William C Dudley: Conducting monetary policy – rules, learning and risk management Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the C Peter McColough Series on International Economics, Council on Foreign Relations, New York, 24 May 2012. *  *  *  It is a great pleasure to have the opportunity to speak here today. My remarks will focus on how I think about monetary policy in today’s challenging economic environment. As part of this, I will discuss how simple policy rules might appropriately be used as a guide to decisionmaking. I do this not because policy rules play a dominant role in my own thinking, but because the use of these tools is widespread, with many framing their arguments this way. To start with the punch line, although I believe simple policy rules can provide useful input into the policymaking process, it would be unwise to rely on them mechanically. As always, what I have to say today reflects my own views and not necessarily those of the Federal Open Market Committee (FOMC) or the Federal Reserve System. Policy must strive to promote the dual mandate objectives of maximum employment and price stability given to the Federal Reserve by Congress. I believe that this should be done in a transparent and systematic manner because this will help us to achieve our objectives.
Thus, the linkage between the policy setting and the economy can be affected by changes in the relationships between policy and financial conditions or between financial conditions and the economy. Let’s consider the linkage between the policy setting and financial conditions first. In my view, the major components of financial conditions include: 1) the value of the equity market; 2) the level of real interest rates across the yield curve; 3) the level of credit spreads; 4) the availability of credit; and 5) the exchange value of the dollar. There are certainly others, but these are probably the most important ones. If we look at these financial indicators as a set, financial conditions do not appear to be unusually tight or easy in aggregate:   For the equity market, the evidence is mixed (Figure 10).   On one hand, the equity risk premium actually appears to be quite elevated relative to historical levels and price/earnings ratios based on current year expected earnings are not unusually high. On the other hand, based on valuation measures using trailing 10-year earnings, the U.S. stock market valuation may be more stretched.   For interest rates, conditions are accommodative. Real rates are unusually low (Figure 11).   For credit spreads, the level is well within normal ranges – neither as narrow as in 2005 or 2006 nor as wide as during 2008 and 2009 (Figure 12).