Janet L Yellen: Monetary policy and the economic recovery
Speech by Ms Janet L Yellen, Chair of the United States' Federal Reserve System, at the
Economic Club of New York, New York, 16 April 2014.
* * *
Nearly five years into the expansion that began after the financial crisis and the Great
Recession, the recovery has come a long way. More than 8 million jobs have been added to
nonfarm payrolls since 2009, almost the same number lost as a result of the recession. Led
by a resurgent auto industry, manufacturing output has also nearly returned to its
prerecession peak. While the housing market still has far to go, it seems to have turned a
corner.
It is a sign of how far the economy has come that a return to full employment is, for the first
time since the crisis, in the medium-term outlooks of many forecasters. It is a reminder of
how far we have to go, however, that this long-awaited outcome is projected to be more than
two years away.
Today I will discuss how my colleagues on the Federal Open Market Committee (FOMC) and
I view the state of the economy and how this view is likely to shape our efforts to promote a
return to maximum employment in a context of price stability. I will start with the FOMC's
outlook, which foresees a gradual return over the next two to three years of economic
conditions consistent with its mandate.
While monetary policy discussions naturally begin with a baseline outlook, the path of the
economy is uncertain, and effective policy must respond to significant unexpected twists and
turns the economy may take. My primary focus today will be on how the FOMC's monetary
policy framework has evolved to best support the recovery through those twists and turns,
and what this framework is likely to imply as the recovery progresses.
The current economic outlook
The FOMC's current outlook for continued, moderate growth is little changed from last fall. In
recent months, some indicators have been notably weak, requiring us to judge whether the
data are signaling a material change in the outlook. The unusually harsh winter weather in
much of the nation has complicated this judgment, but my FOMC colleagues and I generally
believe that a significant part of the recent softness was weather related.
The continued improvement in labor market conditions has been important in this judgment.
The unemployment rate, at 6.7 percent, has fallen three-tenths of 1 percentage point since
late last year. Broader measures of unemployment that include workers marginally attached
to the labor force and those working part time for economic reasons have fallen a bit more
than the headline unemployment rate, and labor force participation, which had been falling,
has ticked up this year.
Inflation, as measured by the price index for personal consumption expenditures, has slowed
from an annual rate of about 2-1/2 percent in early 2012 to less than 1 percent in February of
this year.1 This rate is well below the Committee's 2 percent longer-run objective. Many
advanced economies are observing a similar softness in inflation.
To some extent, the low rate of inflation seems due to influences that are likely to be
temporary, including a deceleration in consumer energy prices and outright declines in core
import prices in recent quarters. Longer-run inflation expectations have remained remarkably
steady, however. We anticipate that, as the effects of transitory factors subside and as labor
market gains continue, inflation will gradually move back toward 2 percent.
In sum, the central tendency of FOMC participant projections for the unemployment rate at
the end of 2016 is 5.2 to 5.6 percent, and for inflation the central tendency is 1.7 to
2 percent.2 If this forecast was to become reality, the economy would be approaching what
my colleagues and I view as maximum employment and price stability for the first time in
nearly a decade. I find this baseline outlook quite plausible.
Of course, if the economy obediently followed our forecasts, the job of central bankers would
be a lot easier and their speeches would be a lot shorter. Alas, the economy is often not so
compliant, so I will ask your indulgence for a few more minutes.
Three big questions for the FOMC
Because the course of the economy is uncertain, monetary policymakers need to carefully
watch for signs that it is diverging from the baseline outlook and then respond in a systematic
way. Let me turn first to monitoring and discuss three questions I believe are likely to loom
large in the FOMC's ongoing assessment of where we are on the path back to maximum
employment and price stability.
Is there still significant slack in the labor market?
The first question concerns the extent of slack in the labor market. One of the FOMC's
objectives is to promote a return to maximum employment, but exactly what conditions are
consistent with maximum employment can be difficult to assess. Thus far in the recovery and
to this day, there is little question that the economy has remained far from maximum
employment, so measurement difficulties were not our focus. But as the attainment of our
maximum employment goal draws nearer, it will be necessary for the FOMC to form a more
nuanced judgment about when the recovery of the labor market will be materially complete.
