Fed Vice Chair Richard H. Clarida on U.S. Monetary Policy
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Adam Posen (AP): Good morning, everyone. I'm Adam Posen, president of the Peterson Institute for International Economics and it's our pleasure to host this event with the Vice Chair of the Board of Governors of the Federal Reserve System, the Honorable Richard H. Clarida. Dr. Clarida was kind enough to let us host his first actual speech as the vice chair of the committee, and we know that he is talking today about the changes to the Fed's statement of longer run goals and monetary strategy. For those of you who are aficionados, you can go back to his October 25, 2018 speech at PIIE and see many of the seeds intellectually for what more fruit in the statement and then Chair Powell's speech last week. Over to Vice Chair Clarida and I will give them a more fulsome introduction after the speech.
Richard Clarida (RC): Thank you, Adam. Last week, the Federal Reserve reached an important milestone in its ongoing review of its monetary policy strategy, tools, and communication practices with the unanimous approval and release of a new Statement on Longer-Run Goals and Monetary Policy Strategy. In my remarks today, I will discuss our new framework and highlight some important policy implications that flow from the revised statement and our new strategy. I believe that this new statement and strategy represent a critical and robust evolution of our framework that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future.
I will divide my remarks into four parts. First, I will discuss the factors that motivated the Federal Reserve in November 2018 to announce it would undertake in 2019 the first-ever public review of its monetary policy strategy, tools, and communication practices. Second, I will discuss the review process itself, with particular focus on the economic analysis and public input the Federal Open Market Committee (FOMC) drew on as it contemplated, over the past 18 months, potential changes to its policy framework. Third, I will briefly summarize the flexible inflation-targeting strategy that has been guiding U.S. monetary policy since 2012 in the context of some important changes in the economic landscape that have become evident since 2012. Fourth, I will discuss the major findings of the review as codified in our new Statement on Longer-Run Goals and Monetary Policy Strategy and highlight some important policy implications that flow from them. Finally, I will offer some brief concluding remarks before joining in conversation with my good friend Adam Posen, which, as always, I very much look forward to.
Motivation for the Review
As my FOMC colleagues and I indicated from the outset, the fact that the Federal Reserve System chose to conduct this review does not indicate that we believed we have been poorly served by the framework in place since 2012. Indeed, I would argue that over the past eight years, the framework served us well and supported the Federal Reserve's efforts after the Global Financial Crisis (GFC) first to achieve and then, for several years, to sustain—until cut short this spring by the COVID-19 pandemic—the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability in what became the longest economic expansion in U.S. history. Nonetheless, both the U.S. economy—and, equally importantly, our understanding of the economy—have clearly evolved along several crucial dimensions since 2012, and we believed that in 2019 it made sense to step back and assess whether, and in what possible ways, we might refine and rethink our strategy, tools, and communication practices to achieve and sustain our goals as consistently and robustly as possible in the global economy in which we operate today and for the foreseeable future.
Perhaps the most significant change since 2012 in our understanding of the economy is our reassessment of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. In January 2012, the median FOMC participant projected a long-run r* of 2.25 percent, which, in tandem with the inflation goal of 2 percent, indicated a neutral setting for the federal funds rate of 4.25 percent. However, in the eight years since 2012, members of the Committee—as well as outside forecasters and financial market participants—have repeatedly marked down their estimates of longer-run r* and, thus, the neutral nominal policy rate. Indeed, as of the most recent Summary of Economic Projections (SEP) released in June, the median FOMC participant currently projects a longer-run r* equal to just 0.5 percent, which implies a neutral setting for the federal funds rate of 2.5 percent. Moreover, as is well appreciated, the decline in neutral policy rates since the GFC is a global phenomenon that is widely expected by forecasters and financial markets to persist for years to come.
