Janet L Yellen, the Federal Reserve chairwoman, did not talk on Friday about the Fed's plans for its benchmark interest rate. Instead, she talked about why those plans have been so hard to make.
In a wide-ranging speech, Yellen said the Fed was struggling to understand the behaviour of the labour market and the weakness of inflation. It is reconsidering how changes in monetary policy ripple through the economy, and the impact of international events. In short, as often happens after a crisis, the Fed is sorting through some existential issues.
"The events of the past few years have revealed limits in economists' understanding of the economy and suggest several important questions I hope the profession will try to answer," she said at a conference here hosted by the Federal Reserve Bank of Boston.
The Fed has indicated it is likely to raise rates in December if economic growth continues, although it has repeatedly retreated from similar predictions in the last nine months. Investors now see more than a 70 per cent chance of a December hike, according to CME Group, and Eric S Rosengren, the Boston Fed's president, buttressed those expectations Friday.
"The market seems to think that there's a very high probability of December," Rosengren told CNBC. "We'll see how the economic data actually comes in, but I think that is priced appropriately."
Rosengren, however, was ready to raise rates in September.
Yellen and most of her colleagues were not.
The debate among Fed officials revolves in part around the consequences of holding down interest rates to push unemployment to an unsustainably low level. A certain amount of unemployment lubricates labor markets, maintaining a ready supply of workers for businesses that are expanding. In the past, pushing unemployment below that level has increased inflation. Mr. Rosengren has warned that could force the Fed to raise rates more sharply, potentially driving the economy into recession.
But an unusually large share of American adults are neither working nor counted among the unemployed. They are not trying to find jobs. Yellen and other Fed officials have raised the possibility that a low unemployment rate could persuade some of these people to start looking. That could increase growth without increasing inflation.
"If strong economic conditions can partially reverse supply-side damage after it has occurred, then policy makers may want to aim at being more accommodative during recoveries than would be called for under the traditional view," Yellen said on Friday.
Yellen described this outcome as "plausible" but not proven. Businesses buoyed by strong sales might expand; workers might find it easier to move into better jobs; increased investment in research might even lead to higher productivity growth.
The Fed is embarked on the experiment. Officials predicted in December that they would raise rates four times this year. So far, they have not raised rates at all. The Fed's benchmark rate remains in a range between 0.25 per cent and 0.5 per cent, a low level that encourages investment and risk-taking.
And over the last year, the unemployment rate has held steady while the labor force has expanded.
The question is how much further the Fed can go. The presenters at the Boston Fed conference, which was devoted to the slow pace of growth in recent years, generally attributed a large share of the economy's underperformance to issues that would seem beyond the reach of monetary policy, including demographic shifts and slow productivity growth. "Just pushing down unemployment, by itself, is unlikely to draw large numbers of workers back into the labor force," said Gabriel Chodorow-Reich, a professor of economics at Harvard University.
James Stock, also a Harvard economist, said annual growth during this expansion has been about 1.74 per centage points slower than the last three expansions. He said demographics and productivity accounted for about 0.9 percentage points of the shortfall. He attributed most of the rest to insufficient government spending and weak demand for exports. Yet few drew the conclusion that the Fed should raise rates.
Peter Ireland, a professor of economics at Boston College, described himself as "really, really nervous" about the judgment that the central bank's work is done. "My December vote is no," said Robert E Hall, a Stanford economist. The Fed is unlikely to act at its next meeting, in November, just a few days before the presidential election on November 8. Patrick T Harker, president of the Federal Reserve Bank of Philadelphia, said on Thursday that the election could cause significant economic disruptions.
"It may be prudent to wait until we have resolved some of that uncertainty," Harker said.
The Fed's last meeting of the year, in December, looks more likely for a rate change. Charles Evans, president of the Federal Reserve Bank of Chicago, said early this month that he wanted the Fed to move forward slowly, but that he did not regard the exact timing of the next rate increase as important.
December would be "fine," Evans told reporters in Auckland, New Zealand. "I am less concerned about the timing of the next increase than I am about the path over the next three years."
Yellen surveyed a number of the issues that are perplexing Fed policy makers.
The conventional understanding of monetary policy is that the Fed raises or lowers interest rates, which moves markets, which changes the behaviour of businesses and consumers, and so the American economy grows or slows. But the Fed has struggled to stimulate the economy.
One possible reason, Ms. Yellen said, is that households and businesses with relatively large debts were unwilling, or unable, to take advantage of low interest rates. She said that the Fed also needed to improve its understanding of the economic impact of changes in financial conditions.
The behaviour of inflation is another mystery. It fell less than expected during the recession; it has strengthened more slowly than expected in the aftermath. "The influence of labor market conditions on inflation in recent years seems to be weaker than had been commonly thought," she said.
Finally, she mentioned the impact of global economic weakness on domestic growth.
"This is a wonderful time to be an academic," Mr. Rosengren said in introducing Ms. Yellen. But, he continued, "I empathise with the challenges our chair has" in charting policy with so many uncertainties.
© 2016 The New York Times News Service
