Federal Reserve Vice Chair Philip N. Jefferson gave a thoughtful speech on the challenges of responding to economic shocks in real time. Jefferson spoke at the Stanford Institute for Economic Policy Research about how the Federal Open Market Committee assesses uncertain developments and makes policy decisions to achieve its goals of maximum employment and stable prices.
Jefferson said the economy always has shocks that can affect either the demand side or the supply side. Demand shocks affect spending but don’t directly influence productive capacity. Supply shocks impact the economy’s long-term capacity to produce goods and services. “Many events impact both sides simultaneously, so real-time analysis is especially complicated,” he said.
The vice chair pointed to two major developments now underway. The Middle East conflict has raised energy prices, creating a supply shock that is pushing up inflation but also weighing on demand. At the same time, the rapid advance of artificial intelligence is a shock that is likely to affect both supply and demand in lasting ways through productivity increases and higher investment.
Jefferson pointed to the output gap as a key tool for evaluating economic conditions. If actual output exceeds potential, then the economy is producing excess demand that can generate inflation. “Our monetary policy approach is geared to foster maximum employment and price stability over a wide spectrum of economic circumstances,” said Jefferson. When output falls short of potential, there is excess supply and downward pressure on prices and employment. “When shocks tend to move inflation and employment in the same direction, then it is easier to make policy choices,” he said. “When they go in opposite directions, policymakers face trade-offs that require careful judgment about relative risks.”
The speech pointed to the uncertainty of how long shocks will last and how they will interact. “Monetary policy works with a lag and so decisions have to be made on the balance of risks to both sides of the dual mandate,” Jefferson said.
For the Federal Reserve, the difficulties presented by this environment involve a continuous process of data analysis, economic modeling, and sound judgment. As new shocks emerge and old ones morph, policymakers will keep adjusting their approach to keep the economy healthy.
Jefferson’s remarks offer a window into the thinking at the very top of the Federal Reserve. They are a reminder that Americans will face some difficult decisions about monetary policy in an economy shaped by complex and sometimes unpredictable forces. “To achieve maximum employment consistent with price stability in an era of rapid technological change and geopolitical tensions, vigilance and flexibility will be required.”
It additionally emphasizes the need for transparency from Fed officials. Explaining how they measure shocks helps the public better understand the rationale behind policy decisions that affect everything from mortgage rates to job prospects. Knowing that the people charged with steering the economy through uncertainty are making smart choices helps build confidence in the institution as it faces the latest round of challenges.
