For release on delivery
1:00 p.m. EST
November 26, 2019
Federal Reserve Review of
Monetary Policy Strategy, Tools, and Communications:
Some Preliminary Views
Remarks by
Lael Brainard
Member
Board of Governors of the Federal Reserve System
at the
Presentation of the 2019 William F. Butler Award
New York Association for Business Economics
New York, New York
November 26, 2019
It is a pleasure to be here with you. It is an honor to join the 45 outstanding
economic researchers and practitioners who are past recipients of the William F. Butler
Award. I want to express my deep appreciation to the New York Association for
Business Economics (NYABE) and NYABE President Julia Coronado.
I will offer my preliminary views on the Federal Reserve's review of its monetary
policy strategy, tools, and communications after first touching briefly on the economic
outlook. These remarks represent my own views. The framework review is ongoing and
will extend into 2020, and no conclusions have been reached at this time.1
Outlook and Policy
There are good reasons to expect the economy to grow at a pace modestly above
potential over the next year or so, supported by strong consumers and a healthy job
market, despite persistent uncertainty about trade conflict and disappointing foreign
growth. Recent data provide some reassurance that consumer spending continues to
expand at a healthy pace despite some slowing in retail sales. Consumer sentiment
remains solid, and the employment picture is positive. Housing seems to have turned a
corner and is poised for growth following several weak quarters.
Business investment remains downbeat, restrained by weak growth abroad and
trade conflict. But there is little sign so far that the softness in trade, manufacturing, and
business investment is affecting consumer spending, and the effect on services has been
limited.
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Employment remains strong. The employment-to-population ratio for prime-age
adults has moved up to its pre-recession peak, and the three-month moving average of the
unemployment rate is near a 50-year low.2 Monthly job gains remain above the pace
needed to absorb new entrants into the labor force despite some slowing since last year.
And initial claims for unemployment insurance-a useful real-time indicator
historically-remain very low despite some modest increases.
Data on inflation have come in about as I expected, on balance, in recent months.
Inflation remains below the Federal Reserve's 2 percent symmetric objective, which has
been true for most of the past seven years. The price index for core personal
consumption expenditures (PCE), which excludes food and energy prices and is a better
indicator of future inflation than overall PCE prices, increased 1.7 percent over the
12 months through September.
Foreign growth remains subdued. While there are signs that the decline in euro-
area manufacturing is stabilizing, the latest indicators on economic activity in China
remain sluggish, and the news in Japan and in many emerging markets has been
disappointing. Overall, it appears third-quarter foreign growth was weak, and the latest
indicators point to little improvement in the fourth quarter.
More broadly, the balance of risks remains to the downside, although there has
been some improvement in risk sentiment in recent weeks. The risk of a disorderly
Brexit in the near future has declined significantly, and there is some hope that a U.S.-
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China trade truce could avert additional tariffs. While risks remain, financial market
indicators suggest market participants see a diminution in such risks, and probabilities of
recessions from models using market data have declined.
The baseline is for continued moderate expansion, a strong labor market, and
inflation moving gradually to our symmetric 2 percent objective. The Federal Open
Market Committee (FOMC) has taken significant action to provide insurance against the
risks associated with trade conflict and weak foreign growth against a backdrop of muted
inflation. Since July, the Committee has lowered the target range for the federal funds
rate by 3/4 percentage point, to the current range of 1-1/2 to 1-3/4 percent. It will take
some time for the full effect of this accommodation to work its way through economic
activity, the labor market, and inflation. I will be watching the data carefully for signs of
a material change to the outlook that could prompt me to reassess the appropriate path of
policy.
Review
The Federal Reserve is conducting a review of our monetary policy strategy,
tools, and communications to make sure we are well positioned to advance our statutory
goals of maximum employment and price stability.3 Three key features of today's new
normal call for a reassessment of our monetary policy strategy: the neutral rate is very
3
Information about the review of monetary policy strategy, tools, and communications is available on the
Board's website at
https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategytools-and-communications.htm. Also see Richard H. Clarida (2019), "The Federal Reserve's Review of Its
Monetary Policy Strategy, Tools, and Communication Practices," speech delivered 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, February 22,
https://www.federalreserve.gov/newsevents/speech/clarida20190222a.htm; and Jerome H. Powell (2019),
"Monetary Policy: Normalization and the Road Ahead," speech delivered at the 2019 SIEPR Economic
Summit, Stanford Institute of Economic Policy Research, Stanford, Calif., March 8,
https://www.federalreserve.gov/newsevents/speech/powell20190308a.htm.
