bluebooks · February 1, 2005
Bluebook
Prefatory Note
The attached document represents the most complete and accurate version available
based on original files from the FOMC Secretariat at the Board of Governors of the
Federal Reserve System.
Please note that some material may have been redacted from this document if that
material was received on a confidential basis. Redacted material is indicated by
occasional gaps in the text or by gray boxes around non-text content. All redacted
passages are exempt from disclosure under applicable provisions of the Freedom of
Information Act.
Content last modified 03/31/2011.
STRICTLY CONFIDENTIAL (FR) CLASS I FOMC
JANUARY 27, 2005
MONETARY POLICY ALTERNATIVES
PREPARED FOR THE FEDERAL OPEN MARKET COMMITTEE
BY THE STAFF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Strictly Confidential (F.R.)
Class I – FOMC
January 27, 2005
MONETARY POLICY ALTERNATIVES
Recent Developments
(1)
The Committee’s decision at its December meeting to increase the target
federal funds rate 25 basis points to 2¼ percent, to assess the risks to both sustainable
economic growth and price stability as balanced, and to retain the “measured pace”
language had been widely anticipated. Nonetheless, the expected path of policy
shifted down a little following the announcement as investors had apparently put
some odds on a firmer tone to the statement. That decline was more than reversed
over the intermeeting period, however, following economic data releases that were
read as confirming that the expansion remains on track and the publication of the
minutes of the December FOMC meeting (see box), on the new, expedited schedule. 1
As to the minutes, market participants reportedly focused on the concerns about
inflation expressed by some at the December meeting as well as comments about
possible excessive risk-taking in asset markets. Judging from federal funds futures
quotes and the Desk’s most recent survey of primary dealers, investors are virtually
certain of a 25 basis point increase in the target federal funds rate at the upcoming
meeting and apparently place high odds on similar hikes at the two subsequent
meetings (Chart 1). Currently, futures quotes suggest an expected federal funds rate
1
The effective federal funds rate averaged close to 2¼ percent over the intermeeting period. The
Desk expanded the System’s outright holdings of securities by about $200 million through purchases
of Treasury bills from customer accounts. The Desk made no purchases of Treasury bills or coupon
securities in the market. The volume of outstanding long-term RPs decreased $4 billion, to $16
billion, as seasonal demand for currency ebbed. In recent days, reserve demands have once again
been shifted forward in the maintenance period given near-universal expectations of an increase in
the target funds rate. This shift has been associated with some upward pressure on the federal funds
rate.
Strictly Confidential (FR) Class I FOMC
Page 2 of 41
of about 3¼ percent at the end of 2005, but primary dealers reported an average
expectation about ¼ percentage point higher.
Expedited Release of the December FOMC Minutes
The minutes of the December 2004 FOMC meeting were published on January 4, the
first release of minutes on the new expedited schedule. Market participants were reportedly a
bit surprised by the extent of the discussion of upside risks to inflation and, in response,
marked up the expected pace of policy tightening somewhat. The discussion of “excessive
risk-taking” also garnered some attention from market participants. Two-year yields rose
about 6 basis points in a narrow window around the release of the minutes, while inflation
compensation measured from TIPS fell a touch.
The figure below shows the change in two-year yields around the release of minutes
over the last eight years. The December minutes had an effect that was among the larger
reactions to minutes releases over the last eight years, but it is hard to know if this is because
they provided more information than usual, because they were more timely, or because the
press and the public paid particularly close attention given the novelty of the expedited
release. The effect of the December minutes was in any case well within the range of
responses to previous FOMC minutes releases. Going forward, the expedited schedule may,
to some extent, speed up the dissemination of information about the FOMC’s outlook that
was previously provided incrementally. If so, market responses to speeches delivered after the
minutes release, and even to the statement at the subsequent FOMC meeting may become
more muted.
Strictly Confidential (FR) Class I FOMC
Page 3 of 41
Strictly Confidential (FR) Class I FOMC
(2)
Page 4 of 41
The upward revision to the anticipated path of monetary policy contributed
to a rise in yields on short- and intermediate-term Treasury notes. In contrast, the
ten-year Treasury yield was little changed, on net, implying that longer-horizon
forward rates declined notably. Much of the drop in these forward rates appears to be
attributable to declines in real rates, judging from TIPS yields and flat survey measures
of long-term inflation expectations. The reasons for the decline in far-ahead nominal
forward rates are not entirely evident. Higher oil prices may have led investors to trim
their assessment of the cumulative amount of monetary policy restraint required to
foster sustainable economic growth. Moreover, actual and implied volatility of
interest rates declined further, possibly contributing to a narrowing of term premiums
embedded in longer-term rates.
.
(3)
Yields on investment- and speculative-grade corporate bonds generally
followed those on Treasuries, and as a result, risk spreads on such securities barely
budged (Chart 2). Spreads in both sectors remain thin by historical standards, no
doubt in part because default rates are quite subdued and corporate balance sheets are
generally healthy. Broad equity indexes, weighed down by higher oil prices and
lackluster earnings announcements and guidance, ended the period down about
2 percent.
(4)
The value of the dollar against a broad index of currencies moved over a
wide range, but ended the intermeeting period about unchanged (Chart 3). Ongoing
concern about the U.S. current account deficit pushed the dollar toward record lows
in December, but the dollar subsequently rolled back those losses as focus shifted to
the continuing strength of the U.S. economic expansion and a firmer outlook for
monetary policy in the United States. Markets were volatile at times following a
variety of comments by officials that were interpreted as offering differing views on
Strictly Confidential (FR) Class I FOMC
Page 5 of 41
Strictly Confidential (FR) Class I FOMC
Page 6 of 41
Chart 3
International Financial Indicators
Nominal Trade-Weighted Dollar Indexes
Index(12/31/02=100)
Daily
FOMC
Broad
Major Currencies
Other Important Trading Partners
Ten-Year Government Bond Yields
Percent
110
105
6.0
3.0
Daily
FOMC
UK (left scale)
Germany (left scale)
Japan (right scale)
5.5
2.5
5.0
2.0
4.5
1.5
4.0
1.0
3.5
0.5
100
95
90
85
80
75
Jan.
Apr.
July
2003
Oct.
Jan.
Apr.
July
2004
Oct.
Jan.
3.0
0.0
Jan.
Stock Price Indexes
Apr.
July
2003
Oct.
Jan.
Apr.
July
2004
Oct.
Jan.
EMBI+ Index
Index(12/31/02=100)
Daily
FOMC
UK (FTSE-350)
Euro Area (DJ Euro)
Japan (Topix)
Basis Points
155
1500
Daily
FOMC
145
Overall
Brazil
1300
135
1100
125
115
900
105
700
95
500
85
75
Jan.
Apr.
July
2003
Oct.
Jan.
Apr.
July
2004
Oct.
Jan.
300
Jan.
Apr.
July
2003
Oct.
Jan.
Apr.
July
2004
Oct.
Jan.
Strictly Confidential (FR) Class I FOMC
Page 7 of 41
the inclinations of foreign officials to intervene to stabilize currency values.2 Against
individual major foreign currencies, the dollar fell 2¼ percent versus the Japanese yen
and very slightly against the Canadian dollar. However, the dollar firmed almost
2 percent against the euro and sterling over the period. Yields on longer-term
government bonds generally were little changed during the intermeeting period, while
foreign stock prices rose between 1 and 4 percent.
(5)
Against several other Asian currencies, the dollar fell about 2 percent, and
monetary authorities in Korea and Taiwan were said to be intervening heavily in
foreign exchange markets to stem upward pressure on their currencies.3 Rates on
forward contracts on the Chinese renminbi fluctuated amid conflicting comments by
Chinese officials about future changes in China’s currency peg and on speculation that
the Chinese currency regime would be a topic at the G-8 meeting in early February.
In Brazil, the central bank increased its policy rate 50 basis points in late December
and another 50 basis points in mid-January in response to inflationary pressures; the
real appreciated almost 4 percent against the dollar, but Brazilian stocks lost about 5
percent over the intermeeting period.
(6)
Domestic nonfinancial business sector debt is estimated to have risen at a
6¼ percent rate in the fourth quarter, up somewhat from its third-quarter pace,
supported by a pickup in net bond issuance and a sizable increase in C&I loans
(Chart 4). According to the latest Senior Loan Officer Opinion Survey, commercial
banks again eased terms and standards for lending to businesses in recent months,
and loan demand from households weakened slightly. Nevertheless, household debt
appears to have continued to grow briskly in the fourth quarter. Federal debt
accelerated to a 7¼ percent annual rate in the final quarter of 2004, and total domestic
nonfinancial debt also expanded at a 7¼ percent pace.
