Janet L Yellen: Semiannual Monetary Policy Report to the Congress
Testimony by Ms Janet L Yellen, Chair of the Board of Governors of the Federal Reserve
System, before the Committee on Financial Services, US House of Representatives,
Washington DC, 10 February 2016.
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Chairman Hensarling, Ranking Member Waters, and other members of the Committee, I am
pleased to present the Federal Reserve's semiannual Monetary Policy Report to the
Congress. In my remarks today, I will discuss the current economic situation and outlook
before turning to monetary policy.
Current economic situation and outlook
Since my appearance before this Committee last July, the economy has made further
progress toward the Federal Reserve's objective of maximum employment. And while
inflation is expected to remain low in the near term, in part because of the further declines in
energy prices, the Federal Open Market Committee (FOMC) expects that inflation will rise to
its 2 percent objective over the medium term.
In the labor market, the number of nonfarm payroll jobs rose 2.7 million in 2015, and posted
a further gain of 150,000 in January of this year. The cumulative increase in employment
since its trough in early 2010, is now more than 13 million jobs. Meanwhile, the
unemployment rate fell to 4.9 percent in January, 0.8 percentage point below its level a year
ago and in line with the median of FOMC participants' most recent estimates of its longer-run
normal level. Other measures of labor market conditions have also shown solid
improvement, with noticeable declines over the past year in the number of individuals who
want and are available to work but have not actively searched recently, and in the number of
people who are working part time but would rather work full time. However, these measures
remain above the levels seen prior to the recession, suggesting that some slack in labor
markets remains. Thus, while labor market conditions have improved substantially, there is
still room for further sustainable improvement.
The strong gains in the job market last year were accompanied by a continued moderate
expansion in economic activity. U.S. real gross domestic product is estimated to have
increased about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth
and the appreciation of the dollar restrained net exports. In the fourth quarter of last year,
growth in the gross domestic product is reported to have slowed more sharply, to an annual
rate of just 3/4 percent; again, growth was held back by weak net exports as well as by a
negative contribution from inventory investment. Although private domestic final demand
appears to have slowed somewhat in the fourth quarter, it has continued to advance.
Household spending has been supported by steady job gains and solid growth in real
disposable income - aided in part by the declines in oil prices. One area of particular
strength has been purchases of cars and light trucks; sales of these vehicles in 2015,
reached their highest level ever. In the drilling and mining sector, lower oil prices have
caused companies to slash jobs and sharply cut capital outlays, but in most other sectors,
business investment rose over the second half of last year. And homebuilding activity has
continued to move up, on balance, although the level of new construction remains well below
the longer-run levels implied by demographic trends.
Financial conditions in the United States have recently become less supportive of growth,
with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers,
and a further appreciation of the dollar. These developments, if they prove persistent, could
weigh on the outlook for economic activity and the labor market, although declines in
longerterm interest rates and oil prices provide some offset. Still, ongoing employment gains and
faster wage growth should support the growth of real incomes and therefore consumer
spending, and global economic growth should pick up over time, supported by highly
accommodative monetary policies abroad. Against this backdrop, the Committee expects
that with gradual adjustments in the stance of monetary policy, economic activity will expand
at a moderate pace in coming years and that labor market indicators will continue to
strengthen.
As is always the case, the economic outlook is uncertain. Foreign economic developments,
in particular, pose risks to U.S. economic growth. Most notably, although recent economic
indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign
exchange value of the renminbi have intensified uncertainty about China's exchange rate
policy and the prospects for its economy. This uncertainty led to increased volatility in global
financial markets and, against the background of persistent weakness abroad, exacerbated
concerns about the outlook for global growth. These growth concerns, along with strong
supply conditions and high inventories, contributed to the recent fall in the prices of oil and
other commodities. In turn, low commodity prices could trigger financial stresses in
commodity-exporting economies, particularly in vulnerable emerging market economies, and
for commodity-producing firms in many countries. Should any of these downside risks
materialize, foreign activity and demand for U.S. exports could weaken and financial market
conditions could tighten further.
Of course, economic growth could also exceed our projections for a number of reasons,
including the possibility that low oil prices will boost U.S. economic growth more than we
expect. At present, the Committee is closely monitoring global economic and financial
developments, as well as assessing their implications for the labor market and inflation and
the balance of risks to the outlook.
As I noted earlier, inflation continues to run below the Committee's 2 percent objective.
Overall consumer prices, as measured by the price index for personal consumption
expenditures, increased just 1/2 percent over the 12 months of 2015. To a large extent, the
low average pace of inflation last year can be traced to the earlier steep declines in oil prices
and in the prices of other imported goods. And, given the recent further declines in the prices
of oil and other commodities, as well as the further appreciation of the dollar, the Committee
expects inflation to remain low in the near term. However, once oil and import prices stop
falling, the downward pressure on domestic inflation from those sources should wane, and as
the labor market strengthens further, inflation is expected to rise gradually to 2 percent over
the medium term. In light of the current shortfall of inflation from 2 percent, the Committee is
carefully monitoring actual and expected progress toward its inflation goal.
