A Strategy for Normalizing Monetary Policy

Early 2017 has brought the United States economy – and Federal Reserve policy with it – to a long-awaited inflection point. Figure 1 provides an overview. Solid growth in payroll employment continues, keeping unemployment low and stable. Labor force participation shows signs of bottoming, wage growth is on the rise, and consumer and business sentiment have clearly improved. Most important for the Fed, key measures of inflation have rebounded smartly. Year-over-year growth in the price index for personal consumption expenditures, at 2.1 percent, is now running slightly above the FOMC’s long-run target. Core PCE price inflation, at 1.7 percent, is not much lower, and converging to target as well.

Against this favorable backdrop, the FOMC raised its target for the federal funds rate last December and once again this March. Recent statements from key Federal Reserve officials, including Chair Janet Yellen, make clear that the process of “scaling back accommodation” will continue to occur more rapidly this year than in 2015 and 2016 (Yellen 2017). Most FOMC members now expect that there will be at least two, and possible three, more rate hikes during 2017 (FOMC 2017). The Fed no longer sees itself struggling to provide enough stimulus to fight deflationary stagnation. That challenge has been supplanted by a new one: the task of taking away the monetary accommodation at a pace that is sufficient to prevent inflation from persistently overshooting its long-run 2 percent target, yet measured enough to avoid shocking the economy and threatening the ongoing expansion.

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