Inflation, Uncertainty, and Monetary Policy (Yellen)

Janet L. Yellen 

Inflation, Uncertainty, and Monetary Policy

September 26, 2017

I summarize some important points in Yellen speech. Firstly, you can directly see Yellen speech from this web-link and pdf-link.

FED has two long-run targets: Inflation and unemployment rate. FED indicated what are exactly its target rate for inflation and unemployment in January 2012. Inflation is %2 and Unemployment is %4.6. FED exceeded its unemployment rate because this rate is %4.4 (09-2017).

FED is close to its inflation rate (PCE) but there is serious gap ( %1.4). Yellen said that inflation will rise and stabilize at around 2 percent over the medium term.

What is reason behind the inflation isn't stabilize at around 2 percent now. Yellen expressed that this problem results from idiosyncratic shifts.

Idiosyncratic shifts: Such as the large decline in telecommunication service prices seen in the one year, that are unlikely to be repeated.

Yellen stressed that uncertainty factors which are affects inflation .

These are, unexpected movements in oil prices and the foreign exchange value of the dollar.

These factors  are important :

Such was the case when rising oil prices pushed headline inflation noticeably above 2 percent for several years prior to the financial crisis.

Similarly, the Committee substantially discounted the reductions in inflation that occurred from 2014 through 2016 as a result of the decline in oil prices and the effects of the dollar's appreciation on import prices.

But such disturbances are not a great concern from a policy perspective because their effects fade away as long as inflation expectations remain anchored.

Yellen turned the real inflation dynamics discussion. What are the main driver of inflation process ?

I- Resource Utilization ( Unemployment Rate ) :

Although the unemployment rate is probably the best single summary measure of labor utilization, some indicators have shown less improvement since the financial crisis. Yellen accepts that natural unemployment rate can change with time to time.

The unemployment rate probably is correct in signaling that overall labor market conditions have returned to pre-crisis levels. But that return does not necessarily demonstrate that the economy is now at maximum employment because, due to demographic and other structural changes, the unemployment rate that is sustainable today may be lower than the rate that was sustainable in the past.Long-run sustainable unemployment rate can drift over time because of demographic changes and other factors. FOMC participants have reduced their estimates of the sustainable unemployment rate appreciably over the past few years in response to the continual flow of information about the always changing economy.

Yellen accepts that we are not in full employment.

Some observers have pointed to the continued subdued pace of wage growth as evidence that the economy is not yet back to full employment.

II- Inflation Expectations :

Fed generally uses TIPS data for analyzing inflation expectations. In theory, differences between yields on conventional Treasury securities and those on Treasury Inflation-Protected Securities (TIPS) are also informative about inflation expectations in that they measure the compensation received by investors for exposing themselves to future changes in consumer prices.

III- Misspecified Inflation Dynamics :

This part is very important for understanding inflation gap.

Increased competition from the integration of China and other emerging market countries into the world economy may have materially restrained price margins and labor compensation in the United States and other advanced economies.

Most of the decline in the labor share of national income in the United States since the late 1980s can be attributed to offshoring of labor-intensive production. It could indirectly hold down the growth of domestic wages and prices in ways not captured by conventional models.

The growing importance of online shopping, by increasing the competitiveness of the U.S. retail sector, may have reduced price margins and restrained the ability of firms to raise prices in response to rising demand.

We understand that FED Chair is fearful how to solve inflation gap problem. I need to add another important point. Yellen is also fearful about other great USA economy trouble. Value of the neutral real interest rate is close to %0.

Yellen indicated :

My FOMC colleagues and I will therefore need to continue to reassess and revise our assessments of the neutral rate in response to incoming data and adjust monetary policy accordingly.

Finally;

USA economy has two great problem

- subdued inflation

- low neutral real interest rate.

These problems will imply that the FOMC will have only limited scope to cut the federal funds rate should the economy be hit with an adverse shock.

Dr. Engin YILMAZ

28.09.2017

Ankara