One of the Fed’s central errors of the 1970s, he argued, was excessive confidence in estimates of the so-called natural rate of unemployment, the level to which joblessness can fall without sparking inflation. That mistake helped fuel double-digit inflation by the end of that decade.
By contrast, in the mid-1990s Chairman Alan Greenspan suspected that the economy’s productive capacity was rising rapidly, and so he resisted calls from his colleagues to raise interest rates to prevent overheating and inflation.
“Under Chairman Greenspan’s leadership,” Mr. Powell said, the Fed “converged on a risk-management strategy that can be distilled into a simple request: Let’s wait one more meeting; if there are clearer signs of inflation, we will commence tightening.”
Inflation fell rather than rose, and the Fed’s caution enabled a boom that drove wages up and unemployment down.
There was a small hint that Mr. Powell was thinking about the possibility that history might repeat. “It is difficult to say,” he said, “when or whether the economy will break out of its low-productivity mode of the past decade or more, as it must if incomes are to rise more meaningfully over time.”
Mr. Powell turned to a nautical pun to explain the challenges of setting monetary policy. When economists refer to the natural rate of unemployment, they use the term “u*,” pronounced U-star, and call the natural interest rate r*, or R-star.
But these natural rates are the Fed’s best estimates, and must be inferred from things that the Fed can measure more directly, like wage growth and inflation.
“Navigating by the stars can sound straightforward,” Mr. Powell said. “Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly.”
