Janet L Yellen: Perspectives on monetary policy
Speech by Ms Janet L Yellen, Vice Chair of the Board of Governors of the Federal Reserve
System, at the Boston Economic Club Dinner, Boston, Massachusetts, 6 June 2012.
* * *
I appreciate assistance from members of the Board staff - Jon Faust, Thomas Laubach, Andrew Levin and David
Reifschneider - who contributed to the preparation of these remarks.
Good evening. I'm honored to have the opportunity to address the Boston Economic Club
and I'm grateful to Chip Case for inviting me to speak to you tonight. As most of you probably
know, Chip was one of the first economists to document worrisome signs of a housing
bubble in parts of the United States. After sounding an early alarm in 2003, Chip watched the
bubble grow and was prescient in anticipating the very serious toll that its unwinding would
impose on the economy. Chip recognized that declining house prices would affect not just
residential construction but also consumer spending, the ability of households to borrow, and
the health of the financial system. In light of these pervasive linkages, the repeat sales house
price index that bears Chip's name is one of the most closely watched of all U.S. economic
indicators. Indeed, as I will discuss this evening, prolonged weakness in the housing sector
remains one of several serious headwinds facing the U.S. economy. Given these headwinds,
I believe that a highly accommodative monetary policy will be needed for quite some time to
help the economy mend. Before continuing, let me emphasize that my remarks reflect my
own views and not necessarily those of others in the Federal Reserve System.
Economic conditions and the outlook
In my remarks tonight, I will describe my perspective on monetary policy. To begin, however,
I'll highlight some of the current conditions and key features of the economic outlook that
shape my views. To anticipate the main points, the economy appears to be expanding at a
moderate pace. The unemployment rate is almost 1 percentage point lower than it was a
year ago, but we are still far from full employment. Looking ahead, I anticipate that significant
headwinds will continue to restrain the pace of the recovery so that the remaining
employment gap is likely to close only slowly. At the same time, inflation (abstracting from
the transitory effects of movements in oil prices) has been running near 2 percent over the
past two years, and I expect it to remain at or below the Federal Open Market Committee's
(the FOMC's) 2 percent objective for the foreseeable future. As always, considerable
uncertainty attends the outlook for both growth and inflation; events could prove either more
positive or negative than what I see as the most likely outcome. That said, as I will explain, I
consider the balance of risks to be tilted toward a weaker economy.
Starting with the labor market, conditions have gradually improved over the past year, albeit
at an uneven pace. Average monthly payroll gains picked up from about 145,000 in the
second half of 2011 to 225,000 during the first quarter of this year. However, these gains fell
back to around 75,000 a month in April and May. The deceleration of payroll employment
from the first to the second quarter was probably exacerbated by some combination of
seasonal adjustment difficulties and an unusually mild winter that likely boosted employment
growth earlier in the year. Payback for that earlier strength probably accounts for some of the
weakness we've seen recently. Smoothing through these fluctuations, the average pace of
job creation for the year to date, as well as recent unemployment benefit claims data and
other indicators, appear to be consistent with an economy expanding at only a moderate
rate, close to its potential.
Such modest growth would imply little additional progress in the near term in improving labor
market conditions, which remain very weak. Currently, the unemployment rate stands around
3 percentage points above where it was at the onset of the recession - a figure that is stark
enough as it is, but does not even take account of the millions more who have left the labor
force or who would have joined under more normal circumstances in the past four years. All
told, only about half of the collapse in private payroll employment in 2008 and 2009 has been
reversed. A critical question for monetary policy is the extent to which these numbers reflect
a shortfall from full employment versus a rise in structural unemployment. While the
magnitude of structural unemployment is uncertain, I read the evidence as suggesting that
the bulk of the rise during the recession was cyclical, not structural in nature.
Consider figure 1, which presents three indicators of labor market slack. The black solid line
is the unemployment gap, defined as the difference between the actual unemployment rate
and the Congressional Budget Office (CBO) estimate of the rate consistent with inflation
remaining stable over time. The red dashed line is an index of the difficulty households
perceive in finding jobs, based on results from a survey conducted by the Conference Board.