2
3
Neither Korea nor Taiwan reports its foreign exchange interventions to the Desk.
Strictly Confidential (FR) Class I FOMC
Changes in Selected Components of
Nonfinancial Business Debt
$Billions
Monthly rate
C&I Loans
Commercial Paper
Bonds
Sum
Page 8 of 41
Chart 4
Debt and Money
Growth of Household Debt
70
Percent
Quarterly, s.a.a.r.
60
18
Consumer
Credit
50
21
15
40
12
30
Q4
e
9
20
6
10
Q4
e
Home
Mortgage
0
-10
0
-20
2002
2003
3
-3
H1
Q3 Oct Nov Dec
2004
Note. Commercial paper and C&I loans are seasonally adjusted,
bonds are not.
1990
1993
1996
1999
2002
e Estimated.
Growth of Nonfinancial Debt
Growth of Federal Debt
Percent
16
Percent, s.a.a.r.
s.a.a.r.
14
Total
______
Nonfederal
___________
8.1
7.5
Q1
9.2
8.6
Q2
6.9
6.1
Q3
7.1
7.6
Q4e
7.2
7.2
12
10
2003
8
2004
6
4
2
0
2002
2003
H1
Q3
Q4
2004
Note. Treasury debt held by the public at period-end.
e Estimated.
M2 Velocity and Opportunity Cost
Growth of M2
Percent
s.a.a.r.
16
12
8
8.00
Percent
Velocity
Quarterly
Opportunity Cost*
(left axis)
4.00
2.3
2.2
2.1
2.00
2.0
4
1.00
Velocity
(right axis)
Q3
1.9
0
H1
H2
2003
J F M A M J
J A S O N D
2004
-4
0.50
Q3
1.8
0.25
1993
1995
1997
1999
*Two-quarter moving average.
2001
2003
Strictly Confidential (FR) Class I FOMC
(7)
Page 9 of 41
M2 increased at about a 4¼ percent annual rate in December and appears
to be accelerating to about a 5¾ percent pace in January.4 Within this aggregate,
growth in small time deposits—returns on which tend to track market rates closely—
was particularly brisk, although apparently at the expense of liquid deposits—whose
return tends to lag market interest rates. Smoothing through monthly fluctuations,
M2 appears to be growing a bit below the pace of nominal income, a pattern
consistent with its rising opportunity cost as monetary policy tightens.
These data incorporate the effects of the annual seasonal factor review and are confidential
until their release, which is planned for February 3.
4
Strictly Confidential (FR) Class I FOMC
Page 10 of 41
Economic Outlook
(8)
The basic contours of the staff forecast have changed little since the
December Greenbook, with real GDP growth again expected to average around
3¾ percent this year and next. The staff has taken on board the upward revision to
market expectations of policy action observed over the intermeeting period and now
envisions that the federal funds rate will reach 3½ percent by the end of 2006, a
quarter-point higher than in the December Greenbook. Long-term yields are
anticipated to remain fairly steady this year and next, as the effects of rising short-term
rates are offset over time by reductions in market participants’ expectations for future
inflation and the path of policy. As in previous forecasts, the stock market is assumed
to generate risk-adjusted returns similar to those on fixed-income investments,
although prices launch off a slightly lower base, reflecting the recent sell-off in shares.
The foreign exchange value of the dollar is assumed to depreciate this year and next at
about the same gradual pace as in the December Greenbook. Oil prices are now
higher than the staff had expected and, in line with futures prices, are projected to
come down a little more steeply. On net, financial conditions still seem quite
supportive of growth, and aggregate demand is seen as expanding at a rate a bit above
that of potential output, putting the unemployment rate on a shallow downward
trajectory that by the end of 2006 nearly reaches 5 percent—the staff’s estimate of the
natural rate of unemployment. Core PCE inflation is expected to remain near 1½
percent this year and next, with the waning influence of resource slack about offset by
the diminished pass-through from oil prices and the dollar.
Longer-Run Strategy
(9)
To analyze strategies and risks for monetary policy, several sets of
simulations were conducted using a version of the FRB/US model with the following
Strictly Confidential (FR) Class I FOMC
Page 11 of 41
properties: policymakers have perfect foresight about the entire economy; financial
markets have perfect foresight regarding the future path of the federal funds rate,
thereby ensuring that the policy path is not associated with systematic forecast errors
by investors; and households and firms form their expectations using more limited
information, as in the standard version of the model. One set of simulations was
oriented toward evaluating the implications of alternative values of a long-run
inflation objective for the core PCE price index, while other simulations were used to
investigate different assumptions about productivity growth and the personal saving
rate. Each of the latter scenarios was simulated under the assumption of a
1½ percent long-run inflation goal. For each simulation, an “optimal” path of the
funds rate was computed by assuming that policymakers have an equal distaste for
deviations of unemployment from its natural rate, deviations of inflation from a longrun goal, and changes in the federal funds rate.5
(10)
The baseline for these simulations was prepared using the FRB/US model
(with judgmental adjustments) to extend the staff forecast through the end of the
decade. On the supply side, structural labor productivity growth is assumed to
moderate toward historical norms, declining from 3 percent last year to 2¾ percent
during 2005 and about 2½ percent by 2010. Adjusting for trend movements in the
labor force and other factors, these productivity gains are sufficient to keep potential
output growing at a fairly steady pace of about 3¼ percent per year during the rest of
the decade, while the NAIRU is assumed to remain at 5 percent. As for aggregate
demand, the personal saving rate is expected to rise gradually back toward its
historical average, while the unified federal budget deficit stays at around 2½ percent
of nominal GDP during the remainder of the decade. Although the foreign exchange
5
More precisely, the federal funds rate path is chosen to minimize the equally weighted sum of three
components: the squared deviations of unemployment from its natural rate; the squared deviations
of core PCE inflation from target; and squared changes in the funds rate. The last term helps ensure
that the optimal funds rate path in the simulation exhibits the smooth adjustment observed in the
historical record.
Strictly Confidential (FR) Class I FOMC
Page 12 of 41
value of the dollar is assumed to depreciate at an average annual rate of about
3 percent after 2006, the current account deficit is projected to widen to almost
7½ percent of nominal GDP. Monetary policy is assumed to adjust to keep core PCE
inflation close to 1½ percent throughout the decade while facilitating the return of
unemployment to its natural rate. In particular, the nominal federal funds rate rises to
4 percent as the real federal funds rate settles in at about 2½ percent.
(11)
The first set of simulations analyzes the implications of alternative
specifications of the long-run objective for core PCE inflation. The solid line in each
panel of Chart 5 denotes the scenario in which policymakers desire that the core PCE
inflation rate eventually settle at 1½ percent. The optimal path of monetary policy in
this case is not much above that assumed in the Greenbook: The funds rate, shown
in the upper-left panel, rises steadily over the next three years, peaking at about
4 percent. With that financial backdrop, the unemployment rate and core PCE
inflation rate—shown in the lower two panels—also follow trajectories similar to
those in the Greenbook extension. The dashed line in each panel corresponds to a
long-run inflation objective of 1 percent. The optimal policy aims to achieve this
outcome by tightening only a bit more rapidly than under the 1½ percent inflation
objective and then holding the real funds rate at a somewhat elevated level over an
extended period (upper-right panel). Given the tighter path of policy, the
unemployment rate stays around 5¼ percent through the remainder of the decade,
while inflation declines gradually toward the long-run objective. In contrast, a higher
inflation objective of 2 percent (dotted line) allows policymakers to pause on the road
to further tightening until the end of this year, and the real funds rate remains a bit
below its value in the benchmark scenario through 2010. This policy fosters a gradual
pickup in inflation, while unemployment declines somewhat more quickly than in the
benchmark case and then remains below the NAIRU throughout the remainder of the
decade.
Strictly Confidential (FR) Class I FOMC
Page 13 of 41
Chart 5
Optimal Policy with Alternative Inflation Objectives
Real Federal Funds Rate 1
Nominal Federal Funds Rate
Percent
4
Percent
5
3
4
2
3
1
Baseline Inflation Objective
Lower Inflation Objective
Higher Inflation Objective
2004
2005
2006
2007
2008
2009
2010
2
0
1
2004
2005
2006
2007
2008
2009
2010
-1
Civilian Unemployment Rate
Percent
6.5
6.0
5.5
5.0
4.5
2004
2005
2006
2007
2008
2009
2010
4.0
PCE Inflation (ex. food and energy)
(Four-quarter percent change)
Percent
2.00
1.75
1.50
1.25
1.00
2004
2005
2006
2007
2008
2009
2010
1. The real federal funds rate is calculated as the quarterly average nominal funds rate minus the four-quarter lagged core PCE inflation rate as a proxy
for inflation expectations.
