, which will reduce slack and allow inflation to move back to target. in this perspective, there are headwinds that are temporarily restraining economic growth, but these can be offset with aggressive monetary accommodation. an alternative view of shocks and gaps but there is an alternative interpretation. let ’ s look at a rather simple, but i think useful, figure. 1 the figure shows the level of real gdp as well as various vintages of potential gdp estimated by the u. s. congressional budget office ( cbo ). the cbo defines potential gdp as a “ measure of the economy ’ s maximum sustainable output, in which the intensity of resource use is neither adding to nor subtracting from inflationary pressure. ” 2 such a definition obviously has embedded in it some implicit assumptions about an underlying economic model, but i will return to this point shortly. i would like to draw your attention to two noteworthy features. first, during the recession, gdp fell sharply, as we all know. but since the end of the recession in june 2009, the economy has continued to grow at roughly the same pace as it grew before the recession. there has been little evidence of the rapid growth required to return the economy to the path of potential gdp as estimated by the cbo in 2007. while that may still happen, there has not been the v - shaped recovery to date anticipated by many. the shock that hit the economy appears to have had very persistent, if not permanent, effects. from a statistical perspective, the economy appears to have taken a permanent hit to the output level. the second noteworthy feature illustrated in the figure is that the cbo has revised its estimate of the path of potential gdp numerous times since the beginning of the recession. specifically, almost every year since 2007, it has revised down potential gdp. i am showing only three vintages here as an example. if you look at the “ gap, ” or the difference between the actual level of gdp – measured as of february 2013 when the latest cbo estimate of potential was released – and estimated potential, it is about half the size that it would have been if the path of potential gdp had not been revised. the gap is closing not because gdp has rebounded toward the earlier estimates of potential – but because potential gdp has fallen. and this has occurred in spite of aggressive policies – especially monetary policy – that were intended to boost economic growth rates. so, what might one infer from these observations? i want to offer a perspective based on

was used to describe episodes when the fed was viewed as providing lots of accommodation to stimulate employment and the economy – the go phase – only to find itself forced to apply the brakes abruptly to prevent a rapid uptick in inflation – the stop phase. this approach to policy led to more volatility and was more disruptive than many found desirable. for these reasons, i would prefer that we start to raise rates sooner rather than later. this may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act. conclusion to summarize, my own forecast is positive. second - quarter growth has rebounded, confirming that the disappointing performance in the first quarter was mostly weather related rather than a retrenchment to the ongoing recovery. unemployment continues to improve more quickly than many had expected, and inflation appears to be drifting up toward our 2 percent goal. if monetary policy is to be truly data dependent, then our stance of policy must begin to change. i ’ m not suggesting a rate increase now, but changing the forward guidance would at least afford us the flexibility to gradually raise rates beginning earlier than currently anticipated. waiting too long to begin raising rates – especially waiting until we have fully met our goals for maximum employment – is risky because we cannot know when we have arrived. that could also put monetary policy behind the curve and could lead to a return to abrupt go - stop policies that in the past led to unwelcome volatility. bis central bankers ’ speeches