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September 12, 2016
The "New Normal" and What It Means for Monetary Policy
Governor Lael Brainard
At the Chicago Council on Global Affairs, Chicago, Illinois
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In the months ahead, my colleagues and I will continue to assess what policy path will best promote the sustained attainment of our goals. With that in mind, I would like to start by describing the contours of today's economy that will be particularly important in shaping the appropriate path of policy before reviewing recent developments. These contours represent noteworthy departures from the "old normal" that prevailed in the decades prior to the financial crisis. I would argue that policy today must rely less on the old normal as a guidepost and instead be sensitive to the contours that shape today's "new normal." 1
Key Features of the "New Normal"
Because monetary policy is forward looking, policymakers must assess how key features of the economic environment are most likely to influence the future path of the economy and shape policy accordingly. At a time when our assessment of the economy is evolving, several features of the "new normal"--some of which are interrelated--appear particularly noteworthy for our policy deliberations:
Notes
- Inflation Has Been Undershooting, and the Phillips Curve Has Flattened First, for the past several decades, policymakers relied on the empirical relationship between unemployment and inflation embodied in the Phillips curve as a key guidepost for monetary policy. The Phillips curve implied that as labor market slack diminished and the economy approached full employment, upward pressure on inflation would result. However, since 2012, inflation has tended to change relatively little--both absolutely and relative to earlier decades--as the unemployment rate has fallen considerably. 2 At a time when the unemployment rate has fallen from 8.2 percent to 4.9 percent, inflation has undershot our 2 percent target now for 51 straight months. 3 In other words, the Phillips curve appears to be flatter today than it was previously. With the Phillips curve appearing to be a less reliable guidepost than it has been in the past, the anchoring role of inflation expectations remains critically important. On expected, similar to realized, inflation, recent developments suggest some reasons to be concerned more about undershooting than overshooting. Although some survey measures have remained well anchored at 2 percent, consumer surveys have moved to the lower end of their historical ranges and have not risen sustainably. 4 Meanwhile, market‑based measures of inflation compensation have declined noticeably over the past two years at longer-term horizons, and have shown little improvement despite the recent stabilization in the price of oil and the exchange rate. Thus, we cannot rule out that the sustained period of undershooting the inflation target along with global disinflationary pressures are weighing on inflation expectations. Recognition of these developments is reflected in the evolution of the forecasts of Federal Open Market Committee (FOMC) participants in the Summary of Economic Projections (SEP) from June 2012 to June 2016. The SEP forecasts have shown repeated mark downs of the central tendency of the projection for core PCE (personal consumption expenditures) inflation, and the attainment of 2 percent at the upper end of the range has been pushed out repeatedly from 2012 initially to 2017 most recently. The apparent flatness of the Phillips curve together with evidence that inflation expectations may have softened on the downside and the persistent undershooting of inflation relative to our target should be important considerations in our policy deliberations. In particular, to the extent that the effect on inflation of further gradual tightening in labor market conditions is likely to be moderate and gradual, the case to tighten policy preemptively is less compelling. ↩
- These remarks represent my own views, which do not necessarily represent those of the Federal Reserve Board or the Federal Open Market Committee. ↩