Sarah Bloom Raskin: Monetary policy and job creation
Speech by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal
Reserve System, at the University of Maryland Smith School of Business Distinguished
Speaker Series, Washington DC, 26 September 2011.
* * *
I appreciate the assistance of Hess Chung, William English, Jean-Philippe Laforte, Andrew Levin, Susan Stawick,
William Wascher, David Wilcox, and Joyce Zickler in the preparation of these remarks.
Good morning. It's a great pleasure to be with you, and I want to thank the Center for
Financial Policy at the Robert H. Smith School of Business for inviting me to participate in
this forum. Indeed, I am delighted to see that the Center for Financial Policy is already
thriving. Back in 2008, when I was the Commissioner of Financial Regulation for the State of
Maryland, two of the founders of the center talked with me about its inception and asked for
my ideas about what it might accomplish. And I am so glad to see that - despite the
formidable challenges facing all such new projects - the center is now fully engaged in
addressing financial policy issues that are critically important to our nation.
Today I want to discuss how monetary policy can promote the objective of maximum
employment in a context of price stability. I will set the stage by reviewing current labor
market conditions, and then I will talk about the tools that the Federal Reserve has been
deploying to foster job creation and promote a stronger economic recovery. I will do my best
to make these points in plain English rather than economic jargon, but feel free to correct me
if I lapse back into it - my children certainly do. Of course, it goes without saying that these
remarks are intended to express my views only and not necessarily the opinions of my
colleagues on the Federal Reserve Board or the Federal Open Market Committee (FOMC).
Current labor market conditions
The global economy began slowing in late 2007 and early 2008 and turned downward
sharply in the autumn of 2008 when the financial crisis intensified, resulting in the worst
recession in many decades. By the end of 2009, the unemployment rate reached a horrifying
10 percent, corresponding to more than 15 million Americans being out of work, with all of
the attendant social consequences, including lost income and wealth, mortgage foreclosures,
family strains, health problems, and so on.
Officially, the recovery from the recession began in the third quarter of 2009, but the pace of
recovery has been modest. We have learned from recent comprehensive revisions of
government economic data that the recession was deeper and the recovery weaker than had
previously been thought. Indeed, the most recent reading on real gross domestic product
(GDP) in the United States - the one for the second quarter of this year - still has not
returned to the level that it had attained before the crisis, and the increases in economic
activity over the past two years have been at a rate insufficient to achieve any sustained
reduction in the unemployment rate.
The latest employment report issued by the Bureau of Labor Statistics was bleak.
Privatesector employers added only 17,000 nonfarm jobs in August, far fewer than the already weak
average monthly gain of about 110,000 recorded over the previous three months. The
headline unemployment rate was 9.1 percent, representing about 14 million Americans who
were out of work in August.
Nonetheless, as many families know, the headline unemployment numbers don't fully
capture the weakness in labor market conditions. Beyond the headline number, an additional
8.8 million workers were classified as "part time for economic reasons" in August because
their hours had been cut back or they were unable to find a full-time job. In addition, about
2-1/2 million Americans were classified as "marginally attached" to the labor force because
even though they wanted to get a job, they had not searched for one in the past four weeks.
And almost half of that group - nearly 1 million individuals - have given up searching for
employment altogether, because they do not believe any jobs are available for them.
So it is not just those who are currently classified as unemployed who are excluded from
work. The underemployed, the marginally attached, and the discouraged - all of whom are
concerned about the security of their livelihood, their housing, and the rising cost of living -
can speak powerfully to the weaknesses of the recovery.
The economic data in this regard correspond to what I have seen firsthand over the past
several years. I have traveled to once-robust manufacturing cities in the Midwest and have
observed vacant lots, burnt-out factories, metal scrap heaps, and foreclosed homes. I have
visited unemployment insurance offices and job training centers, and I have met lots of
people who have been out of work for more than a year or two - out of work for so long that
some of them are embarrassed to show their resumes to potential employers.
