Richard H Clarida: Outlook for the US economy and monetary
policy
Speech by Mr Richard H Clarida, Vice Chairman of the Board of Governors of the Federal
Reserve System, at the Peterson Institute for International Economics, Washington DC, 25
October 2018.
* * *
I see some familiar faces in the audience, and I am delighted to be at Peterson today to offer my
first public remarks since being sworn in last month as Vice Chairman of the Federal Reserve
Board. As some of you know, I have been a student of U.S. monetary policy for more than 30
years. So, for me, personally, it is a distinct honor and real privilege to have the opportunity to
serve with my colleagues on the Board of Governors and, along with the 12 Reserve Bank
presidents, on the Federal Open Market Committee (FOMC).
Now, of course, I fully realize that I have participated in just one FOMC meeting to date, so my
remarks today will not come with a patina earned from long experience as a monetary
policymaker. That said, I thought it might be of interest to share my thinking on the current state
of the U.S. economy, to explain how it informed my support for the FOMC's policy decision last
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month, and to discuss my views on the way forward for U.S. monetary policy.
The Economic Expansion in Year 10
The U.S. economic expansion, now in its 10th year, is marked by strong growth in the gross
domestic product (GDP) and a job market that has been surprising on the upside for nearly two
years. It is impossible today to know with much precision how much of the pickup in growth and
the decline in unemployment that we have seen over the past two years is structural and how
much is cyclical. Most likely, both factors are at work. That said, based on my reading of the
accumulating evidence, I believe that trend growth in the economy may well be faster and the
structural rate of unemployment lower than I would have thought several years ago. Let me
elaborate.
First, let's look at the demand side of the economy. Consider the benchmark revisions to the
household saving rate. Recently revised Commerce Department data now show that the
aggregate household saving rate is running at 6.7 percent of disposable income. This revised
estimate is nearly double the previous estimate. The higher level suggests that, in contrast to the
previous economic expansion from 2001 to 2007, when households were borrowing to maintain
consumption while income growth slowed, households today, at least in the aggregate, are well
positioned to maintain or even increase consumption relative to gains in income. To me, at this
stage in the business cycle, a historically high household saving rate is a tailwind for the
economy, not a headwind. And, of course, recent reductions in personal income tax rates are
also a tailwind for the economy.
Productivity and investment data provide another vantage point from which to assess both the
demand and supply sides of the current expansion. Over the past few years, we have seen
some pickup in productivity growth, albeit from a very depressed pace. By contrast, at a
comparable stage in both the 2001-07 and 1982-90 economic expansions, productivity growth
(as measured by an eight-quarter moving average) was actually slowing relative to its
contemporaneous peak-to-present pace.
I should also note that this recent pickup in productivity has coincided with a rebound in business
investment, and that this increase in capital spending has been evident in both the equipment
and intellectual property categories; it is not just an "oil patch" story. Business investment is
being supported by recent changes in the tax code that lower the cost of capital as well as by
continued strong profitability of U.S. companies. While capital investment is one important
source of productivity growth and recent data on this front are encouraging, predicting future or
even identifying past inflection points in productivity growth is notoriously difficult. Although it may
be tempting simply to extrapolate a decade of disappointing productivity data into a distant future,
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a pickup in trend productivity growth is a possibility that deserves close monitoring.
Let me now turn to the job market and inflation outlook. Average monthly job gains continue to
outpace the increase needed to provide jobs for new entrants to the labor force over the longer
run. At 3.7 percent in September, the unemployment rate has not been this low since 1969. In
addition, after remaining stubbornly sluggish throughout much of the expansion, wage growth is
picking up. A sustained rise in inflation-adjusted, or "real," wages at or above the pace of
productivity growth is typical in an economy operating in the vicinity of full employment, and we
are starting to see some evidence of this. I certainly hope it continues. Now, some might see a
rise in wages as leading to upside inflationary pressures, but here, again, the experience of
earlier cycles is instructive. In the past two U.S. expansions, gains in real wages in excess of
productivity growth were not accompanied by a material rise in price inflation.
Of course, this time may be different, and as with growth, the job market could perform better or
worse than the baseline outlook. However, for now, the increase in wages has been broadly
consistent with the pickup in productivity growth that I have just discussed, and a rise in the
stilllow rate of labor force participation among the prime-age population provides scope for the job
market to strengthen further without generating inflationary pressures.
