Janet Yellen: From adding accommodation to scaling it back
Speech by Ms Janet L Yellen, Chair of the Board of Governors of the Federal Reserve System, at
the Executives' Club of Chicago, Chicago, Illinois, 3 March 2017.
* * *
I am pleased to join you today to discuss the U.S. economy and the Federal Reserve's monetary
policy. I strongly believe that my colleagues and I should explain, as clearly as we can, both the
reasons for our decisions and the fundamental principles that underlie our strategy.
Today I will review the conduct of monetary policy during the nearly 10 years since the onset of
the financial crisis. Although the Federal Reserve's policy strategy for systematically pursuing its
congressionally mandated goals of maximum employment and price stability has not changed
during this period, the Federal Open Market Committee (FOMC) has made significant tactical
adjustments along the way. I will spend most of my time today discussing the rationale for the
adjustments the Committee has made since 2014, a year that I see as a turning point, when the
FOMC began to transition from providing increasing amounts of accommodation to gradually
scaling it back.
The process of scaling back accommodation has so far proceeded at a slower pace than most
FOMC participants anticipated in 2014. Both unexpected economic developments and deeper
reevaluations of structural trends affecting the U.S. and global economies prompted us to
reassess our views on the outlook and associated risks and, consequently, the appropriate
stance of monetary policy, both in the near term and the longer run. Looking ahead, we continue
to expect the evolution of the economy to warrant further gradual increases in the target range for
the federal funds rate. However, given how close we are to meeting our statutory goals, and in
the absence of new developments that might materially worsen the economic outlook, the
process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016.
I should note that I will discuss the process of scaling back accommodation mostly from the
perspective of our interest rate decisions, which my FOMC colleagues and I see as our primary
tool for actively adjusting the stance of monetary policy when our actions are not constrained by
1
the zero lower bound on short-term interest rates.
Assessing the degree of monetary policy accommodation
In our monetary policy deliberations, the FOMC always faces two fundamental questions: First,
how do we assess the current stance of monetary policy? Second, what are the strategic and
tactical considerations that underpin our decisions about the appropriate stance of monetary
policy going forward? These questions are difficult because the interactions between monetary
policy and the economy are complex. Policy affects the economy through many different
channels, and, in turn, many factors influence the appropriate course of policy.
Gauging the current stance of monetary policy requires arriving at a judgment of what would
constitute a neutral policy stance at a given time. A useful concept in this regard is the neutral
"real" federal funds rate, defined as the level of the federal funds rate that, when adjusted for
inflation, is neither expansionary nor contractionary when the economy is operating near its
potential. In effect, a "neutral" policy stance is one where monetary policy neither has its foot on
the brake nor is pressing down on the accelerator. Although the concept of the neutral real
federal funds rate is exceptionally useful in assessing policy, it is difficult in practical terms to
know with precision where that rate stands. As a result, and as I described in a recent speech,
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my colleagues and I consider a wide range of information when assessing that rate. As I will
discuss, our assessments of the neutral rate have significantly shifted down over the past few
years.
In the Committee's most recent projections last December, most FOMC participants assessed
3
the longer-run value of the neutral real federal funds rate to be in the vicinity of 1 percent. This
level is quite low by historical standards, reflecting, in part, slow productivity growth and an aging
population not only in the United States, but also in many advanced economies. Moreover,
the current value of the neutral real federal funds rate appears to be even lower than this
longerrun value because of several additional headwinds to the U.S. economy in the aftermath of the
financial crisis, such as subdued economic growth abroad and perhaps a lingering sense of
caution on the part of households and businesses in the wake of the trauma of the Great
Recession.
It is difficult to say just how low the current neutral rate is because assessments of the effect of
post-recession headwinds on the current level of the neutral real rate are subject to a great deal
of uncertainty. Some recent estimates of the current value of the neutral real federal funds rate
4
stand close to zero percent. With the actual value of the real federal funds rate currently near
minus 1 percent, a near-zero estimate of the neutral real rate means that the stance of monetary
policy remains moderately accommodative, an assessment that is consistent with the fact that
employment has been growing at a pace-around 180,000 net new jobs per month-that is
notably above the level estimated to be consistent with the longer-run trend in labor force growth
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-between 75,000 and 125,000 per month. As I will explain, this policy stance seems
appropriate given that the underlying trend in inflation appears to be still running somewhat below
2 percent. But as that gap closes, with labor market conditions now in the vicinity of our
maximum employment objective, the Committee considers it appropriate to move toward a
neutral policy stance.
