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Financial Services Innovation Lab, Georgia Tech 19

And our plan as we do that is, as those purchases get to that level, we believe we can gradually reduce them, and we believe we can also gradually reduce repo as—as we reach an ample level, as we’re satisfying demand now more from underlying reserves from bill purchases rather than from repo.

Risks to the inflation projection also were seen as balanced.

In the absence of such offsetting operations, a decrease in currency demand would raise the amount of reserves and hence lower the federal funds rate.

The disruptions to global economic activity had significantly affected financial conditions and impaired the flow of credit to U. S. households and businesses.

Although the initial offerings of these securities were well received, investor demand at the most recent sales was not as strong, a development consistent with the declines in the prices of non-agency residential mortgage-backed securities over the intermeeting period.

From a policy perspective, a difficulty with all these measures is that they reflect expectations of headline inflation rather than the core inflation measures usually emphasized in the monetary policy context.

This approach adds to what we have learned from earlier papers that have examined the performance of unconventional policy tools with respect to individual components of financial conditions—most notably, long-term sovereign yields, but also mortgage rates, equities, exchange rates, and corporate debt spreads.3 Empirically assessing the question in the report is not only important, but also challenging, as the report readily acknowledges.

One of the things we’ve learned from our financial crisis and from a series of financial crises in history and around the globe is that, very commonly, when the economy takes a hit and falls into a recession, that productivity doesn’t pick up to pre-recession levels and that there looks like there is a permanent hit to the path of potential output for the economy, which is called “hysteresis.” And I raised the question as to whether or not this might operate in the opposite direction as well.

However, in light of the projected persistence of slack in labor and product markets and the anticipated stability in long-term inflation expectations, the increase in inflation was expected to be mostly transitory if oil and other commodity prices did not rise significantly further.

However, most participants judged that inflation would stabilize around the Committee's 2 percent objective over the medium term.

A key purpose of our review has been to take stock of the lessons learned over this period and identify any further changes in our monetary policy framework that could enhance our ability to achieve our maximum-employment and price-stability objectives in the years ahead.9 Our evolving understanding of four key economic developments motivated our review.

For example, as table 1 shows, the collective current account surplus of the Middle East and Africa rose more than $40 billion between 1996 and 2003; it continued to swell in 2004 as oil prices increased yet further.

In Latin America, indicators suggested that economic activity in Mexico and Brazil expanded further in the first quarter.

however, for the two months combined, the deficit was considerably wider than its average rate for the second quarter.

In the emerging market economies (EMEs), a pickup in growth in China in the second quarter, supported by policy stimulus, appeared to be more than offset by slower growth in Latin America.

The labor force participation rate, along with the employment-to-population ratio, increased, on net, in recent months.

But the advent of the war has led to a significant hit to real incomes from large price increases in energy and other commodities in some of the most severely affected economies.

Turning now to monetary policy, at both its July and September meetings, the FOMC voted to lower the target range for the federal funds rate by 25 basis points.3 With these decisions, the current target range for the federal funds rate is 1.75 to 2 percent, which compares with the range of 2.25 to 2.5 percent that prevailed between December 2018 and July 2019.

Central banks have adopted price stability as a key long-term objective, and they have become more transparent and systematic in their operations.

That said, many of my colleagues and I would see a portion of the decline in the unemployment rate as perhaps not representing a diminution of slack in the labor market.

Over the 1994-2002 period, seven prominent inflation-targeting industrial countries had a mean inflation rate of consumer prices of 2.1 percent per year with a standard deviation of 1.7 percent.

A couple of participants referred to information from business contacts suggesting that inflation was unlikely to decline further, and a few expressed concerns that maintaining a highly accommodative stance of monetary policy for an extended period could erode the stability of inflation expectations over time and hence posed upside risks to the inflation outlook.

These rates of growth were associated with ranges for the civilian rate of unemployment of 5-1/4 to 5-1/2 percent in the fourth quarter of 2004 and 5 to 5-1/2 percent in the fourth quarter of 2005.

there are some indications that headwinds to global growth may be beginning to abate.

It was to do with, you know, strong monetary policy and fiscal stimulus into an economy that was recovering rapidly, and in which there were these supply-side barriers which effectively led to, you know, in certain parts of the economy, what you might call a vertical supply curve.

In their discussion of monetary policy for the intermeeting period, Committee members agreed that keeping the target range for the federal funds rate at 0 to 1/4 percent would be appropriate.

