Wednesday, March 07,
2018 09.26AM / Federal Reserve Governor Lael Brainard
Being a speech delivered
at the Money Marketers Of New York University, New York, New York
I appreciate the invitation from the
Money Marketeers to discuss the path ahead for our economy and monetary policy.
Many of the forces that acted as
headwinds to U.S. growth and weighed on policy in previous years are generating
tailwinds currently. Today many economies around the world are experiencing
synchronized growth, in contrast to the 2015-16 period when important foreign
economies experienced adverse shocks and anemic demand. The International
Monetary Fund revised up its outlook for the world economy in January,
continuing a recent pattern of upward revisions, in contrast to a string of
downward revisions in 2015 and 2016.2 Stronger economies abroad should
increase demand for America's exports and boost the foreign earnings of U.S.
The upward revisions to the foreign
economic outlook are also pulling forward expectations of monetary policy
tightening abroad and contributing to an appreciation of foreign currencies and
increases in U.S. import prices. By contrast, foreign currencies weakened in
the earlier period, pushing the dollar higher and U.S. import prices lower.
Since the end of 2016, a broad index of the exchange value of the dollar has
depreciated nearly 8 percent, whereas it appreciated by 25 percent from
mid-2014 to 2016.
In recent quarters, the combination of
higher oil prices and robust global demand has been providing strong support to
business investment--in contrast to the sharp pullback from 2015 to 2016.
Business spending on fixed investment
rose at more than a 6 percent pace in 2017. This rise followed two years of
weak growth, dragged down by declines in the drilling and mining sector.
Financial conditions are currently
supportive of economic growth despite the recent choppiness in financial
markets and some tightening since the beginning of the year. Various measures
of equity valuations remain elevated relative to historical norms even after
recent movements, and corporate bond spreads remain quite compressed.3 This compares with the period from
mid-2014 through the second half of 2016, when equity prices were flat and the
dollar rose steeply. The Federal Reserve Bank of Chicago's National Financial
Conditions Index provides a useful summary statistic.4 According to this measure, financial
conditions tightened significantly from the middle of 2014 to early 2016. By
comparison, financial conditions today remain near the accommodative end of the
range since the financial crisis, even with the recent tightening in
conditions. The most notable tailwind is the shift
in America's fiscal policy stance from restraint to substantial stimulus in an
economy close to full employment. In the earlier period, the economy had just
weathered a challenging adjustment to a sharp withdrawal of fiscal support.
Today, from a position near full employment, the economy is poised to absorb
$1-1/2 trillion in personal and corporate tax cuts and a $300 billion increase
in federal spending. Estimates suggest December's tax legislation could boost
the growth rate of real gross domestic product (GDP) as much as 1/2 percentage
point this year and next.5 On top of that, the recently agreed-to
budget deal is likely to raise federal spending by around 0.4 percent of GDP in
each of the next two years.
Our Inflation Objective and Sustaining Full Employment
Although the economy is currently around full employment and has been expanding
at an above-trend pace, inflation has remained subdued for quite some time.
Over the past year, overall PCE (personal consumption expenditures) inflation
was 1.7 percent, and core PCE inflation was 1.5 percent--not very different
from the average level of core inflation over the past five years.
The persistence of subdued inflation,
despite an unemployment rate that has moved below most estimates of its natural
rate, suggests some risk that underlying inflation may have softened. While
transitory factors no doubt played a role in last year's step-down in core PCE
inflation, various empirical analyses conclude that persistent factors are at
play in the stubbornly low level of core inflation. According to a variety of
measures, underlying inflation--the slow-moving trend that exerts a pull on
wage and price setting--may be running below levels that are consistent with
the Federal Open Market Committee's (FOMC) 2 percent inflation objective.
For example, some survey measures of
longer-run inflation expectations are currently lower than they were before the
financial crisis, as are most estimates based on statistical filters. Inflation
compensation has moved up recently, but is still running somewhat below levels
that prevailed before the crisis.
Thus, it is important for monetary
policy to ensure that underlying inflation is re-anchored firmly at 2 percent.