The substantial decline in the neutral policy rate since 2012 has critical implications for the design, implementation, and communication of Federal Reserve monetary policy because it leaves the FOMC with less conventional policy space to cut rates to offset adverse shocks to aggregate demand. With a diminished reservoir of conventional policy space, it is much more likely than was appreciated in 2012 that, in economic downturns, the effective lower bound (ELB) will constrain the ability of the FOMC to rely solely on the federal funds rate instrument to offset adverse shocks. This development, in turn, makes it more likely that recessions will impart elevated risks of more persistent downward pressure on inflation and upward pressure on unemployment that the Federal Reserve's monetary policy should, in design and implementation, seek to offset throughout the business cycle and not just in downturns themselves.
Two other, related developments that have also become more evident than they appeared in 2012 are that price inflation seems less responsive to resource slack, and also, that estimates of resource slack based on historically estimated price Phillips curve relationships are less reliable and subject to more material revision than was once commonly believed. For example, in the face of declining unemployment rates that did not result in excessive cost-push pressure to price inflation, the median of the Committee's projections of u*—the rate of unemployment consistent in the longer run with the 2 percent inflation objective—has been repeatedly revised lower, from 5.5 percent in January 2012 to 4.1 percent as of the June 2020 SEP. Projections of u* by the Congressional Budget Office and professional forecasters show a similar decline during this same period and for the same reason. In the past several years of the previous expansion, declines in the unemployment rate occurred in tandem with a notable and, to me, welcome increase in real wages that was accompanied by an increase in labor's share of national income, but not a surge in price inflation to a pace inconsistent with our price-stability mandate and well-anchored inflation expectations. Indeed, this pattern of mid-cycle declines in unemployment coincident with noninflationary increases in real wages has been evident in the U.S. data since the 1990s.
With regard to inflation expectations, there is broad agreement among academics and policymakers that achieving price stability on a sustainable basis requires that inflation expectations be well anchored at the rate of inflation consistent with the price-stability goal. This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation. The pre-GFC academic literature derived the important result that a credible inflation-targeting monetary policy strategy that is not constrained by the ELB can deliver, under rational expectations, inflation expectations that themselves are well anchored at the inflation target. In other words, absent a binding ELB constraint, a policy that targets actual inflation in these models delivers long-run inflation expectations well anchored at the target "for free." But this "copacetic coincidence" no longer holds in a world of low r* in which adverse aggregate demand shocks are expected to drive the economy in at least some downturns to the ELB. In this case, which is obviously relevant today, economic analysis indicates that flexible inflation-targeting monetary policy cannot be relied on to deliver inflation expectations that are anchored at the target, but instead will tend to deliver inflation expectations that, in each business cycle, become anchored at a level below the target. This is the crucial insight in my colleague John Williams' research with Thomas Mertens. Indeed John's research over the past 20 years on r* estimation and monetary policy design at the ELB have been enormously influential, not only in the profession but also at Fed and certainly in my own thinking about how our framework should evolve. This downward bias in inflation expectations under inflation targeting in an ELB world can in turn reduce already scarce policy space—because nominal interest rates reflect both real rates and expected inflation—and it can open up the risk of the downward spiral in both actual and expected inflation that has been observed in some other major economies.
Inflation expectations are, of course, not directly observed and must be imperfectly inferred from surveys, financial market data, and econometric models. Each of these sources contains noise as well as signal, and they can and sometimes do give contradictory readings. But, at minimum, the failure of actual PCE (personal consumption expenditures) inflation—core or headline—over the past eight years to reach the 2 percent goal on a sustained basis cannot have contributed favorably to keeping inflation expectations anchored at 2 percent. Indeed, my reading of the evidence is that the various measures of inflation expectations I follow reside at the low end of a range I consider consistent with our 2 percent inflation goal.
The Review Process
With this brief overview of important changes in the economic landscape since 2012, I would now like to discuss the review process itself. In November 2018, the Federal Reserve announced that in 2019 the System would undertake a wide-ranging, public review of its monetary policy strategy, tools, and communication practices. This initiative would be the first-ever public review of monetary policy strategy ever undertaken by the Fed. From the outset, it was conceived that the review would build on three pillars: a series of livestreamed Fed Listens events hosted by each of the 12 Reserve Banks and the Board, a flagship research conference hosted by the Federal Reserve Bank of Chicago, and a series of 13 rigorous briefings for the Committee by System staff at a succession of five consecutive FOMC meetings commencing in July 2019 and running through January 2020.
