Is Unemployment Helpful in Understanding Inflation

Price stability is one of the main objectives of Federal Reserve monetary policy. To achieve this objective, the Federal Reserve employs forecasts of inflation. These forecasts help policymakers determine the appropriate stance of monetary policy. Economic slack is one of the most widely used short-term predictors for inflation. Economic slack is a measure of underutilized resources in the economy, such as labor and capital. A large amount of economic slack is commonly thought to exert downward pressure on inflation. For example, the Federal Open Market Committee (FOMC) explicitly mentioned “increasing economic slack ” in its March 2009 meeting as a basis for the outlook that “inflation will remain subdued.” This outlook for inflation, along with the elevated unemployment rate, was an important element in the FOMC’s decision to increase monetary accommodation through purchases of long-term Treasuries and an expansion of agency Mortage Backed Securities (MBS) purchases.