Janet Yellen, governor of the Federal Reserve, seems willing to accept a "high pressure" economy, one in which inflation rises above the annual target of 2% and the unemployment rate drops significantly. "The influence of labor market conditions on inflation in recent years appears to be weaker than it was before the financial crisis" of 2008, she said speaking at an event hosted by the Boston Regional Fed. Yellen explained that the financial crisis has prompted central bankers to review their approach. The idea is that subdued aggregate demand can push labor force participation and investment down. A drop in demand can cause the so-called hysteresis.
"Assuming that hysteresis is present after severe recessions, the natural question that arises is whether it is possible to reverse these supply effects by temporarily allowing for a high-pressure economy with strong aggregate demand and a tight labor market." According to Yellen, cutting rates by itself is not enough in a world where the cost of money is low. That's why he suggests that new ways to respond to economic slowdowns may be needed. Indeed Yellen does not rule out the use of tools to condition inflation expectations. Yellen then specified that the role of US monetary policy is crucial. "Research by Fed staff suggests that the effects of US monetary policy on other economies are positive, in the sense that policies designed to provide stimulus to the US economy also boost activity abroad."
