The Fed "will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective", Chair Jerome H. Powell said at a conference in Chicago. The chairman also noted that the proximity of interest rates to the effective lower bound (ELB) has become "the preeminent monetary policy challenge of our time", as it limits the central bank's ability to support growth by cutting rates.
Excerpts from opening remarks by Chair Jerome H. Powell at the "Conference on Monetary Policy Strategy, Tools, and Communications Practices" sponsored by the Federal Reserve, Federal Reserve Bank of Chicago, Chicago, Illinois:
I’d like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.
Before turning to the specifics of the review, I want to focus a little more closely on the challenges we face today. For a reference point, at the time of the 1999 conference, the United States was eight years into an expansion; core inflation was 1.4 percent, and the unemployment rate was 4.1 percent—not so different from today. Macroeconomists were puzzling over the flatness of the Phillips curve, the level of the natural rate of unemployment, and a possible acceleration in productivity growth—questions that are also with us today.
The big difference between then and now is that the federal funds rate was 5.2 percent—which, to underscore the point, put the rate 20 quarter-point rate cuts away from the ELB. Since then, standard estimates of the longer-run normal or neutral rate of interest have declined between 2 and 3 percentage points, and some argue that the effective decline is even larger. The combination of lower real interest rates and low inflation translates into lower nominal rates and a much higher likelihood that rates will fall to the ELB in a downturn.
As the experience of the past decade showed, extended ELB episodes can be associated with painfully high unemployment and slow growth or recession. Economic weakness puts downward pressure on inflation, which can raise real interest rates and reinforce the challenge of supporting needed job growth. In addition, over time, inflation has become much less sensitive to tightness in resource utilization. This insensitivity can be a blessing in avoiding deflation when unemployment is high, but it means that much greater labor market tightness may ultimately be required to bring inflation back to target in a recovery. Using monetary policy to push sufficiently hard on labor markets to lift inflation could pose risks of destabilizing excesses in financial markets or elsewhere.
In short, the proximity of interest rates to the ELB has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance. For example, the behavior of inflation now draws much sharper focus. When nominal interest rates were around 4 or 5 percent, a low-side surprise of a few tenths on inflation did not raise the specter of the ELB. But the world has changed. Core inflation is currently running a bit below 2 percent on a trailing 12-month basis. In this setting, a similar low-side surprise, if it were to persist, would bring us uncomfortably closer to the ELB. My FOMC colleagues and I must—and do—take seriously the risk that inflation shortfalls that persist even in a robust economy could precipitate a difficult-to-arrest downward drift in inflation expectations. At the heart of the review is the evaluation of potential changes to our strategy designed to strengthen the credibility of our symmetric 2 percent inflation objective.
6/4/2019 2:46:49 PM