Good evening everyone. Many thanks to the organizers for inviting me to the lecture. It’s a pleasure to be here. I welcome hearing different views on how best to conduct monetary policy, and this conference certainly provides an invigorating debate on the subject.
Before I begin, I want to briefly touch on some news from this morning. I am deeply honored by the confidence shown in me by President Biden and Vice President Harris in nominating me as the next vice chairman of the board. I am honored to have this extraordinary opportunity and I am grateful to my colleagues, friends and family for their support.
Coming back to the conference and joining this debate, I would like to remind you that the views I am going to express today are my own and not necessarily those of my colleagues in the Federal Reserve System.
introduction
The title of the conference, How to Get Back on Track: A Policy Conference, is meaningful. Its intent and ambiguity are striking. First, the title assumes that US monetary policy is currently on the wrong track. Second, this conference’s website provides an enigmatic definition of “on track.” How come? According to the Hoover website, “A key objective of the conference is to explore how to get back on track and thereby lower inflation without slowing economic growth” (emphasis added).1 As this audience knows, there are macroeconomic models that allow for disinflation without slowing economic growth, but the assumptions underlying these models are very strong.2 It is not clear, at least to me, why such a rigorous metric should be used to assess real monetary policy. Third, the definition of “on track” in the title contrasts with more general definitions such as “accomplish or do what is necessary or expected” as offered in a standard reference such as the Merriam-Webster dictionary.3 In my view if so, the general definition provides a more practical perspective for assessing real-world policy-making.
Against this semantic background, I will begin my remarks with my perspective on the current inflation and economic situation. I will then look at credit conditions in response to the recent stress events in the banking sector. Next, I will set out some normative thoughts on strategic monetary policy in a highly uncertain environment. In conclusion, I would like to argue that if one is willing to broaden the perspective and include a more general definition, one can conclude that current monetary policy is indeed “on track”.
Current inflation in the US
Current inflation is still high. Figure 1 illustrates this point. Personal consumption expenditure (PCE) inflation, the black line, is 4.2 percent as of year-end March 2023, and core PCE inflation, the red line, is 4.6 percent.
Overall, news on inflation has been mixed so far this year. The good news is that both food and energy prices fell in March and headline PCE inflation slowed to 4.2 percent from 5 percent in February. Since its peak last June, inflation has fallen by about 2.75 percentage points – with the fall almost entirely attributable to falling energy prices and falling food prices. The bad news is that core inflation has made little progress.
To understand why, I find it useful to separately analyze three broad categories that together make up the core PCE: non-food and non-energy goods, the red line in Figure 2; housing services, the black line; and services excluding housing and energy, the blue dashed line. The drivers of inflation in each of these sectors are somewhat different, and understanding the different causes and their impact on the different components can help predict the future trajectory of inflation.
Core inflation on goods, the red line in Figure 2, has fallen from its peak of 7.6 percent in February 2022, but recent news has been discouraging. Except for used car prices, which fell unexpectedly in March, the fall in core commodity prices is slower than expected. The imbalance between supply and demand in the goods sector appears to be resolving more slowly than expected. Core housing services inflation, the black line in Figure 2, has risen sharply in recent years as demand in the housing sector has changed significantly during the pandemic. Recent monthly readings have started to slow down, although this is not yet evident in the 12-month changes shown in Figure 2. The latest slowdown was heralded by rents flattening on new leases to new tenants since the middle of last year. In contrast, core services excluding housing inflation (the blue dashed line in Figure 2) didn’t show much sign of a slowdown.
Labor market and GDP growth
Turning to labor markets, April 2023 Employment Report data continues to point to a strong labor market amid improving labor supply, with prime-age participation rates above pre-pandemic levels. Wage growth remains above the pace consistent with 2% inflation and current trends in productivity growth. Wage increases are welcome as long as they are compatible with price stability. In the 12 months ended March 2023, the employment cost index (ECI) for total hourly wages of workers in the private sector rose 4.8 percent, just slightly below its peak of 5.5 percent last June.
Despite strong consumer spending growth, gross domestic product (GDP) grew moderately at an annual rate of 1.1 percent in the first quarter of 2023 as inventory investment slowed significantly, similar to the below-trend pace of growth in 2022. Looking ahead valid: The growth in consumer spending in the last quarter does not appear to be sustainable. In fact, after a very sharp increase in January 2023, consumer spending fell in February and stagnated in March. In addition, I expect slower consumer spending growth for the remainder of the year in response to tight financial conditions, depressed consumer sentiment, increased uncertainty, and the decline in total household wealth and excess savings.
Current stress in the banking sector
The tightening in financing conditions that we have seen in response to our monetary policy actions is likely to be exacerbated by the impact on credit conditions of recent banking sector tensions. The US banking system is solid and resilient. The Federal Reserve, in cooperation with other agencies, has taken decisive action to protect the US economy. Nonetheless, it is likely that recent stress events will prompt banks to further tighten credit standards.4 While it is too early to say, I believe that these tightening credit constraints since recent times have been a slight Bank failures have been isolated and quickly addressed through aggressive macro- and micro-prudential policies.