And the red dotted line is an index of firms' ability to fill jobs, based on a survey conducted by
the National Federation of Independent Business. All three measures show similar cyclical
movements over the past 20 years, and all now stand at very high levels. This similarity runs
counter to claims that the CBO's and other estimates of the unemployment gap overstate the
true amount of slack by placing insufficient weight on structural explanations, such as a
reduced efficiency of matching workers to jobs, for the rise in unemployment since 2007. If
that were the case, why would firms now find it so easy to fill positions? Other evidence also
points to the dominant role of cyclical forces in the recent rise in unemployment: job losses
have been widespread, rather than being concentrated in the construction and financial
sectors, and the co-movement of job vacancies and unemployment over the past few years
does not appear to be unusual.1
As I mentioned, I expect several factors to restrain the pace of the recovery and the
corresponding improvement in the labor market going forward. The housing sector remains a
source of very significant headwinds. Housing has typically been a driver of economic
recoveries, and we have seen some modest improvement recently, but continued
uncertainties over the direction of house prices, and very restricted mortgage credit
availability for all but the most creditworthy buyers, will likely weigh on housing demand for
some time to come. When housing demand does pick up more noticeably, the huge
overhang of both unoccupied dwellings and homes in the foreclosure pipeline will likely allow
a good deal of that demand to be met for a time without a sizeable expansion in
homebuilding. Moreover, the enormous toll on household wealth resulting from the collapse
of house prices - almost a 35 percent decline from its 2006 peak, according to the
CaseShiller index - imposes ongoing restraint on consumer spending, and the loss of home equity
has impaired many households' ability to borrow.
A second headwind that will likely become more important over coming months relates to
fiscal policy. At the federal level, stimulus-related policies are scheduled to wind down, while
both defense and nondefense purchases are expected to decline in inflation-adjusted terms
over the next several years. Toward the end of this year, important decisions regarding the
extension of current federal tax and budget policies loom. I will return to the associated
uncertainties and their potentially detrimental effects later.
A third factor weighing on the outlook is the likely sluggish pace of economic growth abroad.
Strains in global financial markets have resurfaced in recent months, reflecting renewed
uncertainty about the resolution of the European situation. Risk premiums on sovereign debt
and other securities have risen again in many European countries, while European banks
continue to face pressure to shrink their balance sheets. Even without a further intensification
of stresses, the slowdown in economic activity in Europe will likely hold back U.S. export
growth. Moreover, the perceived risks surrounding the European situation are already having
a meaningful effect on financial conditions here in the United States, further weighing on the
prospects for U.S. growth.
Given these formidable challenges, most private sector forecasters expect only gradual
improvement in the labor market and I share their view. Figure 2 shows the unemployment
rate together with the median forecast from last month's Survey of Professional Forecasters
(SPF), the dashed blue line.2 The figure also shows the central tendency of the
unemployment projections that my FOMC colleagues and I made at our April meeting: Those
projections reflect our assessments of the economic outlook given our own individual
judgments about the appropriate path of monetary policy. Included in the figure as well is the
central tendency of FOMC participants' estimates of the longer-run normal unemployment
rate, which ranges from 5.2 percent to 6 percent. Like private forecasters, most FOMC
participants expect the unemployment rate to remain well above its longer-run normal value
over the next several years.
Of course, considerable uncertainty attends this outlook: The shaded area provides an
estimate of the 70 percent confidence interval for the future path of the unemployment rate
based on historical experience and model simulations.3 Its width suggests that these
projections could be quite far off, in either direction. Nevertheless, the figure shows that labor
market slack at present is so large that even a very large and favorable forecast error would
not change the conclusion that slack will likely remain substantial for quite some time.
Turning to inflation, figure 3 summarizes private and FOMC forecasts. Overall consumer
price inflation has fluctuated quite a bit in recent years, largely reflecting movements in prices
for oil and other commodities. In early 2011 and again earlier this year, prices of crude oil,
and thus of gasoline, rose noticeably. Smoothing through these fluctuations, inflation as
measured by the price index for personal consumption expenditures (PCE) averaged near
2 percent over the past two years. In recent weeks, however, oil and gasoline prices have
moderated and are now showing through to the headline inflation figures. Looking ahead,
most FOMC participants at the time of our April meeting expected inflation to be at, or a bit
below, our long-run objective of 2 percent through 2014; private forecasters on average also
expect inflation to be close to 2 percent. As with unemployment, uncertainty around the
inflation projection is substantial.
