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Try overshooting for once, please

March 27th 2012, 17:04 by R.A. | WASHINGTON

YESTERDAY, Federal Reserve Chairman Ben Bernanke gave a speech on America's labour market that has central bank tea-leaf readers speculating over its implications for a new round of asset purchases—QE3. Tim Duy has what seems like the most reasonable read of the present FOMC stance.

In essence, Bernanke suggests that the recent rapid improvements in unemployment reflect largely a reversal of out-sized deterioration experienced during the recession. As such, we should not expect a slower pace of improvement given current growth forecasts. Under such conditions, I believe, Bernanke would push for another round of QE - although it stills begs the question of why he doesn't push for more now given the existing forecasts. But he hasn't, so we can only infer that he thinks the costs of additional easing outweigh the benefits.
He leaves open the possibility, however, that labor markets will continue to improve at the recent pace, in which I think QE3 is off the table.

Let me restate that. Mr Bernanke thinks that rapid improvement in labour markets over the past three months is a product of catch-up from previous underperformance (given observed growth in GDP). He does not appear to think the Fed's current policy is sufficient to generate labour market improvements as fast as what we've seen over the past three months. If he is wrong and the economy maintains this pace of improvement, then, as Mr Duy says, QE3 is off the table. If, however, he is right, and the pace of improvement slows, then another round of asset purchases is a real possibility.

Simpler still: the Fed is willing to engineer a labour-market recovery like that observed over the past three months, but would not be willing to engineer anything faster than that.

Keep in mind that the recovery observed over the past three months is a decent one, but not the one we'd expect or hope to see after a downturn as deep as the recession from 2007-2009. Employment has been growing at roughly 750,000 jobs per quarter, at a time when total employment is, conservatively, 7m jobs short of trend. If the economy were able to maintain that pace, in other words, it would still be a bit short of full employment two years from now. And of course, this rate of employment growth was consistent with stable to falling rates of labour compensation and inflation.

I realise I sound like a broken record, but it is remarkable the extent to which the Fed is willing to tolerate a very long period of costly labour-market weakness rather than tolerate any meaningful overshooting on the inflation side. This pathological obsession with the prevention of any meaningful overshooting is itself a substantial constraint on recovery. Forget QE3; the Fed could have a substantial stimulative effect on the economy merely by signaling that it would tolerate a year or two of above-target inflation. That the Fed is nonetheless unwilling to do this is perhaps the strongest argument of all that the present policy target—a 2% rate of inflation—is a poor choice relative to available alternatives.

http://www.economist.com/blogs/freeexchange/2012/03/monetary-policy-5