August 31, 2020
The Federal Reserve’s New Monetary Policy Framework: A Robust Evolution
Vice Chair Richard H. Clarida
At the Peterson Institute for International Economics, Washington, D.C. (via webcast)
Last week, the Federal Reserve reached an important milestone in its ongoing review of its monetary policy strategy, tools, and communication practices with the unanimous approval and release of a new Statement on Longer-Run Goals and Monetary Policy Strategy.1 In my remarks today, I will discuss our new framework and highlight some important policy implications that flow from the revised statement and our new strategy.2 I believe that this new statement and strategy represent a critical and robust evolution of our framework that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future.
I will divide my remarks into four parts. First, I will discuss the factors that motivated the Federal Reserve in November 2018 to announce it would undertake in 2019 the first-ever public review of its monetary policy strategy, tools, and communication practices. Second, I will discuss the review process itself, with particular focus on the economic analysis and public input the Federal Open Market Committee (FOMC) drew on as it contemplated, over the past 18 months, potential changes to its policy framework. Third, I will briefly summarize the flexible inflation-targeting strategy that has been guiding U.S. monetary policy since 2012 in the context of some important changes in the economic landscape that have become evident since 2012. Fourth, I will discuss the major findings of the review as codified in our new Statement on Longer-Run Goals and Monetary Policy Strategy and highlight some important policy implications that flow from them. Finally, I will offer some brief concluding remarks before joining in conversation with my good friend Adam Posen, which, as always, I very much look forward to.
Motivation for the Review
As my FOMC colleagues and I indicated from the outset, the fact that the Federal Reserve System chose to conduct this review does not indicate that we believed we have been poorly served by the framework in place since 2012. Indeed, I would argue that over the past eight years, the framework served us well and supported the Federal Reserve's efforts after the Global Financial Crisis (GFC) first to achieve and then, for several years, to sustain—until cut short this spring by the COVID-19 pandemic—the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability in what became the longest economic expansion in U.S. history. Nonetheless, both the U.S. economy—and, equally importantly, our understanding of the economy—have clearly evolved along several crucial dimensions since 2012, and we believed that in 2019 it made sense to step back and assess whether, and in what possible ways, we might refine and rethink our strategy, tools, and communication practices to achieve and sustain our goals as consistently and robustly as possible in the global economy in which we operate today and for the foreseeable future.3
Perhaps the most significant change since 2012 in our understanding of the economy is our reassessment of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. In January 2012, the median FOMC participant projected a long-run r* of 2.25 percent, which, in tandem with the inflation goal of 2 percent, indicated a neutral setting for the federal funds rate of 4.25 percent. However, in the eight years since 2012, members of the Committee—as well as outside forecasters and financial market participants—have repeatedly marked down their estimates of longer-run r* and, thus, the neutral nominal policy rate.4 Indeed, as of the most recent Summary of Economic Projections (SEP) released in June, the median FOMC participant currently projects a longer-run r* equal to just 0.5 percent, which implies a neutral setting for the federal funds rate of 2.5 percent. Moreover, as is well appreciated, the decline in neutral policy rates since the GFC is a global phenomenon that is widely expected by forecasters and financial markets to persist for years to come.5
The substantial decline in the neutral policy rate since 2012 has critical implications for the design, implementation, and communication of Federal Reserve monetary policy because it leaves the FOMC with less conventional policy space to cut rates to offset adverse shocks to aggregate demand. With a diminished reservoir of conventional policy space, it is much more likely than was appreciated in 2012 that, in economic downturns, the effective lower bound (ELB) will constrain the ability of the FOMC to rely solely on the federal funds rate instrument to offset adverse shocks.6 This development, in turn, makes it more likely that recessions will impart elevated risks of more persistent downward pressure on inflation and upward pressure on unemployment that the Federal Reserve's monetary policy should, in design and implementation, seek to offset throughout the business cycle and not just in downturns themselves.7
Two other, related developments that have also become more evident than they appeared in 2012 are that price inflation seems less responsive to resource slack, and also, that estimates of resource slack based on historically estimated price Phillips curve relationships are less reliable and subject to more material revision than was once commonly believed.8 For example, in the face of declining unemployment rates that did not result in excessive cost-push pressure to price inflation, the median of the Committee's projections of u*—the rate of unemployment consistent in the longer run with the 2 percent inflation objective—has been repeatedly revised lower, from 5.5 percent in January 2012 to 4.1 percent as of the June 2020 SEP.9 Projections of u* by the Congressional Budget Office and professional forecasters show a similar decline during this same period and for the same reason.10 In the past several years of the previous expansion, declines in the unemployment rate occurred in tandem with a notable and, to me, welcome increase in real wages that was accompanied by an increase in labor's share of national income, but not a surge in price inflation to a pace inconsistent with our price-stability mandate and well-anchored inflation expectations. Indeed, this pattern of mid-cycle declines in unemployment coincident with noninflationary increases in real wages has been evident in the U.S. data since the 1990s.11
With regard to inflation expectations, there is broad agreement among academics and policymakers that achieving price stability on a sustainable basis requires that inflation expectations be well anchored at the rate of inflation consistent with the price-stability goal. This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation.12 The pre-GFC academic literature derived the important result that a credible inflation-targeting monetary policy strategy that is not constrained by the ELB can deliver, under rational expectations, inflation expectations that themselves are well anchored at the inflation target.13 In other words, absent a binding ELB constraint, a policy that targets actual inflation in these models delivers long-run inflation expectations well anchored at the target "for free." But this "copacetic coincidence" no longer holds in a world of low r* in which adverse aggregate demand shocks are expected to drive the economy in at least some downturns to the ELB. In this case, which is obviously relevant today, economic analysis indicates that flexible inflation-targeting monetary policy cannot be relied on to deliver inflation expectations that are anchored at the target, but instead will tend to deliver inflation expectations that, in each business cycle, become anchored at a level below the target.14 This is the crucial insight in my colleague John Williams' research with Thomas Mertens. Indeed John's research over the past 20 years on r* estimation and monetary policy design at the ELB have been enormously influential, not only in the profession but also at Fed and certainly in my own thinking about how our framework should evolve. This downward bias in inflation expectations under inflation targeting in an ELB world can in turn reduce already scarce policy space—because nominal interest rates reflect both real rates and expected inflation—and it can open up the risk of the downward spiral in both actual and expected inflation that has been observed in some other major economies.