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low here and abroad, trend inflation is running below target, and the sensitivity of price
inflation to resource utilization is very low.4
First, trend inflation is below target.5 Underlying trend inflation appears to be
running a few tenths below the Committee's symmetric 2 percent objective, according to
various statistical filters. This raises the risk that households and businesses could come
to expect inflation to run persistently below our target and change their behavior in a way
that reinforces that expectation. Indeed, with inflation having fallen short of 2 percent for
most of the past seven years, inflation expectations may have declined, as suggested by
some survey-based measures of long-run inflation expectations and by market-based
measures of inflation compensation.
Second, the sensitivity of price inflation to resource utilization is very low. This
is what economists mean when they say that the Phillips curve is flat. A flat Phillips
curve has the important advantage of allowing employment to continue expanding for
longer without generating inflationary pressures, thereby providing greater opportunities
to more people. But it also makes it harder to achieve our 2 percent inflation objective on
a sustained basis when inflation expectations have drifted below 2 percent.
Third, the long-run neutral rate of interest is very low, which means that we are
likely to see more frequent and prolonged episodes when the federal funds rate is stuck at
4
See Lael Brainard (2016), "The 'New Normal' and What It Means for Monetary Policy," speech delivered
at the Chicago Council on Global Affairs, Chicago, September 12,
https://www.federalreserve.gov/newsevents/speech/brainard20160912a.htm.
5
See Lael Brainard (2017), "Understanding the Disconnect between Employment and Inflation with a Low
Neutral Rate," speech delivered at the Economic Club of New York, September 5,
https://www.federalreserve.gov/newsevents/speech/brainard20170905a.htm ; and James H. Stock and
Mark W. Watson (2007), "Why Has U.S. Inflation Become Harder to Forecast?" Journal of Money, Credit
and Banking, vol. 39 (s1, February), pp. 3-33; this paper is also available at
https://scholar.harvard.edu/stock/publications/why-has-inflation-become-harder-forecast.
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its effective lower bound (ELB).6 The neutral rate is the level of the federal funds rate
that would keep the economy at full employment and 2 percent inflation if no tailwinds
or headwinds were buffeting the economy. A variety of forces have likely contributed to
a decline in the neutral rate, including demographic trends in many large economies,
some slowing in the rate of productivity growth, and increases in the demand for safe
assets. When looking at the Federal Reserve's Summary of Economic Projections (SEP),
it is striking that the Committee's median projection of the longer-run federal funds rate
has moved down from 4-1/4 percent to 2-1/2 percent over the past seven years.7 A
similar decline can be seen among private forecasts.8 This decline means the
conventional policy buffer is likely to be only about half of the 4-1/2 to 5 percentage
points by which the FOMC has typically cut the federal funds rate to counter recessionary
pressures over the past five decades.
This large loss of policy space will tend to increase the frequency or length of
periods when the policy rate is pinned at the ELB, unemployment is elevated, and
inflation is below target.9 In turn, the experience of frequent or extended periods of low
6
See Lael Brainard (2015), "Normalizing Monetary Policy When the Neutral Interest Rate Is Low," speech
delivered at the Stanford Institute for Economic Policy Research, Stanford, Calif., December 1,
https://www.federalreserve.gov/newsevents/speech/brainard20151201a.htm.
7
The projection materials for the Federal Reserve's SEP are available on the Board's website at
https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm.
8
For example, the Blue Chip Consensus long-run projection for the three-month Treasury bill has declined
from 3.6 percent in October 2012 to 2.4 percent in October 2019. See Wolters Kluwer (2019), Blue Chip
Economic Indicators, vol. 44 (October 10); and Wolters Kluwer (2012), Blue Chip Economic Indicators,
vol. 37 (October 10).
9
See Michael Kiley and John Roberts (2017), "Monetary Policy in a Low Interest Rate World," Brookings
Papers on Economic Activity, Spring, pp. 317-72,
https://www.brookings.edu/wpcontent/uploads/2017/08/kileytextsp17bpea.pdf; Eric Swanson (2018), "The Federal Reserve Is Not Very
Constrained by the Lower Bound on Nominal Interest Rates," NBER Working Paper Series 25123
(Cambridge, Mass.: National Bureau of Economic Research, October),
https://www.nber.org/papers/w25123; and Hess Chung, Etienne Gagnon, Taisuke Nakata, Matthias
Paustian, Bernd Schlusche, James Trevino, Diego Vilán, and Wei Zheng (2019), "Monetary Policy Options
at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit," Finance and
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inflation at the ELB risks eroding inflation expectations and further compressing the
conventional policy space. The risk is a downward spiral where conventional policy
space gets compressed even further, the ELB binds even more frequently, and it becomes
increasingly difficult to move inflation expectations and inflation back up to target.
