Risk Management in Monetary Policy

The economy is giving us conflicting signals. The strength of the labor market might be saying “hold” or even “raise rates,” while low inflation and the bond market might be saying “lower rates.” There are risks both on both sides. On one hand, additional easing could overstimulate inflation, distort labor markets or fuel an asset price bubble. On the other hand, not easing could undermine the credibility of the Fed’s 2 percent inflation target or leave policymakers behind the curve if economic activity slows further. The Fed manages these risks by specifying a clear risk strategy and communicating its reaction function. It also operates by committee and is data-focused. The Fed also reviews and revises its operations to evolve along with the economy and to learn from past experiences. Currently, the Fed is reviewing its monetary policy strategy, tools and communication practices to ensure that we can continue to achieve our dual mandate, given low inflation and the risk of returning to the effective lower bound.