Lael Brainard: Bringing the statement on longer-run goals and monetary policy strategy into alignment with longer-run changes in the economy

Speech (via webcast) by Ms Lael Brainard, Member of the Board of Governors of the Federal Reserve System, at "How the Fed Will Respond to the COVID-19 Recession in an Era of Low Rates and Low Inflation", an event hosted by the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, Washington DC, 1 September 2020.

The views expressed in this speech are those of the speaker and not the view of the BIS.

I want to thank David Wessel for hosting this event. It is an honor to be here with Ben Bernanke and Janet Yellen, who pioneered the original Statement on Longer-Run Goals and Monetary Policy Strategy in 2012. It is a pleasure to discuss the new statement, unanimously approved by the Federal Open Market Committee (FOMC) last week. By bringing our longer-run goals and strategy into alignment with key longer-run changes in the economy, the new statement will strengthen our support for the recovery. In my view, the new statement breaks important ground and will serve the country well as we respond to the economic repercussions of the COVID-19 crisis.

Key Longer-Run Changes in the Economy

Three related features of the economy's new normal called for the reassessment of the Committee's longer-run goals and strategy. First, the equilibrium interest rate has fallen to low levels, which implies a large decline in how much we can cut interest rates to support the economy. That was abundantly clear in March, when we were able to cut the policy rate by only 1-1/2 percentage points before hitting the effective lower bound-in contrast to previous decades when the policy rate would have been cut by 4-1/2 to 5 percentage points, on average, to buffer the economy from an adverse shock. The reduced scope to cut the interest rate could increase the frequency and duration of periods when the policy rate is pinned close to zero, unemployment is elevated, and inflation is below target. In turn, the greater likelihood of extended periods of low inflation at the lower bound risks eroding inflation expectations and further compressing the scope for cutting the interest rate. The risk here is a downward spiral where the scope for cutting the interest rate gets compressed even further, the lower bound binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. The experience of some foreign central banks illustrates the challenges associated with such a downward spiral.