This outlook for the labor market also reflects my view that the structural, or longer-run, rate of
unemployment that is, the unemployment rate consistent with stable inflation over the longer run
-may be somewhat lower than I would have thought several years ago. What this means is
that, even with today's very low unemployment rate, the labor market might not be as tight and
inflationary pressures not as strong as I once would have thought. I am certainly not alone in this
thinking. Over the past several years, most FOMC participants have been reducing their
individual estimates of the longer-run level of the unemployment rate. The median assessment of
FOMC participants fell from around 5-1/2 percent five years ago to 4-1/2 percent in the
projections published last month. Outside estimates, such as those from the Congressional
Budget Office and the Blue Chip Economic Indicators survey, show a similar pattern of
downward revisions. This makes sense. With unemployment falling and wage gains thus far in
line with productivity and expected inflation, the traditional indicators of cost-push price pressure
are not flashing red right now.
Both total and core personal consumption expenditure inflation are now running close to the
FOMC's 2 percent objective. When thinking about the inflation outlook, I pay attention to
marketbased measures of inflation compensation from the TIPS (Treasury Inflation-Protected
Securities) market as well as to surveys of inflation expectations. These "breakeven inflation
rates" are simply the difference between yields on traditional Treasury securities and those on
TIPS with comparable maturities. While these market-based measures are not perfect and need
to be adjusted for liquidity and term premium factors, they can provide a useful signal about
market inflation expectations, which can be combined with signals from surveys of expected
inflation to get a read on inflation expectations. Breakeven inflation rates have only recently risen
to a range that is in line but just barely with the expectation that inflation will remain close to our
2 percent inflation goal over the medium-to-longer run. Survey-based measures of inflation
expectations also appear consistent with the Fed's inflation goal.
In short, the labor market today is robust, and inflation is at or close to the Fed's 2 percent
inflation goal. Thus, the economy is as near as it has been in a decade to meeting both of the
Fed's dual-mandate objectives, which suggests to me that monetary policy at this stage of the
economic expansion should be aimed at sustaining growth and employment at levels consistent
with keeping inflation at or close to the 2 percent rate consistent with price stability. By contrast,
until this year, the appropriate focus of policy had been to return employment and inflation to
levels consistent with our dual-mandate objectives. With the economy now operating at or close
to mandate-consistent levels for inflation and unemployment, the risks that monetary policy must
balance are now more symmetric and less skewed to the downside.
Policy Remains Accommodative
I supported the FOMC's decision last month to raise the target for the federal funds rate to a
range of 2 to 2-1/4 percent. With the economy growing briskly, the labor market operating in the
vicinity of full employment, and inflation running close to 2 percent, I saw our decision as another
step in removing the extraordinary degree of accommodation put in place in the aftermath of the
Global Financial Crisis. However, even after our September decision, I believe U.S. monetary
policy remains accommodative. The funds rate is just now for the first time in a decade above
the Fed's inflation objective, but the inflation-adjusted real funds rate remains below the range of
estimates for the longer-run neutral real rate, often referred to as r*, computed from the
projections submitted by Board members and the Reserve Bank presidents.
This longer-run r*, like the natural rate of unemployment, is both unobserved and time
varying and thus must be inferred as a signal extracted from noisy macro and financial data.
That said, and notwithstanding the imprecision with which r* is estimated, it remains to me a
relevant consideration as I assess the current stance and best path forward for policy. The
reason for this is because, as Milton Friedman argued in his classic American Economic
Association presidential address, a central bank that seeks to consistently keep real interest
rates below r* will eventually face rising inflation and inflation expectations, while a central bank
that seeks to keep real interest rates above r* will eventually face falling inflation and inflation
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expectations. My own and others' research suggests that the failure of the Fed to respect this
principle contributed to the Great Inflation of the 1970s, while the incorporation of this principle
into Fed policy in the 1990s and 2000s contributed to the achievement of stable and low inflation
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during and since those years. So, even though estimates of r* are imprecise, I do not believe
they should be ignored. Instead, when thinking about monetary policy, I believe it is best not to
ignore entirely an admittedly imprecise estimate of r* today, but instead to update that estimate
as new data on inflation, inflation expectations, employment, growth, and productivity arrive.