Inflation expectations are, of course, not directly observed and must be imperfectly inferred from surveys, financial market data, and econometric models. Each of these sources contains noise as well as signal, and they can and sometimes do give contradictory readings. But, at minimum, the failure of actual PCE (personal consumption expenditures) inflation—core or headline—over the past eight years to reach the 2 percent goal on a sustained basis cannot have contributed favorably to keeping inflation expectations anchored at 2 percent. Indeed, my reading of the evidence is that the various measures of inflation expectations I follow reside at the low end of a range I consider consistent with our 2 percent inflation goal.15
The Review Process
With this brief overview of important changes in the economic landscape since 2012, I would now like to discuss the review process itself. In November 2018, the Federal Reserve announced that in 2019 the System would undertake a wide-ranging, public review of its monetary policy strategy, tools, and communication practices. This initiative would be the first-ever public review of monetary policy strategy ever undertaken by the Fed. From the outset, it was conceived that the review would build on three pillars: a series of livestreamed Fed Listens events hosted by each of the 12 Reserve Banks and the Board, a flagship research conference hosted by the Federal Reserve Bank of Chicago, and a series of 13 rigorous briefings for the Committee by System staff at a succession of five consecutive FOMC meetings commencing in July 2019 and running through January 2020.
The Fed Listens series built on a long-standing practice at the Reserve Banks and the Board of hosting outreach events that included a wide range of community groups, but, by focusing on a common format in which representatives of these groups were encouraged to tell their stories about our policies' effect on their communities and daily lives, it became a potent vehicle for us to better connect with the people our policies are meant to benefit. Although many people across the System were involved in making Fed Listens the success it was, I would be more than remiss if I did not single out Ellen Meade for her indefatigable contributions and attention to detail and organization that were essential to pulling the whole thing off. A report on the Fed Listens series is available on the Board's web site.16
The second pillar of our review, a research conference hosted by the Federal Reserve Bank of Chicago, brought together some of the world's leading academic experts in monetary economics to present bespoke papers on a range of topics central to the review. These papers and the robust discussion at the conference that they stimulated were an important input to the review process. The proceedings of the Chicago conference are available as a special January 2020 issue of the International Journal of Central Banking.17
The third important pillar of the review is a collection of 13 memos prepared by System staff and discussed by the Committee at a number of FOMC meetings over the past 18 months. These memos were commissioned by a System steering committee that included Jeff Fuhrer, Marc Giannoni, and David Altig, with extensive input from Trevor Reeve. Thomas Laubach chaired the steering committee, and I must note that we simply would not be here today discussing this significant evolution of our framework without Thomas and the insights, inspiration, and good judgment that he brought to the project and the review process. A collection of the staff memos prepared for the review is now available on the Board's website.18
A New Economic Landscape Compels a Framework ReThink
As I mentioned earlier, the Committee devoted five consecutive FOMC meetings between July 2019 and January 2020 to presentations by the staff and Committee discussions of memos touching on various aspects of the framework review, and it held a lengthy discussion at the July 2020 FOMC meeting about the new Statement on Longer-Run Goals and Monetary Policy Strategy.19 While it is fair to say that these Committee discussions revealed among the 17 participants a healthy range of views about and priorities for refining our framework and strategy, some common themes did emerge, and these provided the foundation for the revised Statement on Longer-Run Goals and Monetary Policy Strategy that the Committee discussed in July, approved last week, and released on Thursday, August 27.
