For release on delivery
Noon EDT
May 30, 2019
Sustaining Maximum Employment and Price
Stability
Remarks by
Richard H. Clarida
Vice Chair
Board of Governors of the Federal Reserve System
the
at
Economic Club of New York
New York, New York
May 30, 2019
Thank you for that generous introduction. I have attended Economic Club of
New York events many times over the years and have always enjoyed the programs that
feature engaging speakers sharing important insights on timely topics. It is a distinct
honor to appear before you today from this side of the podium, and I do hope my remarks
will contribute to this proud tradition.1
In July, the current U.S. economic expansion will become the longest on record-
or at least the record since the 1850s, which is as far back as the National Bureau of
Economic Research tracks U.S. business cycles.2 In anticipation of that milestone, I
would like to take stock of where the U.S. economy is today, to assess its future
trajectory, to review some important structural changes in the economy that have
occurred over the past decade, and to explore what all of this might mean for U.S.
monetary policy.
The Federal Reserve has a specific mandate assigned to it in statute by the
Congress, which is the dual mandate of maximum employment and price stability. As I
speak today, the economy is as close to achieving both legs of this dual mandate as it has
been in 20 years. My colleagues and I understand that our responsibility is to conduct a
monetary policy that not only is supportive of and consistent with achieving maximum
employment and price stability, but also, once achieved, is appropriate, nimble, and
consistent with sustaining maximum employment and price stability for as long as
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possible. And thus, the title of my talk today is "Sustaining Maximum Employment and
Price Stability."
Midway through the second quarter of 2019, the U.S. economy is in a good place.
Over the past four quarters, gross domestic product (GDP) growth has averaged
3.2 percent, which compares with an average growth rate of 2.3 percent since the
recovery began in the summer of 2009. By most estimates, fiscal policy played an
important role in boosting growth in 2018, and I expect that fiscal policies will continue
to support growth in 2019. Over the same four quarters, the unemployment rate has
averaged 3.8 percent, and the most recent reading, at 3.6 percent, is near its lowest level
in 50 years. Moreover, average monthly job gains have continued to outpace the
increases needed to provide jobs for new entrants to the labor force. Wages have been
rising broadly in line with productivity and prices and thus, at present, do not signal
rising cost-push pressure. Notwithstanding strong growth and low unemployment, U.S.
inflation remains muted-currently, it is somewhat below our 2 percent longer-run
objective for the personal consumption expenditures (PCE) price deflator-and inflation
expectations, according to a variety of measures, continue to be stable.
As we look ahead, in our March Summary of Economic Projections, the median
projection of Federal Open Market Committee (FOMC) participants was for GDP growth
of around 2 percent as the modal, or most likely, outcome over the next three years, for
PCE inflation to rise to 2 percent, and for the unemployment rate to edge up to
3.9 percent by 2021.
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Before I discuss the outlook for monetary policy, allow me to review some
important structural changes that have taken place in the economy over the past decade
that will be particularly relevant for our monetary policy decisions.
Structural Changes in the U.S. Economy: Demand and Supply
Perhaps the most significant structural change relevant to monetary policy is that
the real, or inflation-adjusted, rate of interest consistent with full employment and price
stability, often referred to as the neutral rate, or r*, appears to have fallen in the United
States and abroad from more than 2 percent before the crisis to less than 1 percent today.3
The decline in neutral policy rates likely reflects several factors, including aging
populations, higher private saving, a greater demand for safe assets, and a slowdown in
global productivity growth. The policy implications of the decline in neutral rates are
important. All else being equal, a lower neutral rate increases the likelihood that a central
bank's policy rate will reach its effective lower bound in a future economic downturn.
Such a development, in turn, could make it more difficult during a future downturn for
monetary policy to provide sufficient accommodation to rapidly return employment and
inflation to mandate-consistent levels.4
Another important potential change in the U.S. economy has been the steady
decline in estimates of the structural rate of unemployment consistent with "maximum"
employment, often referred to as u*. This decline in u* may be due in part to higher
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educational attainment and a larger proportion of older workers in the workforce today
relative to the workforce of past decades.5 If u* is lower than historical estimates
suggest, this would imply that, even with today's historically low unemployment rate, the
labor market would not be as tight-and inflationary pressures would not be as strong-
as one would expect, based on historical estimates of u*. Indeed, I believe the range of
plausible estimates for u* may extend to 4 percent or even below.
