Tuesday, March 29, 2016

Yellen: The Outlook, Uncertainty, and Monetary Policy

by Bill McBride on 3/29/2016 12:25:00 PM

From Fed Chair Janet Yellen: The Outlook, Uncertainty, and Monetary Policy. Excerpts on risks:

Although the baseline outlook has changed little on balance since December, global developments pose ongoing risks. These risks appear to have contributed to the financial market volatility witnessed both last summer and in recent months.

One concern pertains to the pace of global growth, which is importantly influenced by developments in China. There is a consensus that China's economy will slow in the coming years as it transitions away from investment toward consumption and from exports toward domestic sources of growth. There is much uncertainty, however, about how smoothly this transition will proceed and about the policy framework in place to manage any financial disruptions that might accompany it. These uncertainties were heightened by market confusion earlier this year over China's exchange rate policy.

A second concern relates to the prospects for commodity prices, particularly oil. For the United States, low oil prices, on net, likely will boost spending and economic activity over the next few years because we are still a major oil importer. But the apparent negative reaction of financial markets to recent declines in oil prices may in part reflect market concern that the price of oil was nearing a financial tipping point for some countries and energy firms. In the case of countries reliant on oil exports, the result might be a sharp cutback in government spending; for energy-related firms, it could entail significant financial strains and increased layoffs. In the event oil prices were to fall again, either development could have adverse spillover effects to the rest of the global economy.

If such downside risks to the outlook were to materialize, they would likely slow U.S. economic activity, at least to some extent, both directly and through financial market channels as investors respond by demanding higher returns to hold risky assets, causing financial conditions to tighten. But at the same time, we should not ignore the welcome possibility that economic conditions could turn out to be more favorable than we now expect. The improvement in the labor market in 2014 and 2015 was considerably faster than expected by either FOMC participants or private forecasters, and that experience could be repeated if, for example, the economic headwinds we face were to abate more quickly than anticipated. For these reasons, the FOMC must watch carefully for signs that the economy may be evolving in unexpected ways, good or bad.
emphasis added