Broadly, we agreed that the economic landscape has changed in important ways since 2012 and that, as a result, the existing statement and the monetary policy strategy that flows from it need as well to evolve along several dimensions.20 For example, under our previous flexible inflation-targeting framework, the Federal Reserve declared that the 2 percent inflation objective is "symmetric." This term has been interpreted by many observers to mean that the Committee's reaction function aimed to be symmetric on either side of the 2 percent inflation goal, and that the FOMC set policy with the (ex ante) aim that the 2 percent goal should represent an inflation ceiling in economic expansions following economic downturns in which inflation falls below target. Regarding the ELB, the previous statement was silent on the global decline in neutral policy rates, the likelihood that the ELB will constrain monetary policy space in economic downturns, and the implications of this constraint for our ability to achieve our dual-mandate goals. As for inflation expectations, the previous statement did discuss expected inflation, but only in the context of mentioning that the announcement of a 2 percent goal helps anchor inflation expectations. While this is certainly true, it does beg the deeper question of how well anchored inflation expectations can be if the 2 percent goal is seen by the public as—and turns out ex post to be—a ceiling. Regarding the maximum-employment leg of the dual mandate, the previous statement's discussion of minimizing "deviations" of employment from its maximum level does not adequately reflect how the FOMC has actually conducted monetary policy in recent years—before the pandemic—as the actual unemployment rate was declining and, for several years, remained below SEP median projections of u* (although, to be sure, the earlier statement did acknowledge that it can be difficult to estimate the maximum level of employment with precision).21
The New Statement and Strategy
Before discussing how our Statement on Longer-Run Goals and Monetary Policy Strategy has evolved, let me highlight some important elements that remain unchanged. First and foremost, our policy framework and strategy remain focused exclusively on meeting the dual mandate assigned to us by the Congress. Second, our statement continues to note that the maximum level of employment that we are mandated to achieve is not directly measurable and changes over time for reasons unrelated to monetary policy. Hence, we continue not to specify a numerical goal for our employment objective as we do for inflation. Third, we continue to state that an inflation rate of 2 percent over the longer run is most consistent with our mandate to promote both maximum employment and price stability. Finally, because the effect of monetary policy on the economy operates with a lag, our strategy remains forward looking. As a result, our policy actions depend on the economic outlook as well as the risks to the outlook, and we continue in the new statement to highlight potential risks to the financial system that could impede the attainment of our dual-mandate goals on a sustained basis.
With respect to the new framework itself, the statement now notes that the neutral level of the federal funds rate has declined relative to its historical average and therefore that the policy rate is more likely than in the past to be constrained by its ELB, and, moreover, that this binding ELB constraint is likely to impart downside risks to inflation and employment that the Committee needs to consider in implementing its monetary policy strategy. In this regard, the statement now highlights that the Committee is prepared to use its full range of tools to achieve its dual-mandate objectives.22
Regarding the maximum-employment mandate, the new statement now acknowledges that maximum employment is a "broad-based and inclusive goal" and continues to state that the FOMC considers a wide range of indicators to assess the level of maximum employment consistent with this broad-based goal. However, under our new framework, policy decisions going forward will be based on the FOMC's estimates of "shortfalls of employment from its maximum level"—not "deviations."23 This change conveys our judgment that a low unemployment rate by itself, in the absence of evidence that price inflation is running or is likely to run persistently above mandate-consistent levels or pressing financial stability concerns, will not, under our new framework, be a sufficient trigger for policy action.24 This is a robust evolution in the Federal Reserve's policy framework and, to me, reflects the reality that econometric models of maximum employment, while essential inputs to monetary policy, can be and have been wrong, and, moreover, that a decision to tighten monetary policy based solely on a model without any other evidence of excessive cost-push pressure that puts the price-stability mandate at risk is difficult to justify, given the significant cost to the economy if the model turns out to be wrong and given the ability of monetary policy to respond if the model were eventually to turn out to be right.25
With regard to the price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations "well anchored at 2 percent" (and not just "well anchored") in a world of low r* and an ELB constraint that is binding in downturns.26 To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at 2 percent, it "seeks to achieve inflation that averages 2 percent over time," and—in the same sentence—that therefore "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." This is the second robust evolution of our framework, and it reflects the inherent asymmetry of conducting monetary policy in a low r* world with an ELB constraint that binds in economic downturns. As discussed earlier, if policy seeks only to return inflation to 2 percent following a downturn in which the ELB has constrained policy, an inflation-targeting monetary policy will tend to generate inflation that averages less than 2 percent, which, in turn, will tend to put persistent downward pressure on inflation expectations and, potentially, on available policy space. In order to offset this downward bias, our new framework recognizes that monetary policy during economic expansions needs to "aim to achieve inflation moderately above 2 percent for some time." In other words, the aim to achieve symmetric outcomes for inflation (as would be the case under flexible inflation targeting in the absence of the ELB constraint) requires an asymmetric monetary policy reaction function in a low r* world with binding ELB constraints in economic downturns.