I also note that the decline in the unemployment rate in recent years has been
accompanied by a pronounced increase in labor force participation for individuals in their
prime working years.6 It has also been accompanied since 2014 by a rise in labor's share
of national income. As I have documented previously, in the past several U.S. business
cycles, labor's share has risen as those expansions proceeded because workers command
higher wages in a stronger labor market; notably, in those cycles, the rise in labor's share
did not pass through to faster price inflation.7 The previously mentioned increase in
prime-age labor force participation has provided employers with a source of additional
labor input and has been one factor restraining inflationary pressures. Notwithstanding
these recent gains, prime-age participation rates remain somewhat below levels achieved
in the 1990s and may still have some more room to run. If so, then potential output could
be higher than many current estimates suggest.
Over the past few years, we have also seen evidence of a pickup in U.S.
productivity growth, albeit from the very depressed average pace that prevailed
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throughout most of the expansion. Indeed, as of the first quarter of this year, productivity
in the nonfarm business sector rose 2.4 percent over the previous four quarters, its fastest
pace since 2010 when the U.S. economy was coming out of the Great Recession. By
contrast, in both the 2001-07 and 1982-90 economic expansions, productivity growth
was actually slowing relative to its average pace during those expansions. That said,
while identifying inflection points in trend productivity growth in real time is notoriously
difficult, a pickup in trend productivity growth relative to the pace that prevailed earlier
in the expansion is a possibility that we should not, I believe, dismiss.8
Another structural change relevant for monetary policy is that price inflation
appears less responsive to resource slack than it did in the past. That is, the short-run
price Phillips curve appears to have flattened, implying a change in the dynamic
relationship between inflation and employment.9 A flatter Phillips curve is, in a sense, a
proverbial double-edged sword. It permits the Federal Reserve to support employment
more aggressively during downturns-as was the case during and after the Great
Recession-because a sustained inflation breakout is less likely when the Phillips curve
is flatter.10 However, a flatter Phillips curve also increases the cost, in terms of economic
output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a
8
For more on productivity growth, see Brynjolfsson, Rock, and Syverson (forthcoming).
9
For evidence of a flattening of the slope of the Phillips curve in the United States and abroad, see, among
others, Simon, Matheson, and Sandri (2013); Blanchard, Cerutti, and Summers (2015); and Bank for
International Settlements (2017).
10
One potential contributor to the flattening of the Phillips curve is a change in the conduct of monetary
policy since the 1980s toward greater stabilization of inflation and economic activity; for evidence of such
a change, see Clarida, Galí, and Gertler (2000); Boivin and Giannoni (2006); and Boivin, Kiley, and
Mishkin (2010). As discussed in Roberts (2006) and Bullard (2018), greater stabilization on the part of a
central bank can lead to the estimation of flatter Phillips curves in reduced-form regressions. Similarly, the
adoption of an explicit inflation objective, along with greater certainty regarding the conduct of monetary
policy, can help anchor longer-term inflation expectations and stabilize actual inflation in response to
shocks.
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flatter Phillips curve makes it all the more important that longer-run inflation
expectations remain anchored at levels consistent with our 2 percent inflation objective.11
Textbook macroeconomics teaches us that understanding the economy and getting
monetary policy right requires that we do our best to understand if-and if so, how-the
forces of aggregate demand and supply are evolving relative to historical experience and
the predictions of our models. While predicting the future is difficult, with available data
it appears that in 2018 and in the first quarter of 2019, the supply side of the economy-
employment, participation, and productivity-expanded faster than most forecasters
outside and inside the Fed expected. Notwithstanding robust growth in demand over
these five quarters, PCE price inflation fell somewhat short of the Fed's 2 percent
objective. With this background, let me now turn to the outlook for U.S. monetary
policy.