0.75
Strictly Confidential (FR) Class I FOMC
(12)
Page 14 of 41
The second set of simulations highlights the implications of different
assumptions about aggregate supply, under the maintained assumption that the
inflation objective is 1½ percent. 6 The solid lines in Chart 6 are identical to those in
the previous chart, depicting the benchmark scenario (as in the extended Greenbook
baseline) in which structural productivity growth gradually moderates toward
historical norms. The dashed lines in this chart depict an alternative scenario in which
structural productivity continues to grow at a pace close to that experienced in recent
years (similar to the scenario in the Greenbook “Faster Productivity Growth”). In
this case, the real funds rate settles to a value that, because of higher levels of wealth
and permanent income, is about 60 basis points higher than in the benchmark
scenario. Given the benchmark inflation objective of 1½ percent and in light of the
substantial response of aggregate demand to the faster productivity growth, the
assumed policy preference function is maximized with a steeper path for the nominal
funds rate, which peaks at nearly 5 percent in mid-2007 and then declines a bit in
subsequent years. Core PCE inflation remains stable at a rate slightly below
1½ percent, while unemployment falls to just over 4½ percent by 2007 and stays
below the NAIRU for several years thereafter. In contrast, under the assumption that
productivity growth runs along a lower track than the benchmark (dotted lines), the
real funds rate stabilizes at a level that is about 50 basis points lower than in the
benchmark scenario. In this case, the optimal policy prescribes a somewhat flatter
path for the nominal funds rate, which reaches about 3½ percent by mid-2007.
6
An important aspect of an examination of a change in the rate of growth of productivity is the
specification of when the public and policymakers learn of the shift. A change in productivity
growth leaves its imprint on aggregate supply (by tilting the path of potential output over time), on
aggregate demand (by altering wealth and permanent income when households come to recognize
the shift), and on monetary policy (by affecting the central bank’s view of resource slack and the
equilibrium real rate). If monetary policymakers, for instance, catch on to a step-up in structural
productivity growth relatively slowly, they will act on a mistaken notion that the output gap is
narrower than actual for a time. In these perfect-foresight simulations, policymakers do not make
such mistakes.
Strictly Confidential (FR) Class I FOMC
Page 15 of 41
Chart 6
Optimal Policy under Alternative Productivity Growth Scenarios
Real Federal Funds Rate 1
Nominal Federal Funds Rate
Percent
4
Percent
5
3
4
2
3
Baseline Scenario
Lower Productivity Growth
Higher Productivity Growth
1
2
0
2004
2005
2006
2007
2008
2009
2010
1
2004
2005
2006
2007
2008
2009
2010
-1
Civilian Unemployment Rate
Percent
6.0
5.5
5.0
2004
2005
2006
2007
2008
2009
2010
4.5
PCE Inflation (ex. food and energy)
(Four-quarter percent change)
Percent
2.5
2.0
1.5
1.0
2004
2005
2006
2007
2008
2009
2010
1. The real federal funds rate is calculated as the quarterly average nominal funds rate minus the four-quarter lagged core PCE inflation rate as a proxy
for inflation expectations.
0.5
Strictly Confidential (FR) Class I FOMC
Page 16 of 41
Nevertheless, the unemployment rate remains about ¼ percentage point above the
NAIRU, and core PCE inflation around ¼ percentage point above the inflation
objective, through the rest of the decade.
(13)
The third set of simulations illustrates the policy implications of alternative
assumptions about aggregate demand, again assuming a 1½ percent inflation
objective. The solid lines in Chart 7 are identical to those in the previous two charts,
depicting the benchmark scenario in which the personal saving rate gradually rises
toward its long-run historical average. In contrast, the dashed lines depict an
alternative scenario in which the saving rate remains at a relatively low level (similar to
the simulation referred to in the Greenbook as the “Stronger Consumption”
scenario). In this case, the long-run equilibrium value of the real funds rate is about
50 basis points higher than in the benchmark scenario. With a 1½ percent inflation
objective, the optimal policy essentially matches this increase in the equilibrium rate
by prescribing a steeper funds rate path that reaches near 4½ percent by late 2007.
This policy response largely offsets the shift in aggregate demand, so that the
trajectories of unemployment and inflation are essentially the same as in the
benchmark scenario. The dotted lines in this chart depict the alternative scenario in
which the personal saving rate rises even faster than in the benchmark scenario. In
this case, the optimal policy prescribes a somewhat lower path for the real funds rate
and thereby prevents the negative aggregate demand shock from having a noticeable
impact on unemployment or inflation.
Short-Run Policy Alternatives
(14)
The universal expectation of a quarter-point policy firming at the upcoming
meeting makes it more challenging than usual to write down plausible policy
alternatives that could help to inform the Committee’s deliberations. Alternative B, as
presented in Table 1, squarely represents the conventional wisdom, in that it envisions
Strictly Confidential (FR) Class I FOMC
Page 17 of 41
Chart 7
Optimal Policy under Alternative Consumption Scenarios
Real Federal Funds Rate 1
Nominal Federal Funds Rate
Percent
4
Percent
5
3
4
2
3
Baseline Scenario
Lower Saving Rate
Higher Saving Rate
1
2
0
2004
2005
2006
2007
2008
2009
2010
1
2004
2005
2006
2007
2008
2009
2010
-1
Civilian Unemployment Rate
Percent
5.8
5.6
5.4
5.2
5.0
2004
2005
2006
2007
2008
2009
2010
4.8
PCE Inflation (ex. food and energy)
(Four-quarter percent change)
Percent
2.25
2.00
1.75
1.50
1.25
1.00
2004
2005
2006
2007
2008
2009
2010
1. The real federal funds rate is calculated as the quarterly average nominal funds rate minus the four-quarter lagged core PCE inflation rate as a proxy
for inflation expectations.
0.75
Strictly Confidential (FR) Class I FOMC
Page 18 of 41
Table 1: Alternative Language for the January FOMC Announcement
Policy
Decision
Rationale
Assessment
of Risk
December FOMC
Alternative A
Alternative B
1. The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 25 basis points to
2¼ percent.
The Federal Open Market Committee
decided today to keep its target for the
federal funds rate at 2¼ percent. The
Committee’s policy actions since mid2004 have materially reduced the degree
of monetary policy accommodation.
The Committee believes that the stance
of monetary policy remains somewhat
accommodative and, coupled with robust
underlying growth in productivity, is
providing ongoing support to economic
activity.
The Federal Open Market
Committee decided today to raise its
target for the federal funds rate by
25 basis points to 2½ percent.
Output appears to be growing at a
moderate pace despite the earlier rise in
energy prices, and labor market
conditions seem to be improving
gradually.
[Unchanged from
December statement]
Output appears to be growing at a
moderate pace despite the earlier
rise in energy prices, and labor
market conditions continue to
improve gradually.
[Unchanged from
December statement]
2. The Committee believes that, even
after this action, the stance of
monetary policy remains
accommodative and, coupled with
robust underlying growth in
productivity, is providing ongoing
support to economic activity.
3. Output appears to be growing at a
moderate pace despite the earlier rise
in energy prices, and labor market
conditions continue to improve
gradually.
4. Inflation and longer-term inflation
expectations remain well contained.
5. The Committee perceives the upside
and downside risks to the attainment
of both sustainable growth and price
stability for the next few quarters to be
roughly equal.
6. With underlying inflation expected to
be relatively low, the Committee
believes that policy accommodation
can be removed at a pace that is likely
to be measured. Nonetheless, the
Committee will respond to changes in
economic prospects as needed to fulfill
its obligation to maintain price
stability.
[Unchanged from
December statement]
With underlying inflation expected to be
relatively low, the Committee believes
that policy accommodation can be
removed at a pace that is likely to be
measured. Nonetheless, the Committee
will respond to changes in economic
prospects as needed to fulfill its
obligation to promote price stability and
sustainable growth.
[Unchanged from
December statement]
Alternative C
The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 50 basis points to
2¾ percent.
The Committee believes that the stance
of monetary policy remains
accommodative and, coupled with
robust the underlying growth in
productivity, is providing ongoing
support to economic activity.
Output appears to be growing at a
moderate pace despite the earlier rise in
energy prices, and labor market
conditions continue to improve
gradually.
Inflation and longer-term inflation
expectations remain well contained, but
rising business costs have the potential
to put upward pressure on prices.