Still, I acknowledge that there is significant uncertainty about the extent to which credit conditions will tighten over the coming year in response to the banking crisis and the magnitude of the impact that tightening could have on the US economy. As such, there is some downside risk that the additional effect of the credit shock is larger than I expected.
Monetary policy and current uncertainties
The fallout from the pandemic, geopolitical instability and stress in the banking sector have all contributed to a highly uncertain economic environment. In addition, the numerous post-pandemic “surprises” in inflation, employment and economic growth suggest that the underlying structure of the US economy may be changing. Put more simply, the post-pandemic data generation process for US macroeconomics is less clear.
Due to the proximity of the pandemic and its unprecedented disruption to economic and social activity, there is currently insufficient post-pandemic data to identify the parameters and stable relationships that characterize the possible new structure of the economy. Given this observation, what is a sensible monetary policy strategy? The answer to this question is likely to be different for each policy maker.
I would like to share with you some strategic principles that are important to me. First, policymakers should be ready to respond to a variety of economic conditions related to inflation, unemployment, economic growth and financial stability. The unprecedented pandemic shock is a good reminder that, in exceptional circumstances, it will be difficult to formulate accurate real-time forecasts. Our dual mandate from Congress is particularly helpful here. It forms the basis for all our political decisions. Second, policymakers should clearly communicate their monetary policy decisions to the public. Our commitment to transparency should be visible to the public and monetary policy should be conducted in a way that anchors longer-term inflation expectations. Third, and here I express my passion for econometrics, policymakers should continuously update their previous understanding of how the economy works as new data becomes available. In other words, it is appropriate to change perspective as new facts emerge. In this sense, I advocate a Bayesian approach to information processing.
While these principles do not constitute a complete monetary policy framework, I think they are useful when considering the characteristics of such frameworks.
Diploma
Finally, I would like to come back to the question of whether current monetary policy is “on track” but consider the broader definition of “achieving or doing what is needed or expected”. The nationwide unemployment rate was 3.6 percent in March 2022, when the current monetary tightening cycle began. Today, after a 500 basis point hike in interest rates, the nationwide unemployment rate is near a record low of 3.4 percent. At its most recent peak, total PCE inflation was 7 percent in June 2022. It is currently at 4.2 percent in March 2023. Is inflation still too high? Yes. Has the recent disinflation been uneven and slower than any of us would like? Yes. But I read this evidence to mean that we “do what is necessary or expected of us.” In addition, monetary policy affects the economy and inflation with long and variable lags, and the full impact of our rapid tightening is likely to lie ahead. We are balancing the guidelines of the dual mandate given to us by the US Congress. This is not an easy task in these uncertain times, but I can assure you that I and my FOMC colleagues approach it very seriously and with great humility. In this sense, I believe that we are “on the right track”.
Thank you very much.
references
Croushore, Dean (1992). “What is the Cost of Disinflation?” (PDF) Federal Reserve Bank of Philadelphia, Business Review, May/June, pp. 3-15.
Goodfriend, Marvin and Robert G King (2005). “The Incredible Volcker Disinflation,” Journal of Monetary Economics, Vol. 52 (July), pp. 981-1015.
Sargent, Thomas J (1982). “Stopping Moderate Inflation: The Methods of Poincare and Thatcher,” in Rüdiger Dornbusch and Mario Henrique Simonsen (eds.), Inflation, Debt, and Indexation (Cambridge, Mass.: MIT Press), pp. 54–96.
Tetlow, Robert J. (2022). “What is the Cost of Production of Disinflation?” Finance and Economics Discussion Series 2022-079 (Washington: Board of Governors of the Federal Reserve System, November).
1. Visit the conference website at www.hoover.org/events/how-get-back-track-policy-conference. Back to the text
2. Estimates of the cost of disinflation depend on the model used to measure them. Classical models, in which rational expectations play a dominant role in determining the cost of fighting inflation, show low costs, while Keynesian models, in which a slowdown is required to bring down inflation, show high costs. For example, see Sargent (1982), Croushore (1992), Goodfriend and King (2005) and Tetlow (2022) for a comparison of the cost of fighting inflation across macroeconomic forecasting models. Back to the text
3. See the definition of “track” at https://www.merriam-webster.com/dictionary/on%20track. Back to the text
4. The Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), conducted in April 2023, shows that banks, particularly small and medium-sized banks, have reported further tightening of credit standards for loans to businesses and households over the last three months after there had already been widespread tightening in previous years. The April 2023 SLOOS is available on the Board’s website at https://www.federalreserve.gov/data/sloos/sloos-202304.htm. Back to the text