St. Louis Fed's Bullard Discusses Normalization of U.S. Monetary Policy

NASHVILLE, Tenn. – Federal Reserve Bank of St. Louis President James Bullard discussed the case for monetary policy normalization at the annual meeting of the Community Bankers Association of Illinois on Saturday.

Although the Federal Open Market Committee (FOMC) decided not to begin policy normalization when it met this past Wednesday and Thursday, Bullard said he argued against the decision at the FOMC meeting. He noted that a large majority of the FOMC still expects that policy normalization will commence this year.  “The case for policy normalization is quite strong, since Committee objectives have essentially been met,” he said during his presentation titled, “A Long, Long Way to Go.”

However, he noted, “Even during normalization, the Fed’s highly accommodative policy will be putting upward pressure on inflation, encouraging continued improvement in labor markets, and providing the best contribution to global growth that we can provide.”

Objectives for Unemployment and Inflation

Bullard noted that the FOMC wants unemployment at its long-run level and inflation at the target rate of 2 percent.  “The Committee is about as close to meeting these objectives as it has ever been in the past 50 years,” he said.

To measure the distance of the economy from the FOMC’s goals, Bullard used a simple function that depends on the distance of inflation from the target rate of inflation and on the distance of the unemployment rate from its long-run average.  This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard explained.

In his calculations, the target rate of inflation was set at 2 percent, the FOMC’s inflation target.  The inflation measure used was the year-over-year percentage change in the core personal consumption expenditures price index.  The long-run average rate of unemployment was set at 4.9 percent, the median longer-run value of the FOMC’s latest Summary of Economic Projections (SEP).

Monetary Policy Settings Are Far From Normal

While the objectives for unemployment and inflation have essentially been met based on those calculations, Bullard noted that monetary policy settings remain far from normal.  He pointed out that the Fed’s balance sheet is currently about $4.5 trillion, compared to about $800 billion in 2006.  In addition, the policy rate has been about 0.13 percent for close to seven years, compared with the median of the long-run appropriate policy rate across FOMC participants in the latest SEP, which was 3.5 percent.

“With the balance sheet exceptionally large and the policy rate exceptionally low, there is little chance monetary policy will be restrictive any time soon,” Bullard said.  He noted that the FOMC currently expects the policy rate to approach the long-run normal level several years from now.

“To actually implement what would traditionally be viewed as a restrictive monetary policy—one that would put downward pressure on inflation—the policy rate would have to exceed the long-run normal level,” Bullard said, adding, “That is not happening for many years.”

Prudent Monetary Policy

“Why do the Committee’s policy settings remain so far from normal when the objectives have essentially been met?” Bullard asked.  “The Committee has not, in my view, provided a satisfactory answer to this question.”

He added, “A prudent monetary policy based on traditional central banking principles would begin normalizing the Committee’s policy settings gradually, since the goals of policy have essentially been met.”

Even once the FOMC begins to normalize, Bullard emphasized, this will still mean a very accommodative policy stance.  “Policy will remain exceptionally accommodative through the medium term no matter how the Committee proceeds,” he said.  “This means there will continue to be upward pressure on inflation and downward pressure on unemployment.”