The Fed Listens series built on a long-standing practice at the Reserve Banks and the Board of hosting outreach events that included a wide range of community groups, but, by focusing on a common format in which representatives of these groups were encouraged to tell their stories about our policies' effect on their communities and daily lives, it became a potent vehicle for us to better connect with the people our policies are meant to benefit. Although many people across the System were involved in making Fed Listens the success it was, I would be more than remiss if I did not single out Ellen Meade for her indefatigable contributions and attention to detail and organization that were essential to pulling the whole thing off. A report on the Fed Listens series is available on the Board's web site.
The second pillar of our review, a research conference hosted by the Federal Reserve Bank of Chicago, brought together some of the world's leading academic experts in monetary economics to present bespoke papers on a range of topics central to the review. These papers and the robust discussion at the conference that they stimulated were an important input to the review process. The proceedings of the Chicago conference are available as a special January 2020 issue of the International Journal of Central Banking.
The third important pillar of the review is a collection of 13 memos prepared by System staff and discussed by the Committee at a number of FOMC meetings over the past 18 months. These memos were commissioned by a System steering committee that included Jeff Fuhrer, Marc Giannoni, and David Altig, with extensive input from Trevor Reeve. Thomas Laubach chaired the steering committee, and I must note that we simply would not be here today discussing this significant evolution of our framework without Thomas and the insights, inspiration, and good judgement that he brought to the project and the review process. A collection of the staff memos prepared for the review is now available on the Board's website.
A New Economic Landscape Compels a Framework ReThink
As I mentioned earlier, the Committee devoted five consecutive FOMC meetings between July 2019 and January 2020 to presentations by the staff and Committee discussions of memos touching on various aspects of the framework review, and it held a lengthy discussion at the July 2020 FOMC meeting about the new Statement on Longer-Run Goals and Monetary Policy Strategy. While it is fair to say that these Committee discussions revealed among the 17 participants a healthy range of views about and priorities for refining our framework and strategy, some common themes did emerge, and these provided the foundation for the revised Statement on Longer-Run Goals and Monetary Policy Strategy that the Committee discussed in July, approved last week, and released on Thursday, August 27.
Broadly, we agreed that the economic landscape has changed in important ways since 2012 and that, as a result, the existing statement and the monetary policy strategy that flows from it need as well to evolve along several dimensions. For example, under our previous flexible inflation-targeting framework, the Federal Reserve declared that the 2 percent inflation objective is "symmetric." This term has been interpreted by many observers to mean that the Committee's reaction function aimed to be symmetric on either side of the 2 percent inflation goal, and that the FOMC set policy with the (ex ante) aim that the 2 percent goal should represent an inflation ceiling in economic expansions following economic downturns in which inflation falls below target. Regarding the ELB, the previous statement was silent on the global decline in neutral policy rates, the likelihood that the ELB will constrain monetary policy space in economic downturns, and the implications of this constraint for our ability to achieve our dual-mandate goals. As for inflation expectations, the previous statement did discuss expected inflation, but only in the context of mentioning that the announcement of a 2 percent goal helps anchor inflation expectations. While this is certainly true, it does beg the deeper question of how well anchored inflation expectations can be if the 2 percent goal is seen by the public as—and turns out ex post to be—a ceiling. Regarding the maximum-employment leg of the dual mandate, the previous statement's discussion of minimizing "deviations" of employment from its maximum level does not adequately reflect how the FOMC has actually conducted monetary policy in recent years—before the pandemic—as the actual unemployment rate was declining and, for several years, remained below SEP median projections of u* (although, to be sure, the earlier statement did acknowledge that it can be difficult to estimate the maximum level of employment with precision).