At the same time, it is important for monetary policy to sustain full
It is difficult to know with precision
how much slack remains in the labor market. If the unemployment rate were to
continue to fall in the coming year at the same pace as in the past couple of
years, it would reach levels not seen since the late 1960s. On the other hand,
the employment-to-population ratio for prime-age workers remains more than 1
percentage point below its pre-crisis level. If substantially more workers
could be drawn into the labor force, it would be possible for the labor market
to firm notably further without generating imbalances. But it is an open
question as to what portion of the prime-age Americans who are out of the labor
force may prove responsive to tight labor market conditions because declining
labor force participation among prime-age workers predates the crisis,
especially for men. In one encouraging development, the strong labor market has
pulled some discouraged workers back into the labor force and into productive
employment over the past few years. Also encouraging, our Beige Book and
workforce surveys indicate that employers are casting a wider net to find job
candidates and investing more in on-the-job training.
Although last year we faced a disconnect between the continued strengthening in
the labor market and the step-down in inflation, mounting tailwinds at a time
of full employment and above-trend growth tip the balance of considerations in
my view. With greater confidence in achieving the inflation target, continued
gradual increases in the federal funds rate are likely to be appropriate.
Although experience in other countries
suggests it can prove difficult to raise an underlying inflation trend that has
been running below policymakers' target for several years, stronger tailwinds
may help re-anchor inflation expectations at the symmetric 2 percent objective.
Of course, it is conceivable we could see a mild, temporary overshoot of the
inflation target over the medium term. If such a mild, temporary overshoot were
to occur, it would likely be consistent with the symmetry of the FOMC's target
and could help nudge underlying inflation back to our target.8 Recent research has highlighted the
downside risks to inflation and to longer-run inflation expectations that are
posed by the effective lower bound on nominal interest rates, and it suggests
the importance of ensuring underlying inflation does not slip below target in
today's new normal. We also seek to sustain full
employment, and we will want to be attentive to imbalances that could
jeopardize this goal. If the unemployment rate continues to decline on the
current trajectory, it could fall to levels that have been rarely seen over the
past five decades. Historically, such episodes have tended to see elevated
risks of imbalances, whether in the form of high inflation in earlier decades
or of financial imbalances in recent decades. One of the striking features of
the current recovery has been the absence of an acceleration in inflation as
the unemployment rate has declined, a development that is consistent with a
flat Phillips curve.10 Although wage gains have seen some
recent improvements, they continue to fall short of the pace seen before the
financial crisis. However, we do not have extensive
experience with an economy at very low unemployment rates and cannot be sure
how it might evolve. In particular, we will want to remain attentive to the
risk of financial imbalances. While asset valuations appear to be elevated,
overall risks to the financial system remain moderate because household
borrowing is moderate, risks associated with liquidity and maturity
transformation have declined, and, importantly, the banking system appears to
be well capitalized.12 History suggests, however, that a
booming economy can lead to a relaxation in lending standards, and the
attendant excessive borrowing can complicate the task of monetary policy. We
will need to be vigilant.
What do these considerations imply for the path of monetary policy? Continued
gradual increases in the federal funds rate are likely to remain appropriate to
ensure inflation rises sustainably to our target and to sustain full
employment, keeping in mind that interest rate normalization is well under way
and balance sheet runoff is set to reach its steady-state pace later this year.13 Of course, we should be ready to
adjust the path of policy in either direction if developments turn out
differently than expected.
In many respects, the macro
environment today is the mirror image of the environment we confronted a couple
of years ago. In the earlier period, strong headwinds sapped the momentum of
the recovery and weighed down the path of policy. Today, with headwinds
shifting to tailwinds, the reverse could hold true.
Blanchard, Olivier (2016). "The U.S. Phillips
Curve: Back to the '60s? (PDF)" Policy Brief PB16-1. Washington:
Peterson Institute for International Economics, January.
- Board of Governors of the Federal Reserve System
Issues Addendum to the Policy Normalization Principles and Plans,"
press release, June 14.
- (2018a). "Federal Open Market Committee
reaffirms its "Statement
on Longer-Run Goals and Monetary Policy Strategy," press release,
- (2018b). Monetary
Policy Report (PDF). Washington: Board of Governors, February 23.