In the view of some observers, the stability of inflation in the face of high unemployment in
recent years constitutes evidence that much of the remaining unemployment is structural and
not cyclical. They reason that if there were truly substantial slack in the labor market, simple
accelerationist "Phillips curve" models would predict more noticeable downward pressure on
inflation. However, substantial cross-country evidence suggests that, in low-inflation
environments, inflation is notably less responsive to downward pressure from labor market
slack than it is when inflation is elevated. In other words, the short-run Phillips curve may
flatten out.4 One important reason for this non-linearity, in my view, is downward nominal
wage rigidity - that is, the reluctance or inability of many firms to cut nominal wages.
The solid blue bars in figure 4 present a snapshot of the distribution of nominal wage
changes for individual jobs during the depth of the current labor market slump, based on data
collected by the Bureau of Labor Statistics.5 For comparison, the dashed red line presents a
hypothetical distribution of wage changes, using a normal distribution that approximates the
actual distribution of wage changes greater than zero. The distribution of actual wage
changes shows that a relatively high percentage of workers saw no change in their nominal
wage, and relatively few experienced modest wage cuts. This pile-up phenomenon at zero
suggests that, even when the unemployment rate was around 10 percent, many firms were
reluctant to cut nominal wage rates. In the absence of this barrier, nominal gains in wages
and unit labor costs would have likely been even more subdued given the severity of the
economic downturn, with the result that inflation would probably now be running at a lower
rate.
Anchored inflation expectations are another reason why inflation has remained close to
2 percent in the face of very low resource utilization. As shown in figure 5, survey measures
of longer-horizon inflation expectations have remained nearly constant since the mid-1990s
even as actual inflation has fluctuated. As a result, the current slump has not generated the
downward spiral of falling expected and actual inflation that a simple accelerationist model of
inflation might have predicted. Indeed, keeping inflation expectations from declining has been
an important success of monetary policy over the past few years. At the same time, the fact
that longer-term inflation expectations have not risen above 2 percent has also proved
extremely valuable, for it has freed the FOMC to take strong actions to support the economic
recovery without greatly worrying that higher energy and commodity prices would become
ingrained in inflation and inflation expectations, as they did in the 1970s.
While my modal outlook calls for only a gradual reduction in labor market slack and a stable
pace of inflation near the FOMC's longer-run objective of 2 percent, I see substantial risks to
this outlook, particularly to the downside. As I mentioned before, even without any political
gridlock, fiscal policy is bound to become substantially less accommodative from early 2013
on. However, federal fiscal policy could turn even more restrictive if the Congress does not
reach agreement on several important tax and budget policy issues before the end of this
year; in fact, the CBO recently warned that the potential hit to gross domestic product (GDP)
growth could be sufficient to push the economy into recession in 2013.6 The deterioration of
financial conditions in Europe of late, coupled with notable declines in global equity markets,
also serve as a reminder that highly destabilizing outcomes cannot be ruled out. Finally,
besides these clearly identifiable sources of risk, there remains the broader issue that
4
The simplest accelerationist version of the Phillips curve relates the change in inflation to the level of labor
market slack; more-complicated versions also highlight the influence of inflation expectations, changes in
marginal production costs, and other factors. Evidence for the United States and other countries that the
sensitivity of inflation to resource slack may be nonlinear can be found in André Meier (2010), "Still Minding
the Gap - Inflation Dynamics during Episodes of Persistent Large Output Gaps," IMF Working Paper
WP/10/189 (Washington: International Monetary Fund, August).
5
The data shown in figure 4 refers to the change in wages over the twelve months to March 2010. See Bruce
Fallick, Michael Lettau, and William Wascher (2011), "Downward Nominal Wage Rigidity in the United States
during the Great Recession," unpublished manuscript, November. Similar results, based on a different source
of data, are reported in Mary Daly, Bart Hobijn, and Brian Lucking (2012), "Why has Wage Growth Stayed
Strong?" Federal Reserve Bank of San Francisco, FRBSF Economic Letter 2012-10, April 2. I have explored
the implications of downward nominal rigidity for the Phillips curve and stabilization policy in greater depth in
Janet L. Yellen and George A. Akerlof (2006), "Stabilization Policy: A Reconsideration," Economic Inquiry,
vol. 44 (January), pp. 1-22.
6
See Congressional Budget Office (2012), "Economic Effects of Reducing the Fiscal Restraint That Is
Scheduled to Occur in 2013 (PDF)", (Washington: CBO, May).
economic forecasters have repeatedly overestimated the strength of the recovery and so still
may be too optimistic about the prospects that growth will strengthen.
