Uncertainty will continue to be the defining characteristic of the monetary policy landscape for central banks for the foreseeable future, according to John C Williams, President and Chief Executive Officer, Federal Reserve Bank of New York.

“This is especially true as we face issues like artificial intelligence, climate change, deglobalisation, and innovations in the financial system — not to mention the perennial challenges of measuring the so-called star variables such as r-star,” Williams said in his remarks at the Suresh Tendulkar Memorial Lecture organised by the Reserve Bank of India in Mumbai.

r-star is the short-term interest rate that would prevail when the economy is at full employment and stable inflation.

The New York Fed Chief noted that global supply-chain disruptions, along with acute imbalances between supply and demand exacerbated by Russia’s war on Ukraine, caused inflation to skyrocket around the world.

Inflation began to rise in 2021, peaking at over 7 per cent in the US in June 2022, the highest rate recorded in over 40 years. It followed a similar pattern in most OECD economies.

“But its trajectories were different across Asia. For example, in India, inflation was mostly fueled by rising food prices.

“While there are important differences in the sources of inflation, many central banks—including the Reserve Bank of India—have been faced with the same issue: How to restore price stability at a time when so many parts of our economies are spinning in unpredictable ways?” Williams said.

The Federal Reserve restored price stability by relying on central tenets of inflation targeting practiced in the U.S. and many other countries.

One of the principles in restoring price stability is that Central banks must own the responsibility to deliver price stability and have independence to act to achieve it.

“History taught us that central banks can be more successful at delivering sustainably low inflation when they are accountable and independent.

“Today, regardless of economic shocks, changes in fiscal policy, or globalization and deglobalization swings, central banks recognize that attaining and maintaining price stability is their job to do,” the NY Fed Chief said.

The second principle that helped the US Fed manage the known unknowns is transparency—including the clear communication of a central bank’s strategy, policy decisions, and an explicit numerical longer-run inflation target.

“For central banks, transparency enhances accountability and keeps them clearly focused on achieving their goals. For households and businesses, an explicit and credible inflation target helps take some of the uncertainty off the table so they can focus on planning for their future without having to worry about what will happen to inflation,” Williams said.

Referring to the current inflation reading of around 2-1/2 per cent, he underscored that the Fed has seen significant progress in bringing it down.

“But we still have a way to go to reach our 2 percent target on a sustained basis. We are committed to getting the job done,” he said.

The third key principle of well-anchored inflation expectations has become a bedrock of modern central banking, as economic analysis and history have shown that anchoring inflation expectations is important in maintaining low and stable inflation.

While the key tenets of inflation targeting have served the US Fed well in managing the extreme shocks and uncertainty of the past four and a half years, Williams observed that “uncertainty does not only dwell in the past.

“Despite the very best efforts of economists and others to understand how the economic environment is changing and what it means for monetary policy, we must accept that uncertainty will continue to define the future.”

These principles and lessons provide a strong foundation for monetary policy that is robust to uncertainty.

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