These circumstances have called for forceful policy measures. I will now talk about the
conventional and unconventional actions that the Federal Reserve, for its part, has taken to
foster economic recovery and job creation.
Conventional monetary policy actions
The conventional tool of monetary policy is to modify the near-term path of interest rates. To
be more specific, a reduction in current short-term rates and a corresponding downward shift
in private-sector expectations about the future path of such rates will tend to reduce
borrowing rates for households and businesses, including auto loan rates, mortgage rates,
and other longer-term interest rates. This policy accommodation also tends to raise
household wealth by boosting the stock market and prices of other financial assets.
With greater household wealth and cheaper borrowing rates, consumers tend to increase
their purchases of houses, cars, and various other goods and services. In response,
businesses ramp up their production to meet the increased level of sales. Moreover, with
lower costs of financing new equipment and structures, businesses may be inclined to
increase their own spending on investment projects that they might previously have seen as
only marginally profitable. In the near term, firms can meet increased demand by resorting to
temporary and part-time workers, but over time they have strong incentives to increase the
number of regular full-time employees. Consequently, the monetary accommodation leads to
greater job creation, though sometimes with substantial time lags.
The Federal Reserve has used this policy tool aggressively since the onset of the financial
crisis. In particular, the federal funds rate target, which stood at 5-1/4 percent in mid-2007,
was subsequently reduced to a range of 0 to 1/4 percentage point by the end of 2008, and
that target range has been maintained since then. Indeed, because currency has an implicit
interest rate of exactly zero, economists generally agree that a zero interest rate is the
effective lower bound for the federal funds rate because investors could simply choose to
hold cash if a central bank tried to drive short-term interest rates significantly below zero. In
effect, therefore, the FOMC has been deploying its conventional policy tool to the maximum
extent possible since late 2008.
Rather than reviewing the vast academic literature regarding the effect of conventional
monetary policy, I will simply pose the counterfactual question: What would have happened
to U.S. employment if monetary policy had failed to respond forcefully to the financial crisis
and economic downturn? Economic models - the Fed's and others - suggest that if the
federal funds rate target had been held at a fixed level of 5 percent from the fourth quarter of
2007 until now, rather than being reduced to its actual target range of 0 to 1/4 percent,1 then
the unemployment rate would be several percentage points higher than it is today. In other
words, by following our actual policy of keeping the target funds rate at its effective lower
bound since late 2008, the Federal Reserve saved millions of jobs that would otherwise have
been lost. Of course, substantial uncertainty surrounds various specific estimates, but there
should be no doubt that the FOMC's forceful actions helped mitigate the consequences of
the crisis and thereby spared American families and businesses from even greater pain.
Unconventional monetary policy actions
Given the magnitude of the global financial crisis and its aftermath, the Federal Reserve
clearly needed to provide additional monetary accommodation beyond simply keeping
shortterm interest rates close to zero. Consequently, like a number of other major central banks
around the world, the FOMC has been deploying unconventional policy tools to promote the
economic recovery.
In particular, we have provided conditional forward guidance about the likely future path of
the federal funds rate, and we have engaged in balance sheet operations that involve
changes in the size and composition of our securities holdings. Broadly speaking, these
policy tools affect the economy through channels that are similar - though not identical - to
those of conventional monetary policy. I'll now spend a few minutes describing how each
form of unconventional policy can be helpful in promoting a stronger economic recovery.
Monetary policy communication
An essential element of good monetary policy is effective communication. In a democratic
society, central banks have the responsibility to clearly and fully explain their policy
decisions. Good communication is also essential for strengthening the effectiveness of
monetary policy. Expectations about the future play a key role in the decision-making of
households and firms: how much to spend, save, work, invest, or hire. Moreover, when
financial market participants understand how the central bank is likely to react to incoming
information, asset prices can adjust in ways that reinforce the central bank's expected policy
actions and thereby support the central bank's objectives. Finally, clear communication can
help anchor the public's long-term inflation expectations and hence improve the extent to
which the central bank can take forceful actions to promote job creation in a context of price
stability.
