For release on delivery
10:00 a.m. EDT
August 4, 2021
Outlooks, Outcomes, and Prospects for U.S. Monetary Policy
Remarks by
Richard H. Clarida
Vice Chair
Board of Governors of the Federal Reserve System
at the
Peterson Institute for International Economics
Washington, D.C.
(via webcast)
August 4, 2021
Outlooks and Outcomes for the U.S. Economy
With the release of the gross domestic product (GDP) data last week, we learned
that the U.S. economy in the second quarter of this year transitioned from economic
recovery to economic expansion.1 Given the catastrophic collapse in U.S. economic
activity in the first half of 2020 as a result of the global pandemic and the mitigation
efforts put in place to contain it, few forecasters could have expected-or even dared to
hope-in the spring of last year that the recovery in GDP, from the sharpest decline in
activity since the Great Depression, would be either so robust or as rapid. In retrospect, it
seems clear that timely and targeted monetary and fiscal policy actions-unprecedented
in both scale and scope-provided essential and significant support to the economic
recovery as it got under way last year. Indeed, just recently, the National Bureau of
Economic Research's Business Cycle Dating Committee determined that the recession
that began in March of last year ended in April, making it not only the deepest recession
on record, but also the briefest.2 Moreover, with the development and distribution of
several remarkably effective vaccines, the monetary and fiscal policies presently in place
should continue to support the strong expansion in economic activity that is expected to
be realized this year, although, obviously, the rapid spread of the Delta variant among the
still considerable fraction of the population that is unvaccinated is clearly a downside risk
for the outlook. That said, under the latest Congressional Budget Office (CBO) baseline
forecast, the economy by the end of 2021 will have entirely closed the output gap opened
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up by the recession. If so, this would be the most rapid return following a recession to
the CBO estimate of the trend level of real GDP in 50 years.
Importantly, while it is customary in business cycle analysis to date the transition
from the recovery phase to the expansion phase according to the calendar quarter in
which the level of real GDP first exceeds the previous business cycle's peak, in past U.S.
business cycles, the recovery in employment has always lagged the recovery in GDP, and
this cycle is no exception. Indeed, at the end of the second quarter of this year, even
though the level of real GDP was 0.8 percent above the level reached at the previous
business cycle peak, the level of employment as measured by the household survey
remained about 7 million below the level reached at the previous business cycle peak. So
while it is accurate to say we are in the expansion phase of the cycle in terms of economic
activity, we remain in the recovery phase of the cycle in terms of aggregate employment.
In June, the Federal Reserve released its most recent Summary of Economic
Projections (SEP) for GDP, the unemployment rate, inflation, and the federal funds rate.3
The SEP provides summary information about the empirical distribution of the individual
modal projections at the time of the Federal Open Market Committee (FOMC) meeting
submitted by each of the FOMC participants (currently 6 Governors and 12 Reserve
Bank presidents). Each individual submits projections for the modal, or most likely,
outcome for each variable in the survey under his or her assessment of the appropriate
monetary policy path.4 Of course, if a participant's subjective distributions for possible
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outcomes for GDP, unemployment, and inflation are symmetric, the mode of each
distribution submitted by each participant will equal its mean (and median), but in
general, there is no presumption that the subjective distributions-or, for that matter,
observed empirical distributions-for these variables are symmetric. Indeed, an
important addition to the SEP introduced in December 2020 is a set of charts showing the
historical evolution of diffusion indexes for the assessment of the balance of risks to the
GDP, unemployment, and inflation projections submitted by each participant.
In the June SEP round, my individual projections for GDP growth and the
unemployment rate turned out to be quite close to the path of SEP medians for each of
these variables over the 2021-23 projection window. Under the "median of modes"
outlook in the SEP, GDP growth this year is projected to be 7 percent on a Q4-over-Q4
basis, which, if realized, would represent the fastest four-quarter GDP growth since the
1980s. Under the projections, GDP growth does step down to 3.3 percent in 2022 and
further to 2.4 percent in 2023, but to a pace that still exceeds the projected pace of long-
run trend growth in all three years of the projection window. Not surprisingly, the
projected path of robust GDP growth in the SEP translates into rapid declines in the
projected SEP path for the unemployment rate, which is projected to fall to 4.5 percent by
the end of this year, 3.8 percent by the end of 2022, and 3.5 percent by the end of 2023.
