Key messages from Janet Yellen’s Jackson Hole remarks

29 Aug 2016

In opening remarks at the Jackson Hole Symposium Chair Yellen broke little new ground on the event’s theme, designing resilient monetary policy frameworks for the future, and suggested a Committee that is generally satisfied with its strategy for normalization, available policy tools to combat future recessions, and overall policy framework. We find this message somewhat disheartening. Given the Committee’s limited space to cut short-term rates, a persistently low equilibrium policy rate, and likely challenges relying on asset purchases and forward guidance in the future, we had hoped to see some evidence of greater openness to change. Overall, we are left with a sense of “business as usual”, which if indeed is the case implies a Committee that may be unprepared to aggressively counter another recession should potential growth and equilibrium policy rates remain depressed.

This note briefly outlines the messages we gleaned from the Chair’s remarks.  We touch on the short-term policy outlook but our focus is more squarely on the overall approach to policy normalization, the policy toolkit for supporting growth and inflation in different states of the business cycle, and considerations for the longer-term policy framework.

  • A rate hike this year is highly likely. Data has evolved since the surprisingly weak May payrolls report in a manner that is consistent with the Committee’s expectation for moderate growth, continued strengthening in the labor market and gradual firming of inflation. In light of this, the Chair believes that “the case for an increase in the federal funds rate has strengthened in recent months.” We had already assigned a 75 percent probability to a rate increase this year, so Yellen’s remarks were not particularly surprising. Still, the Chair’s decision to address the near-term policy outlook at a conference focused on longer-term policy considerations suggests that the Committee has grown more confident in the economy’s performance and marginally concerned by somewhat complacent market pricing of the path of policy rates. We still see December (45 percent) as somewhat more likely timing than September (40 percent) for a rate increase given below-objective core inflation and risks management considerations discussed below, but we will revisit these probabilities following the August payrolls report. Another strong number (+225,000 private sector jobs) in combination with firming wages and a decline in the unemployment rate could suffice to tip us into the September camp, though we caution that the meeting is still several weeks away.
  • There is very little evidence that the Committee is shifting away from its strategy of arriving at a neutral policy rate around the time that core PCE inflation hits two percent. Overall, we find this disappointing. As discussed in a previous note, we see compelling reasons for the Committee to hold off on raising rates at least until there is more convincing evidence of inflation moving towards mandate-consistent levels (and as the July PCE inflation data confirmed, this is just not the case at present). These reasons include constrained policy options at the lower bound, growth risks that are still tilted to the downside, low inflation expectations, and uncertainty about the current and future level of the equilibrium policy rate. In practice, the Committee will tolerate inflation rising somewhat above two percent. But  the policy setting could achieve better outcomes if the current strategy explicitly allowed for (or even sought) inflation above two percent over the medium term, which would reinforce that the Committee treats the inflation objective symmetrically. Absent such a shift, investors are likely to continue to expect inflation to run below two percent on average over the coming years, as has been the case since the financial crisis. Until there is evidence to the contrary, two percent inflation will continue to be viewed as a policy ceiling, implying an actual inflation objective somewhat below this level.
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