Although I view the bulk of the increase in unemployment since 2007 as cyclical, I am
concerned that it could become a permanent problem if the recovery were to stall. In this
economic downturn, the fraction of the workforce unemployed for six months or more has
climbed much more than in previous recessions, and remains at a remarkably high level.
Continued high unemployment could wreak long-term damage by eroding the skills and labor
force attachment of workers suffering long-term unemployment, thereby turning what was
initially cyclical into structural unemployment. This risk provides another important reason to
support the recovery by maintaining a highly accommodative stance of monetary policy.
The conduct of policy with unconventional tools
Now turning to monetary policy, I will begin by discussing the FOMC's reliance on
unconventional tools to address the disappointing pace of recovery. I will then elaborate my
rationale for supporting a highly accommodative policy stance.
As you know, since late 2008, the FOMC's standard policy tool, the target federal funds rate,
has been maintained at the zero lower bound. To provide further accommodation, we have
employed two unconventional tools to support the recovery - extended forward guidance
about the future path of the federal funds rate, and large-scale asset purchases and other
balance sheet actions that have greatly increased the size and duration of the Federal
Reserve's portfolio.
These two tools have become increasingly important because the recovery from the
recession has turned out to be persistently slower than either the FOMC or private
forecasters anticipated. Figure 6 illustrates the magnitude of the disappointment by
comparing Blue Chip forecasts for real GDP growth made two years ago with ones made
earlier this year. As shown by the dashed blue line, private forecasters in early 2010
anticipated that real GDP would expand at an average annual rate of just over 3 percent from
2010 through 2014. However, actual growth in 2011 and early 2012 has turned out to be
much weaker than expected, and, as indicated by the dotted red line, private forecasters now
anticipate only a modest acceleration in real activity over the next few years.
In response to the evolving outlook, the FOMC has progressively added policy
accommodation using both of its unconventional tools. For example, since the federal funds
rate target was brought down to a range of 0 to 1/4 percent in December 2008, the FOMC
has gradually adjusted its forward guidance about the anticipated future path of the federal
funds rate. In each meeting statement from March 2009 through June 2011, the Committee
indicated its expectation that economic conditions "are likely to warrant exceptionally low
levels of the federal funds rate for an extended period."7 At the August 2011 meeting, the
Committee decided to provide more specific information about the likely time horizon by
substituting the phrase "at least through mid-2013" for the phrase "for an extended period"; at
the January 2012 meeting, this horizon was extended to "at least through late 2014."8 Has
this guidance worked? Figure 7 illustrates how dramatically forecasters' expectations of
future short-term interest rates have changed. As the dashed blue line indicates, the Blue
Chip consensus forecast made in early 2010 anticipated that the Treasury-bill rate would
now stand at close to 3-1/2 percent; today, in contrast, private forecasters expect short-term
interest rates to remain very low in 2014.
Of course, much of this revision in interest rate projections would likely have occurred in the
absence of explicit forward guidance; given the deterioration in projections of real activity due
to the unanticipated persistence of headwinds, and the continued subdued outlook for
inflation, forecasters would naturally have anticipated a greater need for the FOMC to
provide continued monetary accommodation. However, I believe the changes over time in
the language of the FOMC statement, coupled with information provided by Chairman
Bernanke and others in speeches and congressional testimony, helped the public
understand better the Committee's likely policy response given the slower-than-expected
economic recovery. As a result, forecasters and market participants appear to have marked
down their expectations for future short-term interest rates by more than they otherwise
would have, thereby putting additional downward pressure on long-term interest rates,
improving broader financial conditions, and lending support to aggregate demand.
The FOMC has also provided further monetary accommodation over time by altering the size
and composition of the Federal Reserve's securities holdings, shown in figure 8. The
expansion in the volume of securities held by the Federal Reserve is shown in the left panel
of the figure. During 2009 and early 2010, the Federal Reserve purchased about $1.4 trillion
in agency mortgage-backed securities and agency debt securities and about $300 billion in
longer-term Treasury securities. In November 2010, the Committee initiated an additional
$600 billion in purchases of longer-term Treasury securities, which were completed at the
end of June of last year. Last September, the FOMC decided to implement the "Maturity
Extension Program," which affected the maturity composition of our Treasury holdings as
shown in the right panel. Through this program, the FOMC is extending the average maturity
of its securities holdings by selling $400 billion of Treasury securities with remaining
maturities of 3 years or less and purchasing an equivalent amount of Treasury securities with
remaining maturities of 6 to 30 years. These transactions are currently scheduled to be
completed at the end of this month.
