First, the Committee is still undershooting both its employment and inflation objectives. Unemployment is too high and inflation is too low. Thus, monetary policy needs to be very accommodative in order to close these gaps relative to the Committee’s objectives. Second, when interest rates are at the zero lower bound, the risks of tightening a bit too early seem considerably greater than the risks of tightening a bit too late. A premature tightening might lead to financial conditions that are too tight, resulting in a weaker economy and an aborted lift-off. This would be problematic in that it would harm the Fed’s credibility and, more importantly, would be difficult to rectify. The U.S. experience during the Great Depression and the Japanese experience over the past two decades illustrate the risks of raising interest rates too soon, especially when inflation is running below the central bank’s objective. Finally, given the still high level of long-term unemployment, there could be a significant benefit to allowing the economy to run “slightly hot” for a while in order to get these people employed again. If they are not employed relatively soon, their job skills will erode further,  BIS central bankers’ speeches  3  reducing their long-term prospects for employment and, therefore, the productive capacity of the U.S. economy. All that said, I hope the economic outlook evolves so that it will be appropriate to begin to raise interest rates sometime next year.
At the same time, there are a few factors that suggest that there is a relatively low likelihood of growth ending up substantially above the forecast. Three considerations seem important for assessing the degree of upside risk to growth. First, the upside from housing is likely limited compared to what one might expect under more normal conditions. We have seen an impressive recovery of multi-family housing starts over the past few years. In contrast, starts of single-family homes remain at low levels despite the fact that home prices have risen substantially over the past two years and mortgage rates have remained low. A contributing factor is that mortgage lenders continue to be extremely risk averse, and mortgage credit to those with lower credit scores is still significantly constrained. There is little on the horizon that would lead me to believe that this situation will change in a material way any time soon. Second, because motor vehicle sales are now close to their pre-recession levels, the future growth impetus from this cyclical sector probably will also be restrained. Finally, growth in the rest of the world has slowed and the dollar has appreciated somewhat. This will limit the growth in U.S. exports, and suggests that the trade  2  2  See Table 1.2 in the U.S. Department of Energy’s Monthly Energy Review, October 2014. BIS central bankers’ speeches  sector is unlikely to be a strong wind at the back of the U.S. economy over the next year or two.