Richard H Clarida: The Federal Reserve's new framework and outcome-based forward guidance

Speech (via webcast) by Mr Richard H Clarida, Vice Chair of the Board of Governors of the Federal Reserve System, at "SOMC: The Federal Reserve's New Policy Framework", a forum sponsored by the Manhattan Institute's Shadow Open Market Committee, New York City, 14 April 2021.

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

On August 27, the Federal Open Market Committee (FOMC) unanimously approved a revised Statement on Longer-Run Goals and Monetary Policy Strategy, and, at its September and December FOMC meetings, the Committee made material changes to its forward guidance to bring it into line with this new policy framework. Before I discuss the new framework and the policy implications that flow from it, I will first review some important changes in the U.S. economy that motivated the Committee to assess ways we could refine our strategy, tools, and communication practices to achieve and sustain our goals in the economy in which we operate today and for the foreseeable future.

Shifting Stars and the End of "Copacetic Coincidence"

Perhaps the most significant change in our understanding of the economy since the Federal Reserve formally adopted inflation targeting in 2012 has been the substantial decline in estimates of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. Whereas in January 2012 the median FOMC participant projected a longer-run r* of 2.25 percent and a neutral nominal policy rate of 4.25 percent, as of March 2021, the median FOMC participant projected a longer-run r* equal to just 0.5 percent, which implies a neutral setting for the federal funds rate of 2.5 percent. Moreover, as is well appreciated, the decline in neutral policy rates since the Global Financial Crisis (GFC) is a global phenomenon that is widely expected by forecasters and financial markets to persist for years to come (Clarida, 2019).

The substantial decline in the neutral policy rate since 2012 has critical implications for monetary policy because it leaves the FOMC with less conventional policy space to cut rates to offset adverse shocks to aggregate demand.