Janet Yellen: The Biggest Surprise in the US Economy This Year Has Been Inflation

Janet Yellen: "The Biggest Surprise in the US Economy This Year Has Been Inflation"

Third, our framework for understanding inflation dynamics could be misspecified in some way. For example, global developments--perhaps technological in nature, such as the tremendous growth of online shopping--could be helping to hold down inflation in a persistent way in many countries. Or there could be sector-specific developments--such as the subdued rise in medical prices in the United States in recent years--that are not typically included in aggregate inflation equations but which have contributed to lower inflation. Such global and sectoral developments could continue to be important restraining influences on inflation. Of course, there are also risks that could unexpectedly boost inflation more rapidly than expected, such as resource utilization having a stronger influence when the economy is running closer to full capacity.

In this economic environment, with ongoing improvements in labor market conditions and softness in inflation that is expected to be temporary, the FOMC has continued its policy of gradual policy normalization. As the Committee announced after our September meeting, we are initiating our balance sheet normalization program this month. That program, which was described in the June Addendum to the Policy Normalization Principles and Plans, will gradually scale back our reinvestments of proceeds from maturing Treasury securities and principal payments from agency securities. As a result, our balance sheet will decline gradually and predictably.2 By limiting the volume of securities that private investors will have to absorb as we reduce our holdings, the caps should guard against outsized moves in interest rates and other potential market strains.

Changing the target range for the federal funds rate is our primary means of adjusting the stance of monetary policy. Our balance sheet is not intended to be an active tool for monetary policy in normal times. We therefore do not plan on making adjustments to our balance sheet normalization program. But, of course, as we stated in June, the Committee would be prepared to resume reinvestments if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal funds rate.

Also at our September meeting, the Committee decided to maintain its target for the federal funds rate. We continue to expect that the ongoing strength of the economy will warrant gradual increases in that rate to sustain a healthy labor market and stabilize inflation around our 2 percent longer-run objective. That expectation is based on our view that the federal funds rate remains somewhat below its neutral level--that is, the level that is neither expansionary nor contractionary and keeps the economy operating on an even keel. The neutral rate currently appears to be quite low by historical standards, implying that the federal funds rate would not have to rise much further to get to a neutral policy stance. But we expect the neutral level of the federal funds rate to rise somewhat over time, and, as a result, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion. Indeed, FOMC participants have built such a gradual path of rate hikes into their projections for the next couple of years.

Of course, policy is not on a preset course. I have spoken about some of the uncertainties associated with the inflation outlook in particular, and we will be paying close attention to the inflation data in the months ahead. But uncertainty about the outlook is by no means limited to inflation. As always, the Committee will adjust the stance of monetary policy in response to incoming economic information and the evolution of the economic outlook to achieve its objectives of maximum employment and stable prices. Moreover, we are mindful of the possibility that shifting expectations concerning the path of U.S. policy can lead to spillovers to other economies via financial markets and the value of the dollar. We remain committed to communicating as clearly and effectively as possible to help mitigate the risk of sudden changes in the policy outlook among market participants that could spur unintended effects in global financial markets.

*The Group of Thirty, often abbreviated to G30, is an international body of leading financiers and academics which aims to deepen understanding of economic and financial issues and to examine consequences ... http://group30.org/members

1. For further discussion, see Janet Yellen (2017), "Inflation, Uncertainty, and Monetary Policy," speech delivered at "Prospects for Growth: Reassessing the Fundamentals," the 59th annual meeting of the National Association for Business Economics, Cleveland, Ohio, September 26. Return to text

2. For October through December of this year, the decline in the Federal Reserve's securities holdings will be capped at $6 billion per month for Treasury securities and $4 billion per month for agency securities. These caps will gradually rise over the course of the following year to maximums of $30 billion per month for Treasury securities and $20 billion per month for agency securities and will remain in place through the process of normalizing the size of our balance sheet. Return to text

Last Update: October 15, 2017

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Janet Yellen: "The Biggest Surprise in the US Economy This Year Has Been Inflation"

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