It is for this reason that while our new statement no longer refers to the 2 percent inflation goal as symmetric, it does now say that the Committee "seeks to achieve inflation that averages 2 percent over time." To be clear, "inflation that averages 2 percent over time" represents an ex ante aspiration, not a description of a mechanical reaction function—nor is it a commitment to conduct monetary policy tethered to any particular formula or rule.27 Indeed, as summarized in the minutes of the September 2019 FOMC meeting, the Committee (and, certainly, I) was skeptical about the benefit, credibility, or practicality of adopting a formal numerical price level or average inflation target rule, just as it has been unwilling to implement its existing flexible inflation-targeting strategy via any sort of mechanical rule.28 So in practice, what, then, is the policy implication of this stated desire "to achieve inflation that averages 2 percent over time"? Again, the implication of our new strategy for monetary policy is stated explicitly in the new statement, and, at the risk of repeating myself, let me restate it verbatim: "… following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." Full stop. As Chair Powell indicated in his remarks last week, we think of this new strategy as an evolution from flexible inflation targeting to flexible average inflation targeting.29
My remarks today have been focused on our new framework and flexible average inflation targeting strategy. Of course, our review has also explored ways in which we might add to our toolkit and refine our communication practices. With regard to our toolkit, we believe that forward guidance and large-scale asset purchases have been and continue to be effective sources of support to the economy when the federal funds rate is at the ELB, and, of course, both were deployed promptly in our March 2020 policy response to the pandemic. With regard to other monetary policy tools, and as we have made clear previously in the minutes to our October 2019 FOMC meeting, we do not see negative policy rates as an attractive policy option in the U.S. context.30 As for targeting the yield curve, our general view is that with credible forward guidance and asset purchases, the potential benefits from such an approach may be modest. At the same time, the approach brings complications in terms of implementation and communications. Hence, as noted in the minutes from our previous meeting (July 2020), most of my colleagues judged that yield caps and targets were not warranted in the current environment but should remain an option that the Committee could reassess in the future if circumstances changed markedly.31 Regarding communication practices, our new consensus statement does bring greater clarity and transparency to the way we will conduct policy going forward, and in that regard I note that Michelle Smith is leading our efforts to make immediately and readily available on the web a bounty of content that will be invaluable to those who desire a more granular understanding of the review process. Finally, now that we have ratified our new statement, the Committee can assess possible refinements to our SEP with the aim of reaching a decision on any potential changes by the end of this year.32
In closing, let me say that while I was not a member of the Committee in 2012, had I been I would have voted enthusiastically for the January 2012 statement. It was the right statement, and flexible inflation targeting was the right strategy, at that time and for the next eight years. The existing framework served us well by supporting the Federal Reserve's efforts after the GFC first to achieve and then, for several years, to sustain the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability. But times change, as has the economic landscape, and our framework and strategy need to change as well.33 My colleagues and I believe that this new framework represents a critical and robust evolution of our monetary policy strategy that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future. Thank you very much for your time and attention, and I look forward now to my conversation with Adam.
Aaronson, Stephanie R., Mary C. Daly, William L. Wascher, and David W. Wilcox (2019). "Okun Revisited: Who Benefits Most from a Strong Economy? (PDF)" Brookings Papers on Economic Activity, Spring, pp. 333–75.
Abraham, Katharine G., John C. Haltiwanger, and Lea E. Rendell (2020). "How Tight Is the U.S. Labor Market? (PDF)" paper presented at the Brookings Papers on Economic Activity Conference, held at the Brookings Institution, Washington, March 19.
Adam, Klaus, and Roberto M. Billi (2007). "Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates," Journal of Monetary Economics, vol. 54 (April), pp. 728–52.
Ajello, Andrea, Isabel Cairó, Vasco Cúrdia, Thomas A. Lubik, and Albert Queralto (2020). "Monetary Policy Tradeoffs and the FOMC's Dual Mandate (PDF)a," Finance and Economics Discussion Series 2020-066. Washington: Board of Governors of the Federal Reserve System, August.
Altig, David, Jeff Fuhrer, Marc P. Giannoni, and Thomas Laubach (2020). "The Federal Reserve's Review of Its Monetary Policy Framework: A Roadmap (PDF)," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 27.
Arias, Jonas, Martin Bodenstein, Hess Chung, and Thorsten Drautzburg (2020). "Alternative Strategies: How Do They Work? How Might They Help? (PDF)" Finance and Economics Discussion Series 2020-068. Washington: Board of Governors of the Federal Reserve System, August.
Bernanke, Ben S., Michael T. Kiley, and John M. Roberts (2019). "Monetary Policy Strategies for a Low-Rate Environment," AEA Papers and Proceedings, vol. 109 (May), pp. 421–26.
Bernanke, Ben S., Thomas Laubach, Frederick S. Mishkin, and Adam S. Posen (1999). Inflation Targeting: Lessons from the International Experience. Princeton, N.J.: Princeton University Press.
Bianchi, Francesco, Leonardo Melosi, and Matthias Rottner (2019). "Hitting the Elusive Inflation Target (PDF)," NBER Working Paper Series 26279. Cambridge, Mass.: National Bureau of Economic Research, September (revised January 2020).
Blanchard, Olivier, Eugenio Cerutti, and Lawrence Summers (2015). "Inflation and Activity—Two Explorations and Their Monetary Policy Implications (PDF)," IMF Working Paper WP/15/230. Washington: International Monetary Fund, November.
Board of Governors of the Federal Reserve System (2020). Fed Listens: Perspectives from the Public (PDF). Washington: Board of Governors, June.
Caldara, Dario, Etienne Gagnon, Enrique Martínez-García, and Christopher J. Neely (2020). "Monetary Policy and Economic Performance since the Financial Crisis (PDF)," Finance and Economics Discussion Series 2020-065. Washington: Board of Governors of the Federal Reserve System, August.
Campbell, Jeffrey, Thomas B. King, Anna Orlik, and Rebecca Zarutskie (2020). "Issues regarding the Use of the Policy Rate Tool (PDF)," Finance and Economics Discussion Series 2020-070. Washington: Board of Governors of the Federal Reserve System, August.
Carlson, Mark, Stefania D'Amico, Cristina Fuentes-Albero, Bernd Schlusche, and Paul Wood (2020). "Issues in the Use of the Balance Sheet Tool (PDF)," Finance and Economics Discussion Series 2020-071. Washington: Board of Governors of the Federal Reserve System, August.
Cecchetti, Stephen G., Michael E. Feroli, Peter Hooper, Anil K. Kashyap, and Kermit L. Schoenholtz (2017). Deflating Inflation Expectations: The Implications of Inflation's Simple Dynamics (PDF), report prepared for the 2017 U.S. Monetary Policy Forum, sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business, held in New York, March 3.
