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October 12, 2018

Five Takeaways from President Williams’s Speech on Monetary Policy and Global Impacts

On Wednesday, October 10, New York Fed President John Williams delivered keynote remarks at a conference in Indonesia. The speech, titled “Moving Toward ‘Normal’ U.S. Monetary Policy,” came at the Joint Bank Indonesia-Federal Reserve Bank of New York Central Banking Forum.

Here are five takeaways from President Williams’s remarks, with quoted passages from the speech for context:

1. The U.S. economy is in great shape overall, and there may even be room for improvement.

The Federal Reserve has attained its dual mandate objectives of maximum employment and price stability about as well as it ever has. Most indicators point to a very strong labor market — including an unemployment rate of 3.7 percent — and inflation is right on target.

With fiscal stimulus and favorable financial conditions providing tailwinds to the U.S. economy, the outlook is for more strong growth. Let me put some hard numbers to that: I expect real GDP to increase by around 3 percent this year and by 2.5 percent in 2019. Assuming this forecast comes to fruition, this will be the longest expansion in U.S. history based on data going back over 150 years. This above-trend pace of growth should lead to continued solid job gains and further declines in the unemployment rate. I expect the unemployment rate to edge down to slightly below 3.5 percent next year, the lowest level in nearly 50 years.

In keeping with this strong economic outlook, I expect price inflation to move up a bit above 2 percent. Importantly, I don’t see any signs of greater inflationary pressures on the horizon. This is all very good news, especially in the context of the slow recovery and low inflation that has persisted in the years since the financial crisis.

2. Less forward guidance — a description of the planned path for monetary policy — is natural given the state of the economy.

For those who follow the Fed closely, you’ve noticed that the FOMC has been slimming down its statements of late and using less forward guidance about the future path of policy. In this vein, the FOMC in its recent statement removed language indicating that monetary policy remains accommodative. Let me make clear, these more concise statements do not signify a shift in our monetary policy approach. Instead, they represent the natural evolution of the language describing the factors influencing our policy decisions in the context of the strength of the economic outlook and inflation being near our 2 percent longer-run goal.

[C]hanging circumstances call for some changes in how the FOMC communicates its policy views. Now that interest rates are well away from zero and the economy is humming along, the case for strong forward guidance about future policy actions is becoming less compelling. For one, the future direction of policy will no longer be as clear as it was during the past few years. When interest rates were extremely low, it was obvious that the direction for rates was upward, toward more normal levels, and our forward guidance reinforced that point. At some point in the future, it will no longer be clear whether interest rates need to go up or down, and explicit forward guidance about the future path of policy will no longer be appropriate.

3. There’s uncertainty involved in measuring r-star — or the “neutral” rate of interest — and it’s just one factor among many influencing the Fed’s decisions.

In addition, as we have moved far away from near-zero interest rates, it makes sense to shift away from a focus on normalizing the stance of monetary policy relative to some benchmark “neutral” interest rate, often referred to as “r-star.” Now, I have spent a good deal of my career studying r-star and I find it to be a useful concept for describing the economy’s longer-run behavior.

Having said that, at times r-star has actually gotten too much attention in commentary about Fed policy. Back when interest rates were well below neutral, r-star appropriately acted as a pole star for navigation. But, as we have gotten closer to the range of estimates of neutral, what appeared to be a bright point of light is really a fuzzy blur, reflecting the inherent uncertainty in measuring r-star. More than that, r-star is just one factor affecting our decisions, alongside economic and labor market indicators, wage and price inflation, global developments, financial conditions, the risks to the outlook… the list goes on and on.

4. The U.S. economy cannot be viewed in isolation from global economic and financial developments, so effective communication is critical to minimizing misunderstanding and market disruptions.

In today’s highly interconnected global economy and financial system, international developments affect the U.S. economy, and our policy actions in turn impact the rest of the world. Therefore, we devote considerable effort to monitoring and analysis of developments around the world to understand how our actions affect the global economy and indirectly feed back to our own economy. These considerations play an important role in my thinking about the economic outlook and the appropriate path for monetary policy, as well as how we best communicate our perspectives and plans.

A key lesson about policy-making in an interconnected world is that transparency and open lines of communication are critical to minimizing misunderstanding, market disruption, and volatility that can interfere with our common goals of having strong and stable economies. As I have mentioned a number of times already, effective communication that provides clarity and predictability to our policy actions is a critical component of successful policy-making.

5. As monetary policy “normalizes,” the Fed will continue to move gradually as it seeks to sustain the current expansion of the U.S. economy.

Monetary policy-making has perhaps never been more challenging than it was following the financial crisis. But, as we move toward more “normal” conduct of monetary policy, we must not rest easy. We will confront our own fair share of future challenges. The most important monetary policy challenge in the United States today is sustaining the long economic expansion without allowing risks to grow that ultimately undermine economic prosperity. Whatever the future may bring, I will be guided by our dual mandate, a heavy dependence on data, and a steadfast commitment to transparency. Such an approach, in my view, will help support prosperity both in the United States and abroad.

This article was originally published by the New York Fed on Medium.

The views expressed in this article are those of the contributing authors and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.


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