Must-Read: Ben Bernanke: The Fed’s Shifting Perspective

Ben Bernanke: The Fed’s Shifting Perspective:

Over the past couple of years, FOMC participants have often signaled…

…that they expected repeated increases in the federal funds rate as the economic recovery continued. In fact, the policy rate has been increased only once, in December 2015, and market participants now appear to expect few if any additional rate rises in coming quarters…. Market commentary on FOMC decisions typically focuses on short-run factors… [but] they can’t account for extended deviations of policy from its expected path. The more fundamental reason for the shift in policy trajectory is the ongoing change in how most FOMC participants view the key parameters of the economy.

The two changes in participants’ views that have been most important in pushing the FOMC in a dovish direction are the downward revisions in the estimates of r* (the terminal funds rate) and u* (the natural unemployment rate). As mentioned, a lower value of r* implies that current policy is not as expansionary as thought…. Likewise, the decline in estimated u* implies that bringing inflation up to the Fed’s target may well take a longer period of policy ease than previously believed. The downward revisions in estimated u* likely have also encouraged FOMC participants who see scope for further sustainable improvement in labor market conditions. The downward revisions to estimates of y* have mixed implications….

FOMC participants’ views of how the economy is likely to evolve have not changed much:  They still see monetary policy as stimulative (the current policy rate is below r*), which should lead over time to output growing faster than potential, declining unemployment, and (as reduced economic slack puts upward pressure on wages and prices) a gradual return of inflation to the Committee’s 2 percent target. However, the revisions in FOMC participants’ estimates of key parameters suggest that they now see this process playing out over a longer timeframe than they previously thought…. Relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited.  Moreover, there may be a greater possibility that running the economy a bit “hot” will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates….

It has not been lost on Fed policymakers that the world looks significantly different… than they thought… and that the degree of uncertainty about how the economy and policy will evolve may now be unusually high. Fed communications have therefore taken on a more agnostic tone recently…. With policymakers sounding more agnostic and increasingly disinclined to provide clear guidance, Fed-watchers will see less benefit in parsing statements and speeches and more from paying close attention to the incoming data…