John C Williams: Moving toward "normal" US monetary policy
Remarks by Mr John C Williams, President and Chief Executive Officer of the Federal Reserve
Bank of New York, at the Joint Bank Indonesia-Federal Reserve Bank of New York Central
Banking Forum, Nusa Dua, Indonesia, 10 October 2018.
* * *
Thank you and good morning. It's a pleasure to speak at the Central Banking Forum
coorganized by Bank Indonesia and the Federal Reserve Bank of New York. This is our second
joint conference, and I am very much looking forward to the exchange of ideas and views on
important economic issues affecting our regions. At the outset, I would like to thank Governor
Perry and Bank Indonesia for their leadership and support in sponsoring this conference, amid
what I am sure has been a very busy time with the IMF/World Bank meetings. Let me also say
that our thoughts and hearts go out to everyone affected by the recent devastating earthquake
and tsunami.
In my remarks, I will focus on the outlook for U.S. monetary policy. The good news is that on the
10th anniversary of the worst days of the global financial crisis, the U.S. economy is doing very
well. From the perspective of the Fed's dual mandate of maximum employment and price
stability, quite honestly, this is about as good as it gets. As a result, the Fed has naturally been
moving toward more "normal" monetary policy.
And that brings me to a theme of my remarks today: What does "normal" monetary policy look
like going forward? Before I say even one more word, I should stress that what I have to say
represents my own views and not necessarily those of the Federal Open Market Committee
(FOMC) or anyone else in the Federal Reserve System.
Strong, Strong, Strong
My view on the U.S. economy is well summarized by the most recent FOMC statement, in which
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variations on the word "strong" appeared five times in describing the U.S. economy. Central
bank communication can be difficult at times, but, at least in this case, our message is very
clear. Indeed, the Federal Reserve has attained its dual mandate objectives of maximum
employment and price stability about as well as it ever has. Most indicators point to a very strong
labor market-including an unemployment rate of 3.7 percent-and inflation is right on target.
With fiscal stimulus and favorable financial conditions providing tailwinds to the U.S. economy,
the outlook is for more strong growth. Let me put some hard numbers to that: I expect real GDP
to increase by around 3 percent this year and by 2.5 percent in 2019. Assuming this forecast
comes to fruition, this will be the longest expansion in U.S. history based on data going back over
150 years. This above-trend pace of growth should lead to continued solid job gains and further
declines in the unemployment rate. I expect the unemployment rate to edge down to slightly
below 3.5 percent next year, the lowest level in nearly 50 years.
In keeping with this strong economic outlook, I expect price inflation to move up a bit above 2
percent. Importantly, I don't see any signs of greater inflationary pressures on the horizon. This
is all very good news, especially in the context of the slow recovery and low inflation that has
persisted in the years since the financial crisis.
In light of the progress we've made on our monetary policy goals, the FOMC has been in the
process of gradually normalizing monetary policy for the past few years. Looking forward, I
continue to expect that further gradual increases in interest rates will best foster a sustained
economic expansion and achievement of our dual mandate goals.
Since first raising rates from near-zero back in December 2015, the FOMC has continued to
raise the target range for the federal funds rate as the economy has improved and moved toward
our maximum employment and 2 percent longer-run inflation objective. Our most recent rate
increase came in late September, when the FOMC set the target range between 2 and 2.25
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percent.
Throughout, we've repeatedly stressed that we foresaw this to be a process of gradual
normalization, reflecting the balancing of risks to reaching our goals. In particular, downside
risks to the achievement of our employment and inflation goals amid very low interest rates were
compelling arguments for a relatively cautious and predictable approach to policy. This proved
its worth: The U.S. economy continued to expand at a healthy pace even as the Fed raised rates
numerous times.
For those who follow the Fed closely, you've noticed that the FOMC has been slimming down its
statements of late and using less forward guidance about the future path of policy. In this vein,
the FOMC in its recent statement removed language indicating that monetary policy remains
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accommodative. Let me make clear, these more concise statements do not signify a shift in our
monetary policy approach. Instead, they represent the natural evolution of the language
describing the factors influencing our policy decisions in the context of the strength of the
economic outlook and inflation being near our 2 percent longer-run goal.
These changes in our communication of policy views are a sign that we are nearing the end of
the process of normalizing monetary policy and are inching closer to conducting normal
monetary policy. Arguably, it's been a long time since monetary policy was normal, so it's worth
describing what "normal" looks like in some detail.
At its most basic level, monetary policy-making will remain the same: The path of interest rates
will continue to be guided strategically by our dual mandate objectives and shaped tactically by
the data and their implications for the economic outlook. We'll continue to be transparent about
our thinking about the economy and monetary policy.
But, changing circumstances call for some changes in how the FOMC communicates its policy
views. Now that interest rates are well away from zero and the economy is humming along, the
case for strong forward guidance about future policy actions is becoming less compelling. For
one, the future direction of policy will no longer be as clear as it was during the past few years.