The staff expected the 12-month change in PCE prices to gradually move down in coming months, reflecting, importantly, the fading of base effects along with smaller expected monthly price increases,

In these circumstances, the Committee believed that policy accommodation could be removed at a pace that would likely be measured but noted that it would respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

Participants discussed their assessments of risks to financial stability, particularly in light of the Committee's highly accommodative stance of monetary policy.

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.

those risks appeared to be quite limited for the nearer term, excessive monetary stimulus had to be avoided to avert rising inflation expectations and added inflation pressures over time.

The unemployment rate is near a 50-year low, and inflation is running close to our 2 percent objective.

While great uncertainty regarding the path of fiscal policy and its economic effects will remain for some time, with the economy getting closer to full employment, the prospect of a material increase in fiscal stimulus over a sustained period could reasonably be expected to shift somewhat greater probability toward stronger inflation outcomes.

The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate.

There is, in my view, a reasonable prospect that each of these two effects will reverse their contributions to inflation over the next couple of years and that balance between them will be important in determining the pattern of core and overall inflation rates.

A few members expressed interest in using language specifying a period of time during which the federal funds rate was expected to remain exceptionally low, rather than a calendar date, arguing that such language might be better to indicate a constant stance of monetary policy over time.

A concern that one might have about price-level targeting, as opposed to more conventional inflation targeting, is that it requires a short-term inflation rate that is higher than the long-term inflation objective.

Broad equity price indexes were higher over the intermeeting period, amid heightened volatility.

In the current decade, however, the standard deviation of inflation has been relatively stable in Brazil, at around 5 percent, and it has been declining in Mexico, where it is now around 2 percent.

Some members expressed concern about the longer-run prospects for large federal deficits and their implications for the future performance of the economy.

The guidance on asset purchases, introduced in December, commits us to increasing our holdings of securities at least at the current pace until substantial further progress has been made toward the Committee's maximum-employment and price-stability goals.

One might even argue that if a central bank ever converged on a single monetary rule, there would be no need for a monetary policy committee.

As the factors restraining economic growth are projected to fade further over time, the median rate rises to 3 percent by the end of 2018, close to its longer-run normal level.

Three Questions The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?"

Participants thought that consumer expenditures likely would expand at a moderate pace in coming quarters, supported by solid gains in employment and real income.

By contrast, raising rates too slowly would raise the risk that monetary policy would need to tighten abruptly down the road, which could jeopardize the economic expansion.

Moreover, the recent relatively low monthly readings on core inflation and modest wage pressures, at least by some measures, suggested that some slack remained in resource utilization.

An important element in interpreting financial market prices is the identification of the risk premiums they contain.

That central bank independence promotes lower inflation in developed countries is well-established by the economic literature.

Members also agreed that there was only a remote possibility that the process of disinflation would cumulate to the point of a decline for an extended period in the general price level.

The Committee took these actions to provide a somewhat more accommodative policy in response to muted inflation pressures and the risks to the outlook I mentioned earlier.

Conclusion The United States productivity growth spurt, realized to a much lesser extent around the world, can be attributed largely to a combination of an investment boom and a technological revolution.

When, when you get to—in, in the forecast, all of that, you know, supply and demand sides of the economy adapt.

And you know, we haven’t yet—we just touched 2 percent core inflation, to pick one measure—just touched it for a few months, and then we’ve fallen back.

But in terms of just targeting growth, you know, I think—I actually think our dual mandate works very well, which is maximum employment and stable prices.

To be clear, when I say "risk premium" I mean the additional compensation required by investors for holding a risky security--that is, one with uncertain returns--above the compensation that would be demanded by risk-neutral investors who care only about expected returns.

The staff's outlook for inflation was broadly unchanged.

He was concerned that the flattening yield curve was partly due to falling longer-term inflation expectations or a lower neutral real rate of interest.

In any event, it was clear that forecasts in recent years typically had overstated the rise in inflation, and a great deal of uncertainty surrounded the extent to which productivity gains and other factors, some unspecified, might continue to hold down inflation in a period of robust economic growth and relatively tight labor markets.

A couple of participants pointed to the decline in credit spreads to relatively low levels by historical standards; one of these participants noted the risk of either a sharp rise in spreads, which could have negative repercussions for aggregate demand, or a continuation of the decline in spreads, which could undermine financial stability over time.

In particular, the Committee noted that it would respond as necessary to maintain price stability.

Rather than rely on Fed watchers employed by primary dealers to read the tea leaves of our daily interventions, we inform everyone, openly, and take responsibility for the level of short-term interest rates.