With the federal funds rate constrained by its effective lower bound, effective
communications with the public have become more important than ever. Since 2009, the
Federal Reserve has published the Committee participants' longer-run projections of the
inflation rate, the unemployment rate, and economic growth four times a year in conjunction
with the minutes of FOMC meetings. Based on their longer-run projections for inflation,
Committee participants judge that an inflation rate of 2 percent or a bit less, as measured by
the price index for personal consumption expenditures, is most consistent with our statutory
mandate of maximum employment and price stability.2 The Committee currently strives for as
low an unemployment rate as possible, consistent with price stability. In our most recent
projections, Committee participants estimated that the longer-run sustainable rate of
unemployment is around 5 to 6 percent - well below the current unemployment rate of
9.1 percent.
Since December 2008, the FOMC has been providing conditional forward guidance about
the likely path of the target federal funds rate. From March 2009 through June 2011, the
Committee's forward guidance indicated that exceptionally low levels of the federal funds
rate were likely to be warranted "for an extended period." In August, we decided to be more
specific about the timing, and our two most recent meeting statements have indicated that
"economic conditions - including low rates of resource utilization and a subdued outlook for
inflation over the medium run - are likely to warrant exceptionally low levels for the federal
funds rate at least through mid-2013."3
Forward guidance can provide monetary accommodation by leading investors to expect a
longer period of low interest rates. As I noted earlier, a downward shift in the expected path
of the federal funds rate is associated with reduced longer-term interest rates and generates
a significant boost to consumer and business spending. Simulations of the FRB/US model
and other evidence suggest that forward guidance can be a potent tool of monetary policy.4
Balance sheet operations
Since late 2008, the FOMC has engaged in two rounds of large-scale asset purchases
(LSAPs). The first round of LSAPs involved purchases of about $1.4 trillion in agency
mortgage-backed securities (MBS) and agency debt securities and about $300 billion in
longer-term Treasury securities; those purchases were executed during 2009 and the first
quarter of 2010. The second round of LSAPs - often referred to as QE2 - involved an
additional $600 billion in purchases of longer-term Treasury securities and was completed at
the end of June of this year.
By purchasing longer-term securities in the open market, the Federal Reserve can exert
downward pressure on longer-term yields, thereby reducing private borrowing rates and
raising household wealth. Consequently, just as with conventional monetary policy, LSAPs
help boost consumer spending, business investment, and net exports. And the resulting
increase in aggregate demand helps generate a stronger pace of job creation.5
At last week's FOMC meeting, the Committee announced that we intend to extend the
average maturity of our securities holdings over the coming months by selling $400 billion of
short-term Treasury securities and purchasing an equivalent amount of long-term Treasury
securities. This maturity extension program - referred to by some as Operation Twist -
should exert downward pressure on longer-term interest rates and help make broader
financial conditions more accommodative, thereby supporting a stronger economic recovery.
Indeed, recent work by an economist at the Federal Reserve Bank of San Francisco
suggests that a similar policy put in place in 1961 had effects on longer-term interest rates
that were roughly comparable to those of QE2.6
3
The August and September FOMC meeting statements, as well as related FOMC information, are available on
the Federal Reserve Board's website at www.federalreserve.gov/monetarypolicy/fomccalendars.htm.
4
See Janet L. Yellen (2011), "Unconventional Monetary Policy and Central Bank Communications," speech
delivered at the U.S. Monetary Policy Forum, New York, February 25,
www.federalreserve.gov/newsevents/speech/yellen20110225a.htm.
5
See Hess Chung, Jean-Philippe Laforte, David Reifschneider, and John C. Williams (forthcoming), "Have We
Underestimated the Likelihood and Severity of Zero Lower Bound Events?" Journal of Money, Credit and
Banking.