While consumers and businesses might see very low inflation as having benefits at the
individual level, at the aggregate level, inflation that is too low can make it very
challenging for monetary policy to cut the short-term nominal interest rate sufficiently to
cushion the economy effectively.10
The experience of Japan and of the euro area more recently suggests that this risk
is real. Indeed, the fact that Japan and the euro area are struggling with this challenging
triad further complicates our task, because there are important potential spillovers from
monetary policy in other major economies to our own economy through exchange rate
and yield curve channels.11
In light of the likelihood of more frequent episodes at the ELB, our monetary
policy review should advance two goals. First, monetary policy should achieve average
inflation outcomes of 2 percent over time to re-anchor inflation expectations at our target.
Second, we need to expand policy space to buffer the economy from adverse
developments at the ELB.
Economics Discussion Series 2019-003 (Washington: Board of Governors of the Federal Reserve System,
January), https://doi.org/10.17016/FEDS.2019.003.
10
The important observation that some consumers and businesses see low inflation as having benefits
emerged from listening to a diverse range of perspectives, including representatives of consumer, labor,
business, community, and other groups during the Fed Listens events; for details, see
https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-andcommunications-fed-listens-events.htm.
11
See Lael Brainard (2017), "Cross-Border Spillovers of Balance Sheet Normalization," speech delivered
at the National Bureau of Economic Research's Monetary Economics Summer Institute, Cambridge, Mass.,
July 13, https://www.federalreserve.gov/newsevents/speech/brainard20170713a.htm.
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Achieving the Inflation Target
The apparent slippage in trend inflation below our target calls for some
adjustments to our monetary policy strategy and communications. In this context and as
part of our review, my colleagues and I have been discussing how to better anchor
inflation expectations firmly at our objective. In particular, it may be helpful to specify
that policy aims to achieve inflation outcomes that average 2 percent over time or over
the cycle. Given the persistent shortfall of inflation from its target over recent years, this
would imply supporting inflation a bit above 2 percent for some time to compensate for
the period of underperformance.
One class of strategies that has been proposed to address this issue are formal
"makeup" rules that seek to compensate for past inflation deviations from target. For
instance, under price-level targeting, policy seeks to stabilize the price level around a
constant growth path that is consistent with the inflation objective.12 Under average
inflation targeting, policy seeks to return the average of inflation to the target over some
specified period.13
To be successful, formal makeup strategies require that financial market
participants, households, and businesses understand in advance and believe, to some
degree, that policy will compensate for past misses. I suspect policymakers would find
communications to be quite challenging with rigid forms of makeup strategies, because
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of what have been called time-inconsistency problems. For example, if inflation has been
running well below-or above-target for a sustained period, when the time arrives to
maintain inflation commensurately above-or below-2 percent for the same amount of
time, economic conditions will typically be inconsistent with implementing the promised
action. Analysis also suggests it could take many years with a formal average inflation
targeting framework to return inflation to target following an ELB episode, although this
depends on difficult-to-assess modeling assumptions and the particulars of the strategy.14
Thus, while formal average inflation targeting rules have some attractive
properties in theory, they could be challenging to implement in practice. I prefer a more
flexible approach that would anchor inflation expectations at 2 percent by achieving
inflation outcomes that average 2 percent over time or over the cycle. For instance,
following five years when the public has observed inflation outcomes in the range of 1-
1/2 to 2 percent, to avoid a decline in expectations, the Committee would target inflation
outcomes in a range of, say, 2 to 2-1/2 percent for the subsequent five years to achieve
inflation outcomes of 2 percent on average overall. Flexible inflation averaging could
bring some of the benefits of a formal average inflation targeting rule, but it would be
simpler to communicate. By committing to achieve inflation outcomes that average 2
percent over time, the Committee would make clear in advance that it would
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accommodate rather than offset modest upward pressures to inflation in what could be
described as a process of opportunistic reflation.15
Policy at the ELB
Second, the Committee is examining what monetary policy tools are likely to be
effective in providing accommodation when the federal funds rate is at the ELB.16 In my
view, the review should make clear that the Committee will actively employ its full
toolkit so that the ELB is not an impediment to providing accommodation in the face of
significant economic disruptions.
