So it really is a pleasure for me to be here today, to have the chance to “get out” and yet still be close to home. Dual mandate The Federal Reserve is charged by Congress with fostering economic conditions consistent with maximum employment and price stability. These two objectives are commonly referred to as our “dual mandate.” The Fed is different from most other central banks in that it has an explicit dual mandate. Although many central banks are instructed to mitigate disturbances to the real economy, most have a mandate to achieve only one goal – maintaining price stability. Usually, this is not an important distinction, since monetary policies that promote price stability are generally consistent with those that support full employment. However, in the rare occasion when tension arises between these two goals, policy must be formulated with careful consideration of the relative performance of one objective against the other and of the risks to the outlooks for both policy goals. Keeping this in mind, I’ll turn now to a discussion of my outlook for the economy and then offer my views on how best to chart a course for monetary policy. Real output gap Four years ago the U.S. economy entered what developed into the deepest downturn since the Great Depression; indeed, many are now referring to 2008–09 as the “Great Recession.” During recoveries from severe recessions, we usually see solid job and output growth, with the improvements in one fostering gains in the other. We are not seeing this today.
Putting these factors together, I would argue that the outlook for inflation is likely to remain low for the foreseeable future. The November FOMC forecasts for core inflation in 2012 were concentrated near 1.8 percent, and the forecasts for total inflation in 2013 and 2014 were in the range of 1.5 percent to 2.0 percent. My own assessment is that inflation will be at the lower end of these ranges. Fed performance Given the high unemployment rate and low job growth, I think it is clear that the Fed has fallen short in achieving its goal of maximum employment. As for the price stability component of our dual mandate, the majority of FOMC participants – including me – judge that our objective is for overall inflation to average 2 percent over the medium term. With my own view that inflation is likely to run below this rate over the next few years, I believe we will miss on our inflation objective as well. What Is the right course for policy? The traditional course of action when inflation is below target and real output is expected to be below potential is to run an accommodative monetary policy. I support such accommodation today. And I believe the degree of accommodation should be substantial. I believe that the disappointingly slow growth and continued high unemployment that we confront today reflects the fact that we are in what economists call a “liquidity trap.” Let me explain.