Regional President Speech

Monetary Policy – Lower for Longer? University Club Chicago, IL October 24, 2016 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. 111 Overview  Relatively good near term growth outlook  Lower potential output growth, lower r*  Inflation is too low, its outlook uncertain – Inflation compensation drifted down – Low-inflation psychology – Global disinflationary forces  My view: Monetary policy needs to – Demonstrate symmetry of inflation target – Relate the pace of rate increases to progress in achieving the inflation target – Take a risk management approach 222 Long-Run Strategy for Monetary Policy (January 2012, reaffirmed thereafter every January)  = 2% PCE inflation – Symmetric ∗ 𝝅𝝅  ≈ 4.8% – Time-varying 𝒏𝒏 𝒕𝒕 𝒖𝒖 – Median of long-run sustainable level from the latest FOMC Summary of Economic Projections  Balanced approach to reducing deviations of inflation and employment from long-run objectives 333 Output Growth Likely Rebounding in H2  GDP growth recovering from slow H1 – Consumption growth good – Business spending not as soft GDP Growth (%) 2015 1.9 2016:H1 1.0 2016:Q3 MA* 2.5 GDPNow* 2.0 *Forecasts from Macroeconomic Advisers and Federal Reserve Bank of Atlanta as of October 19, 2016 444 Growth Projections Above Trend in 2017 and 2018 Change in Real GDP Unemployment Rate (percent) (average) 3 8 Actual Actual 2 6 1 4 2012 '13 '14 '15 '16 '17 '18 '19LonLgoeLnrognegr er 2012 '13 '14 '15 '16 '17 '18 '19LonLgoeLnrognegr er runrurnu n runrurnu n *Forecasts obtained from the September 21, 2016 FOMC Summary of Economic Projections. The red line is the 555 median forecast. Shaded areas depict forecast central tendencies (dark blue) and ranges (light blue). Solid Improvements in Labor Markets Total Nonfarm Payroll Employment Participation Rate (change, thousands) (percent) 400 68.0 Monthly Change 3-month Average 300 66.5 Trend* 200 65.0 Sep-2016 Actual Sep-2016 100 63.5 0 62.0 2011 '12 '13 '14 '15 '16 2000 '05 '10 '15 *FRBCHI Staff Estimate. 666 Only Modest Pick-up in Wage Growth Hourly Wages and Compensation Growth (percent) 5 6 4 5 Range Consistent With 2% Inflation 3 4 Sep-2016 2 3 Average Wage Growth of Continually Employed Individuals* Average Hourly Earnings 1 2 0 1 1995 '99 '03 '07 '11 '15 *FRBCHI Staff estimate based on data from the U.S. Census Bureau Current Population Survey. 777 Solid Consumption, Weak Business Investment Personal Consumption Expenditures Nonresidential Fixed Investment (percent change, annualized*) (quarterly percent change, annualized) 5 20 4 15 Jul/Aug-2016 3 10 Q2-2016 2 5 1 0 0 -5 2010 '11 '12 '13 '14 '15 '16 2010 '11 '12 '13 '14 '15 '16 *Annualized half-year growth rates except for the last bar, which shows the annualize growth rate from the average of 888 April and May, to the average of July and August. Lower Potential Output Growth  FOMC participants’ projections of longer run trend growth (long-run potential) have been declining  Many reasons for lower potential output growth – Slower growth in labor force – Plateauing labor quality – Weak capital investment – Slower pace of technological improvement  Real equilibrium interest rates are lower in an economy with lower potential output growth 999 Declining Long-term Government Bond Yields 10-year Government Bond Yield (percent) 8 6 4 14-Oct-2016 2 U.S. U.K. Germany 0 Japan -2 2000 '02 '04 '06 '08 '10 '12 '14 '16 111000 Inflation is Too Low PCE Price Index (12-month percent change) 5 4 Total 3 FOMC Long-run Target 2 1 Core FOMC Projections* 0 Aug-2016 -1 -2 1999 '02 '05 '08 '11 '14 '17 *Projections are the median values for core PCE inflation from the FOMC Summary of Economic Projections 111111 as of September 21, 2016. Inflation Outlook Still Quite