The Economic Outlook and Monetary Policy

TL;DR

Lael Brainard discusses U.S. economic outlook and monetary policy risks.

Transcript

HILLS: Ah, we've got a wonderful crowd here. Welcome, one and all. I'm Carla Hills, and I co-chair the Council on Foreign Relations, and I feel very privileged today to introduce our outstanding guest. And I know you've been told to turn off your cellphones and so forth, so I'll go in and just tell you some few facts about Governor Lael Brainard, w... Read More

Key Insights

• Lael Brainard emphasizes the importance of waiting for more data before making policy decisions, highlighting current mixed economic signals and international uncertainties such as Brexit and China's economy.
• The labor market shows signs of slowing, with nonfarm payroll employment growth declining significantly from previous averages, despite a drop in unemployment.
• Inflation remains below the Federal Reserve's target, with core inflation measures not convincingly exceeding low levels, suggesting downside risks to inflation expectations.
• Financial conditions have eased since mid-February, partly due to expectations of gradual U.S. monetary policy, but risks remain if these expectations shift.
• The U.S. economy's potential growth has slowed, with productivity growth significantly lower than historical averages, contributing to a lower neutral interest rate.
• Global economic fragility persists, with advanced economies relying heavily on unconventional monetary policies and facing challenges in response to downside risks.
• The Federal Reserve is cautious about exchange rate impacts on U.S. economic activity, as the dollar's appreciation has affected exports and core inflation.
• Governor Brainard suggests a shallow and gradual path for monetary policy adjustments, considering the low neutral rate and persistent global economic challenges.

Questions & Answers

Q: How does Lael Brainard view the current state of the U.S. labor market?

Lael Brainard notes that the U.S. labor market is showing signs of slowing down. Nonfarm payroll employment growth has decreased significantly, with an average monthly pace of 116,000 over the last three months, compared to a previous average of 220,000. Although the unemployment rate has decreased to 4.7 percent, involuntary part-time employment has increased, and labor force participation has declined. These factors suggest that the labor market's resilience cannot be taken for granted, and careful monitoring of incoming data is necessary.

Q: What are the risks associated with inflation according to Brainard?

Lael Brainard highlights that inflation remains below the Federal Reserve's target, with core inflation measures not convincingly exceeding low levels. The 12-month change in core PCE prices was only 1.6 percent, below the target of 2 percent. Low inflation may also affect inflation expectations, with market-based measures remaining extremely low. These factors suggest that the risks are weighted to the downside, and further progress towards full employment and target inflation will depend on a rebound in growth.

Q: How do global economic conditions affect U.S. monetary policy?

Global economic conditions significantly impact U.S. monetary policy. The U.S. economy is closely linked to the rest of the world through trade and financial linkages, with changes in exchange rates affecting exporters and core inflation. The dollar's appreciation since mid-2014 has tightened financial conditions, impacting U.S. economic activity. Additionally, global risks such as Brexit and China's economic transition pose challenges, necessitating a cautious and risk management approach in policy decisions to protect domestic progress.

Q: What is the significance of the neutral interest rate in current policy considerations?

The neutral interest rate is crucial in current policy considerations, as it represents the real federal funds rate consistent with full employment and 2 percent inflation. Brainard suggests that the neutral rate may be persistently low due to factors like low productivity growth, demographic shifts, and global economic challenges. This implies that the current federal funds rate is closer to neutral than previously thought, leading to a more gradual and shallow path for monetary policy adjustments to avoid premature tightening and support economic recovery.

Q: What are the potential impacts of Brexit on the U.S. economy?

Brexit poses significant risks to the U.S. economy, as a vote in favor of Brexit could unsettle financial markets and create uncertainty during the renegotiation of the U.K.-EU relationship. This could lead to a substantial jump in financial risk premiums, affecting U.S. financial markets due to tightly linked international financial systems. Such an adverse reaction could impact U.S. economic activity, highlighting the importance of waiting for greater certainty regarding the Brexit vote before making policy decisions.

Q: How does the Federal Reserve view the role of business investment in economic growth?

Business investment is a critical component of economic growth, as it drives productivity and potential output. However, recent data shows weak business investment, which, along with net exports, has been a drag on GDP growth. Factors such as the rise in the dollar and declining foreign growth have reduced demand for American exports and profits, impacting investment. The Federal Reserve aims to create a supportive environment for business investment through its monetary policy, recognizing its importance for both short-term growth and long-term productivity gains.

Q: What role do financial conditions play in the Federal Reserve's policy decisions?

Financial conditions are a key consideration in the Federal Reserve's policy decisions, as they influence economic activity and inflation. Eased financial conditions since mid-February have been attributed to expectations of gradual U.S. monetary policy, supporting manufacturers, exporters, and business investment. However, these conditions could diminish if expectations shift, leading to renewed financial stress. The Federal Reserve monitors financial conditions closely, recognizing their impact on achieving full employment and target inflation, and adjusts policy accordingly to maintain economic stability.

Q: How does the Federal Reserve address potential financial risks in the economy?

The Federal Reserve systematically assesses potential financial risks in the economy, focusing on areas like leveraged lending, commercial real estate, and subprime auto lending. It employs macro-prudential tools alongside monetary policy to address these risks without overburdening monetary policy, which has specific dual objectives. By monitoring financial sectors for risk buildup and using targeted tools, the Federal Reserve aims to preemptively mitigate risks, ensuring financial stability and supporting its broader economic objectives of full employment and price stability.

Summary & Key Takeaways

• Lael Brainard discusses the current economic outlook, highlighting mixed domestic data and international uncertainties like Brexit and China's economy. She stresses the need for prudent risk management and waiting for more data before adjusting monetary policy.

• The labor market shows signs of slowing, with employment growth declining and inflation remaining below target. Financial conditions have eased, but risks remain if expectations of gradual monetary policy change.

• Global economic fragility continues, with advanced economies relying on unconventional monetary policies. The Federal Reserve considers a gradual path for policy adjustments, acknowledging a lower neutral interest rate due to persistent challenges.