The monetary policy mandates of the Federal Reserve are clear: We must foster monetary and financial conditions that support maximum employment and price stability. Since January 2  BIS central bankers’ speeches  2012, the Fed has set an explicit goal for inflation of 2 percent, as measured by the price index for total personal consumption expenditures, or PCE. So, how are we doing with respect to this 2 percent target and our Zimbabwean risks? Despite many earlier predictions of unacceptably high inflation, total PCE inflation has been hovering around just 1 percent since early 2013. Other inflation measures, notably, the wellknown Consumer Price Index (CPI), are also well below their related benchmarks.1 Forecasters often look at core inflation, which excludes volatile food and energy prices, because it is a better predictor of where overall prices are headed than is total inflation. Our progress toward the inflation target is not noticeably faster by this metric either. Core PCE inflation was just 1.1 percent over the past year and has been at this rate since last spring. Most private sector forecasts and survey measures of inflation expectations have remained well anchored and do not ring any alarms of high inflation. Expectations embedded in asset prices tell a similar story. Sophisticated models that extract inflation expectations from the yield curve show that investors’ inflation expectations at the three-year horizon are below 2 percent and will be below 2 percent for several years. All told, the risk of high inflation seems very low.

This narrow view is unlikely to survive a broader analysis that takes into account all the interactions between financial markets and real economic activity. If more restrictive monetary policies were pursued to generate higher interest rates, they would likely result in higher unemployment and a sharp decline in asset prices, choking the moderate recovery. Such an adverse economic outcome is unlikely to set a favorable foundation for financial stability. Moreover, our short-term interest rate tools are too blunt to have a significant effect only on those pockets of the financial system that are most prone to inappropriate risk-taking. At the same time, these blunt tools could significantly damage other markets, as well as the growth prospects for the economy as a whole. Therefore, stepping away from otherwise appropriate monetary policy to address potential financial instability risks would degrade progress toward maximum employment and price stability. This approach would be a particularly poor choice when other tools are available, at lower social costs, to address the risk of financial instability. Let me be clear. I am not saying that financial stability concerns are not relevant for the economy or that policymakers should not take decisive action against developments that threaten financial stability. Rather, I am saying that the macroprudential tools available to policymakers are better-suited safeguards to addressing financial risks directly. These macroprudential actions can be dialed up or down given the appropriate setting of monetary policy tools; so, undesirable macroeconomic outcomes are less likely than if we were to resort to premature monetary tightening.