[Unchanged from
December statement]
[Unchanged from
December statement]
[Unchanged from
December statement]
[None]
Strictly Confidential (FR) Class I FOMC
Page 19 of 41
raising the federal funds rate target to 2½ percent at this meeting and the release of a
statement little changed from that in December. Alternative A presents a stance of
policy that is easier in multiple dimensions, in that the federal funds rate is held at its
current level, the assessment of the current degree of accommodation is softened, and
language that could be associated with a pause is offered. In stark contrast,
Alternative C envisions a half-point rate hike accompanied by a darker assessment of
inflation risks and the removal of the “measured pace” language. No doubt, the
extremes are extreme, but they contain elements of statement language that the
Committee might find more appealing than the wording of Alternative B. In addition,
these alternatives may be helpful in informing potential changes in the policy
announcement over the next few meetings. All the alternatives suggest stating that
“Output appears to be growing at a moderate pace despite the rise in energy prices,”
which differs from the December announcement only by dropping the word “earlier”
in recognition of recent increases in oil prices.
(15)
If the Committee believes that continued policy firming will likely prove
sufficient to check inflationary pressures while allowing economic slack to be worked
down in an acceptable manner, it might be inclined to raise the target funds rate
another 25 basis points at this meeting, as in Alternative B. Such an increase would
further unwind the unusual degree of policy accommodation prevailing over the past
several years, seen in Chart 8 as the movement of the real funds rate closer to
estimates of its equilibrium, which themselves moved back to a more typical range in
the last year or so. It would also be consistent with the long-run scenario of
maintaining a 1½ percent objective for core PCE inflation, as discussed above, and
with several policy rules based on that objective (Chart 9). While the Committee may
be concerned that financial markets will remain accommodative even after this move,
perhaps encouraging excessive risk-taking, it might also believe that a larger action at
Strictly Confidential (FR) Class I FOMC
Page 20 of 41
Chart 8
Equilibrium Real Federal Funds Rate
Short-Run Estimates with Confidence Bands
Percent
8
Actual real federal funds rate
Range of model-based estimates
70 percent confidence band
90 percent confidence band
Greenbook-consistent measure
7
6
5
4
3
2
50 b.p. Tightening
25 b.p. Tightening
Current Rate
1
0
-1
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Notes: The real federal funds rate is constructed as the difference between the quarterly average of the actual nominal
funds rate and the log difference of the core PCE price index over the previous four quarters. For the current quarter,
the nominal funds rate used is the target federal funds rate as of the close of the Bluebook.
Short-Run and Medium-Run Measures for 2005:Q1
Current Estimate
Previous Bluebook
1.8
1.8
2.9
2.1
1.7
1.8
2.7
2.3
Short-Run Measures
Greenbook-consistent measure
Single-equation model
Small structural model
Large model (FRB/US)
Confidence intervals for three model-based estimates
70 percent confidence interval
90 percent confidence interval
(0.7 - 3.8(
-0.2 - 4.6(
Medium-Run Measures
TIPS-consistent measure
Single-equation model
Small structural model
Confidence intervals for two model-based estimates
70 percent confidence interval
90 percent confidence interval
1.6
2.2
2.8
1.7
2.2
2.8
(1.5 - 3.4(
(0.7 - 3.9(
Notes: The figures in the "Previous Bluebook" column indicate the estimates for the current quarter as of the previous
Bluebook. Confidence intervals and bands reflect uncertainties about model specification, coefficients, and the level
of potential output.
-2
Strictly Confidential (FR) Class I FOMC
Page 21 of 41
Equilibrium Real Rate Chart: Explanatory Notes
The equilibrium real rate is the real federal funds rate that, if maintained, would be projected to return
output to its potential level over time. The short-run equilibrium rate is defined as the rate that would
close the output gap in twelve quarters given a model’s projection of the economy, and the medium-run
concept is the value of the real funds rate projected to keep output at potential in seven years under the
assumption that monetary policy acts to bring actual and potential output into line in the short run and
then keep them equal thereafter. With the exception of the TIPS-consistent measure, the real federal
funds rates employ the log difference of the core PCE price index over the previous four quarters as a
proxy for expected inflation, with the staff projection used for the current quarter. TIPS indexation is
based on the total CPI.
Measure
Description
Single-Equation
Model
The measure of the equilibrium real rate in the single-equation model is based on an
estimated aggregate-demand relationship between the current value of the output gap and
its lagged values as well as the lagged values of the real federal funds rate. In light of
this model’s simple structure, the short-run measure of the equilibrium real rate depends
only on the recent position of output relative to potential, and the medium-run measure is
virtually constant.
Small Structural
Model
The small-scale model of the economy consists of equations for five variables: the output
gap, the equity premium, the federal budget surplus, the trend growth rate of output, and
the real bond yield. Unlike the estimates from the single-equation model, values of the
equilibrium real rate also depend directly on conditions associated with output growth,
fiscal policy, and capital markets.
Large Model
(FRB/US)
Estimates of the equilibrium real rate using FRB/US—the staff’s large-scale econometric
model of the U.S. economy—depend on a very broad array of economic factors, some of
which take the form of projected values of the model’s exogenous variables. These
projections make use of several simple forecasting rules which are appropriate for the
three-year horizon relevant for the short-run concept but are less sensible over longer
horizons. Thus, we report only the short-run measure for the FRB/US model.
Greenbookconsistent
Measures of the equilibrium real rate cannot be directly obtained from the Greenbook
forecast, because the Greenbook is not based on a formal model. Rather, we use the
FRB/US model in conjunction with an extended version of the Greenbook forecast to
derive a Greenbook-consistent measure. FRB/US is first add-factored so that its
simulation matches the extended Greenbook forecast, and then a second simulation is run
off this baseline to determine the value of the real federal funds rate that closes the output
gap. The medium-run concept of the equilibrium real rate is not computed because it
requires a relatively long extension of the Greenbook forecast.
TIPS-consistent
Yields on TIPS (Treasury Inflation-Protected Securities) incorporate investors’
expectations of the future path of real interest rates. The seven-year instantaneous real
forward rate derived from TIPS yields reflects the short-term real interest rate expected to
prevail in seven years as well as any applicable term premium. The term premium is
assumed to be 70 basis points.
Strictly Confidential (FR) Class I FOMC
Page 22 of 41
Chart 9
Actual and Assumed Federal Funds Rate and
Range of Values from Policy Rules and Futures Markets
Percent
10
10
Actual federal funds rate and Greenbook assumption
Market expectations estimated from futures quotes
Shaded region is the range of values from rules 1a, 2a, 4, 5, and 6 below
8
8
6
6
4
4
2
2
0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Note: In previous Bluebooks, the shaded region reflected Taylor rules with a 2 percent inflation objective, rather
than 1.5 percent as here.
Values of the Federal Funds Rate from Policy Rules and Futures Markets
2004
2005
Q4
Q1
Q2
Q3
Q4
2.79
2.54
2.08
1.83
1.60
1.35
2.68
2.43
2.10
1.85
2.31
2.06
2.76
2.51
2.27
2.02
2.66
2.16
3.14
2.89
2.74
2.49
2.94
2.19
3.27
3.02
2.94
2.69
3.14
2.14
1.71
1.58
1.40
1.87
2.07
2.22
1.79
2.38
2.18
2.36
2.07
2.42
2.44
1.98
2.64
2.48
2.12
1.95
2.44
2.40
2.86
2.75
3.13
2.75
3.30
3.00
Rules with Imposed Coefficients
1. Baseline Taylor Rule: a) π*=1.5
1. Baseline Taylor Rule: b) π*=2
2. Aggressive Taylor Rule: a) π*=1.5
3. First-difference Rule: b) π*=2
3. First-difference Rule: a) π*=1.5
3. First-difference Rule: b) π*=2
Rules with Estimated Coefficients
4. Outcome-based Rule
5. Greenbook Forecast-based Rule
6. FOMC Forecast-based Rule
7. TIPS-based Rule
Memo
Expected federal funds rate derived from futures
Actual federal funds rate and Greenbook assumption
Note: Rule prescriptions for current and future periods are calculated using Greenbook projections for inflation and
the output gap (or unemployment gap). For rules that contain the lagged funds rate, the rule’s previous prescription
for the funds rate is used to compute prescriptions for subsequent periods. It is assumed that there is no feedback
from the rule prescriptions to the Greenbook projections over the time period shown here. The FOMC forecast-based
rule is estimated using the semiannual central tendency of FOMC forecasts made up until July 2004. The TIPS-based
rule is computed using average TIPS and nominal Treasury yields to date.