Research by Federal Reserve staff and others suggests that our balance sheet operations
have had substantial effects on longer-term Treasury yields, principally by reducing term
premiums on longer-dated Treasury securities.9
Figure 9 provides an estimate, based on
Federal Reserve Board staff calculations, of the cumulative reduction of the term premium on
10-year Treasury securities from the three balance sheet programs. These results suggest
that our portfolio actions are currently keeping 10-year Treasury yields roughly 60 basis
points lower than they otherwise would be.10 Other evidence suggests that this downward
9
The term premium on a longer-dated Treasury security is defined as the return that investors expect to earn
on holding this security in excess of the return from rolling over short-dated Treasury securities, such as
threemonth Treasury bills. For estimates of the Federal Reserve's balance-sheet actions on long-term interest
rates, see Canlin Li and Min Wei (forthcoming), "Term Structure Modeling with Supply Factors and the Federal
Reserve's Large Scale Asset Purchase Programs," Finance and Economics Discussion Series (Washington:
Board of Governors of the Federal Reserve System); Joseph Gagnon, Matthew Raskin, Julie Remache, and
Brian Sack (2010), "Large-Scale Asset Purchases by the Federal Reserve: Did they Work? (PDF)" Staff
Report no. 441 (New York: Federal Reserve Bank of New York, March); Hess Chung, Jean-Philippe Laforte,
David Reifschneider, and John Williams (2012), "Have We Underestimated the Likelihood and Severity of
Journal of Money, Credit and
Zero Lower Bound Events?" supplement, Banking, vol. 44 (S1, February),
47-82; Arvind Krishnamurthy and Annette Vissing-Jorgensen (2011), "The Effects of Quantitative Easing on
Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Fall, 215-65,
www.brookings.edu/about/projects/bpea/editions/fall-2011; and James Hamilton and Jing Cynthia Wu (2012),
"The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," Journal of
Money, Credit and Banking, vol. 44 Issue Supplement s1 (February), 3-46. Estimates of the effects of
largescale asset purchases in the United Kingdom are provided in Michael Joyce, Matthew Tong, and Robert
Woods (2011), "The United Kingdom's Quantitative Easing Policy: Design, Operation and Impact (PDF),"
Bank of England Quarterly Bulletin, Third Quarter, 200-12.
10
The estimates shown in figure 9 employ the methodology discussed by Li and Wei, "Term Structure Modeling
with Supply Factors," in note 10. These calculations require an assumption for market participants'
expectations for the future path of the Federal Reserve's portfolio at different points in time, both in the past
and going forward; accordingly, the estimates are somewhat sensitive to alternative assumptions for market
pressure has had favorable spillover effects on other financial markets, leading to lower
longterm borrowing costs for households and firms, higher equity valuations, and other
improvements in financial conditions that in turn have supported consumption, investment,
and net exports. Because the term premium effect depends on both the Federal Reserve's
current and expected future asset holdings, most of this effect - without further actions - will
likely wane over the next few years as the effect depends less and less on the current
elevated level of the balance sheet and increasingly on the level of holdings during and after
the normalization of our portfolio.11
The rationale for highly accommodative policy
I have already noted that, in my view, an extended period of highly accommodative policy is
necessary to combat the persistent headwinds to recovery. I will next explain how I've
reached this policy judgment. In evaluating the stance of policy, I find the prescriptions from
simple policy rules a logical starting point. A wide range of such rules has been examined in
the academic literature, the most famous of which is that proposed by John Taylor in his
1993 study.12 Rules of the general sort proposed by Taylor (1993) capture well our statutory
mandate to promote maximum employment and price stability by prescribing that the federal
funds rate should respond to the deviation of inflation from its longer-run goal and to the
output gap, given that the economy should be at or close to full employment when the output
gap - the difference between actual GDP and an estimate of potential output - is closed.