When interest rates were extremely low, it was obvious that the direction for rates was upward,
toward more normal levels, and our forward guidance reinforced that point. At some point in the
future, it will no longer be clear whether interest rates need to go up or down, and explicit forward
guidance about the future path of policy will no longer be appropriate.
In addition, as we have moved far away from near-zero interest rates, it makes sense to shift
away from a focus on normalizing the stance of monetary policy relative to some benchmark
"neutral" interest rate, often referred to as "r-star." Now, I have spent a good deal of my career
studying r-star and I find it to be a useful concept for describing the economy's longer-run
behavior.
Having said that, at times r-star has actually gotten too much attention in commentary about Fed
policy. Back when interest rates were well below neutral, r-star appropriately acted as a pole
star for navigation. But, as we have gotten closer to the range of estimates of neutral, what
appeared to be a bright point of light is really a fuzzy blur, reflecting the inherent uncertainty in
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measuring r-star. More than that, r-star is just one factor affecting our decisions, alongside
economic and labor market indicators, wage and price inflation, global developments, financial
conditions, the risks to the outlook... the list goes on and on.
I've talked a lot about normalizing our policy around interest rates. In addition, about a year ago
we started the process of gradually reducing the Fed's balance sheet as we work to unwind the
asset purchase policies put in place during the crisis. In the now-standard Fed practice of
communicate, communicate, and communicate, we published detailed plans well in advance on
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how we would gradually and predictably reduce the balance sheet. This process has
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proceeded smoothly without creating undue market disruption or volatility.
With balance sheet normalization well underway, the Fed is studying the question of what exactly
the new normal looks like. We have indicated that we plan to shrink the balance sheet to the
smallest size consistent with the efficient and effective conduct of monetary policy-and that, in
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the long run, the asset side of the balance sheet will consist primarily of Treasury securities.
That's our strategy, but its execution will depend on the operating framework of monetary policy,
among other factors.
Here, the Fed basically has two choices. We could return to a system similar in spirit to that
used before the financial crisis, in which the supply of reserves in the banking system was kept
relatively scarce, and the interest rate was set by adjusting reserves on a frequent basis through
open market operations. Alternatively, we could continue with the system that we've been using
since the crisis, in which bank reserves are abundant and the federal funds rate target is
achieved through adjustments to administered rates. This approach is working very well at
controlling interest rates and has proven to be easy to communicate and adaptable to changing
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market conditions. The Fed will be looking closely at these options in the coming months and
will subsequently make a decision on the future operating framework. And, as is our standard
practice, we will be sure to communicate our thinking and decisions on this issue as soon and
as thoroughly as practicable.
Global Dimensions of U.S. Monetary Policy
So far, I have described the economic and monetary policy outlook from the perspective of the
U.S. economy and policy. This should not be surprising given that the Fed's mandate-as
defined by the U.S. Congress-concerns domestic economic conditions. Of course, that does
not imply that one can view the U.S. economy and our policy actions in isolation from global
economic and financial developments. Far from it.
In today's highly interconnected global economy and financial system, international developments
affect the U.S. economy, and our policy actions in turn impact the rest of the world. Therefore,
we devote considerable effort to monitoring and analysis of developments around the world to
understand how our actions affect the global economy and indirectly feed back to our own
economy. These considerations play an important role in my thinking about the economic
outlook and the appropriate path for monetary policy, as well as how we best communicate our
perspectives and plans.
Moreover, we actively engage with international counterparts in a range of forums, such as
today's. These exchanges help us understand economic and financial conditions affecting our
respective regions and provide opportunities to share perspectives and insights. A key lesson
about policy-making in an interconnected world is that transparency and open lines of
communication are critical to minimizing misunderstanding, market disruption, and volatility that
can interfere with our common goals of having strong and stable economies. As I have
mentioned a number of times already, effective communication that provides clarity and
predictability to our policy actions is a critical component of successful policy-making.
Conclusion
Monetary policy-making has perhaps never been more challenging than it was following the
financial crisis. But, as we move toward more "normal" conduct of monetary policy, we must not
rest easy. We will confront our own fair share of future challenges. The most important
monetary policy challenge in the United States today is sustaining the long economic expansion
without allowing risks to grow that ultimately undermine economic prosperity. Whatever the
future may bring, I will be guided by our dual mandate, a heavy dependence on data, and a
steadfast commitment to transparency. Such an approach, in my view, will help support
prosperity both in the United States and abroad.
Thank you.
1
See FOMC Statement and Implementation Note, September 26, 2018.
2
See FOMC Statement and Implementation Note, September 26, 2018.
3
See FOMC Statement and Implementation Note, September 26, 2018.
4
See Jerome H. Powell, Monetary Policy in a Changing Economy, August 24, 2018.
5
See FOMC issues addendum to the Policy Normalization Principles and Plans, June 14, 2017.
6
See Simon Potter, Confidence in the Implementation of U.S. Monetary Policy Normalization, August 4, 2018.
7
See Policy Normalization Principles and Plans, as adopted effective September 16, 2014.
8
See Simon Potter, Confidence in the Implementation of U.S. Monetary Policy Normalization, August 4, 2018.