Janet L Yellen: Panel discussion on "Monetary policy - many targets,
many instruments. Where do we stand?"
Speech by Ms Janet L Yellen, Vice Chair of the Board of Governors of the Federal Reserve
System, at the "Rethinking macro policy II," a conference sponsored by the International
Monetary Fund, Washington DC, 16 April 2013.
* * *
The views I express here are my own and not necessarily those of my colleagues in the Federal Reserve System.
Thank you to the International Monetary Fund for allowing me to take part in what I expect
will be a very lively discussion.
Only five or six years ago, there wouldn't have been a panel on the "many instruments" and
"many targets" of monetary policy. Before the financial crisis, the focus was on one policy
instrument: the short-term policy interest rate. While central banks did not uniformly rely on a
single policy target, many had adopted an "inflation targeting" framework that, as the name
implies, gives a certain preeminence to that one objective. Of course, the Federal Reserve
has long been a bit of an outlier in this regard, with its explicit dual mandate of price stability
and maximum employment. Still, the discussion might not have gone much beyond "one
instrument and two targets" if not for the financial crisis and its aftermath, which have
presented central banks with great challenges and transformed how we look at this topic.
Let me start with a few general observations to get the ball rolling. In terms of the targets, or,
more generally, the objectives of policy, I see continuity in the abiding importance of a
framework of flexible inflation targeting. By one authoritative account, about 27 countries now
operate full-fledged inflation-targeting regimes.1 The United States is not on this list, but the
Federal Reserve has embraced most of the key features of flexible inflation targeting: a
commitment to promote low and stable inflation over a longer-term horizon, a predictable
monetary policy, and clear and transparent communication. The Federal Open Market
Committee (FOMC) struggled for years to formulate an inflation goal that would not seem to
give preference to price stability over maximum employment. In January 2012, the
Committee adopted a "Statement on Longer-Run Goals and Monetary Policy Strategy,"
which includes a 2 percent longer-run inflation goal along with numerical estimates of what
the Committee views as the longer-run normal rate of unemployment. The statement also
makes clear that the FOMC will take a "balanced approach" in seeking to mitigate deviations
of inflation from 2 percent and employment from estimates of its maximum sustainable level.
I see this language as entirely consistent with modern descriptions of flexible inflation
targeting.
For the past four years, a major challenge for the Federal Reserve and many other central
banks has been how to address persistently high unemployment when the policy rate is at or
near the effective lower bound. This troubling situation has naturally and appropriately given
rise to extensive discussion about alternative policy frameworks. I have been very keen,
however, to retain what I see as the key ingredient of a flexible inflation-targeting framework:
clear communication about goals and how central banks intend to achieve them.
With respect to the Federal Reserve's goals, price stability and maximum employment are
not only mandated by the Congress, but also easily understandable and widely embraced.
Well-anchored inflation expectations have proven to be an immense asset in conducting
monetary policy. They've helped keep inflation low and stable while monetary policy has
been used to help promote a healthy economy. After the onset of the financial crisis, these
stable expectations also helped the United States avoid excessive disinflation or even
deflation.
Of course, many central banks have, in the wake of the crisis, found it challenging to provide
appropriate monetary stimulus after their policy interest rate hit the effective lower bound.
This is the point where "many instruments" enters the discussion. The main tools for the
FOMC have been forward guidance on the future path of the federal funds rate and
largescale asset purchases.
The objective of forward guidance is to affect expectations about how long the highly
accommodative stance of the policy interest rate will be maintained as conditions improve.
By lowering private-sector expectations of the future path of short-term rates, this guidance
can reduce longer-term interest rates and also raise asset prices, in turn, stimulating
aggregate demand. Absent such forward guidance, the public might expect the federal funds
rate to follow a path suggested by past FOMC behavior in "normal times" - for example, the
behavior captured by John Taylor's famous Taylor rule. I am persuaded, however, by the
arguments laid out by our panelist Michael Woodford and others suggesting that the policy
rate should, under present conditions, be held "lower for longer" than conventional policy
rules imply.
I see these ideas reflected in the FOMC's recent policy. Since September 2012, the FOMC
has stated that a highly accommodative stance of monetary policy will remain appropriate for
a considerable time after the economic recovery strengthens. Since December 2012, the
Committee has said it intends to hold the federal funds rate near zero at least until
unemployment has declined below 6-1/2 percent, provided that inflation between one and
two years ahead is projected to be no more than 1/2 percentage point above the
Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be
well anchored. I believe that the clarity of this commitment to accommodation will itself
support spending and employment and help to strengthen the recovery.
Asset purchases have complemented our forward guidance, and the many dimensions of
different purchase programs arguably constitute "many instruments." In designing a purchase
program, one must consider which assets to buy: Just Treasury securities or agency
mortgage-backed securities as well? Which maturities? The Federal Reserve, the Bank of
England, and, more recently, the Bank of Japan have emphasized longer-duration securities.
At what pace should the securities be purchased? And how long should they be held once
purchases cease? Each of these factors may affect the degree of accommodation delivered.
Two innovations in the FOMC's current asset purchase program, for example, are that it is
open-ended rather than fixed in size like past programs, and that the overall size of the
program is explicitly linked to seeing a substantial improvement in the outlook for the labor
market.
In these brief remarks, I won't thoroughly review the benefits or costs of our highly
accommodative policies, emphasizing only that I believe they have, on net, provided
meaningful support to the recovery. But I do want to spend a moment on one potential
cost - financial stability - because this topic returns us to the theme of "many targets" for
central banks. As Chairman Bernanke has observed, in the years before the crisis, financial
stability became a "junior partner" in the monetary policy process, in contrast with its
traditionally larger role. The greater focus on financial stability is probably the largest shift in
central bank objectives wrought by the crisis.
Some have asked whether the extraordinary accommodation being provided in response to
the financial crisis may itself tend to generate new financial stability risks. This is a very
important question. To put it in context, let's remember that the Federal Reserve's policies
are intended to promote a return to prudent risk-taking, reflecting a normalization of credit
markets that is essential to a healthy economy. Obviously, risk-taking can go too far. Low
interest rates may induce investors to take on too much leverage and reach too aggressively
for yield. I don't see pervasive evidence of rapid credit growth, a marked buildup in leverage,
or significant asset bubbles that would threaten financial stability. But there are signs that
some parties are reaching for yield, and the Federal Reserve continues to carefully monitor
this situation.
However, I think most central bankers view monetary policy as a blunt tool for addressing
financial stability concerns and many probably share my own strong preference to rely on
micro- and macroprudential supervision and regulation as the main line of defense. The
Federal Reserve has been working with a number of federal agencies and international
bodies since the crisis to implement a broad range of reforms to enhance our monitoring,
mitigate systemic risk, and generally improve the resilience of the financial system.
Significant work will be needed to implement these reforms, and vulnerabilities still remain.
Thus, we are prepared to use any of our many instruments as appropriate to address any
stability concerns.
Let me conclude by noting that I have touched on only some of the important dimensions of
monetary policy targets and instruments that have arisen in recent years. I look forward to a
discussion that I expect will explore these issues and perhaps raise others.