Charles I Plosser: Economic outlook and communicating monetary
policy
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal
Reserve Bank of Philadelphia, at the 2012 Economic Forecast Breakfast and Annual Meeting
of the Main Line Chamber of Commerce and the Main Line Chamber Foundation, Gladwyne,
Pennsylvania, 1 February 2012.
* * *
Introduction
Good morning and thank you for inviting me to participate in the 2012 Economic Forecast
Breakfast. We are in that season when traditionally we reflect upon the past year and look
ahead. So in the spirit of the season, I will give you my take on the economic outlook. Then I
want to spend the remainder of my time discussing recent steps taken by the FOMC to
enhance the way we communicate about monetary policy.
Before I begin, though, I should note that one of the strengths of the Federal Reserve
System and its Federal Open Market Committee is that it brings together a wide range of
independent assessments of economic conditions and perspectives on policy. As that
famous American journalist Walter Lippmann once said: "Where all men think alike, no one
thinks very much." So let me assure you that there is a lot of thinking going on among
policymakers at the Fed, but my views are my own and not necessarily those of the Federal
Reserve Board or my colleagues on the Federal Open Market Committee.
Economic outlook
Let me start with some general comments on the state of the economy as we enter 2012. A
year ago, most economists were forecasting that economic growth would be 3 percent or a
bit more in 2011. Instead, the latest numbers released last Friday showed that real GDP in
2011 was 1.6 percent, compared to 3.1 percent in the prior year.
Some of this weakness is perfectly understandable, given the shocks we experienced
throughout most of the year. Last year began with severe snowstorms in the East. As 2011
progressed, there were the earthquake and ensuing disasters in Japan, followed by the
unrest in the Middle East and North Africa, which led to a run-up in oil prices. In addition,
there were renewed concerns about European sovereign debt and the midsummer uproar in
Washington over fiscal policy and the debt ceiling. All of these events weighed heavily on
growth, as well as on business and consumer confidence.
Yet, the economy persevered. Indeed, growth accelerated across each of the four quarters,
from less than 0.5 percent in the first quarter to around 2-3/4 percent in the fourth quarter. I
anticipate that we will continue to see moderate growth of around 3 percent for 2012 and
2013, which is slightly above trend.
Business spending, especially investments in equipment and software, was relatively healthy
last year, buoyed by solid growth in corporate earnings. In January, the Philadelphia Fed's
Business Outlook Survey showed that regional manufacturing activity continued to expand at
a moderate pace, the fourth consecutive monthly increase since a late summer lull. The
survey's measures of future activity also indicated that our respondents expect activity to
continue to pick up over the next six months. I take this as a sign that business sentiment is
also improving.
On the housing front, I expect to see stabilization but not much improvement in 2012. We
entered the Great Recession over-invested in residential real estate, and we are not likely to
see a housing recovery until the surplus inventory of foreclosed and distressed properties
declines. Even as the economy rebalances, we should not seek nor should we expect
housing and related sectors to return to those pre-recession highs. Those exuberant days
were simply not sustainable, and it would be a mistake to retain that standard as our
benchmark for recovery.
The housing crash destroyed a great deal of wealth for the average consumer and the
economy as a whole. The losses are real and the consequences severe for many individuals
and many businesses. Moreover, the losses cannot be papered over with monetary policy
nor should it try to do so. Households and businesses, however, continue to make progress
on restoring the health of their balance sheets by paying down debt and increasing savings.
Most economists, including myself, believe that this process will continue into 2012. But the
drag on growth from this rebalancing will gradually lessen over time.
While there is a long way to go in restoring a vibrant labor market, I am encouraged by the
employment reports released over the past several months. The December employment
report showed a net gain of 200,000 jobs and a decline in the unemployment rate to
8.5 percent. The economy added over 1.6 million jobs during 2011, and the unemployment
rate fell nearly a full percentage point. Interestingly, the last time the unemployment rate fell
by this much in one year was in 1995. As growth continues and strengthens, I expect further
gradual declines in the unemployment rate, with the rate falling to around 8 percent or a little
less, by the end of 2012.
