The U.S. Federal Reserve's latest $600 billion bond-buying program is built on the idea that most of the stubbornly high unemployment rate is reversible, if only borrowing costs are pushed low enough.
But what about the part that isn't?
The bursting of the housing bubble and the ensuing deep recession caused the loss of a huge number of jobs, many of which are not expected to come back. A growing number of economists, as well as Fed officials, believe this may have fundamentally altered the economy, boosting the natural rate of unemployment.
The natural rate is the level of unemployment below which troublesome price pressures might begin to build. A higher rate would suggest the Fed may need to reverse its massive monetary easing sooner than would otherwise be the case.
How far do you let the unemployment rate fall before you have to start raising rates to head off inflation? That's what the debate is about, said Paul Ashworth, an economist at Capital Economics.
Over the last decade economists have pegged the natural rate of unemployment at about 5 percent, according to a survey by the Philadelphia Fed. Last October, the average estimate jumped to 5.8 percent, the highest level in the survey's 15-year history.
Some Fed officials have also hiked their estimates, pushing the Fed's central tendency of policymaker forecasts for the long-run jobless rate to a range of 5 percent to 6 percent in November, from a June range of 5 percent to 5.3 percent.
Officials will bring fresh forecasts to the table next week, but those will only become public when meeting minutes are released three weeks later.
Minutes from policy-setting meetings last year suggest a continuing discussion over how much of the unemployment rate is structural.
With the U.S. jobless rate at 9.4 percent, the debate for now is purely academic. Even Minneapolis Fed President Narayana Kocherlakota, who has said that the natural rate of unemployment may now run as high as 8 percent, concedes that the current jobless rate is too high by any standard.
But as that rate declines -- and forecasters think it will do so only slowly, falling to just 9 percent by year's end -- Kocherlakota expects the debate will move to the Fed's front burner.
If things go as I expect, then I think it's going to be really important toward the end of the year, toward the end of 2011, to have some notion of what this level of structural employment is, Kocherlakota told the Wall Street Journal earlier this month.
BERNANKE NOT CONVINCED
The Fed took short-term interest rates to near zero in December 2008 and then bought $1.7 trillion of Treasuries and mortgage-backed securities to help pull the nation out of a financial crisis and the depths of a recession.
Late last year, with unemployment still near 10 percent and inflation running below the Fed's 2-percent target, the U.S. central bank embarked on a new round of Treasury purchases to lower borrowing costs still further.
Since then, the economy has been gaining some steam, but most analysts do not believe the improvement is strong enough to convince Fed officials to cut short the bond-buying program when they meet to consider policy next week. Economists and futures traders alike do not see the Fed raising interest rates before early next year.
Those who see a rise in structural unemployment blame it largely on two factors: a mismatch between the skills of those who are looking for work and the needs of those who are hiring, and the inability of some workers to relocate for new jobs because their mortgages are underwater.
Fed Chairman Ben Bernanke and other core members of the central bank's policy-setting committee -- including Fed Vice Chair Janet Yellen and New York Fed President William Dudley -- are not buying it.
Conceding it is essential to understand how much of the unemployment rate is structural, Bernanke in an October speech went on to conclude that the bulk of the increase in joblessness is due to weak demand rather than structural factors.
Bernanke's statement on this topic is the dominant view and the one that matters, said Michael Feroli, an economist at JPMorgan. Feroli said the outcome of the debate could impact Fed policy, but hastened to add: We're so far from that point that right now it is idle speculation about a choice that will have to be made in the distant future.
Policymakers concerned the Fed's easing policies could stoke future inflation are likely to raise the issue with greater force in coming months, analysts said.
If you were one of the hawks on the committee and you were trying to convince Bernanke, Yellen or Dudley to support you, the only way you would do that is by arguing structural unemployment is higher, said Eric Stein, a fund manager at Eaton Vance. But we probably need to see a real decline in the unemployment rate to get Bernanke himself thinking about this.
(Editing by Andrea Ricci)