But much more importantly, our dual mandate does not state that we should do what is necessary to promote full employment and price stability only at times when we are virtually certain that in doing so we will make a profit. It directs us to promote full employment and price stability at all times. Profits and losses in any given year are much less important than getting the U.S. economy back to the highest level of employment consistent with price stability. BIS Review 127/2010  7  In making our assessments about next steps, we need to be a bit humble about our capacity to forecast how market participants would respond to our actions. We do not control their behavior nor have much historical experience that we can draw on to easily assess how they are likely to behave. Even viewpoints that turned out to be incorrect could persist for a long time and generate adverse consequences. It is not enough for us to be right in theory. We also have to be convincing in practice and in explaining why concerns we think are misplaced are indeed unwarranted. As Chairman Bernanke indicated at Jackson Hole, the FOMC’s decision with respect to providing additional accommodation will be made by weighing the costs against the benefits. This is a dynamic process, which depends on the evolution of the economic outlook and our own ability to learn how to become more effective in improving the cost/benefit trade-offs.
This compares with a 1.5 percent year-over-year rate for the PCE deflator and 1.4 percent rate for the core PCE deflator, which excludes food and energy prices. Low and falling inflation is a problem for several reasons. First, low and declining inflation makes it harder to accomplish needed balance sheet adjustments. That is because, all other things being equal, lower inflation means slower nominal income growth. Slower nominal income growth, in turn, means that less of the needed adjustment in household debt-toincome ratios will come from rising incomes. This puts more of the adjustment burden on paying down debt. 1  Chairman Ben S. Bernanke, Addendum: Addressing the Financing Needs of Small Businesses, Monetary Policy Report to Congress, July 21, 2010. 4  BIS Review 127/2010  Second, and even more importantly, low and falling inflation can cause inflation expectations to decline. This is important because inflation expectations are an important factor that influences actual future inflation. Moreover, when inflation expectations decline, the expected real cost of credit increases – a subject I will return to in a moment. So what could the Federal Reserve do? As I see it, there are two potentially complementary avenues. First, we could take steps to make our current highly accommodative stance of monetary policy more effective in stimulating economic activity by providing additional guidance about what we are trying to achieve today and in the future. Second, we could find ways to increase the amount of stimulus we currently provide via our balance sheet.