In such an environment, a central bank mandated to pursue price stability can be flexible according to the circumstances, while one with a numerical target may need to obtain formal modification of its objectives.

This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. "

And what we—it looks like we’re seeing a slowdown in the rate of growth.

Nonetheless, all but one of the members believed that in light of the uncertainties about the economic outlook, an immediate policy tightening was not needed in the absence of firmer indications that inflationary pressures might be emerging.

A couple of participants indicated that they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation.

Monetary Policy Spillovers Flow in Both Directions There is a vast literature that documents the existence of international spillovers from U.S. monetary policy, especially to emerging markets (EMs).

Later in the period, AFE yields partially rebounded and foreign equity prices fully recovered on some easing of U. S. ­–China trade tensions, as well as perceptions of reduced political uncertainty in the United Kingdom and Italy.

The staff also reduced slightly its forecast of growth next year

The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen.

Inflation readings available since the April meeting continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and continued decreases in prices of non-energy imports.

the very shortest maturities, and with the additional tightening and deceleration in inflation that is expected over coming quarters, the entire real curve will soon move into positive territory.

Some may see a monetary policy that actively addresses episodes of financial instability along the lines that I have just described as promoting excessive risk-taking and thus increasing the probability of future crises.

You know, it says that we will seek to—seek inflation that runs moderately above 2 percent for some time.

In some models, these factors can be explicitly tied to observable economic variables, such as inflation; in other models, the factors represent statistical summaries of the data and have no explicit economic interpretations.

Similarly, I don't think we yet fully understand the role of Year 2000 preparations in either the late 1990s investment boom or the acceleration in productivity.

That apparently has not made its way into prices yet,

As always, our actions are guided by our congressional mandate to promote maximum employment and price stability.

But, I would say, overall, we’re trying to sustain the expansion and keep, you know, close to our statutory goals, which are maximum employment and stable prices.

Although some decline in inflation could not be ruled out, persistence of the current degree of tightness in labor markets, consistent with the economy growing at a pace near its potential, could at some point begin to put more pressure on costs and prices, and growth somewhat above potential, which some members saw as a distinct possibility, would be even more likely to produce that result.

There should be able to be an adjustment that would have lower than—perhaps lower-than-expected increases in unemployment—lower than would be expected in the ordinary course of events because the level—the ratio of, of vacancies to unemployed is just out of keeping with historical experience.

In a virtuous circle, stable inflation expectations help the central bank to keep inflation low even as it retains substantial freedom to respond to disturbances to the broader economy.

For example, the Stock-Watson indicator and other indicators based on interest rates and spreads signaled the 1990-91 recession very weakly and rather late.

Subsequent to monetary union, harmonized consumer prices can be used as the best available measure of inflation in the Euro area.

Overall consumer prices increased in July and August at about the second-quarter rate.

Economic data releases were mixed, on balance, over the intermeeting period, but market participants were especially attentive to incoming information on the labor market--most notably, the private payroll figures in the employment report for May, which were considerably weaker than investors expected.

Longer-term inflation expectations have remained stable.

I will then discuss the prospects for adjusting monetary policy in the manner needed to sustain a strong job market

Nonetheless, on balance, most members currently considered the upside risks to inflation to be a bit less pressing than those on the downside for the next few quarters.

One prominent example is with semiconductor producers and their need to dramatically alter the mix of production to meet demands of the high-tech and automotive industries.

I look forward, as always, to my conversation with Tim, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework.

Participants expected that, with further gradual increases in the federal funds rate, economic activity would expand at a solid rate during the remainder of this year and a moderate pace in the medium term, and that labor market conditions would remain strong.

Others indicated that because part of the recent decline in the jobless rate was associated with a reduction in labor force participation, the drop in the unemployment rate likely overstated the overall improvement in the labor market.

One prominent example is the work in behavioral finance on how alternative assumptions regarding rationality can affect predictions for asset prices and saving behavior

As far as—as the policy rate, what we’ve said is that we will maintain the rate at this level until we’re confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals.

Inflation-targeting regimes make sense only if the central bank has independent control of the instruments of monetary policy, as holding the central bank responsible for meeting its inflation target is hardly possible otherwise.

The run-up in mortgage rates since the latter part of June was expected to curb housing demand to a limited extent in coming months,

Nevertheless, most participants agreed that, although the level of inventories of unsold homes that homebuilders desired was uncertain, the correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year--somewhat longer than previously expected.

Survey measures give us an idea of what the average household expects inflation to be in the coming years.