Fed Chair Yellen’s latest speech confirms that rate rises are still on the cards, at some point despite the latest poor jobs data. But is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy?
Let me now turn to the implications of the economic outlook, as well as the uncertainties associated with that outlook, for monetary policy. My overall assessment is that the current stance of monetary policy is generally appropriate, in that it is providing support to the economy by encouraging further labor market improvement that will help return inflation to 2 percent. At the same time, I continue to think that the federal funds rate will probably need to rise gradually over time to ensure price stability and maximum sustainable employment in the longer run.
Several considerations lead me to this conclusion. First, the current stance of monetary policy is stimulative, although perhaps not as stimulative as might appear at first glance. One useful measure of the stance of policy is the deviation of the federal funds rate from a “neutral” value, defined as the level of the federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential. This neutral rate changes over time, and, at any given date, it depends on a constellation of underlying forces affecting the economy. At present, many estimates show the neutral rate to be quite low by historical standards–indeed, close to zero when measured in real, or inflation-adjusted, terms.13 The current actual value of the federal funds rate, also measured in real terms, is even lower, somewhere around minus 1 percent. With the actual real federal funds rate modestly below the relatively low neutral real rate, the stance of monetary policy at present should be viewed as modestly accommodative.
Although the economy is now fairly close to the FOMC’s goal of maximum employment, I view our modestly accommodative stance of policy as appropriate for several reasons. First, with inflation continuing to run below our objective, a mild undershooting of the unemployment rate considered to be normal in the longer run could help move inflation back up to 2 percent more quickly. Second, a stronger job market could also support labor market improvement along other dimensions, including greater labor force participation. A third reason relates to the risks associated with the constraint on conventional monetary policy when the federal funds rate is near zero. If inflation were to move persistently above 2 percent or the economy were to become notably overheated, the Committee could readily increase the target range for the federal funds rate. However, if inflation were to remain persistently low or the expansion were to falter, the FOMC would be able to provide only a limited amount of additional stimulus through conventional means.
These motivations notwithstanding, I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our 2 percent objective. Because monetary policy affects the economy with a lag, steps to withdraw this monetary accommodation ought to be initiated before the FOMC’s goals are fully reached. And if the headwinds that have lingered since the crisis slowly abate as I anticipate, this would mean that the neutral rate of interest itself will move up, providing further impetus to gradually increase the federal funds rate. But I stress that the economic outlook, including the pace at which the neutral rate may shift over time, is uncertain, so monetary policy cannot proceed on any preset path.
This point is well illustrated by events so far this year. For a time in January and early February, financial markets here and abroad became turbulent and financial conditions tightened, reflecting and reinforcing concerns about downside risks to the global economy. In addition, data received during the winter suggested that U.S. growth had weakened even as progress in the labor market remained solid. Because the implications of these developments for the economic outlook were unclear, the FOMC decided at its January, March, and April meetings that it would be prudent to maintain the existing target range for the federal funds rate.
Over the past few months, financial conditions have recovered significantly and many of the risks from abroad have diminished, although some risks remain. In addition, consumer spending appears to have rebounded, providing some reassurance that overall growth has indeed picked up as expected. Unfortunately, as I noted earlier, new questions about the economic outlook have been raised by the recent labor market data. Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015? Does the latest reading on the unemployment rate indicate that we are essentially back to full employment, or does relatively subdued wage growth signal that more slack remains? My colleagues and I will be wrestling with these and other related questions going forward.