6
See Eric T. Swanson (2011), "Let's Twist Again: A High-Frequency Event-Study Analysis of Operation Twist
and Its Implications for QE2 (PDF)," Federal Reserve Bank of San Francisco Working Paper 2011-08
(San Francisco: Federal Reserve Bank of San Francisco, February),
www.frbsf.org/publications/economics/papers/2011/wp11-08bk.pdf.
Another significant policy action taken at last week's FOMC meeting is that the principal
payments from our holdings of agency securities will now be reinvested in agency MBS
rather than in Treasury securities. Our announcement appears to have been successful in
narrowing the spread between rates on agency MBS and Treasury securities of comparable
maturity. That spread had widened substantially since earlier this year, and the continuation
of such a trend could have pushed up mortgage rates and adversely affected the housing
sector.
Potential attenuating factors
In my judgment, the Federal Reserve's deployment of our policy tools has been completely
appropriate in promoting maximum employment and price stability. Ideally, such policy
decisions would be informed by precise quantitative information about the effects of each
tool. In reality, however, the estimated effects of the FOMC's policy actions are subject to
considerable uncertainty. Such uncertainty is intrinsic to real-world monetary policymaking at
any time but is particularly relevant under circumstances where the scope for conventional
monetary policy is constrained by the zero lower bound on the federal funds rate, leaving
unconventional tools as the only means of providing further monetary accommodation.
Although these monetary policy tools have been successful in pushing down interest rates
across the maturity spectrum, the magnitude of the transmission to economic growth and
employment has been somewhat more muted than I might have expected. Indeed, it seems
plausible that the effectiveness of our policy tools is being attenuated by a number of unusual
persisting factors, including an excess supply of housing and impaired access to credit for
many households and small businesses.
Under normal circumstances, residential construction is an interest-sensitive sector of the
economy that has played an important role in contributing to previous economic recoveries -
especially the brisk recovery that followed the steep downturn in 1981 and 1982. In the wake
of the bursting of the housing bubble, however, the housing sector has remained exceedingly
weak. In effect, there is an excess supply of housing that seems likely to decline only
gradually despite the record-low level of mortgage rates. Thus, in this crucial sector, one can
argue that lower interest rates have not shown through to higher activity in the same way that
would be expected under more usual recoveries.
Consumer spending is also being restrained by the excess supply of housing, which has put
downward pressure on home equity values and household wealth. A substantial portion of
homeowners now have negative home equity and are effectively unable to refinance at
historically low mortgage rates. Many more have seen a drastic decline in the value of their
homes, which would typically serve as collateral for home equity lines of credit or second
mortgages.
The slow progress in repairing and restructuring households' balance sheets may also be
lowering the normal responsiveness of consumer spending to a decline in market interest
rates. In particular, lenders continue to maintain relatively tight terms and standards on credit
cards and, to a lesser extent, other consumer loans. Consequently, many households may
be unable to take advantage of the lower borrowing rates that are available to those who
have a high net worth and pristine credit records.
Many small businesses also appear to be facing unusual obstacles in obtaining credit. If
times were more typical, we would expect a smooth transmission in which lower interest
rates would fuel credit expansion that would be used to finance expanding payrolls, capital
investment, inventories, and other short-term operating expenses. Nonetheless, the latest
Federal Reserve Senior Loan Officer Opinion Survey on Bank Lending Practices, which was
taken in July, indicated that although domestic banks continued to ease standards on their
commercial and industrial loans, the net fraction reporting easing on such loans to smaller
firms (those with annual sales of less than $50 billion) remained low and was well below that
of loans to large and middle-sized firms.7 In its August survey, the National Federation of
Independent Businesses reported a noticeable increase in the proportion of small businesses
reporting that credit has become more difficult to obtain.8 These businesses not only expect
credit to become tighter in coming months but - like other businesses - have turned sharply
more pessimistic about the broader economic outlook.