0
Strictly Confidential (FR) Class I FOMC
Page 23 of 41
Policy Rules Chart: Explanatory Notes
In all of the rules below, it denotes the federal funds rate, Bt the staff estimate at date t of trailing fourquarter core PCE inflation, (yt-yt*) the staff estimate (at date t) of the output gap, B* policymakers’
long-run objective for inflation, it-1 the lagged federal funds rate, gt-1 the residual from the rule’s
prescription the previous quarter, (yt+3|t-yt+3|t*) the staff’s three-quarter-ahead forecast of the output gap,
() yt+3|t-) yt+3|t*) the staff’s forecast of output growth less potential output growth three quarters ahead,
Bt+3|t a three-quarter-ahead forecast of inflation, and (ut+3|t-ut+3|t*) a three-quarter-ahead forecast of the
unemployment gap. Data are quarterly averages taken from the Greenbook and staff memoranda
closest to the middle of each quarter, unless otherwise noted.
Rule
Specification
Root-meansquare error
1988:1200 4:4
2001:1200 4:4
Rules with Imposed Coefficients
1. Baseline Ta ylor Rule
it = 2 + Bt + 0.5(yt-yt*) + 0.5(Bt-B*)
.98a
1.11a
2. Aggr essive Taylor Rule
it = 2 + Bt + (yt-yt*) + 0.5(Bt-B*)
.68a
.65a
3. First-diffe rence R ule
it = it-1 + 0.5() yt+3|t-) yt+3|t*)
+ 0.5(Bt+3|t-B*)
.98a
.44a
Rules with Estimated Coefficients
4. Estimated O utco me-b ased Rule
Rule includes both lagged interest rate and
serial co rrelation in residual.
it = .52it-1 + 0.48 [1.14 + 0.96(yt-yt*)
+ 1.49Bt]+ 0.49gt-1
.23
.24
5. Estimated Greenbook Forecast-based
Ru le
Rule includes both lagged interest rate and
serial co rrelation in residual.
it = .71it-1 + 0.29 [0.59 + 1.06(yt+3|t-yt+3|t*)
+ 1.62Bt+3|t] + 0.33gt-1
.25
.27
.45
.61
.42b
.44
6. Estimated F OM C F orecast-base d Rule
Unemp loyment and inflation forecasts are
from semiannual “central tendency” of FOMC
forecasts, interpolated if necessary to yield 3qtr-ahe ad va lues; u t* forecast is from staff
memoranda. Inflation forecasts are adjusted
to core PCE deflator basis. Rule is estimated
at semiannual frequency, and projected
forward using G reenbo ok forecasts.
7. Estimated T IPS-based R ule
Bcomp5|t denotes the time-t difference between
5-yr nominal T reasury yields an d T IPS .
Sam ple begins in 1 999 due to TIP S volatility
in 1997-8.
it = 0.49it-2 + 0.51 [0.27
! 2.10(ut+3|t-ut+3|t*) + 1.60Bt+3|t]
it = 0.97it-1+ [-1.24 + 0.68Bcomp5|t ]
a
RM SE for rules with imposed co efficients is calculated setting
b
RMSE for TIPS-based rule is calculated for 1999:1-2004:4.
B*=1.5.
Strictly Confidential (FR) Class I FOMC
Page 24 of 41
this time would sow confusion about its assessment of the economy or its objectives,
and perhaps roil financial markets.
(16)
The draft statement offered in Alternative B is quite similar to that released
following the December meeting in its evaluation of recent economic conditions,
assessment of balanced risks to the goals of stable prices and sustainable growth, and
retention of the familiar “measured pace” language. Futures market quotes suggest
that investors are confident of quarter-point policy steps at this meeting and the next,
and primary dealers responding to the Desk’s survey were unanimous in expecting no
change in the Committee’s assessment of the balance of risks at this meeting. The
minutes of the December meeting, however, may have led analysts to expect a sign of
heightened worries about the inflation outlook, which is missing from the draft
statement provided in Table 1, and its release probably would be accompanied by an
edging lower of yields, a bit of a rally in equity markets, and a small decline in the
exchange value of the dollar.
(17)
If the Committee believes that a more rapid return to a neutral policy stance
is needed to prevent output overshooting its potential and putting upward pressures
on inflation down the road, it may choose one or all of the components included in
the statement under Alternative C. A 50 basis point increase in the target funds rate
at this meeting might be selected if members believe that a more gradual tightening,
along the lines of the Greenbook assumption or the expectations of market
participants, could promote excessive risk-taking, unsustainable spending, and an
increase in inflation. Private forecasters continue to anticipate a higher rate of
inflation than the staff, and the Committee may share such a forecast under the policy
paths implied by market prices or assumed in the Greenbook. Members may place
high odds on aggregate demand being stronger than in the staff forecast because they
believe that the saving rate will stay persistently low or that investment spending will
not slip with the end of the partial expensing tax provisions. Similarly, a less
Strictly Confidential (FR) Class I FOMC
Page 25 of 41
optimistic outlook for aggregate supply and the attendant consequences for inflation
might incline the Committee to pick up the pace of policy firming.7
(18)
Even if the Committee prefers a 25 basis point tightening at this meeting, it
may wish to couple such a move with some of the changes in the announcement
listed under Alternative C in Table 1. For instance, to suggest greater uncertainty
about the pace of structural productivity growth, the announcement could simply
speak of “the underlying growth in productivity” as helping to support economic
activity, without characterizing productivity growth as “robust.” To signal a relatively
greater concern about the inflation outlook, the Committee could note in the rationale
paragraph that labor market conditions “continue to improve,” without indicating that
the improvement was gradual, and also mention that “rising business costs have the
potential to put upward pressure on prices.” The Committee could also drop the
“measured pace” language, although, in the absence of other changes in the balanceof-risks framework, that would place a greater burden on the rationale paragraph to
guide market participants’ expectations for policy, at least until release of the minutes
three weeks later. If the Committee did choose to firm 50 basis points at this
meeting, the draft language in Table 1 would serve to clarify that the larger move was
not intended to presage a pause.
(19)
A 50 basis point policy firming and an announcement like that indicated
under Alternative C would lead to a sharp rise in short-term interest rates and a
decline in bond and stock prices. Market participants would likely mark up the
amount of cumulative tightening expected over the next year or so. At the same time,
uncertainty about future policy moves might increase substantially, and market prices
probably would respond more forcefully to data releases and especially to news on
inflation. The direction of the market moves would be the same, but the amounts
7
Referring back to the discussion of a productivity shock in paragraph 12, the implicit concern
presumably would be that the Committee is late in appreciating that structural productivity growth
had ratcheted down some time ago so that the true output gap is smaller than suspected.
Strictly Confidential (FR) Class I FOMC
Page 26 of 41
attenuated, if the Committee married a quarter-point rate firming with some of the
drafting language of Alternative C.
(20)
If the Committee wanted to pause in the process of removing policy
accommodation at this meeting, it might adopt Alternative A. The Committee may
believe that more of the increases in productivity in recent years have been structural
than assumed by the staff, leaving the economy with more resource slack currently
and raising the odds of a lower inflation rate prospectively under the Greenbook
policy path. In addition, members may foresee a continuation of labor market slack,
rather than the gradual elimination forecasted by the staff, because of continued
business caution, a faster return to the trend rate of labor force participation, or a
lower NAIRU. The Committee may also harbor some suspicions about the resilience
of aggregate demand, perhaps on the thought that the saving rate could rise more
rapidly or the drag from net exports intensify more substantially than in the staff
forecast.
(21)
Even if concerns about the vigor of the expansion or confidence in the
prospects for aggregate supply were not, on balance, significant enough to dissuade
the Committee from tightening at this meeting, it might wish to signal in its
announcement that such a possibility may come soon. This could be accomplished,
for instance, by adding after the first sentence of the announcement, “The
Committee’s policy actions since mid-2004 have materially reduced the degree of
monetary policy accommodation.” The Committee could emphasize the extent to
which policy has firmed since June by stating that “the stance of policy remains
somewhat accommodative” rather than simply “accommodative.” It might also
include a note of uncertainty about improvements in the labor market by commenting
that “labor market conditions seem to be improving gradually.” Finally, it could
allude to both its policy objectives by mentioning “sustainable growth” along with
price stability in the last sentence of the announcement.
Strictly Confidential (FR) Class I FOMC
(22)
Page 27 of 41
Adoption of all aspects of Alternative A—that is, keeping the funds rate
unchanged and softening the cast of the statement language—would come as a
considerable surprise to market participants, especially after the release of the minutes
of the December meeting. If the Committee chose a more limited number of the
changes in that column of Table 1, investors would probably mark down their
expectations for the path of policy, causing a decline in short- and longer-term
interest rates, a stock market rally, and a drop in the foreign exchange value of the
dollar. The decline in longer-term interest rates would be larger and the rise in stock
prices would be smaller to the degree that investors responded to the surprising
FOMC statement by marking down their outlook for economic activity.