The New Statement and Strategy
Before discussing how our Statement on Longer-Run Goals and Monetary Policy Strategy has evolved, let me highlight some important elements that remain unchanged. First and foremost, our policy framework and strategy remain focused exclusively on meeting the dual mandate assigned to us by the Congress. Second, our statement continues to note that the maximum level of employment that we are mandated to achieve is not directly measurable and changes over time for reasons unrelated to monetary policy. Hence, we continue not to specify a numerical goal for our employment objective as we do for inflation. Third, we continue to state that an inflation rate of 2 percent over the longer run is most consistent with our mandate to promote both maximum employment and price stability. Finally, because the effect of monetary policy on the economy operates with a lag, our strategy remains forward looking. As a result, our policy actions depend on the economic outlook as well as the risks to the outlook, and we continue in the new statement to highlight potential risks to the financial system that could impede the attainment of our dual-mandate goals on a sustained basis.
With respect to the new framework itself, the statement now notes that the neutral level of the federal funds rate has declined relative to its historical average and therefore that the policy rate is more likely than in the past to be constrained by its ELB, and, moreover, that this binding ELB constraint is likely to impart downside risks to inflation and employment that the Committee needs to consider in implementing its monetary policy strategy. In this regard, the statement now highlights that the Committee is prepared to use its full range of tools to achieve its dual-mandate objectives.
Regarding the maximum-employment mandate, the new statement now acknowledges that maximum employment is a "broad-based and inclusive goal" and continues to state that the FOMC considers a wide range of indicators to assess the level of maximum employment consistent with this broad-based goal. However, under our new framework, policy decisions going forward will be based on the FOMC's estimates of "shortfalls of employment from its maximum level"—not "deviations." This change conveys our judgment that a low unemployment rate by itself, in the absence of evidence that price inflation is running or is likely to run persistently above mandate-consistent levels or pressing financial stability concerns, will not, under our new framework, be a sufficient trigger for policy action. This is a robust evolution in the Federal Reserve's policy framework and, to me, reflects the reality that econometric models of maximum employment, while essential inputs to monetary policy, can be and have been wrong, and, moreover, that a decision to tighten monetary policy based solely on a model without any other evidence of excessive cost-push pressure that puts the price-stability mandate at risk is difficult to justify, given the significant cost to the economy if the model turns out to be wrong and given the ability of monetary policy to respond if the model were eventually to turn out to be right.
With regard to the price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations "well anchored at 2 percent"(and not just "well anchored") in a world of low r* and an ELB constraint that is binding in downturns. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at 2 percent, it "seeks to achieve inflation that averages 2 percent over time," and—in the same sentence—that therefore "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." This is the second robust evolution of our framework, and it reflects the inherent asymmetry of conducting monetary policy in a low r* world with an ELB constraint that binds in economic downturns. As discussed earlier, if policy seeks only to return inflation to 2 percent following a downturn in which the ELB has constrained policy, an inflation-targeting monetary policy will tend to generate inflation that averages less than 2 percent, which, in turn, will tend to put persistent downward pressure on inflation expectations and, potentially, on available policy space. In order to offset this downward bias, our new framework recognizes that monetary policy during economic expansions needs to "aim to achieve inflation moderately above 2 percent for some time." In other words, the aim to achieve symmetric outcomesfor inflation (as would be the case under flexible inflation targeting in the absence of the ELB constraint) requires an asymmetric monetary policy reaction function in a low r* world with binding ELB constraints in economic downturns.
It is for this reason that while our new statement no longer refers to the 2 percent inflation goal as symmetric, it does now say that the Committee "seeks to achieve inflation that averages 2 percent over time." To be clear, "inflation that averages 2 percent over time" represents an ex ante aspiration, not a description of a mechanical reaction function—nor is it a commitment to conduct monetary policy tethered to any particular formula or rule. Indeed, as summarized in the minutes of the September 2019 FOMC meeting, the Committee (and, certainly, I) was skeptical about the benefit, credibility, or practicality of adopting a formal numerical price level or average inflation target rule, just as it has been unwilling to implement its existing flexible inflation-targeting strategy via any sort of mechanical rule. So in practice, what, then, is the policy implication of this stated desire "to achieve inflation that averages 2 percent over time"? Again, the implication of our new strategy for monetary policy is stated explicitly in the new statement, and, at the risk of repeating myself, let me restate it verbatim: "… following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." Full stop. As Chair Powell indicated in his remarks last week, we think of this new strategy as an evolution from flexible inflation targeting to flexible average inflation targeting.