Of course, forecasting is a hazardous business, even in the best of times, and we should all
take any economic forecast with at least a grain or two of salt - if not more. So it is important
to recognize that there are some obvious risks to the growth forecast. The largest of these
are the ramifications for the U.S. economy of the continuing sovereign debt crisis in Europe.
An economic slowdown in the euro zone will likely restrain U.S. exports. And while strains in
financial markets have been limited to European institutions so far, the situation bears
watching to ensure that there are no adverse spillovers to U.S. financial institutions. Of
course, regardless of how the European situation plays out, it has already imposed
considerable uncertainty on growth prospects for the global economy.
That uncertainty has been compounded by our own nation's inability to establish a clear plan
to put our fiscal policy on a sustainable path. Until the economic environment becomes
clearer, firms and consumers are likely to postpone significant spending and hiring decisions
- posing a drag on the recovery, even as economic developments in the U.S. continue to
improve.
Just as growth was weaker in 2011 than many forecasters had anticipated, inflation was
higher. A year ago, many were concerned about the risks of a sustained deflation. I was not
among them. Instead, I thought we would see inflation at about 2 percent for the year.
It turns out we were all wrong. Total inflation in 2011, as measured by the CPI on a
yearover-year basis, was 3 percent, reflecting strong increases in energy and food prices,
particularly in the early part of the year. Core inflation, which excludes food and energy
prices, rose to about 2.2 percent. I anticipate, however, that with many commodity prices
now leveling off or falling, and inflation expectations relatively stable, inflation will moderate in
the near term. Indeed, total inflation has been more subdued over the past several months.
As a policymaker, though, I focus less on the near term and more on the medium term.
Given the very accommodative monetary policy that has been in place for more than three
years, I believe we must continue to monitor inflation measures very carefully.
Inflation most often develops gradually, and if monetary policy waits too long to respond, it
can be very costly to correct. Measures of slack such as the unemployment rate are often
thought to prevent inflation from rising. But that did not turn out to be true in the 1970s. Thus,
we need to proceed with caution as to the degree of monetary accommodation we supply to
the economy. So let me review some of the policy actions the Fed has taken.
Monetary policy
As you know, the Fed has kept the federal funds rate near zero for more than three years to
support the recovery. We have also conducted two rounds of asset purchases that have
more than tripled the size of the balance sheet and changed its composition from short-term
Treasuries to longer-term Treasuries and housing-related securities, mostly
mortgagebacked securities.
In the most recent meeting, the Federal Open Market Committee announced that economic
conditions were "likely to warrant exceptionally low levels for the federal funds rate at least
through late 2014" - that's almost three years from now. Last August when the FOMC first
signaled a time frame for continued low rates, it was until mid-2013. So our announcement
last week lengthened the period of anticipated very low rates by 18 months. In addition, the
Committee announced that the Fed intends to continue the maturity extension program, or
"operation twist," first launched last September. In this program, to be completed by the end
of June, the Fed is buying $400 billion of longer-term Treasuries and selling an equal amount
of shorter-term Treasuries, in an effort to reduce yields from already historically low levels.
The FOMC is also continuing to reinvest principal payments from its holdings of agency debt
and MBS into MBS in an effort to help mortgage markets.
You may know that I dissented from the FOMC decisions in August and September because
it was not clear to me that further monetary policy accommodation was appropriate. After all,
inflation was higher and unemployment was lower relative to the previous year. Moreover,
policy actions are never free; they need to be evaluated based on a thorough analysis of
costs and benefits. I believed that the benefits of further monetary policy easing were small
at best, since, in my view, they would do little to help resolve the challenges we face on the
employment front. But the potential costs of this further accommodation could translate into a
steady rise in inflation over the medium term, even without much of a drop in the
unemployment rate. In my assessment, the potential costs of further accommodation
outweighed the potential benefits.