- Brainard, Lael (2015). "Normalizing
Monetary Policy When the Neutral Interest Rate Is Low," speech
delivered at the Stanford Institute for Economic Policy Research,
Stanford, California, December 1.
- (2016). "The
'New Normal' and What It Means for Monetary Policy," speech
delivered at the Chicago Council on Global Affairs, Chicago, September 12.
- (2017). "Understanding
the Disconnect between Employment and Inflation with a Low Neutral Rate,"
speech delivered at the Economic Club of New York, New York, September 5.
- Congressional Budget Office (2018). Bipartisan
Budget Act of 2018: Cost Estimate. (PDF) Washington: CBO, February 8.
- Kiley, Michael T. (2015). "Low
Inflation in the United States: A Summary of Recent Research,"
FEDS Notes. Washington: Board of Governors of the Federal Reserve System,
- Kiley, Michael T., and John M. Roberts (2017).
Policy in a Low Interest Rate World (PDF)," Brookings Papers on Economic Activity,
Spring, pp. 317-396.
- Nakata, Taisuke, and Sebastian Schmidt (2016).
Risk-Adjusted Monetary Policy Rule," Finance and Economics
Discussion Series 2016-061. Washington: Board of Governors of the Federal
Reserve System, August.
- Simon, John, Troy Matheson, and Damiano Sandri (2013).
Dog That Didn't Bark: Has Inflation Been Muzzled or Was It Just Sleeping?
(PDF)" chapter 3 in World
Economic Outlook: Hopes, Realities, Risks. Washington:
International Monetary Fund, April.
- I am grateful to John Roberts of the Federal
Reserve Board for his assistance in preparing this text. These remarks
represent my own views, which do not necessarily represent those of the
Federal Reserve Board or the Federal Open Market Committee.
- See various issues of the International Monetary
Fund (IMF) World Economic
Outlook and World
Economic Outlook (WEO) Updates.
- See Board of Governors (2018b).
- The National Financial Conditions Index is
available on the Federal Reserve Bank of Chicago's website at https://www.chicagofed.org/publications/nfci/index.
Other indexes of financial conditions, such as the indexes published by
the Federal Reserve Banks of Kansas City and St. Louis, tell a similar
- For example, the IMF 2018 WEO Updates (see note 2)
estimates that the tax cut legislation will raise the level of U.S. GDP
1-1/4 percent by 2020.
- The Congressional Budget Office (2018) estimates
that increased spending caps will allow additional spending worth about
3/4 percent of GDP in fiscal year 2019.
- See Brainard (2017).
- See Board of Governors (2018a).
- See, for example, Kiley and Roberts (2017),
Nakata and Schmidt (2016), and Brainard (2015, 2016).
- See Blanchard (2016) and Simon, Matheson, and
- Over the 12 months through January, average
hourly earnings were up 2.9 percent relative to a year earlier, the
highest 12-month change in almost nine years. The employment cost index
rose 2.6 percent last year.
- See Board of Governors (2018b).
- As laid out in Board of Governors (2017), the
caps determining the degree of reinvestment of maturing securities in the
System Open Market Account are increasing gradually. The caps on the
monthly runoff in the portfolio are expected to reach their maximum levels
of $30 billion for Treasury securities and $20 billion for agency debt and
mortgage-backed securities later this year. The actual pace of runoff will
vary, however, depending on the volume of securities maturing in any given
- Weaker Dollar, Higher US
Interest Rates, a Dilemma for a Central Bank With No Quorum
- Foreign Direct Investment
and the Central Bank of Nigeria’s Monetary Policy
- Personal Statement by the
MPC Members at the 116 MPC Meeting of Nov 20-21, 2017
- MPC: No Change With or
Without a Meeting
- Statement on January 2018
Meeting of the Monetary Policy Committee
- January 2018 MPC Meeting:
Caught Between Two Arms
- Senate Refuses to Budge
on The Approval of Monetary Policy Committee Nominees
- Personal Statement by the
MPC Members at the 115 MPC Meeting of Sep 25-26, 2017
- MPC: A Tale of
- CBN Communiqué No. 116 of
the MPC Meeting – Nov 20-21, 2017
- As Expected, MPC Leaves
Policy Rates Unchanged