Regional President Speech

Monetary Policy: Lessons from the Past and Looking Forward to the Future Columbus State University March 10, 2014 Charles L. Evans President and CEO Federal Reserve Bank of Chicago The views I express here are my own and do not necessarily reflect the views of the Federal Reserve Bank of Chicago, my colleagues on the Federal Open Market Committee (FOMC) or within the Federal Reserve System. Three Big Events in Fed History  The Great Depression (1929-1938)  “Inept monetary policy” failed to adequately combat credit contraction, deflation, and depression  The Great Inflation (1965-1980)  Monetary policy failed to recognize structural changes and expectational dynamics that led to double-digit inflation  The Treasury Accord (1951)  An example highlighting the importance of central bank independence 1 Long-Run Strategy for Monetary Policy (January 2012, reaffirmed thereafter every January)  π* = 2% PCE inflation  U * ~ 5.2% - 5.8% time-varying t Central tendency of SEP longer-run normal rate  Balanced approach to reducing deviations of inflation and employment from long-run objectives 2 Would Today’s Dilemma Be Different under a Single Mandate? Total PCE Price Index (level) Dec. 2007 120 2% Price-Line from December 2007 110 Average PCE Inflation (2000-2007): 2.3% Path Implied by Current 100 FOMC Inflation Forecasts 90 80 2000 '02 '04 '06 '08 '10 '12 '14 '16 Inflation (percent) QE1 QE2 MEP QE3 3 Total PCE (36-mo. Average) 2 1 Core PCE (12-mo. Change) 0 2000 '02 '04 '06 '08 '10 '12 '14 '16 Source: Inflation forecasts are from the December 18, 2013 FOMC Summary of Economic Projections 3 Inflation Is Low Globally Consumer Inflation* (Q4/Q4 percent change) 4 3 2000-2007 avg. 2008-2012 avg. 2 2013 Latest 1 0 -1 Canada Euro zone Japan U.K. U.S. *Consumer inflation in the U.S. is as measured by the total price index for Personal Consumption Expenditures; in other countries, it is measured by the Consumer Price Index. Latest data is year-over-year change in the monthly index. 4 Long-Run Strategy for Monetary Policy (January 2012, reaffirmed thereafter every January)  π* = 2% PCE inflation  U * ~ 5.2% - 5.8% time-varying t Central tendency of SEP longer-run normal rate  Balanced approach to reducing deviations of inflation and employment from long-run objectives 5 Balanced Approach to the Dual Mandate Is Consistent with Mainstream Macroeconomics Loss Function L = (π - π*)2 + 0.25 (y – y*)2 (percent) L = (π - 2)2 + (u – un)2 Inflation π = 5.5% u = 9% π* 2015 2016 2014 September 2011 Value Latest Value FOMC Forecast (December 18, 2013) un Unemployment 6 Why Has Achieving Dual Mandate Been So Hard?  Deleveraging in the aftermath of the financial crisis  Global risks  Unusually restrictive fiscal policy  Monetary policy constrained by zero lower bound 7 Policy Rate Constrained by Zero Lower Bound Fed Funds Rate (percent) 8 6 History 4 2 Q4-2013 0 -2 Taylor (1999) rule based on inflation and output gap -4 -6 1999 '01 '03 '05 '07 '09 '11 '13 8 Policy Tools at the Zero Lower Bound  Large Scale Asset Purchases  Forward Guidance  Features of Both Unconventional Tools  Lower long-term interest rates  Disciplined by economic conditionality 9 Asset Purchases: The Fed’s Balance Sheet Federal Reserve Assets (Bil. $) 4,500 Mar. 5, 2014 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 2007 2008 2009 2010 2011 2012 2013 2014 All Other Assets ($301.5 bil.) Treas. Sec ($2,284.2 bil.) Agency Debt ($51.4 bil.) Agency MBS ($1,570.1 bil.) Lending and Liquidity Facilities ($2.2 bil.) 10 Forward Guidance on the Federal Funds Rate  Zero interest rate at least until U < 6.5% or π > 2.5%  Thresholds, not triggers  Likely to remain near zero “well past” U < 6.5%, especially if projected inflation continues to run below the 2% target. 11 Output Gap: 1982 Recovery vs. Today Actual and Potential GDP: 1982 Actual and Potential GDP: 2007 (1981 Q3 = 100) (2007 Q4 = 100) 130 130 115 115 Q4-2013 100 100 85 85 70 70 1976 '78 '80 '82 '84 '86 2003 '05 '07 '09 '11 '13 12 Fiscal Policy: Historically Unusual Contributions of Government Purchases to Real GDP Growth (percent) 12 12 10 8 8 6 4 4 2 Q4-2013 0 0 -2 -4 -4 1965 '70 '75 '80 '85 '90 '95 '00 '05 '10 13 Looking Ahead: Exit Principles (June 2011 Minutes)  Balance sheet size  Smallest level consistent with efficient monetary policy operation  Balance sheet composition  Treasury only  Likely normalization sequence  Taper, then end LSAPs  Cease reinvestment of maturing securities  Begin raising rates and drain reserves  New tools: IOER, RRP Facility, term deposits 14 Looking Ahead to the Future  Balanced approach to deviations from goals  Inflation preferences should be symmetric  Must recognize limitations of monetary policy during episodes in which real cycles dominate 15

Charles L. Evans (2014, March 9). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20140310_charles_l_evans

@misc{wtfs_regional_speeche_20140310_charles_l_evans,
  author = {Charles L. Evans},
  title = {Regional President Speech},
  year = {2014},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20140310_charles_l_evans},
  note = {Retrieved via When the Fed Speaks corpus}
}