Question

Would a $U6$ version of the natural unemployment rate likely be higher or lower than the traditional natural unemployment rate? Explain your reasoning.

Short answer

As a result, maintaining both direct and indirect policy is challenging.When the jobless rate reaches an unacceptably low level, the Fed may opt to reduce the stimulus, raising the interest rate to prevent inflation.

Step-by-step solution

Step: 1 Introduction:

In $2012$, the Fed took a middle ground by attaching its interest rate objective to the unemployment rate. As far as jobless rates were high, the (passive) monetary policy was focused on maintaining the targeted interest rate. However, when the objective was altered as fast as the rate of unemployment went below that threshold, this became active. The other option was to maintain a level of inflation and unemployment.

Step: 2 Inflation:

Fixing inflation to remain around a certain level indicates lower unemployment rate, which limits the interest rate's flexibility. A stimulus will boost aggregate demand, inflation, and unemployment rates, bringing them closer to their natural levels. When the jobless rate reaches an unacceptably low level, the Fed may opt to reduce the stimulus, raising the interest rate to prevent inflation.

Step: 3 About unemployment rate:

If inflation has risen, the necessary solution would be to reduce the money supply to reduce the stimulus. However, this raises the unemployment rate above its natural level. As a result, maintaining both direct and indirect policy is challenging.