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Labor Market Dynamics, Monetary Policy Tradeoffs, and a Shortfalls Approach to Pursuing Maximum Employment

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Abstract

This paper reviews recent academic studies to assess the implications of adopting a shortfalls, rather than a deviations, approach to pursuing maximum employment. Model-based simulations from these studies suggest three main findings. First, shortfalls rules generate inflationary pressure relative to deviations rules, which offsets downward pressure on inflation stemming from the presence of the effective lower bound. Second, since monetary policy leans against these inflationary pressures, a shortfalls rule implies a limited effect on average outcomes in the labor market. Finally, studies suggest that monetary policy can offset higher-than-desired average inflation under a shortfalls rule by leaning more strongly against deviations of inflation from the 2 percent objective, thereby keeping longer-term inflation expectations well anchored.

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  • Brent Bundick & Isabel Cairó & Nicolas Petrosky-Nadeau, 2025. "Labor Market Dynamics, Monetary Policy Tradeoffs, and a Shortfalls Approach to Pursuing Maximum Employment," Finance and Economics Discussion Series 2025-068, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2025-68
    DOI: 10.17016/FEDS.2025.068
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    1. Bruce Fallick & Pawel Krolikowski, 2022. "Excess Persistence in Employment of Disadvantaged Workers," International Journal of Central Banking, International Journal of Central Banking, vol. 18(4), pages 1-52, October.
    2. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
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    Keywords

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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