As the FOMC's statement on longer-term goals and policy strategy emphasizes, these
judgments are inherently uncertain and must be based on a wide range of indicators.3
I will refer to the shortfall in employment relative to its mandate-consistent level as labor
market slack, and there are a number of different indicators of this slack. Probably the best
single indicator is the unemployment rate. At 6.7 percent, it is now slightly more than
1 percentage point above the 5.2 to 5.6 percent central tendency of the Committee's
projections for the longer-run normal unemployment rate. This shortfall remains significant,
and in our baseline outlook, it will take more than two years to close.4
Other data suggest that there may be more slack in labor markets than indicated by the
unemployment rate. For example, the share of the workforce that is working part time but
would prefer to work full time remains quite high by historical standards. Similarly, while the
share of workers in the labor force who are unemployed and have been looking for work for
more than six months has fallen from its peak in 2010, it remains as high as any time prior to
the Great Recession.5 There is ongoing debate about why long-term unemployment remains
so high and the degree to which it might decline in a more robust economy. As I argued more
fully in a recent speech, I believe that long-term unemployment might fall appreciably if
economic conditions were stronger.6
The low level of labor force participation may also signal additional slack that is not reflected
in the headline unemployment rate. Participation would be expected to fall because of the
aging of the population, but the decline steepened in the recovery. Although economists
differ over what share of those currently outside the labor market might join or rejoin the labor
force in a stronger economy, my own view is that some portion of the decline in participation
likely represents labor market slack.7
Lastly, economists also look to wage pressures to signal a tightening labor market. At
present, wage gains continue to proceed at a historically slow pace in this recovery, with few
signs of a broad-based acceleration. As the extent of slack we see today diminishes,
however, the FOMC will need to monitor these and other labor market indicators closely to
judge how much slack remains and, therefore, how accommodative monetary policy should
be.
Is inflation moving back toward 2 percent?
A second question that is likely to figure heavily in our assessment of the recovery is whether
inflation is moving back toward the FOMC's 2 percent longer-run objective, as envisioned in
our baseline outlook. As the most recent FOMC statement emphasizes, inflation persistently
below 2 percent could pose risks to economic performance.
The FOMC strives to avoid inflation slipping too far below its 2 percent objective because, at
very low inflation rates, adverse economic developments could more easily push the
economy into deflation. The limited historical experience with deflation shows that, once it
starts, deflation can become entrenched and associated with prolonged periods of very weak
economic performance.8
A persistent bout of very low inflation carries other risks as well. With the federal funds rate
currently near its lower limit, lower inflation translates into a higher real value for the federal
funds rate, limiting the capacity of monetary policy to support the economy.9 Further, with
longer-term inflation expectations anchored near 2 percent in recent years, persistent
the labor force of those unemployed for more than 26 weeks rose from less than 1 percent prior to the
recession to 4.5 percent, and it has since declined to just below 2.5 percent; the previous peak for this series
was 2.5 percent in 1983. The records for long-term unemployed begin in 1948.
6
See Janet L. Yellen (2014), "What the Federal Reserve Is Doing to Promote a Stronger Job Market," speech
delivered at the 2014 National Interagency Community Reinvestment Conference, Chicago, March 31.
7
For the view that most of the recent decline in labor force participation reflects retirement, see Shigeru Fujita
(2014), "On the Causes of Declines in the Labor Force Participation Rate," (PDF) Federal Reserve Bank of
Philadelphia, special report, Research Rap, February 6. The view that a larger share of the recent decline
reflects cyclical factors is expressed by Christopher J. Erceg and Andrew T. Levin (2013), "Labor Force
Participation and Monetary Policy in the Wake of the Great Recession," paper presented at "Fulfilling the Full
Employment Mandate - Monetary Policy and the Labor Market," 57th Economic Conference of the Federal
Reserve Bank of Boston, April 12.
8
See Ben S. Bernanke (2002), "Deflation: Making Sure 'It' Doesn't Happen Here," speech delivered at the
National Economists Club, Washington, November 21.
