Monetary Policy: Lessons from the Past and Looking Forward to the - - PowerPoint PPT Presentation

Monetary Policy: Lessons from the Past and Looking Forward to the Future

The Federal Reserve at 100 Loyola University Chicago December 6, 2013 Charles L. Evans President and CEO Federal Reserve Bank of Chicago

The views I express here are my own and do not necessarily reflect the views of the Federal Reserve Bank of Chicago, my colleagues on the Federal Open Market Committee (FOMC) or within the Federal Reserve System.

1

Three Big Events in Fed History

 The Great Depression (1929-1938)

– “Inept ¡monetary ¡policy” ¡failed ¡to ¡adequately ¡combat ¡ credit contraction, deflation, and depression

 The Great Inflation (1965-1980)

– Monetary policy failed to recognize structural changes and expectational dynamics that led to double-digit inflation

 The Treasury Accord (1951)

– An example highlighting the importance of central bank independence

2

Academic Foundations of Modern Central Banking

 Great Depression: Central banks must address nominal crises

– Friedman and Schwartz (1963) – Bernanke (1983, 1985)

 Great Inflation: Central banks must distinguish real

from nominal cycles – Friedman (1968) – Lucas (1972) – Kydland and Prescott (1982)

 Central bank independence: Central banks must be able to

act as necessary – Kydland and Prescott (1977) – Barro and Gordon (1983) – Rogoff (1985)

3

Long-Run Strategy for Monetary Policy

(January 2012 and January 2013)  π* = 2% PCE inflation  Ut

* ~ 5¼% - 6%

time-varying SEP long-run sustainable range

 Balanced approach to reducing deviations of inflation

and employment from long-run objectives

4 1 2 3 2000 '02 '04 '06 '08 '10 '12 '14 '16 80 90 100 110 120 2000 '02 '04 '06 '08 '10 '12 '14 '16

Total PCE Price Index

(level)

2% Price-Line from December 2007

Source: Inflation forecasts are from the September 18, 2013 FOMC Summary of Economic Projections

• Dec. 2007

Would ¡Today’s ¡Dilemma ¡Be ¡Different ¡under ¡a ¡Single ¡Mandate?

Path Implied by Current FOMC Inflation Forecasts

Inflation

(percent) QE1 QE2 MEP QE3

Core PCE (12-mo. Change) Average PCE Inflation (2000-2007): 2.3% Total PCE (36-mo. Average)

5

Inflation is Low Globally

Consumer Price Index

(Q4/Q4 percent change)

• 1.0

0.0 1.0 2.0 3.0 4.0 Canada Euro zone Japan U.K.

2000-2007 avg. 2008-2011 avg. 2012 Latest

6

Balanced Approach to the Dual Mandate Is Consistent with Mainstream Macroeconomics

Loss Function

(percent)

L = (π ¡ - π*)2 + 0.25 (y – y*)2 L = (π ¡ - 2)2 + (u – un)2

FOMC Forecast (September 18, 2013) Current Value

u = 9%

September 2011 Value

π ¡= ¡5.5%

2016 2014 2015

π* un Inflation Unemployment

7

Why Has Achieving Dual Mandate Been So Hard?

 Deleveraging in the aftermath of the financial crisis  Global risks  Unusually restrictive fiscal policy  Monetary policy constrained by zero lower bound

8

• 6
• 4
• 2

2 4 6 8 1999 '01 '03 '05 '07 '09 '11 '13

Fed Funds Rate

(percent)

History

Q3-2013

Policy Rate Constrained by Zero Lower Bound

Taylor (1999) Rule based on inflation and output gap

9

Policy Tools at the Zero Lower Bound

 Large Scale Asset Purchases  $45 bil. in Treasuries & $40 bil. in agency MBS per month

until substantial improvement in labor market outlook

 Forward Guidance  Zero interest rate at least until U < 6.5% or π > 2.5%  Features of both unconventional tools  Lower long-term interest rates  Disciplined by economic conditionality

10

Asset ¡Purchases: ¡The ¡Fed’s ¡Balance ¡Sheet ¡

Federal Reserve Assets

(Bil. $) 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 2007 2008 2009 2010 2011 2012 2013 All Other Assets ($305.1 bil.)

• Treas. Sec ($2,158.5 bil.)

Agency Debt ($58.4 bil.) Agency MBS ($1,443.7 bil.) Lending and Liquidity Facilities ($2.1 bil.)

• Nov. 27, 2013

11

Forward Guidance on the Federal Funds Rate

 Zero interest rate at least until U < 6.5% or π > 2.5%  Thresholds  December ¡2012: ¡ ¡ ¡“Economic conditions likely to warrant

exceptionally low level of the funds rate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between

• ne and two years ahead is projected to be no more than a half of a

percentage point above the ¡Committee’s ¡2 percent long-run goal, and longer-term inflation expectations continue to be well- anchored.”

12

Output Gap: 1982 Recovery vs. Today

Actual and Potential GDP: 2007

(2007 Q4 = 100)

Actual and Potential GDP: 1982

(1981 Q3 = 100) 70 85 100 115 130 1976 '78 '80 '82 '84 '86 70 85 100 115 130 2003 '05 '07 '09 '11 '13 Q3-2013

13

Fiscal Policy: Historically Unusual

• 1

1 2 3 1965 '70 '75 '80 '85 '90 '95 2000 '05 '10

Contributions of Government Purchases to Real GDP Growth

(percent)

14

Looking Ahead: Exit Principles (June 2011 Minutes)

 Balance sheet size

– Smallest level consistent with efficient monetary policy operation

 Balance sheet composition

– Treasury only

 Likely normalization sequence

– Taper, then end LSAPs – Cease reinvestment of maturing securities – Begin raising rates and drain reserves

 New tools: IOER, RRP Facility, term deposits

15

Looking Ahead to the Future

 Balanced approach to deviations from goals  Inflation preferences should be symmetric  Must recognize limitations of monetary policy during

episodes in which real cycles dominate