Janet Yellen's Speech to the NABE

Turning to inflation, signs of improvement in underlying inflationary pressures are evident in recent data.  Over the past twelve months, the price index for personal consumption expenditures excluding food and energy, or the core PCE price index, has increased by 1.9 percent.  Just several months ago, the twelve-month change was quite a bit higher, at nearly 2½ percent.  I anticipate that the core PCE price index will edge down slightly further over the next few years.  This view is predicated on continued well-anchored inflation expectations.  It also assumes the emergence of some slack in the labor market, as well as the ebbing of the upward effects of several special factors—including energy and commodity prices and owners’ equivalent rent. 

With that view of recent financial developments and the outlook for the U.S. economy, I’d like to turn to Fed policies. It’s unusual for me to use the plural—policies—because I’m normally referring only to monetary policy in which the FOMC pursues its dual mandate for the overall economy of full employment and price stability.
However, this time around the Fed took a number of steps to help restore liquidity in the financial markets, some of which I have already mentioned.  One step involved a sizable injection of reserves to prevent the federal funds rate from rising above its 5¼ percent target in the face of huge demands for short-term, liquid funds. In addition, on August 17 the Fed announced that the discount rate had been cut 50 basis points to narrow the spread with the target federal funds rate.  The statement also indicated a change to the usual procedure, namely, to allow loans of up to 30 days, renewable by the borrower.  Furthermore, the Fed made clear that asset-backed commercial paper, which had become highly illiquid, is acceptable as collateral for discount window borrowing.  These efforts to encourage the use of the discount window were designed to promote the restoration of orderly conditions in financial markets by providing depositories with greater assurance about the cost and availability of funding. While helpful, these actions have not, however, served as a panacea.

On the same day, the Fed also issued a new statement on monetary policy, which said, and I quote:  “although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably.”  This assessment apparently is similar to that of market participants.  Investors’ perceptions of increased downside risks have resulted in a notable decline in the rates on federal funds futures contracts and their counterparts abroad.  The statement emphasized that the Committee is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets. 

    
In determining the appropriate course for monetary policy, we must recognize that most of the data available now reflect conditions before the disruptions began and, therefore, tell us less about the appropriate stance of policy than they normally would.  In addition to data lags, appropriate policy decisions must also, I believe, entail consideration of the role of policy lags--that is, the lag between a policy action and its impact on the economy.  Addressing these policy complications requires not only careful and vigilant monitoring of financial market developments, but also the formation of judgments about how these developments will affect employment, output, and inflation. In other words, I believe it is critical to take a forward-looking approach—gauging the effects of recent developments on the outlook, and, importantly, the risks to that outlook.