Money and Debt Forecasts
(23)
Under the staff forecast, M2 is expected to expand about 4 percent this
year, 1½ percentage points slower than nominal GDP growth, owing to the lagged
response of money demand to increases in short-term interest rates and associated
opportunity costs. Under the financial assumptions in the Greenbook, potential
substitutability of M2 assets with capital market instruments could have offsetting
effects: Households may shift out of deposits if they gain confidence in higher
returns on stocks, but the flattening of the yield curve could increase the
attractiveness of the short-term instruments in M2 relative to bonds. With fewer
policy tightenings in 2006, M2 is expected to expand 4½ percent, only ¾ percentage
point slower than nominal spending. The growth of domestic nonfinancial sector
debt is expected to fall from the 7¾ percent pace of 2004 to around 7¼ percent this
year and 6½ percent in 2006, reflecting a moderation of government and household
borrowing. Rising interest rates and less rapid home price increases finally temper the
accumulation of mortgage debt by households. Business debt growth is projected to
Strictly Confidential (FR) Class I FOMC
Page 28 of 41
Alternative Growth Rates for M2
(percent, annual rate)
Monthly Growth Rates
Nov-04
Dec-04
Jan-05
Feb-05
Mar-05
Apr-05
May-05
Jun-05
Quarterly Growth Rates
2004 Q1
2004 Q2
2004 Q3
2004 Q4
2005 Q1
2005 Q2
Annual Growth Rates
2003
2004
2005
2006
From
Dec-04
Dec-04
Jan-05
To
Mar-05
Jun-05
Jun-05
No change
Raise 25 bp*
Raise 50 bp**
Greenbook***
6.9
4.3
5.7
5.3
4.9
4.2
5.6
5.9
6.9
4.3
5.7
5.0
4.2
3.4
4.9
5.4
6.9
4.3
5.7
4.7
3.5
2.6
4.2
4.8
6.9
4.3
5.7
5.0
4.2
3.0
4.1
4.6
3.4
7.8
3.6
5.5
5.4
5.0
3.4
7.8
3.6
5.5
5.2
4.3
3.4
7.8
3.6
5.5
5.1
3.6
3.4
7.8
3.6
5.5
5.2
3.9
5.3
5.2
5.3
5.2
5.3
5.2
5.3
5.2
4.0
4.5
5.3
5.3
5.2
5.0
4.8
4.6
4.6
4.3
4.0
5.0
4.5
4.2
* Increase of 25 basis points in the target federal funds rate at this meeting and no change thereafter.
** Increase of 50 basis points in the target federal funds rate at this meeting and no change thereafter.
*** This forecast is consistent with nominal GDP and interest rates in the Greenbook forecast.
Strictly Confidential (FR) Class I FOMC
Page 29 of 41
pick up a little, however, from the sluggish pace of recent years with capital spending
eventually notably exceeding the generation of internal funds.
Directive and Balance-of-Risks Statement
(24)
Draft language for the directive and draft risk assessments identical to those
presented in Table 1 are provided below.
(1) Directive Wording
The Federal Open Market Committee seeks monetary and financial
conditions that will foster price stability and promote sustainable growth
in output. To further its long-run objectives, the Committee in the
immediate future seeks conditions in reserve markets consistent with
MAINTAINING/increasing/REDUCING the federal funds rate
AT/to an average of around _______ 2¼ percent.
(2) Risk Assessments
A. The Committee perceives the upside and downside risks to the
attainment of both sustainable growth and price stability for the next few
quarters to be roughly equal. With underlying inflation expected to be
relatively low, the Committee believes that policy accommodation can be
removed at a pace that is likely to be measured. Nonetheless, the
Committee will respond to changes in economic prospects as needed to
fulfill its obligation to promote price stability and sustainable growth.
B. The Committee perceives the upside and downside risks to the
attainment of both sustainable growth and price stability for the next few
quarters to be roughly equal. With underlying inflation expected to be
relatively low, the Committee believes that policy accommodation can be
removed at a pace that is likely to be measured. Nonetheless, the
Strictly Confidential (FR) Class I FOMC
Page 30 of 41
Committee will respond to changes in economic prospects as needed to
fulfill its obligation to maintain price stability.
C. The Committee perceives the upside and downside risks to the
attainment of both sustainable growth and price stability for the next few
quarters to be roughly equal.
Strictly Confidential (FR) Class I FOMC
Page 31 of 41
Appendix Chart 1
Treasury Yield Curve
Spread Between Ten−year Treasury Yield and Federal Funds Rate
Percentage Points
4
Quarterly
2
+
0
−2
−4
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
+ Denotes most recent weekly value.
Note. Blue shaded regions denote NBER−dated recessions.
Treasury Yield Curve*
Percent
7
January 27, 2005
December 13, 2004
6
5
4
3
2
1
3
5
7
10
20
Maturity in Years
*Smoothed yield curve estimated from off−the−run Treasury coupon securities. Yields shown are those on notional par
Treasury securities with semi−annual coupons.
Strictly Confidential (FR) Class I FOMC
Page 32 of 41
Appendix Chart 2
Dollar Exchange Rate Indexes
Nominal
Ratio Scale
March 1973=100
150
Monthly
140
130
120
Major
Currencies
110
100
90
+
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
80
2003
+ Denotes most recent weekly value.
Ratio Scale
March 1973=100
Real
140
Monthly
130
120
Other Important
110
100
Broad
90
Major
Currencies
80
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
Note. The major currencies index is the trade−weighted average of currencies of the Euro area, Canada, Japan,
the U.K., Switzerland, Australia, and Sweden. The other important trading partners index is the trade−weighted
average of currencies of 19 other important trading partners. The Broad index is the trade−weighted average of
currencies of all important trading partners. Real indexes have been adjusted for relative changes in U.S. and
foreign consumer prices. Blue shaded regions denote NBER−dated recessions.
Strictly Confidential (FR) Class I FOMC
Page 33 of 41
Appendix Chart 3
Stock Indexes
Nominal
Ratio Scale
1941−43=10
Ratio
45
2000
Monthly
1500
40
+
S&P 500
35
1000
30
500
25
P/E Ratio*
+
20
15
10
5
0
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
* Based on trailing four−quarter earnings.
+ Denotes most recent weekly value.
Real
Ratio Scale
1941−43=10
160
140
Monthly
120
+
100
80
60
S&P 500*
40
20
1960
1963
1966
1969
1972
1975
1978
1981
* Deflated by the CPI.
+ Denotes most recent weekly value.
Note. Blue shaded regions denote NBER−dated recessions.
1984
1987
1990
1993
1996
1999
2002
2005
Strictly Confidential (FR) Class I FOMC
Page 34 of 41
Appendix Chart 4
One−Year Real Interest Rates
One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Michigan Survey)*
Percent
8
Monthly
4
0
+
−4
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
* Mean value of respondents.
One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Philadelphia Fed)*
Percent
8
Monthly
GDP Deflator
4
CPI
+
+
0
−4
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
* ASA/NBER quarterly survey until 1990:Q1; Philadelphia Federal Reserve Bank Survey of Professional Forecasters
thereafter. Median value of respondents.
One−Year Treasury Constant Maturity Yield Less Change in the Core CPI from Three Months Prior
Percent
8
Monthly
4
+
0
−4
1985
1987
1989
1991
1993
1995
1997
1999
2001
+ Denotes most recent weekly Treasury constant maturity yield less most recent inflation expectation.
Note. Blue shaded regions denote NBER−dated recessions.
2003
2005
Strictly Confidential (FR) Class I FOMC
Page 35 of 41
Appendix Chart 5
Long−Term Real Interest Rates*
Real Ten−Year Treasury Yields
Percent
10
Monthly
8
Real rate using
Philadelphia Fed Survey
6
Ten−year TIPS yield
4
Real rate using
Michigan Survey
+
+
2
0
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
Nominal and Real Corporate Bond Rates
Percent
14
Monthly
12
Nominal rate on Moody’s
A−rated corporate bonds
10
8
Real rate using
Philadelphia Fed Survey
+
6
4
Real rate using
Michigan Survey
1985
1987
1989
+
+
1991
1993
1995
1997
1999
2001
2003
2005
* For real rates, measures using the Philadelphia Fed Survey employ the ten−year inflation expectations from the
Blue Chip Survey until April 1991 and the Philadelphia Federal Reserve Bank Survey of Professional Forecasters
thereafter (median value of respondents). Measures using the Michigan Survey employ the five− to ten−year
inflation expectations from that survey (mean value of respondents).
