The only major missing piece of the puzzle is the absence of strong payroll employment growth. We will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established. With respect to the labor market, there are conflicting signals. On one hand, the unemployment rate has fallen sharply over the past two months, dropping to 9.0 percent from 9.8 percent two months earlier (Chart 4). This is the biggest two-month drop in the unemployment rate since November of 1958. On the other hand, payroll employment gains have remained very modest – rising by only 83,000 per month over the last three months  BIS central bankers’ speeches  1  (Chart 5). Such modest payroll growth is not consistent with a sustained drop in the unemployment rate. The true story doubtless lies somewhere in between – but probably more on the side of the household survey that tracks unemployment. That is because measured payroll employment growth in January was probably temporarily depressed by unusually bad winter weather. Although some of the recent decline in unemployment is due to a drop in the number of people actively seeking work, the household survey does show a pick-up in hiring. Other labor market indicators, such as initial claims and the employment components of the ISM surveys for manufacturing and nonmanufacturing, have also shown improvement recently (Chart 6 and Chart 7), which suggests that the weakness in payroll growth is the outlier.
In terms of the ability to expand credit rapidly, it makes no difference whether the banks have lots of excess reserves on their own balance sheets or can source whatever reserves they need from the fed funds market at the fed funds rate. 3  2  The IOER rate and the federal funds rate are likely to track each other closely in most circumstances. Banks do not have any incentive to lend reserves in the fed funds market at rates below the IOER rate, and can arbitrage away any significant price gap that emerges from the activity of non-depository institutions that can buy and sell federal funds, but cannot hold reserves at the Fed. Thus, through the IOER rate, the Federal Reserve can effectively control the fed funds rate. 3  Indeed, even the opportunity cost of making the loan is similar in both instances. A bank that has excess reserves and decides to extend credit forgoes the chance to earn the IOER on the money lent out. A bank that borrows reserves in the fed funds market in order to extend credit pays the fed funds rate in order to do so. The IOER and fed funds rate are likely to be similar. BIS central bankers’ speeches  7  So we have the means to tighten monetary policy when the time comes, but do we have the will? I think there should be no doubt about this.