For Federal Reserve chairwoman Janet Yellen, monetary policy now is all about a simple rule familiar to any subway rider: mind the gap.
In her first major speech on her policy framework as Fed chairwoman, Yellen said US central bankers must be mindful of how short the Fed is of its goals of full employment and price stability.
"The larger the shortfall of employment or inflation from their respective objectives, and the slower the projected progress toward those objectives, the longer the current target range for the federal funds rate is likely to be maintained," Yellen said on Wednesday to the Economic Club of New York.
The gap, in both cases, is large, with a jobless rate of 6.7 per cent more than a percentage point higher than the top end of the Federal Open Market Committee's estimate of full employment. Inflation, by the Fed's preferred measure, is more than a percentage point below its 2 per cent goal. It will take more than two years for the economy to close in on the Fed's goals, she said, adding that the Fed's forecasts in the past were disrupted by negative surprises, not positive ones.
"She clarified exactly what her views are and what the committee's views are about what the Fed may do over the next six to 12 months or even the next three years," said Brian Jacobsen, who helps oversee US$241 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Wisconsin. Her speech "better managed the messages she wanted to get out of the last policy statement."
In her address, Yellen spoke of a "continuing commitment" to support the economy, which since December 2008 has taken the form of a policy rate held in a range of zero to 0.25 per cent.
While Yellen used the word "expansion" to describe current economic conditions, her preferred word was "recovery," which she used more than a dozen times, including it in the title of her remarks.
"Thus far in the recovery and to this day, there is little question that the economy has remained far from maximum employment," she said. Yellen, in her third month leading the US central bank, gave more detail on her data-driven framework after the Fed dropped a link to a specific level of unemployment for raising the benchmark lending rate last month.
At 6.7 per cent for March, she said the unemployment rate was more than a percentage point higher than policymakers' estimate for full employment of 5.2 to 5.6 per cent. "This shortfall remains significant, and in our baseline outlook, it will take more than two years to close," Yellen said.
"The progress that they've made so far has been a result of the Fed continuing to provide even more accommodation than anyone anticipated," said Laura Rosner, an economist at BNP Paribas in New York and former researcher at the Federal Reserve Bank of New York. "That's important. She's willing and ready to provide that in order to sustain progress."
Harvard University economist Martin Feldstein asked Yellen whether short-term unemployment rates might provide an early indicator of inflation pressures. She replied it would be "premature" to conclude that wages would necessarily be pushed higher as people out of work less than six months find jobs.