My remarks today have been focused on our new framework and flexible average inflation targeting strategy. Of course, our review has also explored ways in which we might add to our toolkit and refine our communication practices. With regard to our toolkit, we believe that forward guidance and large-scale asset purchases have been and continue to be effective sources of support to the economy when the federal funds rate is at the ELB, and, of course, both were deployed promptly in our March 2020 policy response to the pandemic. With regard to other monetary policy tools, and as we have made clear previously in the minutes to our October 2019 FOMC meeting, we do not see negative policy rates as an attractive policy option in the U.S. context. As for targeting the yield curve, our general view is that with credible forward guidance and asset purchases, the potential benefits from such an approach may be modest. At the same time, the approach brings complications in terms of implementation and communications. Hence, as noted in the minutes from our previous meeting (July 2020), most of my colleagues judged that yield caps and targets were not warranted in the current environment but should remain an option that the Committee could reassess in the future if circumstances changed markedly. Regarding communication practices, our new consensus statement does bring greater clarity and transparency to the way we will conduct policy going forward, and in that regard I note that Michelle Smith is leading our efforts to make immediately and readily available on the web a bounty of content that will be invaluable to those who desire a more granular understanding of the review process. Finally, now that we have ratified our new statement, the Committee can assess possible refinements to our SEP with the aim of reaching a decision on any potential changes by the end of this year.
In closing, let me say that while I was not a member of the Committee in 2012, had I been I would have voted enthusiastically for the January 2012 statement. It was the right statement, and flexible inflation targeting was the right strategy, at that time and for the next eight years. The existing framework served us well by supporting the Federal Reserve's efforts after the GFC first to achieve and then, for several years, to sustain the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability. But times change, as has the economic landscape, and our framework and strategy need to change as well. My colleagues and I believe that this new framework represents a critical and robust evolution of our monetary policy strategy that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future. Thank you very much for your time and attention, and I look forward now to my conversation with Adam.
AP: Without further ado, let us get into the questions because there are so many, not because of lack of clarity or of purpose but the opposite. This is a historic moment in the development of monetary policy by the Federal Reserve. Again, as I noted earlier, we were proud of PIIE to host your first speech as vice chair and at that time you already were indicating many of these concerns and of course that followed immediately in November 2018 with your leadership and the committee announcing the work on the statement which was as you said was an incredibly public process. So let me congratulate you and the chair and all the Members for the unanimous vote in favor of the statement. Let me now turn to some questions for you.
There are a number of questions from market types and others who have more rule-based interpretations asking, What does this moderate overshoot or required overshoot actually entail. How fuzzy is this rule about averaging inflation targeting? I think you were pretty clear that the committee does not intend this to be a strict rule, but could you expand a bit more on what's involved in the moderate overshoot?
RC: Sure. Well, as I mentioned in the speech, Adam, of course, under the existing inflation targeting framework we and other central banks don't mechanically follow any particular rule, although I should say that rules are an essential input into the policy process for thinking of options and communications. The statement of longer run goals and monetary strategy within the Fed is thought of as basically a quasi constitutional documented sort of at the 30,000 foot level of the parameters and objectives, certainly. Right now, we have an initial condition because of the pandemic. With a very elevated rate of unemployment and with inflation certainly below our objective and of course our focus as policymakers is to put in place, what we can to get the economy back as quickly as possible to achieving our, our dual mandate objectives obviously fiscal policy will also have an important role to play in that. I would expect as we as the economy recovers and as we approach our dual mandate goals that there will be further communication from the committee on the points that you raised. But right now, given our initial conditions, the focus really is on the framework.
