120613 loyola fed centennial

8/13/2019 120613 Loyola Fed Centennial

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Monetary Policy: Lessons from the Past

and Looking Forward to the Future

The Federal Reserve at 100

Loyola University ChicagoDecember 6, 2013

Charles L. EvansPresident and CEOFederal Reserve Bank of Chicago

The views I express here are my own and do not necessari ly r ef lect the views of the Federal Reserve Bank of Chicago, mycolleagues on the Federal Open M arket Commi ttee (FOMC) or within the Federal Reserve System.


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Three Big Events in Fed History

The Great Depression (1929-1938)

Inept monetary policy failed to adequately combatcredit contraction, deflation, and depression

The Great Inflation (1965-1980)

Monetary policy failed to recognize structuralchanges and expectational dynamics that led to

double-digit inflation

The Treasury Accord (1951)

An example highlighting the importance of central

bank independence


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Academic Foundations of Modern Central Banking

Great Depression: Central banks must address nominal crises

Friedman and Schwartz (1963)

Bernanke (1983, 1985)

Great Inflation: Central banks must distinguish realfrom nominal cycles

Friedman (1968) Lucas (1972)

Kydland and Prescott (1982)

Central bank independence: Central banks must be able toact as necessary

Kydland and Prescott (1977)

Barro and Gordon (1983)

Rogoff (1985)


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Long-Run Strategy for Monetary Policy(January 2012 and January 2013)

*= 2% PCE inflation

Ut*~ 5% - 6% time-varying

SEP long-run sustainable range

Balanced approach to reducing deviations of inflation

and employment from long-run objectives


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0

1

2

3

2000 '02 '04 '06 '08 '10 '12 '14 '16

80

90

100

110

120

2000 '02 '04 '06 '08 '10 '12 '14 '16

Total PCE Price Index(level)

2% Price-Line fromDecember 2007

Source: Inflation forecasts are from the September 18, 2013 FOMC Summary of Economic Projections

Dec. 2007

Would Todays Dilemma Be Different under a Single Mandate?

Path Implied by CurrentFOMC Inflation Forecasts

Inflation(percent) QE1 QE2 MEP QE3

Core PCE (12-mo. Change)

Average PCE Inflation(2000-2007): 2.3%

Total PCE (36-mo. Average)


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Inflation is Low Globally

Consumer Price Index(Q4/Q4 percent change)

-1.0

0.0

1.0

2.0

3.0

4.0

Canada Euro zone Japan U.K.

2000-2007 avg.

2008-2011 avg.

2012

Latest


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Balanced Approach to the Dual Mandate IsConsistent with Mainstream Macroeconomics

Loss Function(percent)

L = ( - *)2+ 0.25 (yy*)2

L = (

- 2)2

+ (u

un

)2

FOMC Forecast(September 18, 2013)

Current Value

u = 9%

September 2011Value

= 5.5%

2016 2014

2015*

un

Inflation

Unemployment


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Why Has Achieving Dual Mandate Been So Hard?

Deleveraging in the aftermath of the financial crisis

Global risks

Unusually restrictive fiscal policy

Monetary policy constrained by zero lower bound


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-6

-4

-2

0

2

4

6

8

1999 '01 '03 '05 '07 '09 '11 '13

Fed Funds Rate(percent)

History

Q3-2013

Policy Rate Constrained by Zero Lower Bound

Taylor (1999) Rule based oninflation and output gap


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Policy Tools at the Zero Lower Bound

Large Scale Asset Purchases

$45 bil. in Treasuries & $40 bil. in agency MBS per month

until substantial improvement in labor market outlook

Forward Guidance

Zero interest rate at least until U < 6.5% or > 2.5%

Features of both unconventional tools

Lower long-term interest rates

Disciplined by economic conditionality


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Asset Purchases: The Feds Balance Sheet

Federal Reserve Assets(Bil. $)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2007 2008 2009 2010 2011 2012 2013

All Other Assets ($305.1 bil.) Treas. Sec ($2,158.5 bil.)

Agency Debt ($58.4 bil.) Agency MBS ($1,443.7 bil.)

Lending and Liquidity Facilities ($2.1 bil.)

Nov. 27, 2013


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Forward Guidance on the Federal Funds Rate

Zero interest rate at least until U < 6.5% or > 2.5%

Thresholds

December 2012: Economic conditions likely to warrant

exceptionally low level of the funds rate at least as long as the

unemployment rate remains above 6-1/2 percent,inflation between

one and two years ahead is projected to be no more than a half of a

percentage point above the Committees 2 percent long-run goal,

and longer-term inflation expectations continue to be well-

anchored.


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Output Gap: 1982 Recovery vs. Today

Actual and Potential GDP: 2007(2007 Q4 = 100)

Actual and Potential GDP: 1982(1981 Q3 = 100)

70

85

100

115

130

1976 '78 '80 '82 '84 '86

70

85

100

115

130

2003 '05 '07 '09 '11 '13

Q3-2013


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Fiscal Policy: Historically Unusual

-1

0

1

2

3

1965 '70 '75 '80 '85 '90 '95 2000 '05 '10

Contributions of Government Purchases to Real GDP Growth(percent)


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Looking Ahead: Exit Principles (June 2011 Minutes)

Balance sheet size

Smallest level consistent with efficient monetary

policy operation

Balance sheet composition

Treasury only

Likely normalization sequence

Taper, then end LSAPs

Cease reinvestment of maturing securities Begin raising rates and drain reserves

New tools: IOER, RRP Facility, term deposits


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Looking Ahead to the Future

Balanced approach to deviations from goals

Inflation preferences should be symmetric

Must recognize limitations of monetary policy during

episodes in which real cycles dominate

120613 loyola fed centennial

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