This modal projection for the path of the unemployment rate is, according to the Atlanta
Fed jobs calculator, consistent with a rebound in labor force participation to its estimated
demographic trend and is also consistent with cumulative employment gains this year and
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next that, by the end of 2022, eliminate the 7 million "employment gap" relative to the
previous cycle peak I mentioned earlier.5
As is the case for GDP growth and the unemployment rate, my projections for
headline and core PCE (personal consumption expenditures) inflation are also similar to
the paths of the SEP median of modal projections for these variables. Under the
projected SEP path for inflation, core PCE inflation surges to at least 3 percent this year
before reverting back to 2.1 percent for the next two years. Thus, the modal baseline
outlook for inflation over the three-year projection window reflects the judgment, shared
with many outside forecasters, that most of the inflation overshoot relative to the longer-
run goal of 2 percent will, in the end, prove to be transitory. But, as I have noted before,
there is no doubt that it is taking longer to fully reopen a $20 trillion economy than it did
to shut it down. Although in a number of sectors of the economy the imbalances between
demand and supply-including labor supply-are substantial, I do continue to judge that
these imbalances are likely to dissipate over time as the labor market and global supply
chains eventually adjust and, importantly, do so without putting persistent upward
pressure on price inflation, wage gains adjusted for productivity, and the 2 percent
longer-run inflation objective. But let me be clear on two points. First, if, as projected,
core PCE inflation this year does come in at, or certainly above, 3 percent, I will consider
that much more than a "moderate" overshoot of our 2 percent longer-run inflation
objective. Second, as always, there are risks to any outlook, and I believe that the risks to
my outlook for inflation are to the upside.
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Prospects for U.S. Monetary Policy
In September 2020, the FOMC introduced-and since then has, at each
subsequent meeting, reaffirmed-outcome-based, threshold guidance that specifies three
conditions that the Committee expects will be met before it considers increasing the
target range for the federal funds rate, currently 0 to 25 basis points.6 This guidance in
September of last year brought the forward guidance on the federal funds rate in the
statement into alignment with the new policy framework adopted in August 2020.7 To
quote from the statement, these conditions are that "labor market conditions have reached
levels consistent with the Committee's assessments of maximum employment and
inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some
time."
While, as Chair Powell indicated last week, we are clearly a ways away from
considering raising interest rates and this is certainly not something on the radar screen
right now, if the outlook for inflation and outlook for unemployment I summarized earlier
turn out to be the actual outcomes for inflation and unemployment realized over the
forecast horizon, then I believe that these three necessary conditions for raising the target
range for the federal funds rate will have been met by year-end 2022.8 Core PCE
inflation since February 2020-a calculation window that smooths out any base effects
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resulting from "round trip" declines and rebounds in the price levels of COVID-19-
sensitive sectors and, coincidentally, also measures the average rate of core PCE inflation
since hitting the effective lower bound (ELB) in March 2020-is running at 2.7 percent
through June 2021 and is projected to remain above 2 percent in all three years of the
projection window. Moreover, my inflation projections for 2022 and 2023, which
forecast somewhat higher inflation than do the SEP medians, would also, to me, satisfy
the "on track to moderately exceed 2 percent for some time" threshold specified in the
statement. Finally, while my assessment of maximum employment incorporates a wide
range of indicators to assess the state of the labor market-including indicators of labor
compensation, productivity, and price-cost markups-the employment data I look at,
such as the Kansas City Fed's Labor Market Conditions Indicators, are historically highly
correlated with the unemployment rate.9 My expectation today is that the labor market
by the end of 2022 will have reached my assessment of maximum employment if the
unemployment rate has declined by then to the SEP median of modal projections of
3.8 percent.
Given this outlook and so long as inflation expectations remain well anchored at
the 2 percent longer-run goal-which, based on the Fed staff's common inflation
expectations (CIE) index, I judge at present to be the case and which I project will remain
true over the forecast horizon-commencing policy normalization in 2023 would, under
these conditions, be entirely consistent with our new flexible average inflation targeting
framework.10 I note that under the June SEP median of modal projections, annualized
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PCE inflation since the new framework was adopted in August 2020 is projected to
average 2.6 percent through year-end 2022 and 2.5 percent through year-end 2023.11 In
the context of our new framework, it is important to note that while the ELB can be a
constraint on monetary policy, the ELB is not a constraint on fiscal policy, and
appropriate monetary policy under our new framework, to me, must-and certainly
can-incorporate this reality. Indeed, under present circumstances, I judge that the
support to aggregate demand from fiscal policy-including the more than $2 trillion in
accumulated excess savings accruing from (as yet) unspent transfer payments-in tandem
with appropriate monetary policy, can fully offset the constraint, highlighted in our
Statement on Longer-Run Goals and Monetary Policy Strategy, that the ELB imposes on
the ability of an inflation-targeting monetary policy, acting on its own and in the absence
of sufficient fiscal support, to restore, following a recession, maximum employment and
price stability while keeping inflation expectations well anchored at the 2 percent longer-
run goal.12
Before I conclude, let me say a few words about our Treasury and mortgage-
backed securities (MBS) purchase programs. In our December 2020 FOMC statement,
we indicated, and have reaffirmed since then, that we will maintain the pace of Treasury
and MBS purchases at $80 billion and $40 billion per month, respectively, until
"substantial further progress" has been made toward our maximum-employment and
price-stability goals. Since then, the economy has made progress toward these goals. At
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our meeting last week, the Committee reviewed some considerations around how our
asset purchases might be adjusted, including their pace and composition, once economic
conditions warrant a change. Participants expect that the economy will continue to move
toward our standard of "substantial further progress." In coming meetings, the
Committee will again assess the economy's progress toward our goals. As we have said,
we will provide advance notice before making any changes to our purchases.
