narayana kocherlakota : further thoughts on making monetary policy speech by mr narayana kocherlakota, president of the federal reserve bank of minneapolis, to the harvard club of minnesota, minneapolis, minnesota, 21 october 2011. * * * i thank doug clement, david fettig, terry fitzgerald and kei - mu yi for their helpful comments. thank you very much for that generous introduction. it is a special pleasure to meet with this group so soon after the announcement that two of your fellow alums have been awarded the 2011 prize in economic sciences in memory of alfred nobel. i am referring, of course, to thomas sargent and christopher sims, and i would like to begin my remarks by congratulating tom and chris on this well - deserved honor. in the 1970s, in independent research, they developed systematic approaches to distinguishing between cause and effect in macroeconomic data. now, almost 40 years later, their thinking informs the making of macroeconomic policy around the world. i am especially pleased to acknowledge chris and tom ’ s achievement because of their connection to the state of minnesota. after earning their ph. d. s in economics at harvard, where chris also received his undergrad degree in mathematics, tom and chris went on to do much of their prize - winning work right here in minneapolis, as professors at the university of minnesota and consultants at the federal reserve bank of minneapolis. i ’ m sure that many of you in the room today followed that same career path, from an education at one of america ’ s oldest colleges to accomplishing great things here in the north star state. in my remarks today, i ’ d like to touch on several topics. i ’ ll begin with a quick description of the structure of the federal reserve system and the deliberative process of the federal open market committee – the committee that makes monetary policy for the nation. then i ’ ll describe the fomc ’ s objectives and discuss how the fomc makes decisions so as to achieve those objectives. i ’ ll close with a discussion of my dissents on recent fomc decisions and some perspectives on monetary policy going forward. after that, i ’ ll be pleased to answer any questions you may have. and before i begin, i should remind you that my comments here today reflect my views alone, and not necessarily those of others in the federal reserve system, including my fomc colleagues. some fomc basics the federal reserve bank of minneapolis is one of 12 regional reserve banks

technological productivity, job market efficiency, unemployment insurance benefits, entrepreneurial credit access and social norms all influence what we might consider “ maximum employment. ” trying to offset these changes in the economy with monetary policy can lead to a dangerous drift in inflationary expectations and ultimately in inflation itself. over the past year, the fomc has communicated through its statements that it perceives the current unemployment rate to be elevated relative to levels that it views as consistent with its dual mandate. in this situation, there is a trade - off involved in the making of monetary policy. on the one hand, adding monetary accommodation reduces unemployment. on the other hand, adding accommodation increases the risk of generating inflation markedly higher than the committee ’ s objective of 2 percent for a significant period of time. in choosing whether to add monetary stimulus or not, the committee must resolve this trade - off between the fall in unemployment and the increase in the risk of inflation. i ’ ve described the relevant trade - off in the traditional way as being one between employment gains and inflation risks. this description emphasizes a tension between the two mandates of the federal reserve. but, as i explained earlier, if the public observes inflation running at more than 2 percent for multiple years, their inflation expectations may drift upward. this increase in expectations can give rise to a need for monetary tightening that may generate large employment losses. in other words, when thinking about adding monetary the discussion in this paragraph is largely consistent with the following quote from chairman bernanke ’ s response to a reporter ’ s question in april about the fed ’ s ability to lower the rate of unemployment more rapidly : “ even purely from an employment perspective – that if inflation were to become unmoored, inflation expectations were to rise significantly, that the cost of that in terms of employment loss in the future, as we had to respond to that, would be quite significant. ” ( see transcript of chairman bernanke ’ s april 27, 2011, press conference, p. 14. ) bis central bankers ’ speeches accommodation, the federal reserve confronts a basic trade - off that can be framed without reference to its price stability mandate : a trade - off between short - term employment gains and the risk of larger longer - term employment losses. making monetary policy : responding to a mandate dashboard the fomc ’ s dual mandate, as i ’ ve said, is to keep inflation at 2 percent or a bit under and to promote maximum employment – that is, to keep unemployment low. but how