Federal funds rate and unemployment relationship: does business confidence matter?

Abstract

Following the 2008 financial crisis, the United States’ economy went into one of the most severe recessions since the Great Depression. In an attempt to stimulate the economy, the Federal Reserve lowered the federal funds rate to near zero in 2008. The unemployment decrease is not as large or fast as many had hoped, spurring much debate on whether business confidence may play a role in the federal funds rate’s inability to affect the unemployment rate. It was hypothesized that high levels of economic policy uncertainty and low levels of business confidence negatively affect the unemployment rate. Using a regression analysis, results indicate that a negative contemporaneous relation exists between the federal funds rate and unemployment. Given the long term positive relationship between the federal funds rate and unemployment, lowering the federal funds rate should have brought down the unemployment rate, but that hasn’t happened. The persistently high unemployment exists because the low level of business confidence is deterring businesses from hiring in the face of economic policy uncertainty despite the incentive of a low interest rate’s incentive to do so.