NEW YORK (MNI) – The following is the text of Chicago Federal
Reserve Bank Pres. Charles Evans’ remarks prepared Tuesday for the Money
Marketeers of New York University:

Monetary Policy: Recurring Themes

I. Introduction

Thank you so much for the invitation to speak to you tonight. It’s
a pleasure to appear before the Money Marketeers, a group whose members
are very well acquainted with issues affecting the broad economy,
including the unprecedented situation in which we find ourselves today.
Over the years, this distinguished group has attracted an impressive
number of speakers, Federal Reserve presidents and Governors among them,
who have shared their insight and understanding of the economy.

So tonight I don’t intend to retread overly familiar ground.
Instead, I hope to build on the conversation that Fed Vice Chair Janet
Yellen started here just a few weeks ago. First, I will briefly discuss
my economic outlook. Then I will point to the elements of Governor
Yellen’s speech that capture my own policy prescriptions so well.
Finally, I will address a few issues that have come up repeatedly during
sessions such as this one.

Before I turn to the focus of today’s discussion, I would like to
remind you that the views expressed are my own and do not necessarily
represent those of the Federal Open Market Committee (FOMC) or the
Federal Reserve System.

II. Outlook

Let’s start with the economic outlook. We are all too familiar with
the fact that the financial crisis that unfolded in 2007 and 2008
precipitated an unusually deep and lengthy recession. According to the
detailed analysis by Carmen Reinhart and Kenneth Rogoff (2009), in their
recent book titled This Time Is Different: Eight Centuries of Financial
Folly, recessions caused by financial crises generally are followed by
anemic recoveries. By any yardstick, this certainly describes the U.S.
recovery to date: Output growth has averaged only 2-1/2 percent
annually, and resource gaps remain huge. In particular, the unemployment
rate remains over 8 percent — well above the 5-1/4 to 6 percent rate
most FOMC participants view as being consistent with a fully employed
labor force over the longer run.

Both public and private sector forecasts are projecting relatively
moderate rates of growth over the next few years. For example, the
midpoint of the FOMC participants’ forecast made in April was for growth
to average a bit under 3 percent over the next three yearsonly modestly
above the longer-run trend. And I’d have to say the incoming data since
those forecasts were made have been on the soft side.

With such growth rates, we would close the large existing resource
gaps only gradually. Indeed, I expect that we will face unemployment
well above sustainable levels for some time to come.

With regard to inflation, as you know, the FOMC’s long-run
inflation objective is 2 percent as measured by the price index for
personal consumption expenditures (PCE).

For a number of reasons, I don’t foresee much risk that inflation
will rise above reasonable tolerance levels for this objective. First,
the ten-year Treasury rate is below 1-1/2 percent! And its decomposition
into a long-run real rate and an inflation expectation is flashing
something very different than dangerous inflationary pressures. I’ll
have more on this later. Second, energy and commodity prices have fallen
well off their recent peaks as the global outlook dims. Third, as I just
noted, the output gap remains large and is likely to close only slowly.
In this economic environment, wage pressures are anemic. And it is
simply hard to see how any persistent outsized inflation pressures could
occur without some parallel building of wage costs. That was the case in
the 1970s inflation, a scenario some fear repeating today. Fourth,
inflationary dynamics depend in large part on the momentum generated by
peoples expectations of future inflation. Currently, inflation
expectations are well anchored, and so they impart little pull on
inflation one way or the other. Putting all of this together (and given
that inflation has stood at 1.8. percent over the past year), I conclude
that inflation will likely remain near or below our 2 percent target
over the medium term.

III. Policy Choices

Since the summer of 2010, I have consistently argued for the
strongest policy accommodation available. With huge resource gaps, slow
growth and low inflation, the economic circumstances warrant extremely
strong accommodation. Many of my views were well captured in the
macro-model analyses discussed here last April by Janet Yellen (2012).

If you recall, Governor Yellen compared two approaches to
evaluating the stance of monetary policy to a baseline constructed from
the midpoint of FOMC participants’ forecasts made in January. The first
was an optimal control policy, which prescribes the interest rate path
that, in a well-specified econometric model for the U.S. economy,
minimizes the deviations in inflation and unemployment from their policy
goals. The optimal monetary policy in that analysis kept the federal
funds rate near zero into early 2015 — a year later than in the
baseline — in order to keep the cost of capital extremely low.

Of course, economic models, at best, are only approximations to
real-world behavior. So it’s also prudent to look at policy
prescriptions other than the optimal control policy. The most familiar
of these are interest rate rules, like the Taylor rule (1993). These
interest rate policy prescriptions are relatively simple empirical
descriptions of the Fed’s historical reactions to misses from its policy
goals. If we apply the 1999 version of John Taylor’s rule, we see the
funds rate rising in early 2015. But even this delayed interest rate
liftoff relative to the 1993 Taylor rule does not take additional
account of the prolonged period that policy rates have been constrained
to be higher than where they could have been because of the zero lower
bound on the federal funds rate. Taking account of this additional
condition would delay the Taylor Rule’s lift-off towards the optimal
control policy.1

Furthermore, neither exercise considers the asymmetric downside
balance of risks to the forecast coming from Europe and the U.S. fiscal
cliff. Considering all of these factors, I conclude that both policy
prescriptions support the need for a high degree of monetary
accommodation.

These two conclusions highlighted in Governor Yellen’s speech are
not much different from the policy recommendation that I have been
consistently advocating. Specifically, additional monetary accommodation
is needed to more quickly elevate output to its full potential level. In
fact, even under the optimal control exercise, the unemployment rate
does not reach 5-1/2 percent until mid-2016; that’s pretty late, but
because of the lower funds rate path in the optimal control policy, it
is still at least two years earlier than in the baseline scenario.

Furthermore, even with such additional accommodation, the outlook
for inflation remains well contained: The highest that inflation rises
in any simulation is 2.3 percent — only 0.3 percentage points above the
highest rate in the baseline. This is within any reasonable tolerance
band around our 2 percent long-run objective for inflation, especially
given that the unemployment rate currently is 2 to 3 percentage points
above its sustainable rate.

In weighing alternative policy approaches, I do recognize the risk
that these economic model analyses could be wrong. Accordingly, I have
proposed that any further accommodative policies should contain a
safeguard against an unreasonable increase in inflation. In my judgment,
nominal income level targeting is an appropriate policy choice and has
such a safeguard. But recognizing the difficult nature of that policy
approach, I have a more modest proposal: I support a conditional
approach, whereby the federal funds rate is not increased until the
unemployment rate falls below 7 percent, at least, or if inflation rises
above 3 percent over the medium-term. The economic conditionality in my
7/3 threshold policy would clarify our forward policy intentions greatly
and provide a more meaningful guide on how long the federal funds rate
will remain low. In addition, I would indicate that steady progress
toward stronger growth is essential, and I would be willing to buy
mortgage-backed securities to do so.

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** MNI Washington Bureau: 202-371-2121 **

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