The importance and challenge of providing accommodation when the policy rate
reaches the ELB should not be understated. In my own experience on the international
response to the financial crisis, I was struck that the ELB proved to be a severe
impediment to the provision of policy accommodation initially. Once conventional
policy reached the ELB, the long delays necessitated for policymakers in nearly every
jurisdiction to develop consensus and take action on unconventional policy sapped
confidence, tightened financial conditions, and weakened recovery. Economic conditions
in the euro area and elsewhere suffered for longer than necessary in part because of the
lengthy process of building agreement to act decisively with a broader set of tools.
15
See Janice C. Eberly, James H. Stock, and Jonathan H. Wright (2019), "The Federal Reserve's Current
Framework for Monetary Policy: A Review and Assessment," paper presented at "Conference on
Monetary Policy Strategy, Tools and Communication Practices," sponsored by the Federal Reserve Bank of
Chicago, Chicago, June 4,
https://www.chicagofed.org/~/media/others/events/2019/monetary-policyconference/review-current-framework-eberly-stock-wright-pdf.
16
See Board of Governors of the Federal Reserve System (2019), "Minutes of the Federal Open Market
Committee, July 31-August 1, 2018," press release, August 1,
https://www.federalreserve.gov/monetarypolicy/fomcminutes20180801.htm; and Board of Governors
(2019), "Minutes of the Federal Open Market Committee, October 29-30, 2019," press release, October 30,
https://www.federalreserve.gov/monetarypolicy/fomcminutes20191030.htm.
Despite delays and uncertainties, the balance of evidence suggests forward
guidance and balance sheet policies were effective in easing financial conditions and
providing accommodation following the global financial crisis.17 Accordingly, these
tools should remain part of the Committee's toolkit. However, the quantitative asset
purchase policies that were used following the crisis proved to be lumpy both to initiate
at the ELB and to calibrate over the course of the recovery. This lumpiness tends to
create discontinuities in the provision of accommodation that can be costly. To the extent
that the public is uncertain about the conditions that might trigger asset purchases and
how long the purchases would be sustained, it undercuts the efficacy of the policy.
Similarly, significant frictions associated with the normalization process can arise as the
end of the asset purchase program approaches.
For these reasons, I have been interested in exploring approaches that expand the
space for targeting interest rates in a more continuous fashion as an extension of our
conventional policy space and in a way that reinforces forward guidance on the policy
rate.18 In particular, there may be advantages to an approach that caps interest rates on
17
For details on purchases of securities by the Federal Reserve, see
https://www.federalreserve.gov/monetarypolicy/timeline-balance-sheet-policies.htm. For a discussion of
forward guidance, see
https://www.federalreserve.gov/faqs/what-is-forward-guidance-how-is-it-used-inthe-federal-reserve-monetary-policy.htm. See, for example, Simon Gilchrist and Egon Zakrajšek (2013),
"The Impact of the Federal Reserve's Large-Scale Asset Purchase Programs on Corporate Credit Risk,"
Journal of Money, Credit and Banking, vol. 45, (s2, December), pp. 29-57; Simon Gilchrist, David
LópezSalido, and Egon Zakrajšek (2015), "Monetary Policy and Real Borrowing Costs at the Zero Lower
Bound," American Economic Journal: Macroeconomics, vol. 7 (January), pp. 77-109; Jing Cynthia Wu
and Fan Dora Xia (2016), "Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower
Bound," Journal of Money, Credit and Banking, vol. 48 (March-April), pp. 253-91; and Stefania D'Amico
and Iryna Kaminska (2019), "Credit Easing versus Quantitative Easing: Evidence from Corporate and
Government Bond Purchase Programs," Bank of England Staff Working Paper Series 825 (London: Bank
of England, September),
https://www.bankofengland.co.uk/working-paper/2019/credit-easing-versusquantitative-easing-evidence-from-corporate-and-government-bond-purchase.
18
See Board of Governors of the Federal Reserve System (2010), "Strategies for Targeting Interest Rates
Out the Yield Curve," memorandum to the Federal Open Market Committee, October 13, available at
https://www.federalreserve.gov/monetarypolicy/fomc-memos.htm#m2010; and Ben Bernanke (2016),
Treasury securities at the short-to-medium range of the maturity spectrum-yield curve
caps-in tandem with forward guidance that conditions liftoff from the ELB on
employment and inflation outcomes.