Of course, inflation expectations play an important role in the inflation process, and the
Committee's confidence in the inflation outlook depends importantly on the degree to which
longer-run inflation expectations remain well anchored. It is worth noting, in this regard, that
market-based measures of inflation compensation have moved down to historically low
levels; our analysis suggests that changes in risk and liquidity premiums over the past year
and a half contributed significantly to these declines. Some survey measures of longer-run
inflation expectations are also at the low end of their recent ranges; overall, however, they
have been reasonably stable.
Monetary policy
Turning to monetary policy, the FOMC conducts policy to promote maximum employment
and price stability, as required by our statutory mandate from the Congress. Last March, the
Committee stated that it would be appropriate to raise the target range for the federal funds
rate when it had seen further improvement in the labor market and was reasonably confident
that inflation would move back to its 2 percent objective over the medium term. In December,
the Committee judged that these two criteria had been satisfied and decided to raise the
target range for the federal funds rate 1/4 percentage point, to between 1/4 and 1/2 percent.
This increase marked the end of a seven-year period during which the federal funds rate was
held near zero. The Committee did not adjust the target range in January.
The decision in December to raise the federal funds rate reflected the Committee's
assessment that, even after a modest reduction in policy accommodation, economic activity
would continue to expand at a moderate pace and labor market indicators would continue to
strengthen. Although inflation was running below the Committee's longer-run objective, the
FOMC judged that much of the softness in inflation was attributable to transitory factors that
are likely to abate over time, and that diminishing slack in labor and product markets would
help move inflation toward 2 percent. In addition, the Committee recognized that it takes time
for monetary policy actions to affect economic conditions. If the FOMC delayed the start of
policy normalization for too long, it might have to tighten policy relatively abruptly in the future
to keep the economy from overheating and inflation from significantly overshooting its
objective. Such an abrupt tightening could increase the risk of pushing the economy into
recession.
It is important to note that even after this increase, the stance of monetary policy remains
accommodative. The FOMC anticipates that economic conditions will evolve in a manner that
will warrant only gradual increases in the federal funds rate. In addition, the Committee
expects that the federal funds rate is likely to remain, for some time, below the levels that are
expected to prevail in the longer run. This expectation is consistent with the view that the
neutral nominal federal funds rate - defined as the value of the federal funds rate that would
be neither expansionary nor contractionary if the economy was operating near potential - is
currently low by historical standards and is likely to rise only gradually over time. The low
level of the neutral federal funds rate may be partially attributable to a range of persistent
economic headwinds - such as limited access to credit for some borrowers, weak growth
abroad, and a significant appreciation of the dollar - that have weighed on aggregate
demand.
Of course, monetary policy is by no means on a preset course. The actual path of the federal
funds rate will depend on what incoming data tell us about the economic outlook, and we will
regularly reassess what level of the federal funds rate is consistent with achieving and
maintaining maximum employment and 2 percent inflation. In doing so, we will take into
account a wide range of information, including measures of labor market conditions,
indicators of inflation pressures and inflation expectations, and readings on financial and
international developments. In particular, stronger growth or a more rapid increase in inflation
than the Committee currently anticipates would suggest that the neutral federal funds rate
was rising more quickly than expected, making it appropriate to raise the federal funds rate
more quickly as well. Conversely, if the economy were to disappoint, a lower path of the
federal funds rate would be appropriate. We are committed to our dual objectives, and we
will adjust policy as appropriate to foster financial conditions consistent with the attainment of
our objectives over time.
Consistent with its previous communications, the Federal Reserve used interest on excess
reserves (IOER) and overnight reverse repurchase (RRP) operations to move the federal
funds rate into the new target range. The adjustment to the IOER rate has been particularly
important in raising the federal funds rate and short-term interest rates more generally in an
environment of abundant bank reserves. Meanwhile, overnight RRP operations complement
the IOER rate by establishing a soft floor on money market interest rates. The IOER rate and
the overnight RRP operations allowed the FOMC to control the federal funds rate effectively
without having to first shrink its balance sheet by selling a large part of its holdings of
longerterm securities. The Committee judged that removing monetary policy accommodation by the
traditional approach of raising short-term interest rates is preferable to selling longer-term
assets because such sales could be difficult to calibrate and could generate unexpected
financial market reactions.
The Committee is continuing its policy of reinvesting proceeds from maturing Treasury
securities and principal payments from agency debt and mortgage-backed securities. As
highlighted in the December statement, the FOMC anticipates continuing this policy "until
normalization of the level of the federal funds rate is well under way." Maintaining our sizable
holdings of longer-term securities should help maintain accommodative financial conditions
and reduce the risk that we might need to return the federal funds rate target to the effective
lower bound in response to future adverse shocks.
Thank you. I would be pleased to take your questions.