For similar reasons, I was not supportive of the most recent decision to extend the time
frame for exceptionally low rates through 2014. In my view, economic conditions have
modestly improved since our December meeting, especially on the employment front, and
the downside risk of a double-dip recession that many feared in September when the
Committee instituted "operation twist" has substantially abated. Thus, with the economy
gradually improving, I saw little justification to further ease monetary policy and felt it risked
undermining confidence in the process.
In addition, I don't support the practice of offering forward policy guidance by saying
economic conditions are likely to lead to low rates through some calendar date. Such
statements are, in my mind, particularly problematic from a communications perspective.
Monetary policy should be contingent on the economic environment and not on the calendar.
For example, I often read comments in the media that the FOMC has "pledged" or "vowed" to
keep rates at zero at least until late 2014. But this is clearly incorrect. The FOMC has made
no such commitment and the statement indicates as much - if economic conditions change,
then so will policy. Yet there continues to be confusion and the confusion stems from our
statement. In my view, there are much better ways to communicate information about the
future path of policy than the use of calendar dates. Indeed, one of these ways was provided
in January when we began providing information on the policy paths that underlie FOMC
participants' forecasts.
Improving communications
So let me turn to our communication initiatives, which have received a fair amount of
attention in the financial press. Improving the transparency of monetary policy has always
been high on my list of things to do since joining the Federal Reserve Bank of Philadelphia in
2006. The Federal Reserve is accountable to the public, so it needs to clearly communicate
its goals and its approach to making policy decisions.
To its credit, the Federal Reserve has strived to increase transparency about its actions and
its policies, particularly during the tenure of Chairman Ben Bernanke. For instance, in an
effort to improve its communications to the public, the FOMC decided in 2007 to release its
Summary of Economic Projections, or SEP, four times a year.
In 2011, Chairman Bernanke introduced press briefings to provide additional context for the
FOMC's policy decisions following the release of the SEP. However, until now, these
releases did not include any information about the assumptions policymakers made about
the path of monetary policy. Therefore, it was difficult for the public to interpret the
projections for growth, employment, and inflation.
Early last summer, Chairman Bernanke asked Governor Yellen, Governor Raskin, President
Evans, and me to serve on a communications subcommittee. In January, the FOMC adopted
two initiatives brought forward by the subcommittee. Both initiatives are important steps
forward for the FOMC and are intended to serve the Committee and the public over the
longer term.
The first concerned improving our communications about FOMC participants' economic
projections in the SEP. So starting with our last meeting, the expanded SEP now contains
information about policymakers' assumed path for monetary policy, along with the projections
for growth, unemployment, and inflation. It is important to keep in mind that the Fed's SEP
projections differ from those of private-sector forecasters. Private-sector forecasters explicitly
or implicitly try to predict what the Fed's next move will be. In the SEP, each policymaker
assumes a path for monetary policy that - based on current economic conditions - he or she
believes will deliver the best outcomes for the economy.
Providing policy projections in the SEP helps the public to interpret the economic forecasts
included in the SEP. For example, FOMC participants might have considerably different
growth forecasts. Is it because they have different views about the underlying dynamics of
the economy? Or is it because they are assuming different policy paths? Alternatively, two
participants may have similar forecasts - say, the same inflation forecast - but they may
believe that these forecasts will be achieved through different policy paths. The expanded
SEP will now show the range of views about the assumed policy paths that give rise to the
projections.
Of course, over time, policymakers' views will evolve as the economy evolves. So, the
expanded SEP will add an important perspective not just of prospective policy at a point in
time, but of how the policy projections are influenced as economic conditions change.
I would argue that adding policymakers' assumptions to the SEP conveys more useful
information about the likely future path of monetary policy than using a calendar date as we
have been doing. It has two main advantages in my view. First, it illustrates the full range of
views and, in doing so, underlines the uncertainty that truly exists about future policy.
