Every once in a while, a member of the FOMC cuts right to the chase in discussing how to set monetary policy. In a recent speech^[1], Governor Lael Brainard did not mince words when describing the real difficulties facing the Federal Reserve as they struggle with setting rate policy in the face of weak inflation.

She begins by bluntly stating the issue:

“there is a notable disconnect between signs that the economy is in the neighborhood of full employment and a string of lower-than-projected inflation readings, especially since inflation has come in stubbornly below target …….what is troubling is five straight years in which inflation fell short of our target despite a sharp improvement in resource utilization”

This goes to the heart of the matter. She observes that over the three years ending in 2007, the unemployment rate averaged 5% and inflation averaged 2.2%. Over the most recent three-year period, unemployment was around the same 5% mark, but inflation averaged 1.5%. In her words,

“ this “casts some doubt on the likelihood that resource utilization is the primary explanation for inflation rates… [ and] that the underlying trend inflation may have moved down by perhaps as much as 1/2 percentage point over the past decade”.

Certainly, the bond market has adopted this new, lower level of inflation expectations. Ten-year Treasury Inflation-Protected Securities (TIPS) are used as a measure of inflationary expectations in the private market.  Using the same three-year comparison, 10-year TIPS yields are ¾ of a percentage point lower.

Finally, in what appears to be a rebuke of statements by other FOMC members, Brainard says that there are temporary factors that both boost inflation and others that depress inflation from time to time. However, overall, she argues that

“Temporary factors, by their nature, have little implication for the underlying trend in inflation”.

So, there we have it. She seems to come down firmly on the side that the world of inflation has changed since the 2008 financial crisis and this should drive policy decisions.

Brainard offers a policy prescription:

“With normalization of the federal funds rate under way and the start of gradual balance sheet normalization widely anticipated, I will want to take some time to assess the path of the federal funds rate that will best support a sustainable move in inflation to our 2 percent goal.”

Simply, she is no hurry to boost rates. Inflation is not about to accelerate, and, if were to pick up, there would be no harm should the rate exceed the target, at least for the interim.

^[1]  Understand the Disconnect between Employment and Inflation with a Low Neutral Rate, at the Economic Club of New York, Sept 5, 2017