Economics Update (July-September 1998)

Ferguson Upbeat But Cautious on Economy

A lthough he called recent U.S. economic performance extraordinary, Federal Reserve Governor Roger Ferguson emphasized that uncertainty about the U.S. economic outlook and the appropriate response of monetary policy to new economic developments is increasing. Ferguson made these remarks recently to an audience at the Atlanta Fed.

Roger Ferguson

Roger Ferguson,
Federal Reserve Governor

Monetary Policy

To determine the appropriate framework for policy analysis, one must be aware of key sources of uncertainty in the economy, he said. These sources currently include the uncertainty over the validity of traditional economic theories, such as the nonaccelerating inflation rate of unemployment (NAIRU), labor productivity, measures of tightness in the economy and Asia's financial crisis.

"What should be done when uncertainties seem particularly acute and we suspect that our understanding of the macroeconomic environment has deteriorated appreciably?" he asked. "I think that the appropriate response is to rely less upon the future predicted by the increasingly unreliable old gauges and more upon inferences from the more recent past, weighing incoming data more heavily relative to more distant data in trying to discern the new environment."

For example, recalling the emphasis that has been placed on NAIRU, Ferguson said that for years economists believed that a linkage exists between declining unemployment and higher inflation. Given the recent success of an economy featuring low unemployment and low inflation, however, this relationship no longer provides clear signals to the Fed.

Response to Uncertainty

"The considerable uncertainty regarding our previous estimates of the capacity of the economy and its sustainable rate of growth . . . suggest the need to downplay forecasts of inflation based on those earlier assessments." He recommends that future forecasts rely more heavily on "more recent observations of inflation and costs for inferring future inflationary pressures."

Ferguson acknowledged that some limits to the economy's growth must be respected. But, he added, "The increased uncertainty also implies that continued strong economic growth with low inflation is not outside the realm of possibility."

In closing, Ferguson said that in the face of uncertainty, especially concerning traditional economic theories and their relationship to the real economy, the Fed should act cautiously while remaining vigilant, take measured steps when necessary and adjust to unforeseen change. "In this way, we will raise the odds of achieving the goals of stable prices and maximum employment."

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