I should point out, as I did in my remarks, Adam, that that 2% not being a ceiling, but an average is an important result in the pre-crisis literature that I worked on with Mark Gertler and Jordi Gali, and forward-looking Taylor rules you worked on with Rick Mishkin, Ben Bernanke, and Tomas Laubach. And that's a very robust framework. So in essence what we're trying to do, Adam, with this framework is achieve the outcomes that you would without a binding ELB constraint, but that recognizes that because it's there, you do need to adjust policy. You've heard the term opportunistic disinflation or my colleague Lael Brainard talked about opportunistic reflation. And that may be a part of it. But as the statement emphasizes, we believe that in many circumstances, it will be appropriate to aim for a modest overshoot of inflation, just to demonstrate that that inflation can operate on 2% to both sides of that 2% goal.
AP: Thank you for that it's really clear. And obviously we're both veterans of the debates and discussions that Rick Mishkin convened back at the New York Fed in the mid-1990s and here you are. Vice Chair. And Ben Bernanke of course went on to become chair, Rick serve as a governor and as you mentioned, Thomas Laubach has continued to play a key role as Director of Monetary Affairs.
RC: Yes indeed.
AP: But, so let me follow up on that, Rich. So in this environment that you've mentioned and talking about the need to account for the asymmetries created by the effective lower bound. One thing that did not seem to get considered was an actual raising of the inflation target. I mean, already by last summer at the Fed Chicago conference, it was clear that was not on the table.
RC: That's right.
AP: Could you say a bit more about why that wasn't considered and whether some future FOMC might consider.
RC: Well, obviously a future FOMC would certainly have that freedom to think about that. You know, very early on in this process in the fall of 2018 when we discussed at an FOMC meeting the broad parameters of this review, there was very widespread of not unanimous support for the fundamental logic of the 2012 statement, which is that price stability in the real world is best achieved with a positive inflation rate of 2% and we all felt that that was an important definition of price stability over the longer run. And so we thought it was more efficient to have the review focus on things that would be potentially that could be refined. I don't think this is the time to sort of, you know, revisit the history of 2% or other numbers, but just to say that the committee felt very comfortable and of course the existing statement retains the language from the 2012 statement that a rate of inflation of 2% over the long run is consistent with price stability. So I think that was the conclusion of this committee, I should also point out, Adam, that we unanimously agree that we think that good practice going forward for future Feds would be roughly every five years to have a review of communication strategy and toolkit. So we think that should be an ongoing part of the feds institutional practice and that would obviously afford an opportunity to do that if a future Fed wanted to.
AP: And again, not to be flattering. But as you and I joke sometimes flattery is for real kudos to you the chair. To Michelle Smith to Ellen Meade and others and made this such a public process which the Fed had not done before. I think that was great.
Continuing on the economic strategy and tools side. You mentioned that effectively you're going to be asymmetric or at least that's how we should interpret the movement to shortfalls on unemployment as opposed to deviations. But you in the chair and others have also mentioned concerns about the measurement of U*. In practical terms, is the staff still going to be putting out estimates of the NAIRU, are we still going to be phrasing things in terms of the SEP or is there just going to be more of a maybe not Yellen 14 point dashboard before have a broad range approach of assessing labor market.
RC: So first of all, to answer one element of your, of your question. The committee will continue going forward to four times a year to survey participants views about longer run magnitudes for potential growth as well as the rate of unemployment, consistent with maximum employment. So, though, that that will still be part of our process and communication. But of course, historically, and you mentioned. Chair Yellen. But certainly it's continued under Chair Powell. And I'm sure under Chair Bernanke and Greenspan we look, as you know, the Fed staff is very capable and we look at a large number of measures of the labor market. And I think our goal in making the change that we did here in the statement is not to emphasize any particular one, for example, the unemployment rate doesn't tell you anything about labor force participation, for example, or it doesn't even tell you anything about the passthrough from wages to prices and so I think we're just acknowledging the reality that in order to achieve price stability and maximum employment, we need to be looking at a lot of data and we didn't want to single out any one particular indicator, but we will still continue to survey the committee and publish those results, four times a year in the SEP.
AP: And obviously the breadth of survey is important and I, among others, are on the record talking about labor force participation and underemployment as being critical.