Monetary Policy
As I mentioned earlier, my colleagues and I on the FOMC understand that our
priority today is to put in place policies that will help sustain maximum employment and
price stability in an economy that appears to be operating close to both of our dual-
mandate objectives. In our most recent statements, we have indicated that "the
11
See Yellen (2015) for a discussion of inflation dynamics and monetary policy, and see Erceg and others
(2018) for a quantitative exploration of the monetary policy implications of a flat Phillips curve in an
uncertain economic environment. Since the mid-1980s, movements in both realized inflation and measures
of longer-term inflation expectations have been somewhat muted, complicating the task of extracting the
precise role of inflation expectations as a determinant of realized inflation. Faust and Wright (2013) review
the literature on inflation forecasting and present evidence in support of the conclusion that measures of
inflation expectations help predict the trend in inflation. Cecchetti and others (2017) show that while the
level of realized inflation and four-quarter-ahead inflation expectations are positively correlated, changes in
these variables have been largely uncorrelated since the mid-1980s. These authors suggest that, in a low
and stable inflation environment, policymakers should pay attention to a wide array of other indicators in
determining the implications of movements in realized inflation and measures of inflation expectations.
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Committee will be patient as it determines what future adjustments to the . . . federal
funds rate may be appropriate to support" our dual-mandate objectives.12 What does this
mean in practice? To me, it means that we should allow the data on the U.S. economy to
flow in and inform our future decisions.
I believe that the path for the federal funds rate should be data dependent in two
distinct ways.13 Monetary policy should be data dependent in the sense that incoming
data reveal at any point in time where the economy is relative to the ultimate objectives
of price stability and maximum employment. This information on where the economy is
relative to the goals of monetary policy is an important input into interest rate feedback
rules. Data dependence in this sense is well understood, as it is of the type implied by a
large family of policy rules, including Taylor-type rules, in which the parameters of the
economy needed to formulate such rules are taken as known.
But, of course, key parameters needed to formulate such rules, including u* and
r*, are unknown. As a result, in the real world, monetary policy should be-and in the
United States, I believe, is-data dependent in a second sense: Policymakers should and
do study incoming data and use models to extract signals that enable them to update and
improve estimates of r* and u*. Consistent with my earlier discussion, in the Summary
of Economic Projections, FOMC participants have, over the past seven years, repeatedly
revised down their estimates of both u* and r* as unemployment fell and real interest
rates remained well below previous estimates of neutral without the rise in inflation those
earlier estimates would have predicted. And these revisions to u* and r* appeared to
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have had an important influence on the path for the policy rate actually implemented in
recent years.
In addition to u* and r*, another important input into any monetary policy
assessment is the state of inflation expectations. Indeed, I believe price stability requires
that not only actual inflation be centered at our 2 percent objective, but also that expected
inflation be equal to our 2 percent inflation objective. Unlike realized inflation, inflation
expectations themselves are not directly observable; they must be inferred from
econometric models, market prices, and surveys of households and firms. As I assess the
totality of the evidence, I judge that, at present, indicators suggest that longer-term
inflation expectations sit at the low end of a range that I consider consistent with our
price-stability mandate.
Where does this leave us today? As I already noted, the U.S. economy is in a
very good place, with the unemployment rate near a 50-year low, inflationary pressures
muted, expected inflation stable, and GDP growth solid and projected to remain so.
Moreover, the federal funds rate is now in the range of estimates of its longer-run neutral
level, and the unemployment rate is not far below many estimates of u*. Plugging these
inputs into a 1993 Taylor-type rule produces a federal funds rate between 2.25 and
2.5 percent, which is the range for the policy rate that the FOMC has reaffirmed since our
January meeting. Most recently, the Committee judged at our May meeting that the
current stance of policy remains appropriate, and that decision reflects our view that some
of the softness in recent inflation data will prove to be transitory. This judgment aligns
with some private-sector forecasts, which now project PCE inflation to return to 2 percent
by 2020. However, if the incoming data were to show a persistent shortfall in inflation
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below our 2 percent objective or were it to indicate that global economic and financial
developments present a material downside risk to our baseline outlook, then these are
developments that the Committee would take into account in assessing the appropriate
stance for monetary policy.
Monetary Policy Implementation and Balance Sheet Decisions
Since the beginning of the year, the FOMC has made several important decisions
about how it will implement monetary policy and how it will conclude the process of
normalizing the size of its balance sheet. These decisions have been made over several
meetings and have been part of an ongoing process of the Committee's deliberations.
Please allow me to summarize them now.