Moreover, research suggests that such simple rules can be reasonably robust to uncertainty
about the true structure of the economy, as they perform well in a variety of models.13 Today,
I will consider the prescriptions of two such benchmark rules - Taylor's 1993 rule, and a
variant that is twice as responsive to economic slack. In my view, this latter rule is more
consistent with the FOMC's commitment to follow a balanced approach to promoting our dual
mandate, and so I will refer to it as the "balanced-approach" rule.14
To show the prescriptions these rules would have called for at the April FOMC meeting, I
start with an illustrative baseline outlook constructed using the projections for unemployment,
expectations. In estimating the current and future effect of the Federal Reserve's securities holdings on term
premiums, market participants are assumed to have expectations consistent with the illustrative baseline
discussed in note 16 and the exit principles outlined by the FOMC in June 2011 (see note 18). In particular,
investors are assumed to expect that the overall size and composition of the portfolio will remain roughly
constant from the end of 2012:Q2 through late 2014 because principal payments on the Federal Reserve's
security holdings will be reinvested until a few months prior to the liftoff of the federal funds rate assumed in
the illustrative baseline. At that point, the portfolio is assumed to begin to contract through redemptions and,
after the assumed liftoff of the federal funds rate, through sales of mortgage-backed securities that bring the
Federal Reserve's holdings of such securities to zero over a three-to-five-year period. As a result, the size of
the portfolio returns to normal within a few years after liftoff.
11
The term premium effect also wanes over time because the size of the effect depends on the expected
difference between the actual size of the balance sheet now and in the future and its normal size, where the
latter is rising steadily over time, primarily as a result of the trend growth in currency.
12
Carnegie-Rochester Conference
See John B. Taylor (1993), "Discretion versus Policy Rules in Practice,"
Series on Public Policy, vol. 39 (December), pp. 195-214.
13
See the discussion in John B. Taylor and John C. Williams (2011), "Simple and Robust Rules for Monetary
Handbook of Monetary
Policy," in Benjamin M. Friedman and Michael Woodford, eds., Economics, vol. 3B,
(San Diego: North Holland), pp. 829-60.
14
The balanced-approach rule is defined as Rt = 2 + pt + 0.5(pt- 2) + 1.0Yt. In this expression, R is the federal
funds rate, p is the percent change in the headline personal consumption expenditures price index from four
quarters earlier, and Y is the output gap. In a recent speech, I dubbed this rule "Taylor (1999)," as John Taylor
described the rule in a paper published that year. Since Taylor's own strong preference is for his original rule -
Taylor (1993) - I now refer to the later rule as the "balanced-approach rule."
inflation, and the federal funds rate that FOMC participants reported in April. I then employ
the dynamics of one of the Federal Reserve's economic models, the FRB/US model, to solve
for the joint paths of these three variables if the short-term interest rate had instead been set
according to the Taylor (1993) rule or the balanced-approach rule, subject, in both cases, to
the zero lower bound constraint on the federal funds rate. The dashed red line in figure 10
shows the resulting path for the federal funds rate under Taylor (1993) and the solid blue line
with open circles illustrates the corresponding path using the balanced-approach rule.16 In
both simulations, the private sector fully understands that monetary policy follows the
particular rule in force.17 Figure 10 shows that the Taylor rule calls for monetary policy to
tighten immediately, while the balanced-approach rule prescribes raising the federal funds
rate in the fourth quarter of 2014 - the earliest date consistent with the FOMC's current
forward guidance of "exceptionally low levels for the federal funds rate at least through late
2014."
Although simple rules provide a useful starting point in determining appropriate policy, they
by no means deserve the "last word" - especially in current circumstances. An alternative
approach, also illustrated in figure 10, is to compute an "optimal control" path for the federal
funds rate using an economic model - FRB/US, in this case. Such a path is chosen to
minimize the value of a specific "loss function" conditional on a baseline forecast of economic
conditions. The loss function attempts to quantify the social costs resulting from deviations of
inflation from the Committee's longer-run goal and from deviations of unemployment from its
longer-run normal rate.18 The solid green line with dots in figure 10 shows the "optimal
control" path for the federal funds rate, again conditioned on the illustrative baseline
outlook.19 This policy involves keeping the federal funds rate close to zero until late 2015,
four quarters longer than the balanced-approach rule prescription and several years longer
than the Taylor rule. Importantly, optimal control calls for a later lift-off date even though this
15
The baseline paths for unemployment and inflation track the midpoint of the central tendency of the
Committee's projections through 2014, and thereafter gradually converge to values consistent with
participants' long-run projections. Similarly, the baseline path for the federal funds rate stays near zero
through late 2014 and then rises steadily back to the long-run value expected by most participants. While
these assumptions are consistent with recent FOMC statements, both the assumed date of liftoff and the
longer-run pace of tightening are merely illustrative and are not based on any internal FOMC deliberations.
For further details on the construction of the baseline, see Yellen, "The Economic Outlook and Monetary
Policy," in note 2.
16
Because both rules respond to the output gap, the projections for t