+ For TIPS and nominal corporate rate, denotes the most recent weekly value. For other real rate series, denotes
the most recent weekly nominal yield less the most recent inflation expectation.
Note. Blue shaded regions denote NBER−dated recessions.
2
Strictly Confidential (FR) Class I FOMC
Page 36 of 41
Appendix Chart 6
Commodity Price Measures
Journal of Commerce Index
Ratio scale, index (1980=100)
140
130
Weekly
120
110
Metals
100
Total
90
80
70
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
CRB Spot Industrials
Ratio scale, index (1967=100)
380
360
340
320
Weekly
300
280
260
240
220
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
CRB Futures
Ratio scale, index (1967=100)
300
Weekly
280
260
240
220
200
1985
1987
1989
1991
1993
Note. Blue shaded regions denote NBER−dated recessions.
1995
1997
1999
2001
2003
2005
Strictly Confidential (FR) Class I FOMC
Page 37 of 41
Appendix Chart 7
Growth of Real M2 and M3
M2
Percent
10
Quarterly
5
0
−5
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
M3
Percent
15
Quarterly
10
5
0
−5
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
Note. Four−quarter moving average deflated by the CPI. Blue shaded regions denote NBER−dated recessions.
Dashed areas denote projection period.
Strictly Confidential (FR) Class I FOMC
Page 38 of 41
Appendix Chart 8
Inflation Indicator Based on M2 and Two
Estimates of V*
Price Level
Ratio Scale
140
Quarterly
Long-run equilibrium
price level (P*) given
current M2 and V* with shift
120
100
GDP implicit
price deflator (P)
80
Long-run equilibrium
price level (P*), given
current M2 and constant V*
60
40
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
Inflation*
Percent
12
Quarterly
10
8
6
4
V* with shift
2
Constant V*
0
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
* Change in GDP implicit price deflator over the previous four quarters.
Note. P* is defined to equal M2 times V* divided by potential GDP. Long-run velocity (V*) is estimated from
1959:Q1 to 1989:Q4. V* after 1992 is estimated from 1993:Q1 to present. For the forecast period, P* is based
on staff M2 forecast and P is simulated using a short-run dynamic model relating P to P*. Vertical lines
mark crossing of P and P*. Dashed areas denote projection period.
2004
Appendix Table 1
Strictly Confidential (FR) Class I FOMC
Page 39 of 41
Selected Interest Rates
(Percent)
Short-term
Treasury bills
secondary market
Federal
funds
1
Long-term
CDs
secondary
market
Comm.
paper
Off-the-run Treasury yields
Indexed yields
Moody’s
Baa
Municipal
Bond
Buyer
Conventional home
mortgages
primary market
4-week
3-month
6-month
3-month
1-month
2-year
5-year
10-year
20-year
5-year
10-year
Fixed-rate
ARM
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
03 -- High
-- Low
1.45
0.86
1.26
0.75
1.22
0.81
1.28
0.82
1.32
0.93
1.28
0.91
2.11
1.09
3.60
2.06
4.80
3.29
5.58
4.21
1.84
0.77
2.48
1.56
7.48
6.01
5.50
4.78
6.44
5.21
4.06
3.45
04 -- High
-- Low
Monthly
Jan 04
Feb 04
Mar 04
Apr 04
May 04
Jun 04
04
Jul
Aug 04
Sep 04
Oct 04
Nov 04
Dec 04
2.34
0.92
2.08
0.73
2.28
0.87
2.63
0.96
2.51
1.04
2.29
0.97
3.13
1.49
4.10
2.65
5.03
3.84
5.64
4.68
1.57
0.42
2.25
1.35
6.90
6.00
5.45
4.73
6.34
5.38
4.27
3.36
1.00
1.01
1.00
1.00
1.00
1.03
1.26
1.43
1.61
1.76
1.93
2.16
0.84
0.92
0.96
0.90
0.90
1.04
1.18
1.37
1.54
1.62
1.91
1.95
0.90
0.95
0.95
0.96
1.04
1.29
1.35
1.51
1.68
1.79
2.11
2.23
0.99
1.01
1.01
1.11
1.33
1.64
1.69
1.76
1.91
2.05
2.33
2.50
1.06
1.05
1.05
1.08
1.20
1.46
1.57
1.68
1.86
2.04
2.26
2.45
0.99
0.99
0.99
1.00
1.00
1.13
1.29
1.48
1.67
1.79
2.01
2.22
1.75
1.73
1.57
2.09
2.56
2.78
2.64
2.50
2.51
2.57
2.86
3.02
3.10
3.05
2.78
3.38
3.86
3.93
3.70
3.49
3.35
3.35
3.52
3.59
4.28
4.22
3.96
4.50
4.88
4.88
4.64
4.43
4.26
4.24
4.32
4.34
5.06
4.99
4.78
5.22
5.51
5.49
5.29
5.12
4.96
4.92
4.95
4.94
1.11
0.88
0.55
1.05
1.37
1.43
1.32
1.15
1.12
1.00
0.93
0.96
1.88
1.77
1.48
1.90
2.09
2.14
2.02
1.86
1.81
1.74
1.69
1.67
6.44
6.27
6.11
6.46
6.75
6.78
6.62
6.46
6.27
6.21
6.20
6.15
4.99
4.86
4.78
5.13
5.39
5.40
5.29
5.18
5.04
4.99
5.06
5.03
5.71
5.64
5.45
5.83
6.27
6.29
6.06
5.87
5.75
5.72
5.73
5.75
3.63
3.55
3.41
3.65
3.88
4.10
4.11
4.06
3.99
4.02
4.15
4.18
Weekly
Nov
Dec
Dec
Dec
Dec
Dec
Jan
Jan
Jan
Jan
Daily
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
Jan
26
3
10
17
24
31
7
14
21
28
04
04
04
04
04
04
05
05
05
05
2.01
2.01
2.02
2.20
2.26
2.21
2.18
2.26
2.27
--
1.98
2.04
2.07
1.97
1.88
1.79
2.01
2.02
1.94
2.10
2.19
2.23
2.25
2.22
2.21
2.24
2.33
2.36
2.38
2.42
2.41
2.42
2.43
2.48
2.55
2.61
2.63
2.66
2.68
2.71
2.34
2.38
2.41
2.46
2.48
2.50
2.54
2.59
2.64
2.67
2.07
2.11
2.20
2.25
2.26
2.24
2.24
2.29
2.35
2.41
3.01
3.04
2.94
2.99
3.05
3.10
3.18
3.23
3.23
3.26
3.59
3.70
3.55
3.53
3.58
3.66
3.71
3.72
3.69
3.70
4.32
4.47
4.31
4.27
4.31
4.40
4.38
4.34
4.27
4.28
4.92
5.07
4.92
4.86
4.90
4.98
4.93
4.85
4.75
4.75
0.94
1.01
0.95
0.93
0.92
1.01
1.14
1.15
1.18
1.18
1.65
1.77
1.67
1.63
1.62
1.68
1.75
1.73
1.69
1.71
6.16
6.30
6.14
6.08
6.12
6.18
6.12
6.05
5.97
--
5.07
5.15
4.99
4.95
5.00
5.04
4.98
4.92
4.89
--
5.72
5.81
5.71
5.68
5.75
5.81
5.77
5.74
5.67
5.66
4.27
4.19
4.15
4.18
4.17
4.19
4.10
4.10
4.11
4.18
11
12
13
14
17
18
19
20
21
24
25
26
27
05
05
05
05
05
05
05
05
05
05
05
05
05
2.24
2.25
2.29
2.29
2.29
2.31
2.19
2.25
2.26
2.26
2.29
2.33
2.35 p
2.02
2.00
2.04
2.03
-1.99
1.93
1.86
1.99
2.00
2.12
2.15
2.14
2.36
2.35
2.36
2.37
-2.41
2.38
2.36
2.36
2.39
2.41
2.42
2.45
2.67
2.64
2.65
2.68
-2.71
2.69
2.67
2.66
2.69
2.70
2.71
2.72
2.58
2.60
2.61
2.61
-2.62
2.64
2.65
2.65
2.65
2.66
2.67
2.69
2.29
2.29
2.30
2.33
-2.33
2.35
2.36
2.37
2.40
2.39
2.43
--
3.23
3.22
3.20
3.25
-3.26
3.26
3.22
3.17
3.21
3.24
3.28
3.29
3.73
3.72
3.67
3.72
-3.72
3.73
3.68
3.65
3.64
3.70
3.71
3.74
4.35
4.34
4.29
4.32
-4.29
4.29
4.27
4.25
4.22
4.30
4.30
4.31
4.87
4.85
4.80
4.81
-4.77
4.76
4.74
4.73
4.70
4.77
4.76
4.77
1.17
1.15
1.11
1.17
-1.18
1.20
1.18
1.17
1.16
1.19
1.18
1.19
1.75
1.73
1.69
1.72
-1.70
1.69
1.68
1.68
1.67
1.74
1.71
1.71
6.07
6.06
6.00
6.02
-5.98
5.96
5.97
5.95
5.91
5.98
5.97
--
--------------
--------------
--------------
NOTE: Weekly data for columns 1 through 13 are week-ending averages. Columns 2 through 4 are on a coupon equivalent basis. Data in column 6 are interpolated from data on certain commercial paper trades settled by the
Depository Trust Company. Column 14 is the Bond Buyer revenue index, which is a 1-day quote for Thursday. Column 15 is the average contract rate on new commitments for fixed-rate mortgages (FRMs) with 80 percent
loan-to-value ratios at major institutional lenders. Column 16 is the average initial contract rate on new commitments for 1-year, adjustable-rate mortgages (ARMs) at major institutional lenders offering both FRMs and
ARMs with the same number of discount points.
