After last week's FOMC decision went over like a ton of bricks, the question became: When will the Fed do damage control?

There were a couple reasons the Fed might want to do this, other than merely the fact that the stock market tanked right after the decision.

First of all, the Fed might have wished to communicate its willingness to do more if things continue to weaken, but beyond that, there was a lot of talk about how maybe the Fed was seeing some bad signs in the economy that the public hadn't seen yet.

That actually seemed pretty implausible, since the weakening seems fairly obvious, even if all you had to go by was the weekly initial claims report.

But it seems that we may have gotten our first damage control today, with a fairly overlooked speech by Minneapolis Fed President Naryana Kocherlakota who gave a speech at Northern Michigan University titled Inside The FOMC, basically going over what happens at these meetings.

Calculated Risk flagged this key section of the speech:

The FOMC’s decision has had a larger impact on financial markets than I would have anticipated. My own interpretation is that the FOMC action led investors to believe that the economic situation in the United States was worse than they, the investors, had imagined. In my view, this reaction is unwarranted. The FOMC’s decisions were largely predicated on publicly available data about real GDP, its various components, unemployment, and inflation. I would say that there is no new information about the current state of the economy to be learned from the FOMC’s actions or its statement.

This isn't much, but at least it attempts to alleviate the issue that maybe something specific had freaked the Fed out, or that the Fed intended to convey some new worry.

The other huge part of the speech, which Ryan Avent flagged, is where Kocherlakota seems to say that monetary policy may not do that much good going forward:

What does this change in the relationship between job openings and unemployment connote? In a word, mismatch. Firms have jobs, but can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs. There are many possible sources of mismatch—geography, skills, demography—and they are probably all at work. Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.



Of course, the key question is: How much of the current unemployment rate is really due to mismatch, as opposed to conditions that the Fed can readily ameliorate? The answer seems to be a lot. I mentioned that the relationship between unemployment and job openings was stable from December 2000 through June 2008. Were that stable relationship still in place today, and given the current job opening rate of 2.2 percent, we would have an unemployment rate of closer to 6.5 percent, not 9.5 percent. Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.

Avent is fairly stunned by that last line, as is Brad Delong, who thinks the mismatch or "structural" explanation for the persistently high unemployment rate is total hogwash, arguing: "If aggregate demand were higher it would melt away just as unemployment in 1982 melted away."

This is probably the question that cuts right at the heart of the economic debate between the side that argues for more stimulus, and their adversaries. We'll work on this question more later, but it is interesting to note that at least on Fed President falls on the opposite side of the notion that more demand would necessarily lead to a quick reduction in unemployment.