Cecchetti, Stephen G., and Kermit L. Schoenholtz (2019). "Improving U.S. Monetary Policy Communications (PDF)," paper presented at the Conference on Monetary Policy Strategy, Tools, and Communication Practices (a Fed Listens event), held at the Federal Reserve Bank of Chicago, June 4.
Chung, Hess, Brian M. Doyle, James Hebden, and Michael Siemer (2020). "Considerations regarding Inflation Ranges (PDF)," Finance and Economics Discussion Series 2020-075. Washington: Board of Governors of the Federal Reserve System, August.
Chung, Hess, Etienne Gagnon, Taisuke Nakata, Matthias Paustian, Bernd Schlusche, James Trevino, Diego Vilán, and Wei Zheng (2019). "Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit (PDF)," Finance and Economics Discussion Series 2019-003. Washington: Board of Governors of the Federal Reserve System, January.
Clarida, Richard H. (2016). "Good News for the Fed," International Economy, Spring, pp. 44–45 and 75–76.
——— (2018a). "Outlook for the U.S. Economy and Monetary Policy," speech delivered at the Peterson Institute for International Economics, Washington, October 25.
——— (2018b). "Data Dependence and U.S. Monetary Policy," speech delivered at the Clearing House and the Bank Policy Institute Annual Conference, New York, November 27.
——— (2019a). "Monetary Policy Outlook for 2019," speech delivered at the Money Marketeers of New York University, New York, January 10, https://www.federalreserve.gov/newsevents/speech/clarida20190110a.htm.
——— (2019b). "The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices," speech delivered at the 2019 U.S. Monetary Policy Forum, sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business, New York, February 22.
——— (2019c). "Models, Markets, and Monetary Policy," speech delivered at the Hoover Institution Monetary Policy Conference "Strategies for Monetary Policy," Stanford University, Stanford, Calif., May 3.
——— (2020). "Financial Markets and Monetary Policy: Is There a Hall of Mirrors Problem?" speech delivered at the 2020 U.S. Monetary Policy Forum, sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business, New York, February 21.
Clarida, Richard, Jordi Galí, and Mark Gertler (1999). "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, vol. 37 (December), pp. 1661–707.
Crump, Richard K., Christopher J. Nekarda, and Nicholas Petrosky-Nadeau (2020). "Unemployment Rate Benchmarks (PDF)," Finance and Economics Discussion Series 2020-072. Washington: Board of Governors of the Federal Reserve System, August.
Del Negro, Marco, Domenico Giannone, Marc P. Giannoni, and Andrea Tambalotti (2017). "Safety, Liquidity, and the Natural Rate of Interest (PDF)," Brookings Papers on Economic Activity, Spring, pp. 235–94.
——— (2019). "Global Trends in Interest Rates," Journal of International Economics, vol. 118 (May), pp. 248–62.
Duarte, Fernando, Benjamin K. Johannsen, Leonardo Melosi, and Taisuke Nakata (2020). "Strengthening the FOMC's Framework in View of the Effective Lower Bound and Some Considerations Related to Time-Inconsistent Strategies (PDF)," Finance and Economics Discussion Series 2020-067. Washington: Board of Governors of the Federal Reserve System, August.
Eberly, Janice C., James H. Stock, and Jonathan H. Wright (2020). "The Federal Reserve's Current Framework for Monetary Policy: A Review and Assessment (PDF)," International Journal of Central Banking, vol. 16 (February), pp. 5–71.
Eggertsson, Gauti B., and Michael Woodford (2003). "The Zero Bound on Interest Rates and Optimal Monetary Policy (PDF)," Brookings Papers on Economic Activity, no. 1, pp. 139–233.
Erceg, Christopher, James Hebden, Michael Kiley, David López-Salido, and Robert Tetlow (2018). "Some Implications of Uncertainty and Misperception for Monetary Policy (PDF)," Finance and Economics Discussion Series 2018-059. Washington: Board of Governors of the Federal Reserve System, August.
Faust, Jon, and Jonathan H. Wright (2013). "Forecasting Inflation," in Graham Elliott, Clive Grander, and Allan Timmermann, eds., Handbook of Economic Forecasting, vol. 2A. Amsterdam: Elsevier, pp. 2–56.
Feiveson, Laura, Nils Goernemann, Julie Hotchkiss, Karel Mertens, and Jae Sim (2020). "Distributional Considerations for Monetary Policy Strategy (PDF)," Finance and Economics Discussion Series 2020-073. Washington: Board of Governors of the Federal Reserve System, August.
Fischer, Stanley (2016). "Why Are Interest Rates So Low? Causes and Implications," speech delivered at the Economic Club of New York, New York, October 17.
Fuhrer, Jeff, Giovanni P. Olivei, Eric S. Rosengren, and Geoffrey M.B. Tootell (2018). "Should the Federal Reserve Regularly Evaluate Its Monetary Policy Framework? (PDF)" Brookings Papers on Economic Activity, Fall, pp. 443–97.
Goldberg, Jonathan, Elizabeth Klee, Edward Simpson Prescott, and Paul Wood (2020). "Monetary Policy Strategy and Tools: Financial Stability Considerations (PDF)," Finance and Economics Discussion Series 2020-074. Washington: Board of Governors of the Federal Reserve System, August.
