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Wednesday, December 02, 2015

Yellen: The Economic Outlook and Monetary Policy

Janet Yellen signals that, absent surprises in incoming data, rates are going up:

Economic Outlook and Monetary Policy: ...Let me now turn to the implications of the economic outlook for monetary policy. Reflecting progress toward the Committee's objectives, many FOMC participants indicated in September that they anticipated, in light of their economic forecasts at the time, that it would be appropriate to raise the target range for the federal funds rate by the end of this year. Some participants projected that it would be appropriate to wait until later to raise the target funds rate range, but all agreed that the timing of a rate increase would depend on what the incoming data tell us about the economic outlook and the associated risks to that outlook.
In the policy statement issued after its October meeting, the FOMC reaffirmed its judgment that it would be appropriate to increase the target range for the federal funds rate when we had seen some further improvement in the labor market and were reasonably confident that inflation would move back to the Committee's 2 percent objective over the medium term. That initial rate increase would reflect the Committee's judgment, based on a range of indicators, that the economy would continue to grow at a pace sufficient to generate further labor market improvement and a return of inflation to 2 percent, even after the reduction in policy accommodation. As I have already noted, I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market. Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane.
Committee participants recognize that the future course of the economy is uncertain, and we take account of both the upside and downside risks around our projections when judging the appropriate stance of monetary policy. In particular, recent monetary policy decisions have reflected our recognition that, with the federal funds rate near zero, we can respond more readily to upside surprises to inflation, economic growth, and employment than to downside shocks. This asymmetry suggests that it is appropriate to be more cautious in raising our target for the federal funds rate than would be the case if short-term nominal interest rates were appreciably above zero.7 Reflecting these concerns, we have maintained our current policy stance even as the labor market has improved appreciably.
However, we must also take into account the well-documented lags in the effects of monetary policy.8 Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.
On balance, economic and financial information received since our October meeting has been consistent with our expectations of continued improvement in the labor market. And, as I have noted, continuing improvement in the labor market helps strengthen confidence that inflation will move back to our 2 percent objective over the medium term. That said, between today and the next FOMC meeting, we will receive additional data that bear on the economic outlook. These data include a range of indicators regarding the labor market, inflation, and economic activity. When my colleagues and I meet, we will assess all of the available data and their implications for the economic outlook in making our policy decision.
As you know, there has been considerable focus on the first increase in the federal funds rate after nearly seven years in which that rate has been at its effective lower bound. We have tried to be as clear as possible about the considerations that will affect that decision. Of course, even after the initial increase in the federal funds rate, monetary policy will remain accommodative. And it bears emphasizing that what matters for the economic outlook are the public's expectations concerning the path of the federal funds rate over time: It is those expectations that affect financial conditions and thereby influence spending and investment decisions. In this regard, the Committee anticipates that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
This expectation is consistent with an implicit assessment that the neutral nominal federal funds rate--defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy were operating near its potential--is currently low by historical standards and is likely to rise only gradually over time. One indication that the neutral funds rate is unusually low is that U.S. economic growth has been quite modest in recent years despite the very low level of the federal funds rate and the Federal Reserve's very large holdings of longer-term securities. Had the neutral rate been running closer to the levels that are thought to have prevailed prior to the financial crisis, current monetary policy settings would have been expected to foster a very rapid economic expansion, with inflation likely rising significantly above our 2 percent objective.
Empirical support for the judgment that the neutral federal funds rate is low comes from both academic research and Federal Reserve staff analysis. ...
The marked decline in the neutral federal funds rate after the crisis may be partially attributable to a range of persistent economic headwinds that have weighed on aggregate demand. These headwinds have included tighter underwriting standards and limited access to credit for some borrowers, deleveraging by many households to reduce debt burdens, contractionary fiscal policy at all levels of government, weak growth abroad coupled with a significant appreciation of the dollar, slower productivity and labor force growth, and elevated uncertainty about the economic outlook.12 As the restraint from these headwinds further abates, I anticipate that the neutral federal funds rate will gradually move higher over time. Indeed, in September, most FOMC participants projected that, in the long run, the nominal federal funds rate would be near 3.5 percent, and that the actual federal funds rate would rise to that level fairly slowly.13 
Because the value of the neutral federal funds rate is not directly measureable and must be estimated based on our imperfect understanding of the economy and the available data, I would stress that considerable uncertainty attends our estimates of its current level and even more to its likely path going forward.14 That said, we will learn more from observing economic developments in the period ahead. It is thereby important to emphasize that the actual path of monetary policy will depend on how incoming data affect the evolution of the economic outlook. Stronger growth or a more rapid increase in inflation than we currently anticipate would suggest that the neutral federal funds rate is rising more quickly than expected, making it appropriate to raise the federal funds rate more quickly as well; conversely, if the economy disappoints, the federal funds rate would likely rise more slowly. ...

"Rise more slowly" if the economy disappoints. Interesting that the possibility that incoming data might cause the rate to go back down is not considered. It seems like "considerable uncertainly" ought to include that possibility.

    Posted by on Wednesday, December 2, 2015 at 09:44 AM Permalink  Comments (13)


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