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The Path Forward for U.S. Monetary Policy James Bullard President and CEO Illinois Bankers Association Annual Conference June 23, 2017 Nashville, Tenn. Any opinions expressed here are my own and do not necessarily reflect those of the Federal Open Market Committee. 1 Introduction 2 Key themes in this talk • • • • The U.S. economy remains in a low-growth, low-inflation, low-interest-rate regime. The current level of the U.S. policy rate is likely to be appropriate for this regime over the forecast horizon. Current data readings suggest the Fed can wait and see how the economy develops before making any further adjustments to the policy rate. Many future developments could impact this policy path, but the Fed does not need to pre-empt any of them. 3 Low Growth 4 U.S. real GDP growth in 2017 • • • • • The current estimate for U.S. real GDP growth in the first quarter of 2017 is 1.2 percent at an annual rate.* U.S. macroeconomic news has surprised to the downside. Tracking estimates for second-quarter real GDP growth now suggest some improvement from the first quarter, but not enough to move the U.S. economy away from a regime characterized by 2 percent trend growth. Real GDP growth measured from one year earlier has averaged 2.1 percent over the last seven years. The 2 percent growth regime appears to remain intact. * This is the Bureau of Economic Analysis’ second estimate released on May 26. 5 Macroeconomic news has surprised to the downside Source: Citigroup and Bloomberg. Last observation: June 20, 2017. 6 Forecasts for 2017-Q2 growth have declined Source: FRB of Atlanta, FRB of New York, FRB of St. Louis, Macroeconomic Advisers. Last observation: See table on p. 8. 7 Tracking estimates for 2017-Q2 U.S. real GDP growth and H1 average Source Date Estimate* 2017-H1† Blue Chip Consensus June 10 3.0% 2.1% St. Louis Fed Economic News Index June 16 2.3% 1.8% FRBNY Staff Nowcast June 16 1.9% 1.6% Atlanta Fed GDPNow June 16 2.9% 2.1% CNBC Moody’s Consensus (median) June 21 2.9% 2.1% Macroeconomic Advisers 2.7% 2.0% * † June 21 percent change from the previous quarter, annualized average of Bureau of Economic Analysis’ 2017-Q1 second estimate (1.2%) and 2017-Q2 estimates 8 Low Inflation 9 U.S. inflation in 2017 • • • The FOMC’s inflation target is 2 percent. The U.S. inflation rate has been below the inflation target since 2012. Recent inflation data have surprised to the downside and call into question the idea that U.S. inflation is reliably returning toward target. 10 Inflation readings are lower Inflation measure Dec-2016 Last obs. Difference Sticky CPI (FRB of Atlanta) 258 214 -44 Median CPI (FRB of Cleveland) 250 228 -22 Core CPI 220 170 -50 Trimmed-mean PCE (FRB of Dallas) 186 175 -11 Core PCE 175 154 -21 Values are expressed in basis points. Inflation rates are measured as percent changes from one year earlier. Source: Bureau of Labor Statistics, FRB of Cleveland, FRB of Atlanta, Bureau of Economic Analysis, FRB of Dallas and author’s calculations. Last observations: April 2017 (PCE) and May 2017 (CPI). 11 Trimmed-mean PCE inflation lower Source: FRB of Dallas and author’s calculations. Last observations: April 2017. 12 Effect of declines in the price of cell services and prescription drugs Source: Bureau of Labor Statistics and author’s calculation. Last observation: May 2017. 13 Low Interest Rates 14 Monetary policy normalization • U.S. monetary policy has been normalizing by increasing the policy rate, but against the backdrop of: o relatively weak U.S. real GDP growth, o downside U.S. inflation surprises and • o a global regime of low policy rates. The financial market reaction has been reflected in: o a lower U.S. 10-year Treasury yield, o lower market-based U.S. inflation expectations and o an implied policy rate path closer to the St. Louis Fed path for 2017 and 2018 of 113 basis points. 15 U.S. policy rate is rising while other key policy rates remain fixed Source: Federal Reserve Board, European Central Bank, Bank of England and Bank of Japan. Last observation: June 21, 2017. 16 Longer-term U.S. yields have declined Source: Federal Reserve Board. Last observation: June 20, 2017. 17 Inflation expectations have weakened Source: Federal Reserve Board. Last observation: June 21, 2017. 18 Market expectations of the policy rate path remain below FOMC projections Source: Bloomberg and author’s calculations. Last observation: June 21, 2017. 