What do these estimates imply? First, real interest rates reflect
the expected return to saving and investing today in order to obtain
more real goods and services tomorrow. Low long-term real rates imply
that agents are expecting such returns to be low for a long timewhich
is consistent with them expecting economic activity to be relatively
weak over the coming years. Next, low expected inflation means that
market participants are building in little chance of a breakout in
inflation. Indeed, if markets were expecting very high inflation, say, 5
percent, then real rates would be on the order of negative 2 or negative
3 percent, implausibly low unless you expected an extraordinary economic
meltdown. And if you believed this, you also would probably not think
that Treasury securities were a safe bet, and their risk premia would be
quite high. These Treasury premia, however, are quite low, reflecting a
high demand for safe assets. Economic agents are cautious, and there is
little appetite for risk-taking at the moment.

What does this add up to? Well, low long-term Treasury rates
support the view that markets are looking for only modest economic
growth with low inflation, and a there is a high degree of caution out
therewhich itself is an important factor holding back economic activity
today.

D. Not punishing savers

Next, let me try to address one of the toughest questions I am
asked about our stance of monetary policy. Current interest rates are
very, very low. Many have expressed concern that the Federal Reserve’s
low interest rate policy is bad for the economy because it punishes
savers. This is an old story with respect to monetary policy when rates
are low. My uncle first expressed this view to me in 1992, frustrated
that the federal funds rate had been slashed to 3 percent.

The argument goes as follows: Low interest rates reduce the return
to savers, and they punish individuals who have played by the rules and
worked hard to be fiscally prudent. Clearly, policies like this
disadvantage the savers. In order to meet their saving goals in such a
low interest rate environment, some claim that these households will
consume less and save even more, and that this reduced consumption in
turn will lower real gross domestic product (GDP).

I am certainly not going to try to dispute this obvious fact:
savers are earning dramatically reduced interest income on their
accumulated savings. Unfortunately, throughout the U.S. economy, there
is a tremendous amount of pain and hardship. The job of monetary policy,
according to the Federal Reserve Act, is to provide monetary and
financial conditions to support maximum employment and stable prices.
Monetary policy aims to set short-term rates so that the supply of
saving equals the demand for investment in a way that facilitates the
economy reaching maximum employment and price stability.

Currently, the forces of supply and demand require very low rates.
The supply of saving is high as households delever and repair their
balance sheets. Furthermore, the demand for investment is low because
most firms have much unused capacity and are unsure of the economic path
forward. Therefore, equilibrium real rates are quite low. Indeed, today
they are lower than actual rates because nominal short-term rates are
constrained by the zero lower bound and can go no lower. Economists
refer to this as a liquidity trap because interest rates cant fall low
enough to reemploy the economys unused productive resources. And the
mainstream remedy to this dilemma, as articulated clearly in the
academic work by Krugman (1998), Eggertsson and Woodford (2003), Werning
(2011) and others, is highly accommodative monetary policy.

But if I were bound and determined to address the concerns that
savers are being disadvantaged by low interest rates, there are three
prescriptions that I could imagine undertaking. And let me tell you, two
of them are bad.

First, the FOMC could immediately undertake a program to raise
short-term interest rates. In other words, monetary policy could
exogenously turn more restrictive. Would this help savers and the
economy? In my judgment, that would be a very bad policy. More
restrictive credit would further reduce investment and job creation and
limit the supply of credit to small business entrepreneurs, resulting in
growth even slower than it is now. Savers would not be left with higher
returns. And savers’ other sources of income would be reduced, like
employment and entrepreneurial income. I have few doubts that policy
would need to quickly retrace such a misguided increase.

Alternatively, the FOMC could decide to undertake expansionary
policies to the point of “recklessness” by pursuing an extremely high
rate of inflation. Persistently higher rates of inflation — outside of
reasonable tolerance bands around our long-run inflation objective —
would indeed lead to higher interest rates for all. Savers would receive
higher nominal interest income; but as Chairman Bernanke said recently,
the FOMC would clearly view this as reckless and would not choose to
pursue such a policy. Again, this is a case where higher nominal
interest rates would be bad for savers and the entire public.

But third, if the FOMC and other policymakers could engineer
stronger growth policies so that the economy boomed again and
unemployment fell, this would organically lead to higher real rates of
return on investment and higher interest rates in general, which would
benefit savers and the entire public. A more vibrant economy would
benefit owners of unused resources, like unused factory capacity and
unemployed workers. This is the policy path that is most desirable in my
opinion. I also think it is most consistent with the accommodative
policies I have been advocating.

V. Conclusion

I have covered a lot of ground here today. But these and other such
issues provide important support for my opinions on the appropriate
stance for monetary policy. Let me leave you with a brief summary of how
all this fits together. With inflation near target, relatively moderate
economic growth expected for several more years, potential productive
capacity at risk, and a symmetric 2 percent inflation target, we should
resist the sirens call to prematurely raise rates or tighten our policy
in any way. Instead, we should be providing more accommodation, in
particular by better articulating the economic conditions under which
our policy moves will be linked to the achievement of our mandated
economic goals. Thank you.

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

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