Question

What is the current macroeconomic situation in the U.S.? What should the Fed do about it? What monetary policy tools should the Fed use to achieve the result(s) you just recommended?

Answer 1

At this point, the United States’ economy is in a recovery. That means that the economy is expanding. Usually, this would mean that the US government would be concerned about inflation. However, this recovery has not been very strong and the government is not particularly worried about inflation at this point. The US government is more worried about unemployment than about inflation.

The GDP will rise to 2.5 percent in 2018. It's the same as in 2017, but better than the 2.1 percent growth in 2016. The unemployment rate will drop to 3.9 percent in 2018 and 2019 but rise to 4.0 percent in 2020. That's better than the 4.1 percent rate in 2017, and the 4.7 percent rate in 2016. It's also better than the Fed's 6.7 percent target. But Federal Reserve Chair Janet Yellen admits a lot of workers are part-time and would prefer full-time work.

The economy added 2.7 million jobs last year, an average of about 230,000 a month. In the first three months of this year, payrolls were growing only modestly slower, at a little less than a 200,000 monthly pace. The unemployment rate had fallen to 5 percent, down from a peak of 10 percent in 2009.

The current stance of monetary policy is generally appropriate, in that it is providing support to the economy by encouraging further labor market improvement that will help return inflation to 2 percent. At the same time, The federal funds rate will probably need to rise gradually over time to ensure price stability and maximum sustainable employment in the longer run.

One useful measure of the stance of policy is the deviation of the federal funds rate from a "neutral" value, defined as the level of the federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential. These motivations notwithstanding, I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our 2 percent objective. Because monetary policy affects the economy with a lag, steps to withdraw this monetary accommodation ought to be initiated before the FOMC's goals are fully reached. And if the headwinds that have lingered since the crisis slowly abate as I anticipate, this would mean that the neutral rate of interest itself will move up, providing further impetus to gradually increase the federal funds rate. But I stress that the economic outlook, including the pace at which the neutral rate may shift over time, is uncertain, so monetary policy cannot proceed on any preset path.

Further gradual increases in the federal funds rate will probably be appropriate to best promote the FOMC's goals of maximum employment and price stability.