The outlook I have described in these remarks is, of course, only one of many
possible paths that the economy may take. I began by noting that the recovery to date has
been surprising, and it is plausible-indeed, probable-that more surprises are in
store. The economic outlook is always uncertain, both because new shocks can arrive-
which, by their nature, cannot be foreseen-and because our knowledge of the workings
of the economy is imperfect. Additionally, the recovery and expansion following the
pandemic are unlike any we have ever seen, and it will serve us well to remain humble in
predicting the future. In light of these uncertainties, the Committee is rightly basing its
judgments on outcomes, not just the outlook. Looking ahead, our policy decisions will
continue to depend on the data in hand at the time, along with their implications for the
outlook and associated risks.
Thank you very much for your time and attention. I look forward, as always, to
my conversation with Adam Posen.
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References
Ahn, Hie Joo, and Chad Fulton (2020). "Index of Common Inflation Expectations,"
FEDS Notes. Washington: Board of Governors of the Federal Reserve System,
September 2, https://doi.org/10.17016/2380-7172.2551.
--- (2021). "Research Data Series: Index of Common Inflation Expectations,"
FEDS Notes. Washington: Board of Governors of the Federal Reserve System,
March 5, https://doi.org/10.17016/2380-7172.2873.
Christiano, Lawrence, Martin Eichenbaum, and Sergio Rebelo (2011). "When Is the
Government Spending Multiplier Large?" Journal of Political Economy, vol. 119
(February), pp. 78-121.
Clarida, Richard H. (2020). "The Federal Reserve's New Framework: Context and
Consequences," speech delivered at "The Economy and Monetary Policy," an
event hosted by the Hutchins Center on Fiscal and Monetary Policy at the
Brookings Institution, Washington (via webcast), November 16,
https://www.federalreserve.gov/newsevents/speech/clarida20201116a.htm.
--- (2021). "The Federal Reserve's New Framework and Outcome-Based Forward
Guidance," speech delivered at "SOMC: The Federal Reserve's New Policy
Framework," a forum sponsored by the Manhattan Institute's Shadow Open
Market Committee, New York (via webcast), April 14,
https://www.federalreserve.gov/newsevents/speech/clarida20210414a.htm.
Eggertsson, Gauti B. (2011). "What Fiscal Policy Is Effective at Zero Interest Rates?" in
Daron Acemoglu and Michael Woodford, eds., NBER Macroeconomics Annual
2010, vol. 25 (Chicago: University of Chicago Press), pp. 59-112.
National Bureau of Economic Research, Business Cycle Dating Committee (2021).
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announcement, July 19,
https://www.nber.org/news/business-cycle-datingcommittee-announcement-july-19-2021.
Powell, Jerome H. (2020). "New Economic Challenges and the Fed's Monetary Policy
Review," speech delivered at "Navigating the Decade Ahead: Implications for
Monetary Policy," a symposium sponsored by the Federal Reserve Bank of
Kansas City, held in Jackson Hole, Wyo., August 27,
https://www.federalreserve.gov/newsevents/speech/powell20200827a.htm.
Woodford, Michael (2011). "Simple Analytics of the Government Expenditure
Multiplier," American Economic Journal: Macroeconomics, vol 3 (January),
pp. 1-35.
Woodford, Michael, and Yinxi Xie (2020). "Fiscal and Monetary Stabilization Policy at
the Zero Lower Bound: Consequences of Limited Foresight," NBER Working
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Paper Series 27521. Cambridge, Mass.: National Bureau of Economic Research,
July, https://www.nber.org/papers/w27521.