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Search Site Home > Newsroom > St. Louis Fed's Bullard Discusses Falling In ation Expectations and Monetary Policy Normalization 2/24/2016 NEW YORK – Federal Reserve Bank of St. Louis President James Bullard discussed “More on the Changing Imperatives for U.S. Monetary Policy Normalization” in a presentation Wednesday to the Money Marketeers of New York University. Bullard said that two pillars of the Federal Open Market Committee’s (FOMC) 2015 case for monetary policy normalization have changed in 2016. In particular, he noted that market-based in ation expectations have fallen further and that the risk of asset price bubbles over the medium term appears to have diminished. “These data-dependent For media inquiries contact: Laura Girresch mediainquiries@stls.frb.org O ce: (314) 444-6166 Cell: (314) 348-3639 James Bullard St. Louis Fed President and CEO changes likely give the FOMC more leeway in its normalization program,” he said. He discussed whether in ation expectations have fallen too far for comfort and raised concerns about central bank credibility with respect to the in ation target. He cited the example of the euro area, where 10-year government bond yields have fallen to the levels of Japan and Switzerland, “arguably because the credibility of the in ation target has eroded,” he said. Bullard also reiterated the need for monetary policy to be more clearly data dependent and whether the FOMC should rethink its approach to the Summary of Economic Projections (SEP). “The Committee may wish to consider changes to the way it approaches the policy rate projections in the SEP to better align market expectations of future policy moves,” he said. Declining In ation Expectations Bullard noted that modern theory suggests in ation expectations are a more important determinant of actual in ation than traditional “Phillips curve” effects, and that marketbased measures of in ation expectations have been declining in the U.S. since the summer of 2014. “The decline has been highly correlated with the decline in oil prices,” he said. While he had suggested in 2015 that in ation expectations would rise back toward July 2014 levels once oil prices stabilized, Bullard noted that oil prices did not stabilize and instead fell further beginning in November 2015. “Since then, market-based measures of in ation expectations have declined too far for comfort, the oil price correlation notwithstanding,” he said. Turning to the FOMC’s normalization strategy being predicated on an environment of stable in ation expectations, Bullard said this renewed downward pressure on marketbased measures of in ation expectations during 2016 has called this assumption into James Bullard is president and chief executive o cer of the Federal Reserve Bank of St. Louis. In these roles, he participates in the Federal Open Market Committee (FOMC) and directs the activities of the Federal Reserve’s Eighth District. President's Website Speeches & Presentations Video Appearances Media Interviews Research Papers question. “I regard it as unwise to continue a normalization strategy in an environment of declining market-based in ation expectations,” he said. “A decline in in ation expectations represents an erosion of central bank credibility with respect to the in ation target.” He addressed the argument sometimes made that the components of TIPS-based measures of in ation compensation other than in ation expectations (i.e., risk premia and liquidity premia) are rather large and volatile. “My preferred interpretation is that risk and liquidity premia associated with in ation compensation are relatively small with low volatility,” he explained. “Hence, I interpret declines in TIPS spreads as re ecting mostly declines in in ation expectations.” The Eurozone Experience Bullard discussed the potential outcome of a scenario in which market-based measures of in ation expectations continue to decline. He said the euro area arguably reacted too slowly to this type of development before it ultimately committed to a major quantitative easing program in January 2015. “The result has been uncomfortably low in ation in the euro area, which is now not projected to rise to target for some time,” he said. He examined a chart of 10-year government bond yields since 2012 for Japan, Switzerland, Germany, the U.K. and the U.S., with the chart showing the 10-year bond yield for Germany dropping to nearly the same level as yields for Japan and Switzerland. Bullard explained that all of these countries have similar in ation goals and, arguably, expected real rates of return on bonds of the same maturity. “What is different is that longer-term in ation credibility may differ across countries,” he said, noting that Germany seems to have moved from the relatively credible group to the less credible group since January 2012. Asset Price Bubbles Bullard then discussed how the risk of asset price bubbles over the medium term has been reduced. “Steps toward normalization of U.S. monetary policy help to lessen the risk that very low interest rates might feed into a third major asset price bubble in the U.S.,” Bullard said, adding, “The recent sell-off in global equity markets, along with increases in risk spreads in corporate bond markets, may have made this risk less of a concern over the medium term.” The FOMC and Data Dependence Bullard noted that the FOMC has repeatedly stated in o cial communication and public commentary that future monetary policy adjustments are data dependent. He addressed the possibility that the nancial markets may not believe this since the SEP may be unintentionally communicating a version of the 2004-2006 normalization cycle, which appeared to be mechanical. “Post liftoff, communicating a path for the policy rate via the median of the SEP could be viewed as an inadvertent calendar-based commitment to increase rates,” he said. “While the Committee has certainly stressed data dependence, its past behavior belies that emphasis and therefore may not carry as much weight as it should with the nancial markets.” Bullard said that a possible change to the SEP is an important issue for the FOMC to consider. “The FOMC could change its approach to the SEP in a way that would cease giving such explicit guidance on the likely path of the policy rate going forward,” he said. “Such a change might help better align the Committee with nancial markets on the idea that policy is data dependent and does not follow a predetermined path.” GENERAL Home About Us Bank Supervision Careers Community Development Economic Education Events Inside the Economy Museum Newsroom On the Economy Blog Open Vault Blog OUR DISTRICT Little Rock Branch Louisville Branch Memphis Branch Agricultural Finance Monitor Housing Market Conditions SELECTED PUBLICATIONS Bridges Economic Synopses Housing Market Perspectives In the Balance Page One Economics The Quarterly Debt Monitor Review Regional Economist ST. 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