[1:00:03] International Impact of US Monetary Policy
Executive Summary
A few highlights from the discussion:
[0:00] Introductory Remarks by Markus Brunnermeier. Many pressing issues face us today: the inflation anchor, labor tightness, monetary policy, as well as monetary policy’s interaction with fiscal policy, and the international impact of US monetary policy.
[4:15]Recent updates to monetary policy. Last week, the fed funds rate increased by another 75 basis points; there are more shifts planned for the future, as the inflation challenge is a larger one. This has been one in a rapid set of shifts, increasing 375 basis points this year, but it is warranted due to the current state of the economy. Inflation is unacceptably high at the moment, as a variety of metrics can show. There has been a decline in underlying inflation over the last few months, and the October CPI report shows that there is some easing in inflation over the past month.
[10:56] Labor markets. There needs to be further slowing in both product and labor markets. While there are still challenges, there has been some easing in supply bottlenecks, though the labor market is still tight. We should expect real GDP growth to be well below trend this year and next year. Job gains are slowing, but the number of openings per unemployed person is much higher than it was in the tighter labor market in 2019. Some metrics like the employment cost index suggest that labor demand may be outpacing labor supply, as the year over year percentage change is at 5%, which is too high to maintain price stability. It is hard to tell whether some of the shifts in labor market participation are going to be lasting, but labor force prime-age participation is lower than pre-pandemic levels.
[17:26] Fighting current inflation. The FOMC is very committed to returning to price stability, and current projections suggest that inflation could return to target by 2025. While near term inflation expectations are high, the medium and longer term inflation expectations remain relatively well anchored. It is critical that policy moves swiftly to retain the inflation expectations anchor. Monetary policy is going to need to be restrictive, and remain restrictive for some time in order to keep decreasing inflation levels, down to 2% over time. There are three key considerations for raising interest rates: how fast, how high, and how long.
[22:18] Understanding inflation expectations. Metrics used for understanding forecasts and expectations are derived from the official metrics, as well as survey data, and business and labor market indicators that provide forward looking information. Looking at a variety of measures can allow a more accurate interpretation of signals.
[27:29] Need for accurate tightening policy. Growth is likely to be well below trend, business indicators suggest that the unemployment rate will not go up too far, but there are high potential costs of upcoming monetary policy. This still may be necessary, in order to combat the harms caused by inflation both today and in the long-run due to a potential lack of price-stability. While this is happening, there needs to be a balance between the risks of tightening too much and the risks of tightening too little. Tightening too little would allow for persistent inflation, and necessitate a much more costly journey back to price stability. The largest risk right now would come from tightening too little, as easing up on the rate hikes would be dangerous if the inflation rate did not adjust as expected.
[32:11] Flexible Average Inflation Targeting. This policy is not a numerical balancing exercise, but focused on keeping inflation roughly two percent, in order to fulfill the dual mandate. There can be no strong labor market without price stability in the intermediate and long-run, which means that the primary focus should be on inflation. This framework gives the ability to bring inflation down over time, which could be a more effective means for price stability. It is important to follow a risk management approach. Losing the inflation anchor is more risky than overshooting the inflation target on the downside. The inflation expectations anchor of households is driven by non-core inflation numbers, like food and energy price changes, while inflation in normal times is better predicted by core-inflation numbers.
[41:03] The Taylor Principle. The Taylor Principle suggests that the Fed should raise rates more than inflation increases, in order for the real rates to increase. Though there are a wide variety of inflation beliefs, the funds rate is used as the anchor. Bringing the funds rate up will make sure that the inflation rate sustainably decreases. Balance sheet runoff is having a good effect on decreasing inflation, but there is more uncertainty about the effects of shrinking the balance sheet.
[53:49] Modern Monetary Theory. Among some policymakers, there was a sense prior to this recent episode that there would not be inflation even with increased fiscal spending. However, most policymakers were not behaving that way, and the FOMC remained resolute in aiming for the 2% goal. Monetary policy must aim to address the issues in both fiscal and financial sectors.
[1:00:03] International Impact of US Monetary Policy. The Fed pays attention to the international impact in that some of the shifts in international markets will also have spillback effects in the United States. While trade may not be as large of a channel as it is in other countries, the US still operates as part of a global economy.