9
If firms' and households' spending decisions depended only on longer-term interest rates, temporarily higher
short-term real interest rates due to low inflation at a time that nominal interest rates are constrained by the
zero lower bound would have little economic effects, provided that these higher short-term real interest rates
would be expected to be compensated by lower short-term real interest rates later on. However, to the extent
that these spending decisions depend in part on shorter-term real interest rates, low inflation can induce
meaningful economic costs.
inflation well below this expected value increases the real burden of debt for households and
firms, which may put a drag on economic activity.
I will mention two considerations that will be important in assessing whether inflation is likely
to move back to 2 percent as the economy recovers. First, we anticipate that, as labor
market slack diminishes, it will exert less of a drag on inflation. However, during the recovery,
very high levels of slack have seemingly not generated strong downward pressure on
inflation. We must therefore watch carefully to see whether diminishing slack is helping return
inflation to our objective.10 Second, our baseline projection rests on the view that inflation
expectations will remain well anchored near 2 percent and provide a natural pull back to that
level. But the strength of that pull in the unprecedented conditions we continue to face is
something we must continue to assess.
Finally, the FOMC is well aware that inflation could also threaten to rise substantially above
2 percent. At present, I rate the chances of this happening as significantly below the chances
of inflation persisting below 2 percent, but we must always be prepared to respond to such
unexpected outcomes, which leads us to my third question.
What factors may push the recovery off track?
Myriad factors continuously buffet the economy, so the Committee must always be asking,
"What factors may be pushing the recovery off track?" For example, over the nearly 5 years
of the recovery, the economy has been affected by greater-than-expected fiscal drag in the
United States and by spillovers from the sovereign debt and banking problems of some
euroarea countries. Further, our baseline outlook has changed as we have learned about the
degree of structural damage to the economy wrought by the crisis and the subsequent pace
of healing.
Let me offer an example of how these issues shape policy. Four years ago, in April 2010, the
outlook appeared fairly bright. The emergency lending programs that the Federal Reserve
implemented at the height of the crisis had been largely wound down, and the Fed was soon
to complete its first large-scale asset purchase program. Private-sector forecasters polled in
the April 2010 Blue Chip survey were predicting that the unemployment rate would fall
steadily to 8.6 percent in the final quarter of 2011.11
This forecast proved quite accurate - the unemployment rate averaged 8.6 percent in the
fourth quarter of 2011. But this was not the whole story. In April 2010, Blue Chip forecasters
not only expected falling unemployment, they also expected the FOMC to soon begin raising
the federal funds rate. Indeed, they expected the federal funds rate to reach 1.3 percent by
the second quarter of 2011.12 By July 2010, however, with growth disappointing and the
FOMC expressing concerns about softening in both growth and inflation, the Blue Chip
10
The uncertainty surrounding the empirical relationship between slack and inflation is discussed in James H.
Stock and Mark W. Watson (2009), "Phillips Curve Inflation Forecasts," in Jeff Fuhrer, Yolanda K. Kodrzycki,
Jane Sneddon Little, and Giovanni P. Olivei, eds., Understanding Inflation and the Implications for Monetary
Policy: A Phillips Curve Retrospective (Cambridge, Mass.: MIT Press). Moreover, with the share of long-term
unemployed in total unemployment unusually elevated in recent years, there is an ongoing discussion about
whether short- and long-term unemployment have differential effects on inflation. See Robert J. Gordon
(2013), "The Phillips Curve Is Alive and Well: Inflation and the NAIRU during the Slow Recovery," NBER
Working Paper Series 19390 (Cambridge, Mass.: National Bureau of Economic Research, August); and Mark
W. Watson (forthcoming), "Inflation Persistence, the NAIRU, and the Great Recession," American Economic
Review.
11
See Aspen Publishers (2010), Blue Chip Economic Indicators, vol. 35, no. 4 (April 10). These forecasts were
similar to the central tendency of FOMC participants' projections for the unemployment rate at the end of 2011
submitted in conjunction with the April 2010 FOMC meeting, which ranged from 8.1 to 8.5 percent. See Board
of Governors of the Federal Reserve System (2010), "Minutes of the Federal Open Market Committee, April
27-28, 2010," press release, May 19.
