Federal Reserve press conference, 2014-12-17 — Chair Janet Yellen

Question (Greg Ip, The Economist): Chair Yellen, the Committee’s projections show unemployment running below your own views on where full employment should be for the next several years. Does that reflect a desire on the part of the Committee that the economy run somewhat above potential for a while? And, if so, can you elaborate on why it wants that and what purpose it achieves? And, related to the question that Jon Hilsenrath asked earlier, you’ve called the decline in inflation— and market-based measures of inflation expectations—transitory. But this decline has been very pronounced in the five-year-forward range. So we’re talking about expectations that inflation many years from now will be below target. And some market participants see that as evidence of declining credibility in the Committee’s long-term objective. Why do you still view that as transitory?
Answer: So you—your first question is: Why is it that the Committee sees unemployment as declining slightly below its estimate of the longer-run natural rate? And, I think, in part, the reason for that is that inflation is running below our objective, and the Committee wants to see inflation move back toward our objective over time. And a short period of a very slight undershoot of unemployment below the natural rate will facilitate a slightly faster return of inflation to our objective. It is, I should say, a very small undershoot in a situation where there is great uncertainty about exactly what constitutes maximum employment or a longer-run normal rate of unemployment. We also do see the different measures of slack in the labor market point to different assessments of just what maximum employment is. The standard unemployment rate, for quite some time now, has been signaling a little bit less slack in the labor market than measures that are somewhat broader that, for example, include the unusually large number of people who were part-time employed but would prefer full-time jobs. And the portion of the decline we’ve seen in labor force participation, that looks like it would disappear in a—or be eroded in a stronger economy. And so it may be that with a very small undershoot of this longer-run normal level of the unemployment rate, as measured by the standard unemployment rate, we’ll be seeing some further progress on those other margins of slack. But it’s important to point out that the Committee is not anticipating an overshoot of its 2 percent inflation objective. Oh, and longer-dated expectations. Well, what I would say, we refer to this in the statement as “inflation compensation” rather than “inflation expectations.” The gap between the nominal yields on 10-year Treasuries, for example, and TIPS have declined—that’s inflation compensation. And five-year, five-year-forwards, as you’ve said, have also declined. That could reflect a change in inflation expectations, but it could also reflect changes in assessment of inflation risks. The risk premium that’s necessary to compensate for inflation, that might especially have fallen if the probabilities attached to very high inflation have come down. And it can also reflect liquidity effects in markets. And, for example, it’s sometimes the case that— when there is a flight to safety, that flight tends to be concentrated in nominal Treasuries and could also serve to compress that spread. So I think the jury is out about exactly how to interpret that downward move in inflation compensation. And we indicated that we are monitoring inflation developments carefully.