For release on delivery
Noon EST
February 22, 2019
The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and
Communication Practices
Remarks by
Richard H. Clarida
Vice Chair
Board of Governors of the Federal Reserve System
at the
2019 U.S. Monetary Policy Forum, sponsored by
the Initiative on Global Markets at the University of Chicago Booth School of Business
New York, New York
February 22, 2019
I am pleased to participate in this year's U.S. Monetary Policy Forum, which,
since its inception, has brought together policymakers, academics, and market
participants to share ideas and perspectives on U.S. monetary policy. Today I would like
to discuss the broad review of the Federal Reserve's monetary policy framework that we
are undertaking this year. We will examine the policy strategy, tools, and communication
practices that we use to pursue our dual-mandate goals of maximum employment and
price stability. In my remarks, I will describe the motivation for and scope of this review
and will preview some of the events we are planning as part of it.1 The U.S. Monetary
Policy Forum is an excellent venue for this presentation. For more than a decade, it has
focused attention and timely analysis on critical issues confronting the Federal Open
Market Committee (FOMC). Its programs have drawn on the latest economic research
and considered a range of views. Similarly, the Federal Reserve's review of its monetary
policy framework will be transparent, will be open minded, and will seek perspectives
from a broad range of interested individuals and groups, including academics, other
specialists, and the public at large.
Motivation for the Review
The fact that the System is conducting this review does not suggest that we are
dissatisfied with the existing policy framework. Indeed, we believe our existing
framework has served us well, helping us effectively achieve our statutorily assigned
dual-mandate goals of maximum employment and price stability. Nonetheless, in light of
the unprecedented events of the past decade, we believe it is a good time to step back and
assess whether, and in what possible ways, we can refine our strategy, tools, and
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communication practices to achieve and maintain these goals as consistently and robustly
as possible. I note that central banks in other countries have conducted periodic reviews
of their monetary policy frameworks, and their experience has informed the approach we
are pursuing.
As Chairman Powell has indicated, with the U.S. economy operating at or close to
our maximum-employment and price-stability goals, now is an especially opportune time
to conduct this review. The unemployment rate is near a multidecade low, and inflation
is running close to our 2 percent objective. By conducting this review, we want to ensure
that we are well positioned to continue to meet our statutory goals in coming years. In
addition, the Federal Reserve used new policy tools and enhanced its communication
practices in response to the Global Financial Crisis and the Great Recession, and the
review will evaluate these changes. Furthermore, U.S. and foreign economies have
significantly evolved since the pre-crisis experience that informed much of the research
that provided the foundation for our current approach.
Perhaps most significantly, neutral interest rates appear to have fallen in the
United States and abroad.2 Moreover, this global decline in r* is widely expected to
persist for years. The decline in neutral policy rates likely reflects several factors,
including aging populations, changes in risk-taking behavior, and a slowdown in
technology growth. These factors' contributions are highly uncertain, but irrespective of
their precise role, the policy implications of the decline in neutral rates are important. All
else being equal, a fall in neutral rates increases the likelihood that a central bank's policy
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rate will reach its effective lower bound (ELB) in future economic downturns. That
development, in turn, could make it more difficult during downturns for monetary policy
to support spending and employment, and keep inflation from falling too low.3
Another key development in recent decades is that inflation appears less
responsive to resource slack. That is, the short-run Phillips curve appears to have
flattened, implying a change in the dynamic relationship between inflation and
employment.4 A flatter Phillips curve is, in a sense, a proverbial double-edged sword. It
permits the Federal Reserve to support employment more aggressively during
downturns--as was the case during and after the Great Recession--because a sustained
inflation breakout is less likely when the Phillips curve is flatter.5 However, a flatter
Phillips curve also increases the cost, in terms of economic output, of reversing
unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve
makes it all the more important that longer-run inflation expectations remain anchored at
levels consistent with our 2 percent inflation objective.6
3
For assessments of the risks that U.S. monetary policy will be constrained by the ELB and its implications
for economic activity and inflation, see Kiley and Roberts (2017), Erceg and others (2018),
Swanson (2018), and Chung and others (2019).
4
For evidence of a flattening of the slope of the Phillips curve in the United States and abroad, see, among
others, Simon, Matheson, and Sandri (2013); Blanchard, Cerutti, and Summers (2015); and Bank for
International Settlements (2017).
5
One potential contributor to the flattening of the Phillips curve is a change in the conduct of monetary
policy since the 1980s toward greater stabilization of inflation and economic activity; for evidence of such
a change, see Clarida, Galí, and Gertler (2000); Boivin and Giannoni (2006); and Boivin, Kiley, and
Mishkin (2010). As discussed in Roberts (2006) and Bullard (2018), greater stabilization on the part of a
central bank can lead to the estimation of flatter Phillips curves in reduced-form regressions. Similarly, the
adoption of an explicit inflation objective, along with greater certainty regarding the conduct of monetary
policy, can help anchor longer-term inflation expectations and stabilize actual inflation in response to
shocks.
