Must-read: Janet Yellen: “The Outlook, Uncertainty, and Monetary Policy”

Must-Read: Back in 1992 Larry Summers and I wrote that pushing the target inflation rate from 5% down to 2% was a very dubious and hazardous enterprise because the zero-lower bound was potentially a big deal: “The relaxation of monetary policy seen over the past three years in the United States would have been arithmetically impossible had inflation and nominal interest rates both been three percentage points lower in 1989. Thus a more vigorous policy of reducing inflation to zero in the mid-1980s might have led to a recent recession much more severe than we have in fact seen…”

Now we have an answer from Janet Yellen: that the zero lower bound is not, in fact, such a big deal:

Janet Yellen: The Outlook, Uncertainty, and Monetary Policy: “One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment…

…Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.10 While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.

The natural next question to ask then is: Then why isn’t nominal GDP on its pre-2008 trend growth path? Why is the five-year ahead five-year market inflation outlook so pessimistic? Why hasn’t the Federal Reserve pushed interest rates low enough so that investment as a whole counterbalances the collapse in government purchases we have seen since 2010?

Gross Domestic Product FRED St Louis Fed Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed FRED Graph FRED St Louis Fed

March 30, 2016


Brad DeLong
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