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U.S. Monetary Policy: Still Appropriate James Bullard President and CEO, FRB-St. Louis Dialogue with the Fed 29 June 2012 Little Rock, Arkansas Any opinions expressed here are my own and do not necessarily reflect those of others on the Federal Open Market Committee. This talk Some aspects of the current macroeconomic situation. Fed communications: Time for a Quarterly Monetary Policy Report? The Current Macroeconomic Situation The Fed has been easing aggressively since 2008 The policy rate was lowered in early 2008, hit near-zero in late 2008, and remains there today. The FOMC purchased agency MBS in 2009. The FOMC began QE2 in 2010 as deflation loomed. In 2011, the FOMC began a version of “Operation Twist” which continues today. Also in 2011, the Committee began to give calendar-date guidance regarding the first increase in the policy rate, currently set at “late 2014.” Easy policy remains in effect These Fed actions remain impactful today: The policy rate remains near-zero. The large Fed balance sheet remains in place. “Operation Twist” is still ongoing and will alter the balance sheet composition through the end of this year. The calendar date language is still in effect. Both real and nominal interest rates are very low In short, current monetary policy remains ultra-easy and is likely appropriately calibrated to the current situation. Most analysis suggests Fed actions have helped produce very low nominal and real interest rates across the yield curve. A regression of the 5-year Treasury yield on an unemployment gap and a core inflation gap suggests yields would normally be considerably higher given current macroeconomic conditions. Part of the explanation is that continued European turmoil has caused U.S. rates to fall due to a “flight-to-safety” effect. Real and nominal interest rates: Lower than normal Source: Federal Reserve Board and author’s calculations. Last observations: May 2012 (nominal and TIPS yields), April 2012 (Taylor rule implied yield). Turmoil in Europe The sovereign debt crisis in Europe does not have easy solutions. The crisis is fundamentally about countries that have borrowed too heavily on international debt markets. This is not a problem that monetary policy can remedy. Attempts to use monetary policy to fix fiscal problems have historically ended with substantial inflation. Debt problems take a long time to work out, so we should expect a drawn-out adjustment process in Europe. Yield Spreads on European debt Source: Federal Reserve Bank of New York. Last observation: June 25, 2012. CDS on European debt Source: Federal Reserve Bank of New York. Last observation: June 25, 2012. Spillover to the U.S.? So far, recent spillover to the U.S. has come mostly in the form of lower U.S. interest rates. Equity prices are down recently, but remain up for 2012. U.S. financial firms have higher levels of capital than they did in 2008. In the event of a severe financial shock, the Fed could re-open liquidity facilities pioneered during 2008-2009. Financial stress in the U.S. has increased only modestly so far. Financial stress measures up modestly Source: Federal Reserve Bank of St. Louis. Last observation: week of June 15, 2012. Equity markets remain higher in 2012 Source: Dow Jones. Last observation: June 25, 2012. Labor markets have improved over the last year Unemployment has fallen by 0.8 percent in the last year. This is relatively fast compared to U.S. macroeconomic history over the last 25 years. That this occurred during a period of relatively slow growth has led to a robust debate. Unemployment changes, 1990-present Source: Bureau of Labor Statistics and author’s calculations. Last observation: May 2012. U.S. inflation: About at target Inflation is close to target by many measures. Expected inflation is also near target. Some claim that “price level targeting” would make a difference. However, the U.S. price level appears to be quite close to an appropriate price level path. The U.S. price level has not strayed from an appropriate path as it did in Japan during the1990s and the U.S. during the 1930s. U.S. inflation: About at target Source: BEA, FRB of Dallas, and Federal Reserve Board. Last observations: May 2012 (TIPS spread) and April 2012 (others). The price level path seems appropriate Source: Bureau of Economic Analysis and author’s calculations. Last observation: April 2012. The Risks The main risk The ultra-easy monetary policy has been appropriate so far, but could reignite a 1970s-type experience globally if pursued too aggressively. The 1970s era included 4 recessions in 13 years, double-digit inflation, and double-digit unemployment. The lesson was clear: “Do not let the inflation genie out of the bottle.” Other risks The Committee has done too little? This seems unlikely given the litany of major policy actions listed in earlier slides. If anything, the Committee may be trying to do too much with monetary policy, risking monetary instability for the U.S. and the global economy. The U.S. economy may encounter further negative shocks? It is possible, but the Committee can respond as appropriate to a significant deterioration relative to the current forecast. The FOMC has allowed the price level to fall off the appropriate path? The earlier chart suggests not. Labor market policies The U.S. has about 12.7m unemployed people, against 142m employed and 88m out of the labor force.* Labor market policies such as unemployment insurance and worker retraining have direct effects on the unemployed. Monetary policy is a blunt instrument which affects the decision making of everyone in the economy. It may be better to focus on labor market policies to directly address unemployment instead of taking further risks with monetary policy. * Source: Bureau of Labor Statistics. May 2012 data. Additional distortions The near-zero rate policy has been in place for more than three years, and is projected for several more. This length of time is far beyond the typical recession/recovery discussion in the academic literature. The near-zero rates cause other distortions in the economy, including punishing savers. Fed Communications The Fed has become more transparent The FOMC has increased the degree of transparency surrounding monetary policy in a variety of ways since the 1990s. In January 2012, the Committee began releasing forecasts of the FOMC participants. The forecasts include a future path for the policy rate. The reception for this aspect of increased transparency has been mixed. Possible improvements to communications The current communication strategy operates with only a few variables, while the economy is described by many variables. The FOMC could instead publish a quarterly document akin to the Bank of England’s “Inflation Report.” This could potentially provide a more fulsome discussion of the outlook for the U.S. economy and for policy than is currently provided. A broader discussion of the U.S. outlook A report of this type could potentially lay down a benchmark “Fed view” on the key issues facing the U.S. economy. Release of the report could be coordinated with the quarterly press briefings conducted by Chairman Bernanke. FOMC participants could point out where their views differ from the benchmark. Many other central banks proceed in this manner. Conclusions Summary The current stance of monetary policy is ultra-easy, and remains appropriately calibrated given the macroeconomic situation in the U.S. FOMC communications could be improved further by producing a quarterly monetary policy report (QMPR) similar to those produced by other central banks. Federal Reserve Bank of St. Louis stlouisfed.org Federal Reserve Economic Data (FRED) research.stlouisfed.org/fred2/ James Bullard research.stlouisfed.org/econ/bullard/