Finally, and perhaps most comprehensively, it is worth observing that the financial crisis has
undermined the wealth of many Americans. Low- and moderate-income families entered the
recession with little financial buffer against the adverse effects of wage cuts, job loss, and
drops in home values. According to the 2007 Survey of Consumer Finances (SCF), home
equity accounted for about half of the total net worth for low- and moderate-income families,
which made them extremely vulnerable to the eventual housing market collapse.9 Families at
the lower end of the income distribution saw a substantial drop in their net worth between
2007 and 2009, and families in the middle of the income distribution fared even worse.10
Combined with widespread unemployment, housing and stock price declines, and increasing
rates of mortgage defaults, foreclosures, and bankruptcies, the assets of many American
families have been significantly eroded. The effect of these developments may be to
attenuate the revival of normal consumption patterns that would otherwise be dictating
increases in consumer demand and growth.
Diversity of views
Even if the usual effectiveness of monetary policy is being attenuated by the factors that I
have mentioned, that conclusion should not be taken as implying that additional monetary
accommodation would be unhelpful. Indeed, the opposite conclusion might well be the
case - namely, that additional policy accommodation is warranted under present
circumstances.
My FOMC colleagues and I have recently been faced with complex decisions about the use
of unconventional policy tools under extraordinary economic and financial conditions. And
while we may not all agree with every decision, I believe that the public can have a very high
degree of confidence in the fundamental integrity and soundness of our decision-making
process.
Indeed, some commentators assign a label of "hawk" or "dove" to the various FOMC
participants in an attempt to characterize how we prioritize the goals of maximum
employment and price stability. In my view, such labels are ill conceived and misleading
because everyone on the Committee is fully committed to promoting both of these goals.
Incidentally, since my kids now love describing everyone as a hawk or a dove or some other
kind of bird, I have taken to reminding them of this conviction I have: When my colleagues
and I are doing our job correctly, we are neither hawks nor doves but owls - that is, we are
trying to be as wise as possible in deploying all the tools we have to fulfill our legal mandate.
7
The Senior Loan Officer Opinion Survey on Bank Lending Practices is available on the Federal Reserve
Board's website at www.federalreserve.gov/boarddocs/SnLoanSurvey.
8
See National Federation of Independent Businesses (2011), NFIB Small Business Economic Trends (PDF)
(Nashville: NFIB, August), www.nfib.com/Portals/0/PDF/sbet/sbet201108.pdf.
9
See Brian K. Bucks, Arthur B. Kennickell, Traci L. Mach, and Kevin B. Moore (2009), "Changes in U.S. Family
Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances (PDF)," Federal Reserve
Bulletin, vol. 95 (February), pp. A1-A55, www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf.
10
See Jesse Bricker, Brian K. Bucks, Arthur B. Kennickell, Traci L Mach, and Kevin B. Moore (2011), "Surveying
the Aftermath of the Storm: Changes in Family Finances from 2007 to 2009 (PDF)," Finance and Economics
Discussion Series 2011-17 (Washington: Board of Governors of the Federal Reserve System, March),
www.federalreserve.gov/pubs/feds/2011/201117/201117pap.pdf.
Conclusion
In summary, the economic recovery has fallen well short of restoring labor market conditions
to historically typical levels. Given the elevated rate of unemployment and the large number
of individuals who are experiencing long spells of unemployment, both fiscal and monetary
policymakers should be considering a wide array of approaches for promoting job creation. In
my view, the deployment of our monetary policy tools needs to be carefully gauged,
appropriately timed, and clearly communicated to the public. Moreover, to the extent that
some factors may attenuate the usual effectiveness of monetary policy, there is a compelling
case to identify and implement policy measures to mitigate those factors and thereby
strengthen the effect of the monetary accommodation that we have already put in place.
Finally, in light of the economic hardships that are facing our nation, I want to underscore that
the Federal Reserve is fully committed to doing everything we can to promote maximum
employment in the context of price stability.
Thank you again for the opportunity to speak with you today, and I look forward to hearing
your comments and questions.