Question

Describe some limitations to the FOMC’s traditional monetary policy strategy.

Answer 1

A low neutral interest rate presents both near-term and longer-term challenges. I will begin with the current context. Because today's setting is both challenging and unique in many ways, it may be useful to lay out some general principles for assessing and implementing appropriate policy and to describe how we have been applying those principles.

Through the FOMC's setting of the federal funds rate target range and our communications about the likely path forward for policy and the economy, we seek to influence broader financial conditions to promote maximum employment and price stability. In forming judgments about the appropriate stance of policy, the Committee digests a broad range of data and other information to assess the current state of the economy, the most likely outlook for the future, and meaningful risks to that outlook. Because the most important effects of monetary policy are felt with uncertain lags of a year or more, the Committee must attempt to look through what may be passing developments and focus on things that seem likely to affect the outlook over time or that pose a material risk of doing so. Risk management enters our decisionmaking because of both the uncertainty about the effects of recent developments and the uncertainty we face regarding structural aspects of the economy, including the natural rate of unemployment and the neutral rate of interest. It will at times be appropriate for us to tilt policy one way or the other because of prominent risks. Finally, we have a responsibility to explain what we are doing and why we are doing it so the American people and their elected representatives in Congress can provide oversight and hold us accountable.

We have much experience in addressing typical macroeconomic developments under this framework. But fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy. There are, however, no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade. We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives.

This approach is illustrated by the way incoming data have shaped the likely path of policy this year. The outlook for the U.S. economy since the start of the year has continued to be a favorable one. Business investment and manufacturing have weakened, but solid job growth and rising wages have been driving robust consumption and supporting moderate growth overall.

As the year has progressed, we have been monitoring three factors that are weighing on this favorable outlook: slowing global growth, trade policy uncertainty, and muted inflation. The global growth outlook has been deteriorating since the middle of last year. Trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States. Inflation fell below our objective at the start of the year. It appears to be moving back up closer to our symmetric 2 percent objective, but there are concerns about a more prolonged shortfall.

Committee participants have generally reacted to these developments and the risks they pose by shifting down their projections of the appropriate federal funds rate path. Along with July's rate cut, the shifts in the anticipated path of policy have eased financial conditions and help explain why the outlook for inflation and employment remains largely favorable.

Turning to the current context, we are carefully watching developments as we assess their implications for the U.S. outlook and the path of monetary policy. The three weeks since our July FOMC meeting have been eventful, beginning with the announcement of new tariffs on imports from China. We have seen further evidence of a global slowdown, notably in Germany and China. Geopolitical events have been much in the news, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government. Financial markets have reacted strongly to this complex, turbulent picture. Equity markets have been volatile. Long-term bond rates around the world have moved down sharply to near post-crisis lows. Meanwhile, the U.S. economy has continued to perform well overall, driven by consumer spending. Job creation has slowed from last year's pace but is still above overall labor force growth. Inflation seems to be moving up closer to 2 percent. Based on our assessment of the implications of these developments, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

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