My colleagues and I generally anticipate that the neutral real federal funds rate will rise to its
longer-run level over the next few years. This expectation partly underlies our view that gradual
increases in the federal funds rate will likely be appropriate in the months and years ahead:
Those increases would keep the economy from significantly overheating, thereby sustaining the
expansion and maintaining price stability.
Post-crisis period: same strategy, new tactics
I will now examine the strategic and tactical considerations that go into FOMC deliberations by
discussing past monetary policy decisions in the context of our mandate from the Congress to
pursue maximum employment and price stability.
The FOMC's monetary policy strategy is based on three basic principles. First, our monetary
policy must be goal driven. We must take care to ensure that our decisions over time are
consistent with our commitment to achieve the Federal Reserve's congressionally mandated
goals of maximum employment and price stability, and that the public understands and has
confidence in that commitment. Second, our monetary policy must be forward looking because
our decisions tend to influence economic activity and inflation with a substantial lag. Among other
things, this implies looking through short-term and transitory developments and focusing on the
medium-term outlook-roughly two or three years out-when making policy decisions. Third, our
monetary policy must be risk sensitive. Because the outlook is uncertain, we must assess
appropriate policy with an eye toward the risk that our expectations about the economy turn out to
be significantly wrong.
We have followed this basic strategy for decades and, in 2012, the FOMC formalized it in our
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"Statement on Longer-Run Goals and Monetary Policy Strategy." The Committee has reaffirmed
this commitment annually. But the challenges brought about by the financial crisis, and the very
deep recession and painfully slow recovery that followed, compelled us to adjust our tactics for
carrying out our policy strategy. In particular, once the Committee had cut the federal funds rate
to near zero in late 2008, it became necessary to deploy new tools to supply the considerable
monetary accommodation required by the extremely weak state of the job market and
persistently low inflation. Those tools-especially our large-scale securities purchases and
increasingly explicit forward guidance pertaining to the likely future path of the federal funds rate
-enabled the Federal Reserve to provide necessary additional support to the U.S. economy by
pushing down longer-term interest rates and easing financial conditions more generally.
Much has been written and said already about the provision of additional accommodation
between 2008 and 2014, when the FOMC completed its latest round of large-scale securities
purchases, so I will turn now to our policy stance since 2014, when the FOMC's main focus
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started to shift from providing additional accommodation to scaling it back.
2014: a turning point for monetary policy
By late 2013, the FOMC concluded that the economy had made sufficient progress, and the
outlook was sufficiently favorable, that it should reduce the pace of its large-scale securities
purchases. But we reiterated that these purchases would continue until the outlook for the labor
market had improved substantially. The U.S. economy made notable progress toward the
FOMC's statutory goals during 2014, with the unemployment rate dropping to close to 6 percent
by mid-year-well below its Great-Recession peak of 10 percent-and other measures of labor
market conditions also showing improvement: Payroll gains were solid; job openings had risen
significantly; and the number of workers voluntarily quitting their jobs-a sign of confidence in the
labor market-was rising back toward pre-crisis levels. We were also seeing progress on
achieving our price stability goal: Total inflation as measured by changes in the headline personal
consumption expenditures (PCE) price index reached about 1-3/4 percent by mid-2014 after
hovering around 1 percent in the fall of 2013. Inflation seemed to be moving toward the FOMC's 2
percent objective, a level that the FOMC judges to be consistent with price stability because it is
low enough that it does not need to figure prominently into people's and businesses' economic
decisions but high enough to serve as a buffer against deflation and provide greater scope for
monetary policy to address economic weakness.
The progress seen during 2014 indicated to the FOMC that it was no longer necessary to provide
increasing amounts of support to the U.S. economy by continuing to add to the Federal
Reserve's holdings of longer-term securities. Accordingly, the Committee continued to reduce
the pace of asset purchases over the course of the year, ending its purchases in October. That
step, however, did not mark an immediate shift toward tighter monetary policy because we also
indicated then that we did not expect to raise interest rates for a considerable time after the end
of our securities purchases. Moreover, as the Committee explained in a set of "normalization
principles" issued that September, the intention was to maintain the overall size of the Federal
Reserve's balance sheet at an elevated level until sometime after the FOMC had begun to raise
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its target for the federal funds rate. We decided that maintaining a highly accommodative stance
of monetary policy remained appropriate because, while the U.S. economy was stronger and
closer to meeting our statutory goals, we saw significant room for improvement. In particular, the
unemployment rate still stood above our assessment of its longer-run normal level-that is, the
unemployment rate that we expect to prevail when the economy is operating at maximum
employment-and inflation remained below the 2 percent objective.