Moreover, because monetary policy operates with a lag, and with inflation presently close to the 2
percent goal, it will be especially important to monitor inflation expectations closely using both
surveys and financial market data to best calibrate the pace and destination for policy
normalization. It will also be important to monitor both model-based and financial-market based
estimates of expected future inflation-indexed real interest rates (for example, 5-year real rates 5
years forward) suitably adjusted for term premium and liquidity effects as one indicator of
longer-run r*. Before the financial crisis, these 5-year real rates 5 years forward averaged around
2 percent after a term premium and liquidity adjustment. Since 2015, they have averaged about
0.50 percent but recently have approached 0.75 percent, also after a term and liquidity premium
adjustment. Given that real interest rates and economic growth tend to move together over the
longer run, one possible source of these upward revisions in forward real rates could be that
financial market participants may have become more optimistic about the growth potential of our
economy. Evidence also suggests that the term premium that investors require to hold
longermaturity bonds has risen as well.
The Way Forward
If the data come in as I expect, I believe that some further gradual adjustment in the federal funds
rate will be appropriate. As I mentioned earlier, I believe monetary policy today remains
accommodative, and that, with the economy now operating at or close to mandate-consistent
levels for inflation and unemployment, the risks that monetary policy must balance are now more
symmetric and less skewed to the downside. Raising rates too quickly could unnecessarily
shorten the economic expansion while moving too slowly could result in rising inflation and
inflation expectations down the road that could be costly to reverse.
As I calibrate, in the months ahead, the pace and ultimate destination for monetary policy
adjustments that will best allow the Fed to achieve its dual-mandate objectives, it will be
important to me to evaluate a wide range of economic and financial market indicators to
complement the predictions yielded by model-based scenarios. As I look ahead, if strong growth
and robust employment gains were to continue into 2019 and be accompanied by a material rise
in actual and expected inflation, that circumstance would indicate to me that additional policy
normalization might well be required beyond what I currently expect. By contrast, if strong growth
and employment gains were to continue and be accompanied by stable inflation, inflation
expectations, and expectations for Fed policy, that situation, to me, would argue against raising
short-term interest rates by more than I currently expect.
Conclusion
In closing, with the economy operating as close as it has in a decade to the Federal Reserve's
dual-mandate objectives of price stability and maximum employment, I believe monetary policy at
this stage of the economic expansion should be aimed at sustaining growth and maximum
employment at levels consistent with keeping inflation at or close to the 2 percent objective. Even
after our most recent policy decision to raise the range for the federal funds rate by 1/4
percentage point, monetary policy remains accommodative, and I believe some further gradual
adjustment in the policy rate range will likely be appropriate. That said, at this stage in the
business cycle, I believe it will be especially important to monitor a wide range of data to
continually assess and calibrate the level of the policy rate that is consistent with meeting our
objectives on a sustained basis.
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I am grateful to Antulio Bomfim of the Federal Reserve Board staff for his assistance in preparing this text. The
views expressed are my own and not necessarily those of other Federal Reserve Board members or Federal
Open Market Committee participants. Return to text
2
See Erik Brynjolfsson, Daniel Rock, and Chad Syverson (forthcoming), "Artificial Intelligence and the Modern
Productivity Paradox: A Clash of Expectations and Statistics," in Ajay K. Agrawal, Joshua Gans, and Avi Goldfarb,
eds., The Economics of Artificial Intelligence: An Agenda (Chicago: University of Chicago Press); an earlier
version is available at www.nber.org/chapters/c14007.pdf. Return to text
3
Milton Friedman (1968), "The Role of Monetary Policy," American Economic Review, vol. 58 (March), pp. 1-17.
Return to text
4
Richard Clarida, Jordi Galí, and Mark Gertler (2000), "Monetary Policy Rules and Macroeconomic Stability:
Evidence and Some Theory," Quarterly Journal of Economics, vol. 115 (February), pp. 147-80; Richard Clarida
(2015), "The Fed Is Ready to Raise Rates: Will Past Be Prologue?" International Finance, vol. 18 (Spring), pp.
93-107, doi.org/10.1111/1468-2362.12059; Timothy Cogley and Thomas J. Sargent (2002), "Evolving
PostWorld War II U.S. Inflation Dynamics," in Ben S. Bernanke and Kenneth Rogoff, eds., NBER Macroeconomics
Annual 2001, vol. 16 (Cambridge, Mass.: MIT Press), pp. 331-87, www.nber.org/chapters/c11068.pdf; and
Michael Woodford (2003), Interest and Prices: Foundations of a Theory of Monetary Policy (Princeton, N.J.:
Princeton University Press). Return to text