Although the economy has made progress, inflation still remains below target, which gives the Federal Reserve time to wait before raising rates, Fed Governor Lael Brainard said Monday.
"The apparent flatness of the Phillips curve together with evidence that inflation expectations may have softened on the downside and the persistent undershooting of inflation relative to our target should be important considerations in our policy deliberations," Brainard told the Chicago Council on Global Affairs, according to prepared text released by the Fed. "In particular, to the extent that the effect on inflation of further gradual tightening in labor market conditions is likely to be moderate and gradual, the case to tighten policy preemptively is less compelling."
Labor markets have improved , but there is "evidence of greater slack than previously anticipated. This uncertainty about the true state of the economy suggests we should be open to the possibility of material further progress in the labor market," she said.
Despite adding an average 180,000 jobs a month this year, the unemployment rate is "moving sideways" rather than falling, Brainard said. And while the 4.9% unemployment rate is just a tick from the median estimate of the long-run unemployment rate in the Summary of Economic Projections, Brainard noted, "the natural rate of unemployment is uncertain and can vary over time."
The projection of the natural unemployment rate in the SEP has dropped over time, she noted, and "We cannot rule out that estimates of the natural unemployment rate may move even lower." Besides, there are other gauges of labor market slack that have suggested "there is some room to go."
With some uncertainty and no inflationary pressures, Brainard said, "it would be unwise for policy to foreclose on the possibility of making further gains in the labor market."
Foreign economic weakness should continue to "weigh on the U.S. outlook for some time, and fragility in global markets could again pose risks here at home," she added.
"[T]he neutral rate of interest remains considerably and persistently lower than it was before the crisis," she said. With near zero interest rates during the expansion, gross domestic product growth averaged "a very modest rate upward of 2 percent, and inflation has averaged only 1-1/2 percent." A decade ago such a scenario "would have seemed inconceivable … given the stance of monetary policy."
Early in the recovery, most observers expect the neutral rate to gradually return to about 2%. "But seven years into the expansion and with little sign of a significant acceleration in activity, the low neutral rate looks likely to persist. Indeed, developments over the past year confirm that the underlying causes will be with us for some time."
Among those causes, Brainard named: soft foreign consumption and investment and slow productivity growth.
The new normal means "the ability of monetary policy to respond to shocks is asymmetric. With policy rates near the zero lower bound and likely to return there more frequently even if the economy only experiences shocks similar in magnitude to those experienced pre-crisis, due to the low level of the neutral rate, there is an asymmetry in the policy tools available to respond to adverse developments. Conventional changes in the federal funds rate, our most tested and best understood tool, cannot be used as readily to respond to downside shocks to aggregate demand as it can to upside shocks. While there are, of course, other policy options, these alternatives have constraints and uncertainties that are not present with conventional policy. From a risk-management perspective, therefore, the asymmetry in the conventional policy toolkit would lead me to expect policy to be tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks."
