PALM BEACH, Fla. (PRWEB) June 09, 2014
Federal Reserve Bank of St. Louis President James Bullard discussed “How Far Is the FOMC from Its Goals?” at the Tennessee Bankers Association’s annual meeting on Monday.
Bullard noted that improving economic conditions have resulted in the Federal Open Market Committee (FOMC) now being much closer to its macroeconomic goals than it has been in the past five years. In particular, unemployment has continued to trend lower and inflation is low but moving back toward the FOMC’s 2 percent target.
While the FOMC is closer to its macroeconomic goals, Bullard noted that the stance of monetary policy remains far from its pre-crisis settings. “The monetary policy stance remains far from normal, despite recent reductions in the pace of asset purchases.” He explained that concerns remain about the overall performance of the labor market and, until recently, inflation was unexpectedly low.
“The Committee now faces a classic challenge concerning the appropriate pace of monetary policy normalization,” Bullard said.
Much Closer to Macroeconomic Goals
Over the past five years, U.S. unemployment has been high and inflation has remained relatively low. The FOMC was a long way from its macroeconomic goals, Bullard said, adding that this situation has led to an extraordinary monetary policy response. “But today, the FOMC is much closer to its macroeconomic goals.”
To measure the distance of the economy from the FOMC’s goals, Bullard used a simple function that depends on the distance of inflation from the FOMC’s long-run target and on the distance of the unemployment rate from its long-run average. This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard noted.
In his calculations, the target rate of inflation was set at 2 percent, the FOMC’s inflation target. The long-run average rate of unemployment was set at 5.4 percent, the midpoint of the central tendency of the FOMC’s Summary of Economic Projections.
Bullard examined how often the FOMC has been as far from its objectives as it is today. The function value is closer to the FOMC’s goals than it has been about 75 percent of the time since 1960, he said. “That is, if we do this calculation for every month of data since 1960, 75 percent of the time the FOMC was in a worse position with respect to its goals than it is today,” Bullard explained.
Thus, “the FOMC is closer to target today than it has been most of the time since 1960,” he said, adding that the function value is currently below the average over this period.
Bullard then looked at a more recent time frame. Considering data only since 2006, the function value is close to pre-crisis levels. “In this sense, the macroeconomy is much closer to normal than it has been during the past five years,” Bullard said. “The monetary policy stance, on the other hand, is not close to pre-crisis levels.”
Monetary Policy Stance
In response to the financial crisis, the FOMC lowered the policy rate to zero and implemented outright asset purchases. While the FOMC recently began tapering the pace of asset purchases, Bullard noted that the two main policy actions have not been reversed so far. That is, the Fed balance sheet is still large and increasing, and the policy rate remains at the zero lower bound.
Bullard said there are two likely reasons why monetary policy is so far from normal even though the FOMC is relatively close to its objectives: Labor markets do not seem to be fully recovered, and inflation has been low. However, he noted that while inflation is low, it is moving back toward the FOMC’s target.
“With inflation still below target, albeit rising, and unemployment still high, but falling, the Committee faces a classic monetary policy challenge,” Bullard said. He added that the challenge is how quickly the FOMC should move to return monetary policy to normal given improving macroeconomic conditions. “The debate on this topic is likely to garner significant attention as the economy continues to improve during 2014,” he concluded.
Headquartered in St. Louis, with branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the states that comprise the Federal Reserve’s Eighth District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, provides payment services to financial institutions and the U.S. government, and promotes financial literacy, economic education, and community development.