Uncertain  Supporting higher inflation projections: – Energy price and dollar stabilization – Tighter labor market  However: – Financial market and survey indicators of inflation expectations at very low levels – Low inflation psychology among many contacts – Global disinflationary forces Inflation is below target in all major advanced  economies 111222 Survey-Based Inflation Expectations Are Low University of Michigan Median Inflation S u r v e y of Professional Forecasters (percent) (percent) 3.5 3.0 CPI 10 Year Q3-2016 3.0 2.5 Oct-2016 2.5 2.0 5-10 Years Ahead 2.0 1.5 2000 '02 '04 '06 '08 '10 '12 '14 '16 2000 '02 '04 '06 '08 '10 '12 '14 '16 111333 So Are TIPS Inflation Compensation Implicit Inflation Compensation Embedded in TIPS (percent) 3.0 2.5 5-10 Year Ahead 2.0 21-Oct-2016 1.5 1.0 2012 '13 '14 '15 '16 111444 Markets More Concerned About Low Inflation 10-Year CPI Inflation Probabilities as Priced by Inflation Derivatives (probability) 75 Probability Inflation Falls Below 1 Percent Probability Inflation Rises Above 3 Percent 14-Sep-2016 50 25 0 2009 '10 '11 '12 '13 '14 '15 *Board of Governors, staff calculations. 111555 Inflation is Too Low Globally Consumer Inflation (year-over-year percent change, deviation from target) 2 1 0 -1 -2 Latest 2008-2015 Average 2000-2007 Average -3 -4 U.S. Eurozone Switzerland Sweden Norway U.K. Japan Consumer inflation in the U.S. is as measured by the core price index for Personal Consumption Expenditures; in other countries, it is measured by the core Consumer Price Index. Latest data are year-over-year changes in the most 111666 recently published monthly price index. FOMC Inflation Projections Too High Core PCE Inflation (year-over-year percent change) 2.5 Actual 2012* 2014* 2016* 2.0 2008* 1.5 2010* Q2-2016 1.0 0.5 2006 '08 '10 '12 '14 '16 '18 *Projections obtained from the October 2008, November 2010, and September 2012, 2014, and 2016 releases of the Summary of Economic Projections of the FOMC. Projections are median values of the central tendency through 111777 September 2014, and median values for September 2016. FOMC Fed Funds Projections Revised Lower Federal Funds Rate (percent) 2014* 4 2015* 2016* 3 2013* 2 1 Effective Q2-2016 0 2009 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 *Projections are the median values obtained from the September releases of the Summary of Economic Projections of 111888 the FOMC for each year from 2013 to 2016. Evans’ Appropriate Monetary Policy  The need to demonstrate commitment to achieving the inflation target sustainably, symmetrically, and sooner rather than later  Lower r* means current policy not as accommodative – Have less headroom to increase rates  Relate pace of rate increases to markers on inflation fundamentals – Sustained higher readings on core inflation – Higher private-sector inflation expectations – Lower unemployment rate and other resource slack  Might require: – Undershooting the unemployment rate, overshooting the inflation target 111999 Appropriate Pace of Policy Firming Federal Funds Rate at Year-End (percent) 5 4 3 2 1 Market Pricing 0 2016 2017 2018 2019 Long-run Source: Interest rate projections are from the September 21, 2016 FOMC Summary of Economic Projections. 222000 Red dots indicate the median projection. Market expectations are from OIS futures as of October 20, 2016.

Charles L. Evans (2016, October 23). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20161024_charles_l_evans

@misc{wtfs_regional_speeche_20161024_charles_l_evans,
  author = {Charles L. Evans},
  title = {Regional President Speech},
  year = {2016},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20161024_charles_l_evans},
  note = {Retrieved via When the Fed Speaks corpus}
}