Now let's go to what's really a big question that has also been implied by some of your colleagues on the FOMC who already spoke since the chair, which is the issue of how much the committee, the Fed can actually raise the inflation rate. I mean you are proposing obviously a framework and the strategy throughout the whole cycle. But is there any reason to think that the Fed actually can push up inflation at this point, or in the near term?
RC: Well, Adam. I think so. I think the record shows that in 2018, core PCE inflation was just a touch above 2% that coincided with the strongest labor market in 50 years, so that's not ancient history. Really what this framework is about is trying to put in place the policies that get us to those mandate consistent goals as quickly as possible and just communicating that we're willing to allow the economy to operate at full strength, even if that means a modest overshoot of the inflation objective. But to your narrow question of "can the Fed do it", we did it as recently as two years ago.
AP: No, no. Of course you did. But you did that also at the end of a very long expansion. It was turned out to be the end of the long expansion process and with a lot of fiscal stimulus. So I understand the Fed may not want to comment on fiscal policy. But looking forward in terms of the statement in terms of what happens in the future. Are there any further thoughts about the role of coordination between monetary policy and fiscal policy since, as you mentioned, near the effective lower bound, fiscal policy seems to be a central tool.
RC: Good question. And what I'll say on that is obviously in order to do monetary policy, you have to have an understanding and a forecast of the parameters of fiscal policy. So in that context, fiscal policy is really an input to the way that we think about policy, but I don't really have anything to say about coordination. It's just we have to understand fiscal policy to implement monetary policy. And that's the way that we're continuing to proceed.
AP: You mentioned in your referral to recent minutes that the idea that yield curve control is not being considered for example, but it's not completely off the table and you make clear, as in contrast as you're well aware from the writing, as opposed to negative rates which are very clearly set to be off the table. I'm not asking to speculate forward., but just what is the factors in determining whether something like yield curve control or more explicit ties to fiscal policy should or should not be adopted.
RC: So let me talk briefly about yield curve control. I personally believe and I think a number of members of the committee, believe that there's potentially a place for yield curve control. But that yield curve control really most robustly is a complement to forward guidance and traditional large-scale asset purchases programs. But there certainly could be circumstances where it would be considered, and we were very clear in the minutes of our July meeting. I tried to be very clear in my speech today that it's certainly something that's in the toolkit. We're not inclined or thinking about deploying it right now, but it's certainly in the toolkit and potentially can have a place, and of course other central banks, most recently the Reserve Bank of Australia, have deployed a version of that, as indeed did the Fed way back in the 1940s. And so it's in the toolkit, but it's not something that which right now is something that we're about to deploy.
AP: Thank you very much. Continuing on the subject of the tool kit.
AP: So you mentioned, of course, that forward guidance as part of the toolkit. At least this is thought to be and obviously this framework as Ben Bernanke has commented potentially has an effect. The statement announcement has an effect through forward guidance. I mean, are you and the FOMC watching to see the market reaction and the yield curve reaction to the statement or are you expecting that you have to take more actual steps in September beyond simply the announcement?
RC: Well, let me say a couple of things. First, Adam, one of the implications of running a very public process is that even if there is a robust evolution and a very important evolution in our framework, which I would argue is the case here, market reaction was rather modest because we had done such an effective job at being transparent about the process. I don't think market reaction is indicative of a very much in this case. In terms of guidance, I'm obviously not going to comment on any particular meeting, what I would say is that the minutes in our July meeting indicated that we did have discussions at that meeting about potential ways that we might refine our rates guidance and thinking about the balance sheet. Now that we have concluded our review, I would anticipate that we would return to those discussions. But I wouldn't really want to prejudge where we are going to end up on that.
AP: Thank you. One other tool which you did not mention is the issuance of threshold type rules that we will counter-based or, in my opinion, better indicator-based guidance about what you will do that might seem to be consistent with the kind of statement you are talking about. Is that something under discussion? Was that something that you feel is consistent with the statement made for future use?
RC: Well, a couple of points on that. Of course threshold-based guidance is something that was deployed by the Bernanke and Yellen Fed, and so that's certainly something that's in the tool kits, since it's already been deployed and potentially has potentially has a role. I know the minutes do reveal that we have had in our general discussions about policy. Some participants have discussed versions of threshold guidance. And so as I mentioned, now that we have concluded the review, I imagine will be returning to a discussion of potentially refining guidance and our balance sheet communication, but I don't want to prejudge again where that's going to end up.