12
See Aspen Publishers (2010), Blue Chip Financial Forecasts, vol. 29, no. 4 (April 1).
forecast of the federal funds rate in mid-2011 had fallen to 0.8 percent, and by October the
forecasters expected that the rate would remain in the range of 0 to 25 basis points
throughout 2011, as turned out to be the case.13 Not only did expectations of policy tightening
recede, the FOMC also initiated a new $600 billion asset purchase program in November
2010.
Thus, while the reductions in the unemployment rate through 2011 were roughly as forecast
in early 2010, this improvement only came about with the FOMC providing a considerably
higher level of accommodation than originally anticipated.
This experience was essentially repeated the following year. In April 2011, Blue Chip
forecasters expected the unemployment rate to fall to 7.9 percent by the fourth quarter of
2012, with the FOMC expected to have already raised the federal funds rate to near
1 percent by mid-2012.14
As it turned out, the unemployment rate forecast was once more remarkably accurate, but
again this was associated with considerably more accommodation than anticipated. In
response to signs of slowing economic activity, in August 2011 the FOMC for the first time
expressed its forward guidance in terms of the calendar, stating that conditions would likely
warrant exceptionally low levels for the federal funds rate at least through mid-2013. The
following month, the Committee added to accommodation by adopting a new balance sheet
policy known as the maturity extension program.15
Thus, in both 2011 and 2012, the unemployment rate actually declined by about as much as
had been forecast the previous year, but only after unexpected weakness prompted
additional accommodative steps by the Federal Reserve. In both cases, I believe that the
FOMC's decision to respond to signs of weakness with significant additional accommodation
played an important role in helping to keep the projected labor market recovery on track.16
These episodes illustrate what I described earlier as a vital aspect of effective monetary
policymaking: monitor the economy for signs that events are unfolding in a materially
different manner than expected and adjust policy in response in a systematic manner. Now I
will turn from the task of monitoring to the policy response.
Policy challenges in an unprecedented recovery
Fundamental to modern thinking on central banking is the idea that monetary policy is more
effective when the public better understands and anticipates how the central bank will
respond to evolving economic conditions. Specifically, it is important for the central bank to
make clear how it will adjust its policy stance in response to unforeseen economic
13
See, respectively, Aspen Publishers (2010), Blue Chip Financial Forecasts, vol. 29, no. 7 (July 1); and Aspen
Publishers (2010), vol. 29, no. 10 (October 1). In the statement following its August 10, 2010, meeting, the
FOMC noted that "the pace of recovery in output and employment has slowed in recent months." See Board of
Governors of the Federal Reserve System (2010), "FOMC Statement," press release, August 10. See also the
discussion in the minutes of that meeting: Board of Governors of the Federal Reserve System (2010),
"Minutes of the Federal Open Market Committee, August 10, 2010," press release, August 31.
14
See, respectively, Aspen Publishers (2011), Blue Chip Economic Indicators, vol. 36, no. 4 (April 10); and
Aspen Publishers (2011), Blue Chip Financial Forecasts, vol. 30, no. 4 (April 1).
15
For the FOMC's calendar-based forward guidance as communicated in its August 2011 statement, see Board
of Governors of the Federal Reserve System (2011), "FOMC Statement," press release, August 9. For the
description of the FOMC's maturity extension program that appeared in its September 2011 statement, see
Board of Governors of the Federal Reserve System (2011), "Federal Reserve Issues FOMC Statement," press
release, September 21.
16
There are a range of estimates on the effectiveness of these policies. A review is provided in Ben S. Bernanke
(2012), "Monetary Policy since the Onset of the Crisis," speech delivered at "The Changing Policy
Landscape," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole,
Wyo., August 30-September 1.
developments in a manner that reduces or blunts potentially harmful consequences. If the
public understands and expects policymakers to behave in this systematically stabilizing
manner, it will tend to respond less to such developments. Monetary policy will thus have an
"automatic stabilizer" effect that operates through private-sector expectations. It is important
to note that tying the response of policy to the economy necessarily makes the future course
of the federal funds rate uncertain. But by responding to changing circumstances, policy can
be most effective at reducing uncertainty about the course of inflation and employment.