Gust, Christopher, Edward Herbst, David López-Salido, and Matthew E. Smith (2017). "The Empirical Implications of the Interest-Rate Lower Bound," American Economic Review, vol. 107 (July), pp. 1971–2006.
Hamilton, James D., Ethan S. Harris, Jan Hatzius, and Kenneth D. West (2016). "The Equilibrium Real Funds Rate: Past, Present, and Future," IMF Economic Review, vol. 64 (4), pp. 660–707.
Hebden, James, Edward P. Herbst, Jenny Tang, Giorgio Topa, and Fabian Winkler (2020). "How Robust Are Makeup Strategies to Key Alternative Assumptions? (PDF)" Finance and Economics Discussion Series 2020-069. Washington: Board of Governors of the Federal Reserve System, August.
Hebden, James, and David López-Salido (2018). "From Taylor's Rule to Bernanke's Temporary Price Level Targeting (PDF)," Finance and Economics Discussion Series 2018-051. Washington: Board of Governors of the Federal Reserve System, July.
Heise, Sebastian, Fatih Karahan, and Ayşegül Şahin (2020). "The Missing Inflation Puzzle: The Role of the Wage-Price Pass-Through," NBER Working Paper Series 27663. Cambridge, Mass.: National Bureau of Economic Research, August.
Holston, Kathryn, Thomas Laubach, and John C. Williams (2017). "Measuring the Natural Rate of Interest: International Trends and Determinants," Journal of International Economics, vol. 108 (May, S1), pp. S59–75.
Johannsen, Benjamin K., and Elmar Mertens (2018). "A Time Series Model of Interest Rates with the Effective Lower Bound (PDF)," BIS Working Papers 715. Basel, Switzerland: Bank for International Settlements, April.
Kashyap, Anil K., and Caspar Siegert (2020). "Financial Stability Considerations and Monetary Policy (PDF)," International Journal of Central Banking, vol. 16 (February), pp. 231–66.
Kiley, Michael T., and John M. Roberts (2017). "Monetary Policy in a Low Interest Rate World (PDF)," Brookings Papers on Economic Activity, Spring, pp. 317–72.
King, Mervyn, and David Low (2014). "Measuring the 'World' Real Interest Rate (PDF)," NBER Working Paper Series 19887. Cambridge, Mass.: National Bureau of Economic Research, February.
Krugman, Paul R. (1998). "It's Baaack: Japan's Slump and the Return of the Liquidity Trap (PDF)," Brookings Papers on Economic Activity, no. 2, pp. 137–87.
Laubach, Thomas, and John C. Williams (2016). "Measuring the Natural Rate of Interest Redux (PDF)," Finance and Economics Discussion Series 2016-011. Washington: Board of Governors of the Federal Reserve System, February.
López-Salido, David, Gerardo Sanz-Maldonado, Carly Schippits, and Min Wei (2020). "Measuring the Natural Rate of Interest: The Role of Inflation Expectations," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, June 19.
Mavroeidis, Sophocles, Mikkel Plagborg-Møller, and James H. Stock (2014). "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve," Journal of Economic Literature, vol. 52 (March), pp. 124–88.
Mertens, Thomas M., and John C. Williams (2019). "Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates," Staff Report 887. New York: Federal Reserve Bank of New York, May (revised August 2019).
Obstfeld, Maurice (2020). "Global Dimensions of U.S. Monetary Policy (PDF)," International Journal of Central Banking, vol. 16 (February), pp. 73–132.
Pfajfar, Damjan, and John M. Roberts (2018). "The Role of Expectations in Changed Inflation Dynamics (PDF)," Finance and Economics Discussion Series 2018-062. Washington: Board of Governors of the Federal Reserve System, August.
Powell, Jerome H. (2019a). "Monetary Policy: Normalization and the Road Ahead," delivered at the 2019 SIEPR Economic Summit, Stanford Institute of Economic Policy Research, Stanford, Calif., March 8.
——— (2019b). "Opening Remarks: Challenges for Monetary Policy (PDF)." In Federal Reserve Bank of Kansas City, ed., "Challenges for Monetary Policy," A Symposium Sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyo., August 22–24. Kansas City, Mo.: FRB Kansas City, pp. 1–16.
——— (2020). "New Economic Challenges and the Fed's Monetary Policy Review," speech delivered at "Navigating the Decade Ahead: Implications for Monetary Policy," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole, Wyo., August 27.
Rachel, Lukasz, and Thomas D. Smith (2017). "Are Low Real Interest Rates Here to Stay? (PDF)" International Journal of Central Banking, vol. 13 (September), pp. 1–42.
Simon, John, Troy Matheson, and Damiano Sandri (2013). "The Dog That Didn't Bark: Has Inflation Been Muzzled or Was It Just Sleeping? (PDF)" in World Economic Outlook: Hopes, Realities, Risks. Washington: International Monetary Fund, April, pp. 1–17.
Sims, Eric, and Jing Cynthia Wu (2020). "Are QE and Conventional Monetary Policy Substitutable? (PDF)" International Journal of Central Banking, vol. 16 (February), pp. 195–230.
Svensson, Lars E.O. (1997). "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," European Economic Review, vol. 41 (June), pp. 1111–46.
——— (2020). "Monetary Policy Strategies for the Federal Reserve (PDF)," International Journal of Central Banking, vol. 16 (February), pp. 133–93.
