Monetary Policy in a Low Inflation and Low Unemployment Economy Monetary Policy in a Low Inflation and Low Unemployment Economy

May 21, 2019

In remarks on Tuesday, Boston Fed president Eric Rosengren explored the current economic environment, characterized by low unemployment and lower-than-target inflation – which are somewhat opposing signals for monetary policymakers. “The Fed’s dual mandate from Congress had not posed this type of conflict in the early years after the global financial crisis, as unemployment had been undesirably high and inflation somewhat low. Both implied the need for monetary stimulus. But today, the two elements of the Fed’s mandate are sending opposing signals for monetary policy, with low unemployment perhaps suggesting a bit tighter policy, and low inflation the opposite.”

Rosengren described the economy as displaying a sounder footing than it was at the start of 2019. He expects the unemployment rate to fall even further. “Equity markets declined significantly in the fourth quarter of last year, but had largely recovered prior to recent events. Other concerns – for example, worries about foreign growth slowing as a result of Brexit, and about the Chinese economy faltering – appear to have subsided since the beginning of the year. And first-quarter growth in the U.S. was stronger than many forecasters expected.”

Rosengren believes there is no clear need to alter the current stance of monetary policy in the near term. “I see no clarion call to alter current policy in the near term. I view current policy as slightly accommodative and likely to be consistent with inflation returning to the Fed’s 2 percent inflation target over time.”

Clearly there are challenges associated with regularly undershooting inflation, including a resulting decline in inflation expectations that have proven difficult to reverse in other areas, said Rosengren. “While policy should not overreact to temporary inflation misses from the Fed’s target, it would not be desirable to continue consistently undershooting inflation. Regularly undershooting could cause inflation expectations to decline, a process that has been shown to be difficult to reverse in other developed areas, including Japan and Europe.”

A prominent downside risk – more disruptive trade negotiations – is another reason for policymaker patience, although Rosengren’s forecast assumes resolution of the U.S.-China trade dispute and projects the uncertainly it has created will be temporary and have only a modest effect on the economy. “For now, I am optimistically assuming that both sides in the trade negotiations will work to reach an agreement. I am also assuming that while the uncertainty is not helpful, it will be transitory, and thus have only a modest effect on the forecast for the U.S. economy overall.”

Rosengren says it’s worth discussing whether the Fed should aim for somewhat above-target inflation during recoveries, knowing it will likely undershoot the target during downturns. “Such an approach would not change the Fed’s inflation target over the cycle. Rather, it might reinforce the notion that policymakers aim to achieve 2 percent inflation on average, not allowing long periods of below-2 percent inflation to reset inflation expectations below the 2 percent inflation goal.”

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