Question

In his speech Monetary Policy and the Dual Mandate, Frederic Mishkin states: “…the level of maximum sustainable employment is not something that can be chosen by the Federal Reserve because no central bank can control the level of real economic activity or employment over the longer run.” What is the reasoning behind this statement?

Answer 1

Central banks can ensure economic and financial stability but it can't control completely the level of real economic activity because there are several factors which impact the real economic activity which are beyond the control of the central bank such as global recession, pandemic, foreign countries reducing demand for goods, slowdown in investments from overseas, etc. Thus all these factors are beyond the realm of the central bank and because of this in the short run the central bank can influence economic activity by changing the output gap, but it can't impact it over the long run.

At the same time, the main mandate of the central bank is to control the level of inflation, interest rates and attain maximum employment. The level of sustainable employment depends on several factors which are also beyond the realm of the central bank such as preferences, demographics, structural changes in the workforce.

There is also the case that the maximum sustainable level of employment is not directly observed which leads to uncertainty in determining the level. There is also major contention by economists on the right method of metrics to use in order to determine the sustainable level of employment, which generates further uncertainty.

As the U.S economic structure is not constant year after year and is subject to change, estimates over the long run are not reliable.