Woodford, Michael (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, N.J.: Princeton University Press.
Wynne, Mark A., and Ren Zhang (2018). "Measuring the World Natural Rate of Interest," Economic Inquiry, vol. 56 (January), pp. 530–44.
Yellen, Janet L. (2015). " Inflation Dynamics and Monetary Policy," speech delivered at the Philip Gamble Memorial Lecture, University of Massachusetts, Amherst, September 24.
1. The revised statement is available on the Board's website at https://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf. Last week, Chair Powell made the review and the revised statement the focus of his speech at "Navigating the Decade Ahead: Implications for Monetary Policy," a symposium sponsored by the Federal Reserve Bank of Kansas City and held in Jackson Hole, Wyoming; see Powell (2020). Return to text
2. The views expressed are my own and not necessarily those of other Federal Reserve Board members or Federal Open Market Committee participants. I would like to thank Etienne Gagnon, Ellen Meade, Jon Faust, and Trevor Reeve for their assistance in preparing these remarks, and Thomas Laubach for sharing with me throughout the review process his many keen insights on monetary policy strategy and communication. Return to text
3. For a discussion of the elements that motivated the launch of the review and of how the previous policy framework had served us, see Clarida (2019b). See also Powell (2019a). Return to text
4. See Chair Powell's address in Jackson Hole, Wyoming, last week (Powell, 2020) for an illustration of the revisions to the macroeconomic projections—including for the longer-run neutral federal funds rate—of FOMC participants as well as private and public forecasters. The downward revisions to r* over time have been informed, in part, by the general fall in interest rates and by econometric evidence that suggests that this fall is of a permanent rather than a cyclical nature. See, among many contributors, Hamilton and others (2016), Johannsen and Mertens (2018), Laubach and Williams (2016), Del Negro and others (2017), and López-Salido and others (2020). For discussions of the various factors that might have contributed to this fall, see Fischer (2016) and Rachel and Smith (2017). Return to text
5. For evidence on the global nature of the decline in r*, see King and Low (2014); Holston, Laubach, and Williams (2017); Wynne and Zhang (2018); and Del Negro and others (2019). For a discussion of global considerations for U.S. monetary policy, see Obstfeld (2020). Return to text
6. For assessments of the risk that the federal funds rate will be constrained by the ELB in the future, along with policy strategies that might mitigate that risk, see Kiley and Roberts (2017); Chung and others (2019); Hebden and López-Salido (2018); and Bernanke, Kiley, and Roberts (2019). Return to text
7. For pre-GFC discussions of the macroeconomic consequences of policy rates being constrained by the ELB, see Krugman (1998), Eggertsson and Woodford (2003), and Adam and Billi (2007). For the GFC and its aftermath, using a time-series approach, Eberly, Stock, and Wright (2020) estimate that, in the absence of the ELB constraint, the labor market recovery would have proceeded at a significantly more rapid pace than was observed, whereas core inflation would have been only modestly higher because of inflation's limited sensitivity to resource slack. Using a DSGE (dynamic stochastic general equilibrium) approach, the mean estimates of Gust and others (2017) suggest that a binding ELB accounted for about 30 percent (roughly 2 percentage points) of the 6 percent contraction in gross domestic product in 2009 relative to the peak in 2007 and was responsible for an even larger fraction of the ensuing slow recovery. Return to text
8. For evidence of a flattening of the slope of the Phillips curve in the United States and abroad, see, among others, Simon, Matheson, and Sandri (2013); Blanchard, Cerutti, and Summers (2015); and Pfajfar and Roberts (2018). The difficulties in assessing shortfalls from maximum employment using measures of the unemployment rate has motivated researchers to explore alternative approaches. See Abraham, Haltiwanger, and Rendell (2020) for an approach based on the job search and matching framework. See also the staff discussion of various concepts of unemployment rate benchmarks by Crump, Nekarda, and Petrosky-Nadeau (2020), which was prepared as background materials for this review. Return to text
9. The large degree of uncertainty attached to estimates of r*, u*, the slope of the (short-run) Phillips curve, and other key economic objects adds additional risk-management considerations in the conduct of monetary policy, especially in a low r* environment in which the federal funds rate is likely to be constrained by the ELB. See Powell (2019b) for a discussion of the implications for monetary policy and my recent remarks in Clarida (2020). See also the model-based analyses of Erceg and others (2018), Ajello and others (2020), and Hebden and others (2020). Return to text
10. See Powell (2020) for an illustration. See also Caldara and others (2020) for a discussion of how repeated surprises in macroeconomic forecasts affect inference about the appropriate stance of policy. Return to text
11. See Clarida (2016, 2019c) and Heise, Karahan, and Şahin (2020) for discussions. Return to text
12. See Yellen (2015) for a discussion of inflation dynamics and monetary policy and Erceg and others (2018) for a quantitative exploration of the monetary policy implications of a flat Phillips curve in an uncertain economic environment. Since the mid-1980s, movements in both realized inflation and measures of longer-term inflation expectations have been somewhat muted, complicating the task of extracting the precise role of inflation expectations as a determinant of realized inflation. Faust and Wright (2013) review the literature on inflation forecasting and present evidence in support of the conclusion that measures of longer-run inflation expectations help predict inflation. Mavroeidis, Plagborg-Møller, and Stock (2014) discuss the challenges of identifying the precise role of expectations in determining actual inflation. Cecchetti and others (2017) suggest that, in a low and stable inflation environment, policymakers should pay attention to a wide array of indicators in determining the implications for monetary policy of movements in realized inflation and measures of inflation expectations. Return to text
