Economic Uncertainty—The Implications for Monetary Policy
Speaking today at the Rocky Mountain Economic Summit in Victor, Idaho, Boston Fed President Eric Rosengren discussed some of the uncertainties that affect forecasts as well as monetary policy decisions.
One such area of uncertainty centers around inflation in the U.S. - currently at 1.2 percent and well below the Federal Reserve's 2 percent target. The data on core inflation have remained weak, even as labor markets have improved. One of the conditions the Fed's monetary policy committee has for beginning to raise short-term rates is reasonable confidence that inflation will move back to its 2 percent objective over the medium term.
"One reason the inflation rate may be so subdued is that significant slack - that is, excess supply - may remain in the labor market despite the simplest and most widely-reported unemployment rate having fallen to 5.3 percent," Rosengren said. The drop in the percent of the population in the U.S. that is officially employed (the employment to population ratio) may be evidence of such slack, although some of this decline is the result of demographic change.
Rosengren said that he has lowered his own estimate of the so-called natural rate of unemployment to 5 percent. Should inflation continue to undershoot forecasts, he said his own estimate may need to be adjusted even lower.
Rosengren also provided some perspective on a second area of uncertainty, international developments. The fluid situation in Greece is an example of how difficult-to-predict international events can make forecasting the future course of the economy difficult.
"The situation also calls for some sober reflecting on how best to preserve financial stability, in all parties' interests," he added. "I would underline the desirability of Greece and its creditors finding a reasonable compromise, which would not only help Greece but would avoid some unintended consequences for all parties in the Euro Area."
Fortunately, to date geopolitical issues and concerns around the world have not significantly altered the outlook for an improving U.S. economy. As the economy continues to improve, Rosengren expects that inflation will begin to move closer to the Federal Reserve's 2 percent inflation target, making it appropriate to consider starting to normalize monetary policy later this year.
As the Federal Reserve gets closer to its dual mandate goals (stable prices and maximum sustainable employment), Rosengren believes that monetary policymaking needs to be particularly data dependent.
"Data dependence at this point means that we wait for data that gives us greater confidence in our forecast, especially our forecast for inflation. We also wait to get a better handle on how the crisis in Greece gets resolved, so that we can better gauge its potential to impact on financial markets and the domestic economy."