19 Additional Developments 20 Remarks on additional developments • I want to now focus on a few additional developments concerning the U.S. macroeconomic outlook: o Unemployment in the U.S. is relatively low and may head lower—how will this affect the U.S. inflation outlook? o The U.S. fiscal situation may be altered by pending legislation—how will this affect the U.S. macroeconomic outlook? o The global growth outlook has brightened—how will this affect the U.S. macroeconomic outlook? o U.S. financial conditions are easier than they were at the time of the December 2016 FOMC meeting—how should we interpret this? 21 Does the Low U.S. Unemployment Rate Signal a Meaningful Rise in Inflation? 22 Unemployment is low • • • The U.S. unemployment rate declined to 4.3 percent in the May reading. Does this mean that U.S. inflation is about to increase substantially? The short answer is no, based on current estimates of the relationship between unemployment and inflation. 23 The estimated influence of unemployment on inflation • • • Let’s consider one study, Blanchard (2016), which estimates a Phillips curve relationship for the U.S.* Let’s suppose the unemployment rate continued to fall from current levels. How much would the inflation rate increase according to these estimates? * See O. Blanchard, 2016, “The U.S. Phillips Curve: Back to the 60s?” Peterson Institute for International Economics, Policy Brief No. PB16-1. 24 The estimated influence of unemployment on inflation * • If the unemployment rate was … The predicted core PCE inflation rate would be … 4.3% * 1.5% * 4.0% 1.6% 3.5% 1.7% current value (May 2017 for unemployment, April 2017 for inflation) Bottom line: Even if the U.S. unemployment rate declines substantially further, the effects on U.S. inflation are likely to be small. 25 Impact of New Fiscal and Regulatory Policies 26 The prospect of higher growth • • Will the new fiscal and regulatory policies move the U.S. into a higher-growth regime? The Fed can wait and see. Here are two considerations: o The economy is not in recession today, so fiscal policies should not be viewed as countercyclical measures. They should be viewed as supply-side improvements. o U.S. productivity growth is low and could be improved considerably. • Deregulation could improve productivity growth. • Infrastructure spending could improve productivity growth. • Tax reform could improve productivity growth. 27 Global Growth 28 The impact of better global growth prospects on the U.S. economy • • • • The global growth outlook has improved since last year. The International Monetary Fund (IMF) upgraded its world economic outlook for 2017. Key upgrades occurred for Japan, Europe and China. Nevertheless, these upgrades are too small and too uncertain to have a meaningful impact on U.S. macroeconomic performance. 29 Global growth: Forecasts for 2017 have improved since last fall 2017 Real GDP Growth Apr-2017 Oct-2016 Difference World Output 3.5% 3.4% 0.1 U.S. 2.3% 2.2% 0.1 Euro area 1.7% 1.5% 0.2 Japan 1.2% 0.6% 0.6 China 6.6% 6.2% 0.4 Differences are expressed in percentage points. Source: International Monetary Fund, World Economic Outlook. 30 Financial Conditions Indexes 31 U.S. financial conditions indexes suggest improvement • • • • Standard financial conditions indexes (FCI) suggest that financial conditions have improved since the December 2016 FOMC meeting. This is sometimes interpreted to mean that the FOMC decisions to increase the policy rate are not having any effect. Some of the drivers of FCI movements include low volatility as measured by the VIX, higher equity valuations and lower credit spreads. It is far from clear that a goal of monetary policy is to cause a deterioration in these aspects of financial markets. 32 Financial conditions have improved since last November Source: Federal Reserve Bank of St. Louis and Goldman Sachs. Last observation: week of June 16, 2017 and June 21, 2017. Note: lower readings mean improved financial conditions. 33 Higher equity valuations driven in part by technology stocks Source: Bloomberg and author’s calculations. Last observation: June 22, 2017. 34 Conclusion 35 Conclusion • • • • • Recent data indicate that real U.S. GDP growth remains consistent with the low-growth regime of recent years. U.S. inflation and inflation expectations have surprised to the downside in recent months. Low unemployment readings are probably not an indicator of meaningfully higher inflation over the forecast horizon. The FOMC can wait and see how key macroeconomic developments play out in the quarters ahead. The current level of the policy rate is appropriate given current macroeconomic data. 36 Connect With Us James Bullard stlouisfed.org/from-the-president STLOUISFED.ORG Federal Reserve Economic Data (FRED) Thousands of data series, millions of users SOCIAL MEDIA Blogs and Publications News and views about the economy and the Fed Economic Education Resources For every stage of life Community Development Promoting financial stability of families, neighborhoods ECONOMY MUSEUM 37