The FOMC decided at its January meeting to continue to implement monetary
policy in a regime with an ample supply of reserves-a regime often referred to as a floor
system.14 Such a system, which has been in place since late 2008, does not require the
active management of reserves through daily open market operations. Instead, with an
ample level of reserves in the banking system, the effective federal funds rate will settle
at or slightly above the rate of interest paid on excess reserves (IOER).15 This system has
proven to be an efficient means of controlling the policy rate and effectively transmitting
the stance of policy to a wide array of other money market instruments and to broader
financial conditions. The FOMC continues to view the target range for the federal funds
rate as its primary means of adjusting and communicating the stance of monetary policy,
although in doing so, we must and do take into account how our balance sheet size,
composition, and trajectory impact broader financial conditions. And as we stated in
January, although adjustments in the target range for the federal funds rate are our
primary tool for adjusting the stance of monetary policy, we are prepared to adjust the
details of the plans for balance sheet normalization based on economic and financial
developments.
At its March meeting, the Committee announced that it would slow the pace of
the runoff of the securities holdings in its SOMA portfolio, and that it plans to cease
balance sheet runoff entirely by September.16 Since starting the process of balance sheet
normalization in 2017, the Federal Reserve's securities portfolio has shrunk by about
$500 billion (roughly 2-1/2 percent of GDP) and the level of reserve balances has
declined about $700 billion. Consistent with our decision in March, we began to slow the
pace of runoff of our balance sheet earlier this month. When the process of normalizing
the size of our balance sheet concludes in September, we expect that our reserves
liabilities will, for a time, likely remain somewhat above the level necessary for an
efficient and effective implementation of monetary policy. If so, we plan after September
to hold the size of our securities holdings constant for a while. During this period,
reserve balances will continue to decline gradually as currency and other nonreserve
liabilities increase. At the point that the Committee judges that reserve balances have
declined to the level consistent with the efficient and effective implementation of
monetary policy, we plan to resume periodic open market operations to accommodate the
normal trend growth in the demand for our liabilities.17
As balance sheet normalization has progressed, the effective federal funds rate has
firmed relative to the IOER rate. Last year, after the federal funds rate moved up closer
to the top of the target range set by the FOMC, we made technical adjustments in our
operations by lowering the IOER rate relative to the top of the target range by 5 basis
points in June and then again in December to keep the federal funds rate well within its
target range. At our May FOMC meeting, we made another technical adjustment in the
IOER rate, reducing it by another 5 basis points to 2.35 percent. Since then, the effective
federal funds rate has been trading close to the level where it began the year.
Review of Monetary Policy Strategy, Tools, and Communications
Before I conclude my prepared remarks, allow me to say a few words about our
review of our monetary policy strategy, tools, and communication practices.18 While we
believe that our existing approach to conducting monetary policy has served the public
well, the purpose of this review is to evaluate and assess possible refinements that might
help us best achieve our dual-mandate objectives on a sustained basis.
With the U.S. economy operating at or close to our maximum-employment and
price-stability goals, now is an especially opportune time to conduct this review. We
want to ensure that we are well positioned to continue to meet our statutory goals in
coming years. Furthermore, the shifts in r* and u*, as well as the flattening of the
Phillips curve that I discussed earlier, suggest that the U.S. and foreign economies have
evolved in significant ways relative to the pre-crisis experience.
The Federal Reserve System is currently conducting "town hall"-style Fed Listens
events, in which we are hearing from a broad range of interested individuals and groups,
including business and labor leaders, community development advocates, and
academics. In addition, we are holding a System research conference next week at the
Federal Reserve Bank of Chicago that will feature speakers and panelists from outside
the Fed. Building on both the perspectives we hear and staff analysis, the FOMC will
conduct its own assessment of its monetary policy framework, beginning around the
middle of the year. We will share our conclusions with the public in the first half
of 2020.
The economy is constantly evolving, bringing with it new policy challenges. So it
makes sense for us to remain open minded as we assess current practices and consider
ideas that could potentially enhance our ability to deliver on the goals the Congress has
assigned us. For this reason, my colleagues and I do not want to prejudge or predict our
ultimate findings. What I can say is that any refinements or more-material changes to our
framework that we might make will be aimed solely at enhancing our ability to achieve
and sustain our dual-mandate objectives of maximum employment and stable prices.
Thank you very much, and I look forward to your questions.
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