6
See Yellen (2015) for a discussion of inflation dynamics and monetary policy; see Erceg and others
(2018) for a quantitative exploration of the monetary policy implications of a flat Phillips curve in an
uncertain economic environment. Since the mid-1980s, movements in both realized inflation and measures
of longer-term inflation expectations have been somewhat muted, complicating the task of extracting the
precise role of inflation expectations as a determinant of realized inflation. Faust and Wright (2013) review
the literature on inflation forecasting and present evidence in support of the conclusion that measures of
inflation expectations help predict the trend in inflation. In a paper discussed at this forum two years ago,
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Scope of the Review
In the Federal Reserve Act, the Congress assigned the Federal Reserve the
responsibility to conduct monetary policy "so as to promote effectively the goals of
maximum employment, stable prices, and moderate long-term interest rates."7 Our
review this year will take this statutory mandate as given and will also take as given that
inflation at a rate of 2 percent is most consistent over the longer run with the
congressional mandate.
Our existing monetary policy strategy is laid out in the Committee's Statement on
Longer-Run Goals and Monetary Policy Strategy.8 First adopted in January 2012, the
statement has been reaffirmed at the start of each subsequent year, including at the
FOMC's meeting last month with unanimous support from all 17 FOMC participants.
The statement indicates that the Committee seeks to mitigate deviations of inflation from
2 percent and deviations of employment from assessments of its maximum level. In
doing so, the FOMC recognizes that these assessments of maximum employment are
necessarily uncertain and subject to revision. According to the Federal Reserve Act, the
employment objective is on an equal footing with the inflation objective.
Cecchetti and others (2017) showed that while the level of realized inflation and four-quarter-ahead
inflation expectations are positively correlated, changes in these variables have been largely uncorrelated
since the mid-1980s. These authors suggest that, in a low and stable inflation environment, policymakers
should pay attention to a wide array of other indicators in determining the implications of movements in
realized inflation and measures of inflation expectations.
7
Even though the act lists three distinct goals, the Federal Reserve's mandate for monetary policy is
commonly known as the "dual mandate." The reason is that an economy in which people who want to
work either have a job or are likely to find one fairly quickly and in which the price level (meaning a broad
measure of the price of goods and services purchased by consumers) is stable creates the conditions needed
for interest rates to settle at moderate levels. For a discussion, see Mishkin (2007).
8
The statement is available on the Board's website at
https://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf.
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As a practical matter, our current strategy shares many elements with the policy
framework known in the research literature as "flexible inflation targeting."9 However,
the Fed's mandate is much more explicit about the role of employment than that of most
flexible inflation-targeting central banks, and our statement reflects this by stating that
when the two sides of the mandate are in conflict, neither one takes precedent over the
other. We believe this transparency about the balanced approach the FOMC takes has
served us well over the past decade when high unemployment called for extraordinary
policies that entailed some risk of inflation.
The review of our current framework will be wide ranging, and we will not
prejudge where it will take us, but events of the past decade highlight three broad
questions.
Three Questions
The first question is, "Can the Federal Reserve best meet its statutory objectives
with its existing monetary policy strategy, or should it consider strategies that aim to
reverse past misses of the inflation objective?"
Under our current approach as well as that of most flexible inflation-targeting
central banks around the world, the persistent shortfalls of inflation from 2 percent that
many advanced economies have experienced over most of the past decade are treated as
"bygones." This means that policy today is not adjusted to offset past inflation shortfalls
with future overshoots of the inflation target (nor do persistent overshoots of inflation
trigger policies that aim to undershoot the inflation target). Central banks are generally
believed to have effective tools for preventing persistent inflation overshoots, but the
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effective lower bound on interest rates makes persistent undershoots more likely.
Persistent inflation shortfalls carry the risk that longer-term inflation expectations become
poorly anchored or become anchored below the stated inflation goal.10
In part because of that concern, some economists have advocated "makeup"
strategies under which policymakers seek to undo, in part or in whole, past inflation
deviations from target. Such strategies include targeting average inflation over a
multiyear period and price-level targeting, in which policymakers seek to stabilize the
price level around a constant growth path.11 These strategies could be implemented
either permanently or as a temporary response to extraordinary circumstances. For
example, the central bank could commit, at the time when the policy rate reaches the
ELB, to maintain the policy rate at this level until inflation over the ELB period has, on
average, run at the target rate.12 Other makeup strategies seek to reverse shortfalls in
policy accommodation at the ELB by keeping the policy rate lower for longer than
10
These risks could be exacerbated if households and businesses expect monetary policy to be
insufficiently accommodative because of proximity to the ELB. For related discussions, see Reifschneider
and Williams (2000); Adam and Billi (2007); Nakov (2008); and Hills, Nakata, and Schmidt (2016).