Recall how this worked during the couple of decades before the crisis - a period sometimes
known as the Great Moderation. The FOMC's main policy tool, the federal funds rate, was
well above zero, leaving ample scope to respond to the modest shocks that buffeted the
economy during that period. Many studies confirmed that the appropriate response of policy
to those shocks could be described with a fair degree of accuracy by a simple rule linking the
federal funds rate to the shortfall or excess of employment and inflation relative to their
desired values.17 The famous Taylor rule provides one such formula.18
The idea that monetary policy should react in a systematic manner in order to blunt the
effects of shocks has remained central in the FOMC's policymaking during this recovery.
However, the application of this idea has been more challenging. With the federal funds rate
pinned near zero, the FOMC has been forced to rely on two less familiar policy tools - the
first one being forward guidance regarding the future setting of the federal funds rate and the
second being large-scale asset purchases. There are no time-tested guidelines for how
these tools should be adjusted in response to changes in the outlook. As the episodes
recounted earlier illustrate, the FOMC has continued to try to adjust its policy tools in a
systematic manner in response to new information about the economy. But because both the
tools and the economic conditions have been unfamiliar, it has also been critical that the
FOMC communicate how it expects to deploy its tools in response to material changes in the
outlook.
Let me review some important elements in the evolution of the FOMC's communication
framework. When the FOMC initially began using its unconventional tools, policy
communication was relatively simple. In December 2008, for example, the FOMC said it
expected that conditions would warrant keeping the federal funds rate near zero for "some
time." This period before the "liftoff" in the federal funds rate was described in increasingly
specific, and (as it turned out) longer, periods over time - "some time" became "an extended
period," which was later changed to "mid-2013," then "late 2014," then "mid-2015."19 This
fixed, calendar-based guidance had the virtue of simplicity, but it lacked the automatic
stabilizer property of communication that would signal how and why the stance of policy and
forward guidance might change as developments unfolded, and as we learned about the
extent of the need for accommodation.
17
See the discussion in John B. Taylor and John C. Williams (2011), "Simple and Robust Rules for Monetary
Policy," chap. 15 in Benjamin M. Friedman and Michael Woodford, eds., Handbook of Monetary Economics,
vol. 3B (San Diego: North-Holland), pp. 829-59. (An April 2010 working paper version of this chapter is
available on the Federal Reserve Bank of San Francisco's website (PDF))
18
See John B. Taylor (1993), "Discretion versus Policy Rules in Practice," Carnegie-Rochester Conference
Series on Public Policy, vol. 39 (December), pp. 195-214.
19
The references to "some time," "an extended period," "mid-2013," "late 2014," and "mid-2015" appeared in the
FOMC statements of, respectively, December 2008, March 2009, August 2011, January 2012, and September
2012. See Board of Governors of the Federal Reserve System (2008), "FOMC Statement and Board Approval
of Discount Rate Requests of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta,
Minneapolis, and San Francisco," press release, December 16; Board of Governors (2009), "FOMC
Statement," press release, March 18, Board of Governors (2011), "FOMC Statement," press release, August
9; Board of Governors (2012), "Federal Reserve Issues FOMC Statement," press release, January 25; and
Board of Governors (2012), "Federal Reserve Issues FOMC Statement," press release, September 13.