Because my colleagues and I expected that labor market conditions would continue to improve
and that inflation would move back to 2 percent over the medium term, we anticipated that the
time was approaching when the economy would be strong enough that we should start to scale
back our support. Indeed, the FOMC's June 2014 Summary of Economic Projections (SEP)
reported that nearly all FOMC participants saw a higher federal funds rate as appropriate in the
next calendar year. In contrast, only two participants in December 2013 thought that it would be
appropriate to start raising that rate in the next calendar year.
Uneven progress in 2015 and into 2016
In 2015, the unemployment rate fell significantly faster than we generally had anticipated in 2014.
However, a series of unanticipated global developments beginning in the second half of 2014-
including a prolonged decline in oil prices, a sizable appreciation of the dollar, and financial
market turbulence emanating from abroad-ended up having adverse implications for
the outlook for inflation and economic activity in the United States, prompting the FOMC to
remove monetary policy accommodation at a slower pace than we had anticipated in mid-2014.
U.S. gross domestic product (GDP) growth generally surprised to the downside in 2015,
reflecting, in part, weak economic activity abroad, the earlier appreciation of the dollar, and the
effect of falling oil prices on business fixed investment. This unanticipated slowing in the pace of
the economic recovery caused us to worry about the sustainability of ongoing improvements in
employment and, thus, of likely progress toward our maximum employment goal. Our worry was
reinforced by our assessment that, with the federal funds rate still near zero, there would likely be
only limited scope for us to respond by lowering short-term rates if the weakening in economic
activity turned out to be persistent. In contrast, if the weakening proved transitory and the
economy instead began to overheat, threatening to push inflation to an undesirably high level, the
FOMC would have ample scope to respond through tighter monetary policy.
Inflation also was lower than expected, with headline PCE prices rising less than 1 percent over
the course of 2015, instead of around 1-3/4 percent as we had anticipated in June 2014. Much of
this shortfall reflected the effects of falling oil prices and the appreciation of the dollar. My
colleagues and I typically look through the effects on inflation of fluctuations in oil prices and the
dollar because these effects tend to be transitory. However, we became concerned in 2015
about the risk that part of the decline in inflation could prove to be longer lasting, especially given
that inflation had already been running below our 2 percent objective for quite some
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time. These various considerations, along with our reassessment of longer-run economic
conditions-which I will discuss shortly-explain why the Committee ended up raising the target
range for the federal funds rate only 1/4 percentage point in 2015, substantially less than the full
percentage point increase suggested by the median projection of FOMC participants reported in
June 2014.
2016 also brought some unexpected economic developments that led us to proceed cautiously.
During the first half of the year, mixed readings on the job market, along with additional
disappointing data on real GDP growth, suggested again that progress toward the achievement
of our maximum employment goal could be slowing markedly. Meanwhile, inflation hovered just
below 1 percent as dollar appreciation continued to exert downward pressure on import prices,
and financial market turbulence emanating from abroad-associated with concerns about the
Chinese economy and the Brexit referendum-posed new risks to U.S. economic activity and
inflation. Moreover, even as payroll gains turned solid again in the second half of 2016, the
unemployment rate remained relatively flat, suggesting that perhaps there was more room for
improvement in the job market than we had previously thought. Those unanticipated
developments were part of the reason why the Committee again opted to proceed more slowly in
removing accommodation than had been anticipated at the start of the year. We ended up
increasing the target range for the federal funds rate by only 1/4 percentage point over the course
of 2016, rather than the full percentage point suggested by our December 2015 projections.
Reassessing longer-run conditions
The slower-than-anticipated increase in our federal funds rate target in 2015 and 2016 reflected
more than just the inflation, job market, and foreign developments I mentioned. During that
period, the FOMC and most private forecasters generally lowered their assessments of the
longer-run neutral level of the real federal funds rate. Indeed, at our October 2015 meeting, the
FOMC had a comprehensive discussion of neutral real interest rates and was impressed by the
breadth of evidence suggesting that those rates had declined both here and abroad, and that the
decline had been going on for some time. In response to this growing evidence, the median
assessment by FOMC participants of the longer-run level of the real federal funds rate fell from
1-3/4 percent in June 2014 to 1-1/2 percent in December 2015 and then to 1 percent in
December 2016. These reassessments reflected, in part, the persistence of surprisingly
sluggish productivity growth-both in the United States and abroad-and suggested that fewer
federal funds rate increases would be necessary than previously thought to scale back
accommodation.