11
Eggertsson and Woodford (2003) provide an early discussion of how optimal monetary policy at the ELB
entails a commitment to reflate the price level during the subsequent economic expansion. Nessén and
Vestin (2005) discuss the relationship between average inflation targeting and price-level targeting. There
is a dearth of empirical evidence on strategies seeking to make up for inflation deviations. Central banks
that pursue an inflation goal generally seek to achieve a specific rate of inflation by some time
horizon-typically a couple years ahead or over the "medium run"--without regard to past inflation deviations. One
exception is the Reserve Bank of Australia, whose inflation goal is specified as a range of "2-3 per cent, on
average, over the medium term" and thus might embed some notion of history dependence. However,
Ruge-Murcia (2014) argues that the drift in the price level in Australia is comparable with the drifts
observed in economies with purely forward-looking specification of the inflation goal. The only known
historical example of price-level targeting occurred in Sweden from 1931 to 1933 when the country
abandoned the gold standard and attempted instead to maintain its price level. The temporary adoption of
price-level targeting is credited with helping Sweden avoid deflation, an outcome that contrasted with that
in countries that stayed on the gold standard. See Berg and Jonung (1999).
12
See Bernanke (2017) for a discussion of such a strategy. See Hebden and López-Salido (2018) for a
quantitative assessment of that and other strategies. See also Kiley and Roberts (2017) for a strategy in
which policymakers aim for inflation higher than 2 percent during economic expansions to compensate for
below-target realizations of inflation during economic downturns.
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otherwise would be the case.13 In many models that incorporate the ELB, these makeup
strategies lead to better average performance on both legs of the dual mandate and
thereby, viewed over time, provide no conflict between the dual-mandate goals.14
The benefits of the makeup strategies rest heavily on households and firms
believing in advance that the makeup will, in fact, be delivered when the time comes--for
example, that a persistent inflation shortfall will be met by future inflation above 2
percent. As is well known from the research literature, makeup strategies, in general, are
not time consistent because when the time comes to push inflation above 2 percent,
conditions at that time will not warrant doing so. Because of this time inconsistency, any
makeup strategy, to be successful, would have to be understood by the public to represent
a credible commitment. That important real-world consideration is often neglected in the
academic literature, in which central bank "commitment devices" are simply assumed to
exist and be instantly credible on decree. Thus, one of the most challenging questions is
whether the Fed could, in practice, attain the benefits of makeup strategies that are
possible in models.
The next question the review will consider is, "Are the existing monetary policy
tools adequate to achieve and maintain maximum employment and price stability, or
should the toolkit be expanded? And, if so, how?" The FOMC's primary means of
changing the stance of monetary policy is by adjusting its target range for the federal
funds rate. In the fall of 2008, the FOMC cut that target to just above zero in response to
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financial turmoil and deteriorating economic conditions. Because the U.S. economy
required additional policy accommodation after the ELB was reached, the FOMC
deployed two additional tools in the years following the crisis: balance sheet policies and
forward guidance regarding the likely path of the federal funds rate.15
The FOMC altered the size and composition of the Fed's balance sheet through a
sequence of three large-scale securities purchase programs, via a maturity extension
program, and by adjusting the reinvestment of principal payments on maturing securities.
With regard to forward guidance, the FOMC initially made "calendar based" statements,
and, later on, it issued "outcome based" guidance. Overall, the empirical evidence
suggests that these added tools helped stem the crisis and support economic recovery by
strengthening the labor market and lifting inflation back toward 2 percent. That said,
estimates of the effects of these unconventional policies range widely.16
In addition to assessing the efficacy of these existing tools, we will consider
additional tools to ease policy when the ELB is binding. For example, as is presently
Bank of Japan policy, the FOMC could, when the ELB is binding, establish a temporary
ceiling for Treasury yields at longer maturities by standing ready to purchase them at a
15
As an illustration of the shortfall in policy support created by a binding ELB during the Global Financial
Crisis, the simple policy rules considered in a January 2017 speech by then-Chair Janet Yellen prescribed
setting the federal funds rate between negative 1-1/2 and negative 9 percent; see Yellen (2017). In addition
to using these two additional monetary policy tools, the Federal Reserve implemented a number of other
measures to stabilize the financial system, increase households and business confidence, and more
generally support the economic recovery. These supplementary measures included the setting up of several
credit facilities and the introduction of stress tests for systemically important financial institutions.
