NEWS Release - Speech - Chair Janet L. Yellen At the Commonwealth Club, San Francisco, California - January 18, 2017
Good afternoon. It is a pleasure to join all of you at the Commonwealth Club today, not the least because the club and the Federal Reserve have a few things in common. Both organizations, as it happens, have a board of governors and a chair.
And both the club's and the Fed's histories extend back more than a century. The club, as many here know, was founded in 1903, and the Federal Reserve a decade later. Perhaps because of our shared origins in the Progressive Era, a period of reform in American life, we hold certain values in common. According to your website, the club is nonpartisan and dedicated to the impartial discussion of issues important to your community and the nation. At the Fed, we too are nonpartisan and focused squarely on the public interest. We strive to conduct our deliberations impartially and base our decisions on factual evidence and objective analysis. This afternoon I will discuss some challenges we've faced in our recent deliberations and may face in the next few years.
Perhaps, though, it is best to start by stepping back and asking, what is--and, importantly, what isn't--our job as the nation's central bank? And how do we go about trying to accomplish it? The Federal Reserve has an array of responsibilities. I'll mention our principal duties and then focus on one--monetary policy, the responsibility that gets the most public attention.
In addition to monetary policy, we--in collaboration with other regulatory agencies at both the federal and state levels--oversee banks and some other financial institutions to ensure they operate safely and soundly and treat their customers fairly. We monitor the financial system as a whole and promote its stability to help avoid financial crises that could choke off credit to consumers and businesses. We also reliably and safely process trillions of dollars of payments for the nation's banks and the federal government and ensure that banks have an ample supply of currency and coin to meet the demands of their depositors. And we work with communities, nonprofit organizations, lenders, educators, and others to encourage financial and economic literacy, promote equal access to credit, and advance economic and community development.
But, as I noted, monetary policy draws the most headlines. What is monetary policy, exactly? Simply put, it consists of central bank actions aimed at influencing interest rates and financial conditions more generally. Its purpose is to help foster a healthy economy. But monetary policy cannot, by itself, create a healthy economy. It cannot, for instance, educate young people, generate technological breakthroughs, make workers and businesses more productive, or address the root causes of inequality. Fundamentally, the energy, ingenuity, and know-how of American workers and entrepreneurs, along with our natural resources, create prosperity. Regulatory policy and fiscal policy--the decisions by the Administration and the Congress about how much and how the government spends, taxes, and borrows--can influence these more fundamental economic pillars.
I've said what monetary policy cannot do. But what can it do? It can lean against damaging fluctuations in the economy. Nearly 40 years ago, the Congress set two main guideposts for that task--maximum employment and price stability. We refer to these assigned goals as our dual mandate. When the economy is weak and unemployment is on the rise, we encourage spending and investing by pushing short-term interest rates lower. As you may know, the interest rate that we target is the federal funds rate, the rate banks charge each other for overnight loans. Lowering short-term rates in turn puts downward pressure on longer-term interest rates, making credit more affordable--for families, for instance, to buy a house or for businesses to expand. Similarly, when the economy is threatening to push inflation too high down the road, we increase interest rates to keep the economy on a sustainable path and lean against its tendency to boom and then bust.
But what exactly do the terms "maximum employment" and "price stability" mean? Does maximum employment mean that every single person who wants a job has a job? No. There are always a certain number of people who are temporarily between jobs after having recently lost a job or having left one voluntarily to pursue better opportunities. Others may have just graduated and have started looking for a job or have decided to return to working--for instance, when their child starts school. This so-called frictional unemployment is evident even in the healthiest of economies.
Then there is structural unemployment--a difficult problem both for the people affected and for policymakers trying to address it. Sometimes people are ready and willing to work, but their skills, perhaps because of technological advances, are not a good fit for the jobs that are available. Or suitable jobs may be available but are not close to where they and their families live. These are factors over which monetary policy has little influence. Other measures--such as job training and other workforce development programs--are better suited to address structural unemployment.
After taking account of both frictional and structural unemployment, what unemployment rate is roughly equivalent to the maximum level of employment that can be sustained in the longer run? The rate can change over time as the economy evolves, but, for now, many economists, including my colleagues at the Fed and me, judge that it is around 4-3/4 percent. It's important to try to estimate the unemployment rate that is equivalent to maximum employment because persistently operating below it pushes inflation higher, which brings me to our price stability mandate.
Does price stability mean having no inflation whatsoever? Again, the answer is no. By "price stability," we mean a level of inflation that is low and stable enough that it doesn't need to figure prominently into people's and businesses' economic decisions. Based on research and decades of experience, we define that level as 2 percent a year--an inflation objective similar to that adopted by most other major central banks.1 Individual prices, of course, move up and down by more than 2 percent all the time. Such movements are essential to a well-functioning economy. They allow supply and demand to adjust for various goods and services. By "inflation," we mean price changes as a whole for all of the various goods and services that households consume.
No one likes high inflation, and it is easy to understand why. Although wages and prices tend to move in tandem over long periods, inflation erodes household purchasing power if it is not matched with similar increases in wages, and it eats away the value of households' savings. So, then, why don't we and other central banks aim for zero inflation? There are several technical reasons, but a more fundamental reason is to create a buffer against the opposite of inflation--that is, deflation. Deflation is a general and persistent decline in the level of prices, a phenomenon Americans last experienced during the Great Depression of the 1930s and one that Japan has confronted for most of the past two decades. Deflation can feed on itself, leading to economic stagnation or worse. It puts pressure on employers to either cut wages or cut jobs. And it can be very hard on borrowers, who find themselves repaying their loans with dollars that are worth more than the dollars they originally borrowed. I am sure we all remember learning in school about farm families in the Great Depression who couldn't pay their mortgages and lost their homes and their livelihoods when crop prices fell persistently.
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