Partly in response to persistently slow wage growth, FOMC participants and private forecasters
have in recent years lowered their estimates of the normal longer-run rate of unemployment. The
median projection of FOMC participants of the longer-run level of the unemployment rate fell from
about 5-1/4 percent in June 2014 to approximately 4-3/4 percent in December 2016. Other things
being equal, a lower longer-run level of the unemployment rate suggests that the economy has
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greater scope to create jobs without generating too much inflation. Thus, the downward
revisions to FOMC participants' views on the unemployment rate over the longer run contributed
to our assessment that monetary policy could stay accommodative longer than we had
anticipated in 2014.
Further progress since mid-2016
The U.S. economy has exhibited remarkable resilience in the face of adverse shocks in recent
years, and economic developments since mid-2016 have reinforced the Committee's confidence
that the economy is on track to achieve our statutory goals. Job gains have remained quite solid,
and the unemployment rate, at 4.8 percent in January, is now in line with the median of FOMC
participants' estimates of its longer-run normal level. On the whole, the prospects for further
moderate economic growth look encouraging, particularly as risks emanating from abroad
appear to have receded somewhat. The Committee currently assesses that the risks to the
outlook are roughly balanced.
Moreover, after remaining disappointingly low through mid-2016, inflation moved up during the
second half of 2016, mainly because of the diminishing effects of the earlier declines in energy
prices and import prices. More recently, higher energy prices appear to have temporarily boosted
inflation, with the total PCE price index rising nearly 2 percent in the 12 months ending in
January. Core PCE inflation-which excludes volatile energy and food prices and, therefore,
tends to be a better indicator of future inflation-has been running near 1-3/4 percent.
Marketbased measures of inflation compensation have moved up, on net, in recent months, although
they remain low.
With the job market strengthening and inflation rising toward our target, the median assessment
of FOMC participants as of last December was that a cumulative 3/4 percentage point increase
in the target range for the federal funds rate would likely be appropriate over the course of this
year. In light of current economic conditions, such an increase would be consistent with the
Committee's expectation that it will raise the target range for the federal funds rate at a gradual
pace and would bring the real federal funds rate close to some estimates of its current neutral
level. However, partly because my colleagues and I expect the neutral real federal funds rate to
rise somewhat over the longer run, we projected additional gradual rate hikes in 2018 and 2019.
Our individual projections for the appropriate path for the federal funds rate reflect economic
forecasts that generally envision that economic activity will expand at a moderate pace in coming
years, labor market conditions will strengthen somewhat further, and inflation will be at or near 2
percent over the medium term. In short, we currently judge that it will be appropriate to gradually
increase the federal funds rate if the economic data continue to come in about as we expect.
Indeed, at our meeting later this month, the Committee will evaluate whether employment and
inflation are continuing to evolve in line with our expectations, in which case a further adjustment
of the federal funds rate would likely be appropriate.
Nonetheless, as we have said many times-and as my discussion today demonstrates-
monetary policy cannot be and is not on a preset course. As in 2015 and 2016, the Committee
stands ready to adjust its assessment of the appropriate path for monetary policy if unanticipated
developments materially change the economic outlook.
Monetary policy is not a panacea
The U.S. economy has shown great improvement and is close to meeting our congressionally
mandated goals of maximum employment and price stability, but we of course recognize that
important challenges remain. For instance, as we noted in our latest Monetary Policy Report to
the Congress, the ongoing expansion has been the slowest since World War II, with real GDP
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growth averaging only about 2 percent per year. This subdued pace reflects, in part, slower
growth in the labor force in recent years-compared with much of the post-World War II period-
and disappointing productivity growth both in the United States and abroad.
Our report also noted that, despite a notable pickup in 2015, real incomes for the median family
were still a bit lower than they were prior to the Great Recession, and the gains during this
economic recovery have been skewed toward the top of the income distribution, as has been the
case for quite some time. Families at the 10th percentile of the income distribution earned about
4 percent less in 2015 than they did in 2007, whereas families at the 90th percentile earned about
4 percent more. In addition, the economic circumstances of blacks and Hispanics, while
improved since the depths of the recession, remain worse, on average, that those of whites or
Asians.
These unwelcome developments unfortunately reflect structural challenges that lie substantially
beyond the reach of monetary policy. Monetary policy cannot, for instance, generate
technological breakthroughs or affect demographic factors that would boost real GDP growth
over the longer run or address the root causes of income inequality. And monetary policy cannot
improve the productivity of American workers. Fiscal and regulatory policies-which are of
course the responsibility of the Administration and the Congress-are best suited to address
such adverse structural trends.
Conclusion
To conclude, we at the Federal Reserve must remain squarely focused on our congressionally
mandated goals. The economy has essentially met the employment portion of our mandate and
inflation is moving closer to our 2 percent objective. This outcome suggests that our
goalfocused, outlook-dependent approach to scaling back accommodation over the past couple of
years has served the U.S. economy well.
