetary and Fiscal Policies

Since the increasing unemployment was triggered by the current financial crisis, it’s imperative that policy to turn around the economy will have an inevitable effect on the employment.  For decades now policy makers have basically relied on the fiscal and monetary policy to influence the direction of the economy (Farmer, 2009)

Monetary policy basically thrives on lowering the interest rates in order to encourage expenditure. But looking at the 3 consecutive month’s treasury bills we notice that the nominal interest rate has been virtually zero which in essence limits the effectiveness of the monetary policy.  This is casting aspersions on the effectiveness of the fiscal stimulus that was released in February. This stimulus package further exacerbates the already existing burden in the United States China alone has invested $ 1 trillion in the US debt and further $ 750 billion has been compounded by the stimulus packages (Barker & Barrionuevo, 2009)

Therefore attempts to raise full employment now will be adding unexpected burden on future generations considering that there is already the burden of Medicare and Social Security (Farmer, 2009)

Perhaps the viable option of the Federal Reserve is to purchase and sell the stocks.  Against classical view that there is a particular natural rate of unemployment, Keynes says that there are indeed a number of unemployment rates.  Keynes could be right since a number of factors influence the unemployment rates ranging from consumer confidence and other social inefficiencies.  Variations between the natural rates of employment have been noted through recessions and this is mainly attributed to the market participants’ confidence.  Therefore to counter the swings, it’s prudent enough for the Federal Reserve to contemplate influencing the stock prices. It is time the Fed thought of affecting the stock market index besides interest rates.  Here is how; the federal funds rate will be used to manage inflation and the changes in the stock price index to influence the confidence and choose employment equilibrium that is high. To begin with the Fed should define a specific index that will encompass traded stocks with their weighted market capitalization and re-adjusted on a periodical basis show the changes in the size and composition of firms. Secondly, the Fed can buy all traded company shares at the prevailing market prices in line with the weights.  The purchase of these assets will be financed by the floating of 3-month T-bills with the Treasury backing. The pricing of these securities should be same as the T-bills since they are perfect substitutes.  Thirdly the Fed has to decide on its position in the stocks from $ 800 billion held before the expansion to like $1, 600 for a start and by this way it will have no effect on the Federal debt. This is in contrary to the fiscal expansion being pursued by the government.  Fourthly, the Fed should set a market at the new index and be willing to trade at the price that will be determined regularly.  The price should take into account the policy of interest rates (Farmer, 2009)

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