Second, over time it will reveal more information about the reaction function of policymakers'
views of policy to the evolution of economic conditions, which are, after all, the ultimate
drivers of policy decisions. Such communication will prove useful not only in periods such as
the current unusual circumstances but in more normal times as well.
The second important communications initiative adopted by the FOMC in January was to
issue a consensus statement of the longer-run goals and policy strategy.
When households, firms, and markets have a better understanding of what to expect from
monetary policy, they can make better financial plans and spending decisions. Thus, greater
clarity helps monetary policy become more effective at promoting its congressionally
mandated goals of price stability, maximum employment, and moderate long-term interest
rates.
The consensus statement does three very important things never before undertaken by the
Federal Reserve. First, the FOMC explicitly states its goal for inflation as 2 percent, as
measured by the year-over-year change in the overall personal consumption expenditures
(PCE) chain-weighted price index. Being explicit about our inflation objective will enhance the
credibility of our commitment to price stability, which will help anchor inflation expectations
and foster price stability and moderate long-term interest rates. Moreover, a credible
commitment to price stability affords the Fed more flexibility in the short run as it attempts to
mitigate the fluctuations in output and employment in the face of significant economic
disturbances.
Second, the statement explains why the FOMC cannot set a fixed long-run numerical
objective for the employment part of our mandate. This is not because we do not seek
maximum employment or because we want to disregard or downplay its importance. Rather,
it reflects the differences between the economic determinants of the inflation and
employment parts of our mandate. Over the longer run, the economy's inflation rate is
primarily determined by monetary policy. So, the FOMC is able to set a longer-run numerical
goal for inflation and should be held accountable for achieving that goal.
On the other hand, maximum employment is largely determined by factors that are beyond
the direct control of monetary policy. These factors include such things as demographics,
technological innovation, the structure of the labor market, and various governmental policies
- all of which will vary over time. Policymakers consider a wide range of indicators in
assessing employment, but estimates of maximum employment at any point in time are
subject to substantial uncertainty. The FOMC cannot set a fixed numerical objective for
something that it does not directly control and cannot accurately measure.
A third element of the consensus statement is that it makes clear that the FOMC takes a
balanced approach to setting policy. By balanced approach I mean one that promotes all of
our congressionally mandated objectives of maximum employment, stable prices, and
moderate long-term interest rates and does not favor one over the other.
The consensus statement does not provide answers for all the hard policy choices. How best
to implement this balanced approach takes a lot of judgment and may well differ across
policymakers who may have different models of the economy even as they work to promote
the same long-term goals for monetary policy.
Conclusion
In summary, the U.S. economy is continuing to grow at a moderate pace. I expect annual
growth to gradually accelerate to around 3 percent in 2012 and 2013.
Prospects for labor markets will continue to improve, with job growth strengthening and the
unemployment rate falling gradually over time. I believe inflation expectations will be
relatively stable and inflation will moderate in the near term. However, with the very
accommodative stance of monetary policy, the inflation situation is one that bears careful
watching in order to ensure that inflation pressures remain contained over the medium run.
On monetary policy, the Federal Reserve has taken bold and significant steps to improve the
transparency of its policy actions and to create better public understanding of the rationale
behind the FOMC's decisions. Specifically, the FOMC now includes information about each
participant's assessments for the target federal funds rate path in its Summary of Economic
Projections. The FOMC has also clarified its longer-run goals and monetary policy
decisionmaking process and clearly articulated its inflation objective.
Economic research over the past 30 years has shown that setting monetary policy in a
systematic manner leads to better economic outcomes - lower and less volatile inflation and
greater economic stability in general. But the benefit depends on the public's understanding
of the policymaking framework. Transparency not only furthers the effectiveness of monetary
policy by enhancing the credibility of the central bank but also raises the Fed's accountability
to the public. Thus, I remain committed to working to increase the clarity of the Fed's public
communications about current economic conditions, the economic outlook, and our
policymaking framework.