More recently, the Federal Reserve, and I might add, other central banks around the world,
have sought to incorporate this automatic stabilizer feature in their communications.20 In
December 2012, the Committee reformulated its forward guidance, stating that it anticipated
that the federal funds rate would remain near zero at least as long as the unemployment rate
remained above 6-1/2 percent, inflation over the period between one and two years ahead
was projected to be no more than half a percentage point above the Committee's objective,
and longer-term inflation expectations continued to be well anchored. This guidance
emphasized to the public that it could count on a near-zero federal funds rate at least until
substantial progress in the recovery had been achieved, however long that might take. When
these thresholds were announced, the unemployment rate was reported to be 7.7 percent,
and the Committee projected that the 6-1/2 percent threshold would not be reached for
another 2-1/2 years - in mid-2015. The Committee emphasized that these numerical criteria
were not triggers for raising the federal funds rate, and Chairman Bernanke stated that,
ultimately, any decision to begin removing accommodation would be based on a wide range
of indicators.21
Our communications about asset purchases have undergone a similar transformation. The
initial asset purchase programs had fixed time and quantity limits, although those limits came
with a proviso that they might be adjusted. In the fall of 2012, the FOMC launched its current
purchase program, this time explicitly tying the course of the program to evolving economic
conditions. When the program began, the rate of purchases was $85 billion per month, and
the Committee indicated that purchases would continue, providing that inflation remained
well behaved, until there was a substantial improvement in the outlook for the labor market.22
Based on the cumulative progress toward maximum employment since the initiation of the
program and the improvement in the outlook for the labor market, the FOMC began reducing
the pace of asset purchases last December, stating that "[i]f incoming information broadly
supports the Committee's expectation of ongoing improvement in labor market conditions
and inflation moving back toward its longer-term objective, the Committee will likely reduce
the pace of asset purchases in further measured steps at future meetings."23 Purchases are
currently proceeding at a pace of $55 billion per month. Consistent with my theme today,
however, the FOMC statement underscores that purchases are not on a preset course - the
FOMC stands ready to adjust the pace of purchases as warranted should the outlook change
materially.
Recent changes to the forward guidance
At our most recent meeting in March, the FOMC reformulated its forward guidance for the
federal funds rate. While one of the main motivations for this change was that the
unemployment rate might soon cross the 6-1/2 percent threshold, the new formulation is also
well suited to help the FOMC explain policy adjustments that may arise in response to
changes in the outlook. I should note that the change in the forward guidance did not indicate
a change in the Committee's policy intentions, but instead was made to clarify the
Committee's thinking about policy as the economy continues to recover. The new guidance
provides a general description of the framework that the FOMC will apply in making
decisions about the timing of liftoff. Specifically, in determining how long to maintain the
current target range of 0 to 25 basis points for the federal funds rate, "the Committee will
assess progress, both realized and expected, toward its objectives of maximum employment
and 2 percent inflation."24 In other words, the larger the shortfall of employment or inflation
from their respective objectives, and the slower the projected progress toward those
objectives, the longer the current target range for the federal funds rate is likely to be
maintained. This approach underscores the continuing commitment of the FOMC to maintain
the appropriate degree of accommodation to support the recovery. The new guidance also
reaffirms the FOMC's view that decisions about liftoff should not be based on any one
indicator, but that it will take into account a wide range of information on the labor market,
inflation, and financial developments.
Along with this general framework, the FOMC provided an assessment of what that
framework implies for the likely path of policy under the baseline outlook. At present, the
Committee anticipates that economic and financial conditions will likely warrant maintaining
the current range "for the federal funds rate for a considerable time after the asset purchase
program ends, especially if projected inflation continues to run below the Committee's
2 percent longer-run goal, and provided that longer-term inflation expectations remain well
anchored."25
Finally, the Committee began explaining more fully how policy may operate in the period
after liftoff, indicating its expectation that economic conditions may, for some time, warrant
keeping short-term interest rates below levels the Committee views as likely to prove normal
in the longer run. FOMC participants have cited different reasons for this view, but many of
the reasons involve persistent effects of the financial crisis and the possibility that the
productive capacity of the economy will grow more slowly, at least for a time, than it did, on
average, before the crisis. The expectation that the achievement of our economic objectives
will likely require low real interest rates for some time is again not confined to the United
States but is shared broadly across many advanced economies.26 Of course, this guidance is
a forecast and will evolve as we gain further evidence about how the economy is operating in
the wake of the crisis and ensuing recession.
Conclusion
In summary, the policy framework I have described reflects the FOMC's commitment to
systematically respond to unforeseen economic developments in order to promote a return to
maximum employment in a context of price stability.
It is very welcome news that a return to these conditions has finally appeared in the
mediumterm outlook of many forecasters. But it will be much better news when this objective is
reached. My colleagues on the FOMC and I will stay focused on doing the Federal Reserve's
part to promote this goal.