13. See Bernanke and others (1999) for a review of the considerations that led to the adoption of inflation-targeting frameworks and the early international experience. See Svensson (1997), Clarida, Galí, and Gertler (1999), and Woodford (2003) for conceptual treatments of inflation targeting, including of rational expectations. Return to text
14. See Mertens and Williams (2019) and Bianchi, Melosi, and Rottner (2019). Return to text
15. See Clarida (2020). Return to text
16. See Board of Governors (2020). Return to text
17. This special issue, which includes five of the seven papers presented at the research conference, is available on the journal's website at https://www.ijcb.org/journal/ijcb2002.htm. The conference program, conference drafts, presentations, and video recordings of the sessions can be found on the Board's website at https://www.federalreserve.gov/conferences/conference-monetary-policy-strategy-tools-communications-20190605.htm. Return to text
18. An overview of the System staff work in support of the review is presented in Altig and others (2020). Federal Reserve staff analysis on the Fed Listens initiative was presented and discussed at the December 2019 FOMC meeting and is part of the Fed Listens report. Return to text
19. Summaries of these discussions can be found in the minutes of these FOMC meetings, which are accessible on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. Return to text
20. The FOMC published the statement for the first time alongside its January 2012 postmeeting statement; the document is available on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20120125c.htm. This statement has been reaffirmed each year, and was updated in 2016 to include the language on symmetry. The version of the statement that prevailed at the start of the review, which was affirmed in January 2019, can be found on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130b.htm. Return to text
21. See my earlier remarks on these aspects in Clarida (2018a, 2018b, 2019a). Return to text
22. FOMC participants discussed the benefits, limitations, and risks associated with policy tools other than the setting of the federal funds rate target at various points during the review. See, notably, the summaries of FOMC participants' discussions at the July 2019 and October 2019 meetings—available on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm—which covered, respectively, the performance of these tools during the GFC and its aftermath and issues pertaining to the use of these tools in the future. See also the analyses of Sims and Wu (2020), Caldara and others (2020), Campbell and others (2020), and Carlson and others (2020), prepared for this review. Return to text
23. Italics added for emphasis. Return to text
24. For a discussion of financial stability considerations in the conduct of monetary policy, see Kashyap and Siegert (2020) and Goldberg and others (2020), prepared as part of this review. Return to text
25. As I stated in Clarida (2019a, paragraph 17), "For example, were models to predict a surge in inflation, a decision for preemptive hikes before the surge is evident in actual data would need to be balanced against the cost of the model being wrong." One major cost of withdrawing policy accommodation prematurely during an economic expansion is that it prevents job opportunities from reaching all communities. A clear takeaway from our Fed Listens events is that the strong job market that preceded the pandemic was especially beneficial to members of low- and moderate-income communities. The prolonged economic expansion not only helped create job opportunities for marginalized groups and cement their attachment to the labor force, but, as we heard at these events, it also more generally strengthened families, businesses, and communities. See Aaronson and others (2019) for a discussion of how a strong labor market helped address labor market disparities in the previous economic expansion. See also Feiveson and others (2020) for a discussion of distributional considerations and monetary policy. Return to text
26. Italics added for emphasis. Return to text
27. The absence of a commitment to a specific formula or rule should not be interpreted as the absence of a commitment to achieving our mandated goals. To the contrary, the revised statement has strengthened our commitment to achieving these goals in several important ways. Notably, it has clarified that we seek to achieve 2 percent inflation, on average, over time and that, when inflation has been running persistently too low, it is appropriate to aim for inflation outcomes moderately above 2 percent for some time to solidly anchor longer-run inflation expectations at 2 percent. The revised statement also emphasizes our resolve to use our full range of tools to achieve our goals. Clarity about our goals, strategy, and tools fosters greater democratic accountability in the pursuit of our dual mandate. For a discussion of time-consistency issues in monetary policy, see the staff analysis of Duarte and others (2020), prepared for this review. Return to text
28. A summary of the September 2019 FOMC discussion is available on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. For the staff analysis presented as background to that discussion, see Arias and others (2020), Duarte and others (2020), and Hebden and others (2020). See also the related staff analysis by Chung and others (2020) on the use of operational inflation ranges. Return to text
29. Svensson (2020) argues that "forecast targeting" approaches, by which policymakers set the federal funds rate so as to best stabilize forecasts for inflation and employment around the FOMC's longer-run goals, outperform policy strategies that respond only to current economic conditions, past economic conditions, or both. In addition, he finds that average inflation targeting offers some advantages over the other strategies that he considers. Return to text
30. The minutes of the FOMC's October 2019 meeting are available on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. Return to text
31. See the minutes of the FOMC's June 2020 and July 2020 meetings, which can be found on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. Return to text
32. For a discussion of the importance of clear Federal Reserve communications in an uncertain economic environment, along with possible enhancements, see the paper Cecchetti and Schoenholtz (2019) prepared for the research conference at the Federal Reserve Bank of Chicago. Return to text
33. See Fuhrer and others (2018) for a discussion of the benefits of holding periodic reviews of central banks' monetary policy frameworks. Return to text