Mester, Loretta Jean and Federal Reserve Bank of Cleveland. "Inflation and Monetary Policy: Six Research Questions : [Remarks at the] 2014 Inflation Conference: "Inflation, Monetary Policy, and the Public," Federal Reserve Bank of Cleveland" in Statements and Speeches of Loretta J. Mester (May 29, 2014). https://fraser.stlouisfed.org/title/9033/item/669838, accessed on May 10, 2025.

Title: Inflation and Monetary Policy: Six Research Questions : [Remarks at the] 2014 Inflation Conference: "Inflation, Monetary Policy, and the Public," Federal Reserve Bank of Cleveland

Date: May 29, 2014
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image-container-0 Inflation and Monetary Policy: Six Research Questions Introduction I thank the Cleveland Fed for inviting me to speak today. And I thank you, Sandy, for that very warm introduction. I am honored to have been chosen as the Federal Reserve Bank of Cleveland’s next president and CEO. I realize I have a very hard act to follow, but I am very grateful that Sandy has built such a fine institution. The conference we have enjoyed over the past two days underscores the strengths and interests of the researchers at the Cleveland Fed, and I plan to build on that foundation when I officially start my new job next week. Understanding inflation dynamics is of vital importance to central banks. Today I will focus on some open research questions surrounding inflation from a policymaking viewpoint. I toyed with the idea of titling my talk “We Need Your Help,” but thought better of it. Nonetheless, my hope is to inspire researchers to work on some of these questions and perhaps participate in a future conference here at the Cleveland Fed. I view conferences that bring together central bank, academic, and market economists, as well as members of the business community, as important avenues to improve our collective understanding of the economic issues facing monetary policymakers. Before continuing, I note that my remarks represent my own views and not necessarily those of others in the Federal Reserve System. The Benefits of Price Stability Congress has directed the Federal Reserve to conduct monetary policy in pursuit of a dual mandate of maximum employment and stable prices. In my view, these goals are complements. In keeping with the theme of our conference, I am going to concentrate on the price stability part of the mandate. The benefits of price stability for the economy seem clear and have been pointed out by a number of Fed officials over the years.[1] When prices are stable, businesses and consumers can focus on productive activities rather than on ways to protect the purchasing power of their money. They can make long-term plans and commitments without having to deal with the uncertainty about the value of their money. Also, when the price level is stable, any price changes reflect changes in the supplies of certain goods or services relative to others. These relative price changes provide important information for businesses and consumers when deciding where to allocate their scarce resources. Another significant benefit of price stability is that it promotes the other important responsibilities of the central bank. It helps foster financial stability by minimizing unexpected transfers from lenders to borrowers that happen when inflation causes loan values to fall. And by fostering confidence in the economy, price stability supports growth and maximum employment, the other part of the Fed’s dual mandate. Recent Policy Developments So I think you will agree that price stability is valuable and it is an important goal of monetary policy. This is fitting since over the longer run, monetary policy is the principal determinant of inflation. In fact, the Federal Open Market Committee, or FOMC, made this important point in its statement on longer-run goals and monetary policy strategy, which it issued in January 2012 and has affirmed each year since. This statement lays out the guiding principles that the FOMC follows in setting monetary policy. As part of those principles, the statement established for the first time an explicit numerical goal for inflation over the longer run. The goal is 2 percent inflation, as measured by the year-over-year change in the price index for personal consumption expenditures, or PCE inflation. Being explicit about the inflation objective
image-container-1 reflects the FOMC’s desire to be transparent and communicate clearly to the public. But it also underscores the FOMC’s commitment to price stability. When businesses and consumers have confidence that the central bank is committed to 2 percent inflation over the longer run and will defend that target when inflation is either above or below it, they are more likely to look through temporary changes in inflation. This helps anchor inflation expectations at the target. As a result, underlying inflation will be less responsive to one-time supply shocks, such as changes in the price of oil. So having an explicit target helps promote price stability. I view the FOMC’s statement on its longer-run goals as entirely consistent with the Fed’s dual mandate. The statement makes explicit that the FOMC will take a balanced approach to meeting its mandated goals and explains why the FOMC has established a numerical objective for inflation but not a comparable one for maximum employment. Monetary policy is the chief determinant of inflation over the longer run, but the maximum level of employment is largely determined by demographics, production technology, and other factors that change over time and are not influenced by monetary policy. While the FOMC can choose the value of inflation it seeks to achieve over the longer run, it does not have the ability to achieve just any long-run objective for employment. Long-run employment is determined by economic fundamentals. That said, sound monetary policy is a necessary ingredient in promoting strong economic fundamentals, allowing the economy to more effectively achieve its potential. By helping policymakers set appropriate monetary policy, the explicit 2 percent inflation target promotes not only price stability but also full employment over the longer run. Today, the FOMC reiterates that 2 percent inflation goal in the policy statement it releases after its meetings. And the target is an important part of its forward guidance on the policy interest rate. For example, the April policy statement said that in deciding how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the FOMC will assess realized and expected progress toward its objectives of maximum employment and 2 percent inflation. Open Research Questions on Inflation and Inflation Expectations and the Implications for Monetary Policy That the FOMC is now more explicitly formulating its monetary policy in terms of projected progress toward its goals underscores how important it is for policymakers to be able to accurately measure inflation and inflation expectations and to forecast inflation over the medium and longer run. As we have discussed over the past two days of the conference, there has been considerable progress in advancing our knowledge of inflation dynamics, measurement, and forecasting. But there is more work to do. Let me discuss six open questions – not quite as many as a David Letterman Top-Ten List – but questions where I believe further research will help inform our understanding of inflation and in turn, aid monetary policymaking. I will start with a couple of measurement issues. First, how should we estimate the underlying trend in inflation? There are various measures of inflation. The FOMC’s preferred measure of consumer inflation is the PCE inflation rate. A perhaps more familiar measure is the Consumer Price Index, or CPI, inflation rate.[2] Even though these and other measures of inflation tend to move together over the long run, they can diverge in the short run.
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Date: May 29, 2014
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