To be specific, once the policy rate declines to the ELB, this approach would
smoothly move to capping interest rates on the short-to-medium segment of the yield
curve. The yield curve ceilings would transmit additional accommodation through the
longer rates that are relevant for households and businesses in a manner that is more
continuous than quantitative asset purchases. Moreover, if the horizon on the interest rate
caps is set so as to reinforce forward guidance on the policy rate, doing so would
augment the credibility of the yield curve caps and thereby diminish concerns about an
open-ended balance sheet commitment. In addition, once the targeted outcome is
achieved, and the caps expire, any securities that were acquired under the program would
roll off organically, unwinding the policy smoothly and predictably. This is important, as
it could potentially avoid some of the tantrum dynamics that have led to premature
steepening at the long end of the yield curve in several jurisdictions.
Forward guidance on the policy rate will also be important in providing
accommodation at the ELB. As we saw in the United States at the end of 2015 and again
toward the second half of 2016, there tends to be strong pressure to "normalize" or lift off
from the ELB preemptively based on historical relationships between inflation and
employment. A better alternative would have been to delay liftoff until we had achieved
our targets. Indeed, recent research suggests that forward guidance that commits to delay
the liftoff from the ELB until full employment and 2 percent inflation have been achieved
on a sustained basis-say over the course of a year-could improve performance on our
dual-mandate goals.19
To reinforce this commitment, the forward guidance on the policy rate could be
implemented in tandem with yield curve caps. For example, as the federal funds rate
approaches the ELB, the Committee could commit to refrain from lifting off the ELB
until full employment and 2 percent inflation are sustained for a year. Based on its
assessment of how long this is likely take, the Committee would then commit to capping
rates out the yield curve for a period consistent with the expected horizon of the outcome-
based forward guidance. If the outlook shifts materially, the Committee could reassess
how long it will take to get inflation back to 2 percent and adjust policy accordingly. One
benefit of this approach is that the forward guidance and the yield curve ceilings would
reinforce each other.
The combination of a commitment to condition liftoff on the sustained
achievement of our employment and inflation objectives with yield curve caps targeted at
the same horizon has the potential to work well in many circumstances. For very severe
recessions, such as the financial crisis, such an approach could be augmented with
purchases of 10-year Treasury securities to provide further accommodation at the long
end of the yield curve. Presumably, the requisite scale of such purchases-when
combined with medium-term yield curve ceilings and forward guidance on the policy
rate-would be relatively smaller than if the longer-term asset purchases were used
alone.
Monetary Policy and Financial Stability
Before closing, it is important to recall another important lesson of the financial
crisis: The stability of the financial system is important to the achievement of the
statutory goals of full employment and 2 percent inflation. In that regard, the changes in
the macroeconomic environment that underlie our monetary policy review may have
some implications for financial stability. Historically, when the Phillips curve was
steeper, inflation tended to rise as the economy heated up, which prompted the Federal
Reserve to raise interest rates. In turn, the interest rate increases would have the effect of
tightening financial conditions more broadly. With a flat Phillips curve, inflation does
not rise as much as resource utilization tightens, and interest rates are less likely to rise to
restrictive levels. The resulting lower-for-longer interest rates, along with sustained high
rates of resource utilization, are conducive to increasing risk appetite, which could
prompt reach-for-yield behavior and incentives to take on additional debt, leading to
financial imbalances as an expansion extends.
To the extent that the combination of a low neutral rate, a flat Phillips curve, and
low underlying inflation may lead financial stability risks to become more tightly linked
to the business cycle, it would be preferable to use tools other than tightening monetary
policy to temper the financial cycle. In particular, active use of macroprudential tools
such as the countercyclical buffer is vital to enable monetary policy to stay focused on
achieving maximum employment and average inflation of 2 percent on a sustained basis.
Conclusion
The Federal Reserve's commitment to adapt our monetary policy strategy to
changing circumstances has enabled us to support the U.S. economy throughout the
expansion, which is now in its 11th year. In light of the decline in the neutral rate, low
trend inflation, and low sensitivity of inflation to slack as well as the consequent greater
frequency of the policy rate being at the effective lower bound, this is an important time
to review our monetary policy strategy, tools, and communications in order to improve
the achievement of our statutory goals. I have offered some preliminary thoughts on how
we could bolster inflation expectations by achieving inflation outcomes of 2 percent on
average over time and, when policy is constrained by the ELB, how we could combine
forward guidance on the policy rate with caps on the short-to-medium segment of the
yield curve to buffer the economy against adverse developments.