AP: Thank you. We're approaching the end of our time and again, thank you to the Vice Chair for honoring us and giving your speech here at Peterson Institute and have this discussion. So, two more questions if I could.
First, speaking about the guidance and then the past experience and going back to things you said in a number of speeches drawing on your market experience at PIMCO, there are market-based measures of inflation expectations and the key part of the new statement is the anchoring and potentially raising of inflation expectations, or worrying about downsides of inflation expectations. Will you be thinking about featuring, in particular, any kind of measures of inflation expectations more than you used to? Will that become a bigger part of the Fed's discussions?
RC: I'll just limit my comments to what I focus on and I've discussed this in previous speeches, including one I gave in New York in February. Inflation expectations are sort of like maximum employment, they're a crucial input to policy, but they're unobserved. And I think one of the things I've learned in my nearly two years as a governor/Vice Chair is that if there's something that's important to policy that's unobserved., you don't want to put all your eggs in one basket. You want to look at a wide range of noisy signals of in this case inflation expectations. So in my own case, I look at a dozen different measures of inflation expectations. I look at market-based measures, I look at surveys, I look at econometric models, and I tend to do either an informal or more formal model averaging across them. And I think they're pretty useful. There's definitely a common component in those dozen measures that gradually movesup and down. As I said in my remarks and I've said in virtually every speech, I think, including at the Peterson two years ago for my first speech that I look at a wide range of measures of inspected inflation. I think they're consistent with our price stability goal, but they're certainly for me at the lower end of a range that I consider consistent with it. And so certainly in my case, I look at a number of different measures. Just as we said earlier, we look at a number of different measures of labor market maximum employment as well.
AP: Thank you. And just to close this out in your previous life as professor and we mentioned the very fertile intellectual environment in the 90s around New York in monetary economics, you wrote with Mark Gertler and others about international economics and about foreign central banks, which wasn't mentioned in the statement, which wasn't mentioned in your speech or in Chair Powell's speech, was the issue of exchange rates and international feedback on the US economy. You did commission a very good paper by our Peterson Institute colleague Maurice Obstfeld for the 2018 Chicago conference. How do you see international factors feeding in, in this new framework, you're talking about?
RC: Well, international factors are crucial. And I've written about this over my career and given several speeches on it since I joined the board. And so they're actually very relevant to the discussion and, in particular, the most relevant factor, which we did allude to, I did allude to in my remarks, is that this decline in riskless neutral rates is really a global phenomenon, and that has very important implications, because it means that there's a global downward pressure on riskless rates. That means there's global increase in likelihood of hitting the lower bound and it also means, as I've said before, it also means that policymakers in each country need to be humble and cognizant of the fact that there's a substantial global factor driving their neutral interest rates and ignoring that fact, which we don't. But ignoring that fact would you know lead to very as adverse consequences. So I think, as we've said, there's very powerful global forces on rates and they're also very powerful global disinflationary forces and part of what this review was meant to address is to equip our framework and strategy so that we have the best chance of achieving our goals in the global economy that we're facing today.
AP: Thank you, Mr. Vice Chair. Thank you though. Again, this is a historic moment in monetary policy and, in my opinion, a catching up of an adaptation of the past inflation targeting flexibly into the realities that you and Chair Powell last week outlined of lower r*, of less responsive inflation to wage pressures, and of the need to recognize the effective lower bound. Thank you for your clarity and speaking with us today. Thank you for honoring us with your presence.
Thank your patience with our audio feed which luckily did not impede our lively discussion.
RC: Thank you.
AP: This meeting is adjourned.
The Peterson Institute for International Economics (PIIE) hosted the Honorable Richard H. Clarida, Vice Chair of the Board of Governors of the Federal Reserve System, for a webcast presentation on US monetary policy followed by a discussion with PIIE President Adam Posen on Monday, August 31, 2020.