16
On the transmission channels of balance sheet policies, see D'Amico and others (2012), Joyce and others
(2012), Clarida (2012), Woodford (2012), and Bauer and Rudebusch (2014). On the financial market
effects of balance sheet policies, see Gagnon and others (2011), Joyce and others (2011), Hamilton and Wu
(2012), D'Amico and King (2013), and Swanson (2017). For discussions of the macroeconomic effects of
these policy actions, see Chen, Cúrdia, and Ferrero (2012); Baumeister and Benati (2013); Engen, Laubach,
and Reifschneider (2015); Chung and others (2019), and the references therein. For related assessments of
forward guidance, see Campbell and others (2012); Engen, Laubach, and Reifschneider (2015); Campbell
and others (2017); and Swanson (2017).
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preannounced floor price.17 During the crisis and its aftermath, the Federal Reserve
reviewed but ultimately found this tool and some others deployed by foreign central
banks wanting relative to the alternatives it did pursue. But the review will reassess the
case for these and other tools in light of more recent experience in other countries.
The third question the review will consider is, "How can the FOMC's
communication of its policy framework and implementation be improved?" Our
communication practices have evolved considerably since 1994, when the Federal
Reserve released the first statement after an FOMC meeting. Over the past decade or so,
the FOMC has enhanced its communication practices to promote public understanding of
its policy goals, strategy, and actions, as well as to foster democratic accountability.
These enhancements include the Statement on Longer-Run Goals and Monetary Policy
Strategy; postmeeting press conferences; various statements about principles and strategy
guiding the Committee's normalization of monetary policy; and quarterly summaries of
individual FOMC participants' economic projections, assessments about the appropriate
path of the federal funds rate, and judgments of the uncertainty and balance of risks
around their projections.18
17
Compared with asset purchases during the financial crisis, this approach might give us greater rate
control at medium to long maturities but carry a risk that the Federal Reserve's balance sheet could become
unduly large. Japan arguably offers the most direct example of such an approach. In September 2016, the
Bank of Japan announced a target for the yield on the Japanese 10-year government bond and stated its
commitment to expand the monetary base until inflation exceeded its 2 percent objective and stayed above
that level in a stable manner.
18
Starting in 1979, the Federal Reserve published a summary of individual economic projections from
various Board members, FOMC members, or FOMC participants in the semiannual Monetary Policy
Report.
With the introduction of the Summary of Economic Projections (SEP) in 2007, the FOMC
increased the frequency of the releases of policymaker projections, expanded the set of economic variables
included, and extended the forecast horizon. Because the SEP includes individual contributions of
projections and assessments from all FOMC participants, it captures a broader range of views than those of
FOMC members. For a discussion and data, see Bernanke (2007) and Romer (2010).
As part of the review, we will assess the Committee's current and past
communications and additional forms of communication that could be helpful. For
example, there might be ways to improve communication about the coordination of
policy tools or the interplay between monetary policy and financial stability.
Activities and Timeline for the Review
The review will have several components.19 The Board and the Reserve Banks
will be conducting town hall-style "Fed Listens" events this year. We will hear from a
broad range of interested individuals and groups, including business and labor leaders,
community development professionals, and academics. The first of these events will take
place Monday in Dallas. Another is scheduled at the Federal Reserve Bank of
Minneapolis in early April, and other Reserve Banks will host events over the course of
the year.
In addition, we will sponsor a System research conference on June 4-5, 2019, at
the Federal Reserve Bank of Chicago, with speakers and panelists from outside the Fed.
The sessions will include overviews by academic experts of themes that are central to the
review, including the FOMC's monetary policy since the financial crisis, assessments of
the maximum sustainable level of employment, alternative policy frameworks and
strategies to achieve the dual mandate, policy tools, global considerations, financial
stability considerations, and central bank communications. Other sessions will feature
panels of community leaders who will share their perspectives on the labor market and
the effects of interest rates on their constituencies.
We expect to release summaries of the "Fed Listens" events and to livestream the
Chicago conference. Building on the perspectives we hear and on staff analysis, the
FOMC will conduct its own assessment of its monetary policy framework, beginning
around the middle of the year. We will share our conclusions with the public in the first
half 2020.
Concluding Thoughts
The economy is constantly evolving, bringing with it new policy challenges. So it
makes sense for us to remain open minded as we assess current practices and consider
ideas that could potentially enhance our ability to deliver on the goals the Congress has
assigned us. For this reason, my colleagues and I do not want to preempt or to predict
our ultimate finding. What I can say is that any refinements or more material changes to
our framework that we might make will be aimed solely at enhancing our ability to
achieve and sustain our dual-mandate objectives in the world we live in today.
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