This same approach will continue to drive our policy decisions in the months and years ahead.
With that in mind, our policy aims to support continued growth of the American economy in
pursuit of our congressionally mandated objectives. We do that, as I have noted, with an eye
always on the risks. To that end, we realize that waiting too long to scale back some of our
support could potentially require us to raise rates rapidly sometime down the road, which in turn
could risk disrupting financial markets and pushing the economy into recession. Having said that,
I currently see no evidence that the Federal Reserve has fallen behind the curve, and I therefore
continue to have confidence in our judgment that a gradual removal of accommodation is likely to
be appropriate. However, as I have noted, unless unanticipated developments adversely affect
the economic outlook, the process of scaling back accommodation likely will not be as slow as it
was during the past couple of years.
References
Board of Governors of the Federal Reserve System (2017). Monetary Policy Report
(PDF). Washington: Board of Governors, February.
D'Amico, Stefania, William English, David Lopez-Salido, and Edward Nelson (2012). "The
Federal Reserve's Large-Scale Asset Purchase Programmes: Rationale and Effects," Economic
Journal, vol. 122 (November), pp. F415-46.
Engen, Eric M., Thomas Laubach, and David Reifschneider (2015). "The Macroeconomic Effects
of the Federal Reserve's Unconventional Monetary Policies (PDF)," Finance and Economics
Discussion Series 2015-005. Washington: Board of Governors of the Federal Reserve System,
February.
Holston, Kathryn, Thomas Laubach, and John C. Williams (2016). "Measuring the Natural Rate of
Interest: International Trends and Determinants (PDF)," Finance and Economics Discussion
Series 2016-073. Washington: Board of Governors of the Federal Reserve System, September.
Yellen, Janet (2016). "The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future,"
speech delivered at "Designing Resilient Monetary Policy Frameworks for the Future," a
symposium sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole,
Wyo., August 26.
---- (2017). "The Economic Outlook and the Conduct of Monetary Policy," speech delivered
at the Stanford Institute for Economic Policy Research, Stanford University, Stanford, Calif.,
January 19.
1
When the federal funds rate was near zero and we felt the economy still needed more support, the FOMC acted,
beginning in 2008, to purchase longer-term securities. Although we stopped increasing the size of our
securities portfolio in 2014, we have been reinvesting principal payments from our securities holdings ever
since. We have said that we expect to maintain this policy until normalization of the level of the federal funds rate
is well under way. We have also said that, when it becomes appropriate to reduce the size of our balance sheet,
we will do so primarily by letting maturing assets run off our balance sheet.
2
See Yellen (2017).
3
This estimate of the neutral real federal funds rate is based on the difference between the medians of the
longer-run projections for the federal funds rate and inflation submitted by individual FOMC participants for the
December 2016 FOMC meeting. The most recent Summary of Economic Projections, an addendum to the
minutes of that meeting, is available on the Board's website
at www.federalreserve.gov/monetarypolicy/fomcminutes20161214ep.htm.
4
See, for instance, Holston, Laubtach, and Williams (2016).
5
The estimate of the actual value of the real federal funds rate (around minus 1 percent) is based on the
difference between the current value of the effective federal funds rate (close to 0.66 percent) and the latest
reading on inflation as measured by the 12-month change in the price index for personal consumption
expenditures excluding energy and food items (1-3/4 percent).
6
The Statement on Longer-Run Goals and Monetary Policy Strategy is available on the Board's website
at www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf (PDF).
7
See Yellen (2016).
8
For a discussion of our monetary policy during the 2008-14 period, see, for instance, Engen, Laubach, and
Reifschneider (2015).
9
The FOMC's Policy Normalization Principles and Plans are available on the Board's website
at www.federalreserve.gov/newsevents/press/monetary/20140917c.htm. Several studies support the notion that
maintaining the size of the Federal Reserve's balance sheet at an elevated level is consistent with keeping a
highly accomodative policy stance, particularly when short-term interest rates are close to zero, as it was the
case in 2014 - see, for instance, D'Amico and others (2012) and many of the references in Engen, Laubach and
Reifschneider (2015). Large Federal Reserve holdings of longer-term securities reduce the total amount of
such securities available for purchase by the public, exerting upward pressure on their prices and, thus,
depressing their yields and contributing to lower borrowing costs for American families and businesses.
10
These concerns were reinforced somewhat by a decline in market-based measures of inflation compensation.
11
The assessment that there was perhaps more room for improvement in the labor market than previously
thought was reinforced by data showing that the labor force participation rate remained relatively stable in 2016,
rather than declining as many had expected.
12
See Board of Governors (2107).