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

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.