MFMA
p - preliminary data
Strictly Confidential (FR) Class I FOMC
Page 40 of 41
Appendix Table 2
Money Aggregates
Seasonally Adjusted
Period
Annual growth rates (%):
Annually (Q4 to Q4)
2002
2003
2004
3
4
M3
5
6.0
3.5
7.0
6.5
4.7
5.7
5.9
6.1
3.8
5.6
3.4
7.8
3.6
5.5
2.8
8.2
3.5
5.5
10.1
13.0
5.7
-1.3
5.6
9.4
4.2
3.3
-2.7
16.6
12.1
0.4
3.2
7.1
-6.4
16.2
4.0
-0.1
13.4
-0.7
2.5
7.6
7.6
7.3
11.3
2.3
0.5
3.9
6.7
4.7
6.9
4.3
3.9
5.3
6.3
9.2
13.5
1.1
2.4
0.6
7.4
6.0
5.1
5.6
20.0
10.8
16.1
11.9
12.7
11.5
0.1
4.8
5.2
-7.9
-5.2
7.3
8.0
8.6
10.3
8.8
11.7
5.3
0.4
4.2
6.2
0.6
3.0
5.3
-6.8
5.7
9.0
10.3
7.2
1343.4
1347.9
1347.8
1362.8
1362.0
6298.0
6333.0
6357.8
6394.1
6417.0
4954.6
4985.0
5010.1
5031.4
5055.0
3012.3
3025.4
3005.5
2992.4
3010.6
9310.3
9358.4
9363.3
9386.5
9427.6
6
13
20
27
1348.9
1352.0
1360.8
1378.2
6402.8
6411.7
6425.3
6434.8
5053.8
5059.7
5064.6
5056.6
3012.3
2998.8
2991.9
3018.6
9415.0
9410.4
9417.2
9453.4
3
10p
17p
1372.3
1322.1
1336.6
6401.8
6401.2
6436.3
5029.5
5079.1
5099.7
3046.9
3033.3
3036.4
9448.6
9434.5
9472.7
Levels ($billions):
Monthly
2004-Aug.
Sep.
Oct.
Nov.
Dec.
preliminary
estimated
2
in M3 only
7.7
5.0
5.1
2005-Jan. e
p
e
1
nontransactions components
in M2
6.7
5.3
5.2
Monthly
2004-Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sep.
Oct.
Nov.
Dec.
2005-Jan.
M2
3.3
6.6
5.5
Quarterly (average)
2004-Q1
Q2
Q3
Q4
Weekly
2004-Dec.
M1
Strictly Confidential (FR) Class I FOMC
Page 41 of 41
Changes in System Holdings of Securities 1
(Millions of dollars, not seasonally adjusted)
January 27, 2005
Treasury Bills
Treasury Coupons
Net Purchases 3
Net
Redemptions
Net
Purchases 2
(-)
Change
<1
1-5
5-10
Redemptions
(-)
Over 10
Net
Change
Federal
Net change
Agency
total
Redemptions
(-)
outright
holdings 4
Net RPs 5
ShortTerm 6
LongTerm 7
Net
Change
2002
2003
21,421
18,150
-----
21,421
18,150
12,720
6,565
12,748
7,814
5,074
4,107
2,280
220
-----
32,822
18,706
--10
54,242
36,846
-5,366
2,223
517
1,036
-4,850
3,259
2004
18,138
---
18,138
7,994
17,249
5,763
1,364
---
32,370
---
50,507
-2,522
-331
-2,853
2003 QIV
3,299
---
3,299
2,561
3,188
1,350
20
---
7,118
10
10,407
-561
2,750
2,189
2004 QI
QII
1,707
7,756
-----
1,707
7,756
1,311
1,693
2,848
2,543
1,251
988
275
84
-----
5,685
5,307
-----
7,391
13,063
-772
1,133
-3,515
418
-4,286
1,550
QIII
QIV
4,508
4,167
-----
4,508
4,167
1,898
3,092
4,406
7,453
1,507
2,018
434
571
-----
8,244
13,134
-----
12,753
17,301
-1,787
-5,956
782
1,728
-1,005
-4,227
2004 May
Jun
409
3,831
-----
409
3,831
1,693
---
783
1,760
713
275
84
---
-----
3,272
2,035
-----
3,681
5,866
-637
-1,738
710
1,824
73
86
Jul
Aug
952
83
-----
952
83
1,898
---
3,078
428
244
568
29
---
-----
5,249
996
-----
6,202
1,078
1,120
-750
-2,372
-1,323
-1,252
-2,072
Sep
Oct
3,473
500
-----
3,473
500
--1,593
899
2,765
695
1,225
405
400
-----
1,999
5,984
-----
5,473
6,484
-3,176
-2,121
7,895
-4,443
4,718
-6,564
Nov
Dec
3,155
512
-----
3,155
512
--1,499
2,284
2,404
453
340
86
85
-----
2,822
4,328
-----
5,977
4,840
-1,416
-1,492
1,543
812
127
-680
2004 Nov 3
Nov 10
192
327
-----
192
327
-----
1,086
---
118
335
--86
-----
1,204
421
-----
1,396
748
1,739
805
-2,000
-1,714
-261
-909
Nov 17
Nov 24
20
1,451
-----
20
1,451
-----
1,198
---
-----
-----
-----
1,198
---
-----
1,217
1,451
-203
-3,235
3,429
4,429
3,226
1,194
Dec 1
Dec 8
1,286
257
-----
1,286
257
--1,499
--2,404
-----
-----
-----
--3,903
-----
1,286
4,160
3,748
-3,878
857
-2,000
4,605
-5,878
Dec 15
Dec 22
128
---
-----
128
---
-----
-----
340
---
85
---
-----
425
---
-----
553
---
-319
960
-2,000
-1,000
-2,319
-40
Dec 29
2005 Jan 5
109
---
-----
109
---
-----
-----
-----
-----
-----
-----
-----
109
---
1,621
2,373
2,000
---
3,621
2,373
Jan 12
Jan 19
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-5,384
3,277
-5,000
1,000
-10,384
4,277
Jan 26
---
---
---
---
---
---
---
---
---
---
---
-2,766
---
-2,766
2005 Jan 27
---
---
---
---
---
---
---
---
---
---
---
2,654
-1,000
1,654
163
---
163
---
---
---
---
---
---
---
163
4,204
-4,000
204
263.0
117.6
209.7
51.8
717.9
-16.7
16.0
-0.7
Intermeeting Period
Dec 14-Jan 27
Memo: LEVEL (bil. $)
Jan 27
1. Change from end-of-period to end-of-period. Excludes changes in compensation for the effects of
inflation on the principal of inflation-indexed securities.
2. Outright purchases less outright sales (in market and with foreign accounts).
3. Outright purchases less outright sales (in market and with foreign accounts). Includes short-term notes
acquired in exchange for maturing bills. Excludes maturity shifts and rollovers of maturing issues,
except the rollover of inflation compensation.
75.8
4.
5.
6.
7.
454.9
Includes redemptions (-) of Treasury and agency securities.
RPs outstanding less reverse RPs.
Original maturity of 13 days or less.
Original maturity of 14 to 90 days.
MRA:BEW
Cite this document
APA
Federal Reserve (2005, February 1). Bluebook. Bluebooks, Federal Reserve. https://whenthefedspeaks.com/doc/bluebook_20050202
BibTeX
@misc{wtfs_bluebook_20050202,
author = {Federal Reserve},
title = {Bluebook},
year = {2005},
month = {Feb},
howpublished = {Bluebooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/bluebook_20050202},
note = {Retrieved via When the Fed Speaks corpus}
}