bluebooks · May 9, 2006
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 02/09/2012.
CLASS I FOMC - RESTRICTED CONTROLLED (FR)
MAY 5, 2006
MONETARY POLICY ALTERNATIVES
PREPARED FOR THE FEDERAL OPEN MARKET COMMITTEE
BY THE STAFF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Class I FOMC - Restricted Controlled (FR)
May 5, 2006
MONETARY POLICY ALTERNATIVES
Recent Developments1
(1)
Investors had anticipated the FOMC’s decision at its March meeting to raise
the target federal funds rate 25 basis points, to 4¾ percent, but the retention of the
language that “some further policy firming may be needed” evidently led them to
mark up somewhat their expected path for the federal funds rate.2 Subsequently,
speeches by Federal Reserve officials, the release of the minutes of the March FOMC
meeting, and the Chairman's testimony before the Joint Economic Committee were
generally taken to suggest that the FOMC was more likely than had previously been
thought to leave policy unchanged after one more move. Money market futures rates
rose in response to key data releases that were read as indicating greater global
economic strength and higher inflation pressures than had been expected. On net,
federal funds futures rates for the end of this year and beyond increased 25 to 35 basis
points, and the expected policy path currently peaks at about 5.2 percent toward the
end of this year before sloping down gradually over 2007 (Chart 1). Option-implied
uncertainty about the path for money market rates edged up but remains low in its
historical range. The Desk survey and futures quotes suggest that investors are
virtually certain of a 25 basis point increase in the target funds rate at the May FOMC
meeting and see a roughly one-in-three chance of a like-sized move in June.
(2)
Over the intermeeting period, yields on two- and ten-year nominal Treasury
securities rose 25 and 45 basis points, respectively. The ten-year rate, at 5.23 percent,
Financial market quotes are as of the close of business on Thursday, May 4.
The effective federal funds rate averaged 4.79 percent over the intermeeting period. In the
last few days, the funds rate traded on the firm side despite a sizable provision of reserves by
the Desk, as reserve managers at banks once again anticipated policy firming by the
Committee. The Desk purchased $1.1 billion of Treasury coupon securities in the market.
The volume of outstanding long-term RPs increased $1 billion, to $15 billion.
1
2
Class I FOMC - Restricted Controlled (FR)
Page 2 of 41
Chart 1
Interest Rate Developments
Expected Federal Funds Rates*
Implied Volatilities
Percent
Percent
6.0
11
May 4, 2006
March 27, 2006
5.5
Basis points
220
Daily
FOMC
Ten-Year Treasury (left scale)
Six-Month Eurodollar (right scale)
9
180
160
7
5.0
140
5
4.5
200
120
100
3
80
4.0
May
July
Oct.
Jan.
Apr.
2006
July
2007
Oct.
1
60
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
*Estimates from federal funds and Eurodollar futures, with an allowance
for term premiums and other adjustments.
Nominal Treasury Yields*
Change in Implied One-Year Forward Treasury
Rates since Last FOMC
Percent
Basis points
7
Daily
FOMC
Ten-Year
Two-Year
60
6
50
5
40
4
30
3
20
2
10
1
0
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
1
2
3
*Par yields from a smoothed nominal off-the-run Treasury yield curve.
Inflation Compensation*
FOMC
Next Five Years
Five-to-Ten Years Ahead
7
10
Oil Prices
Percent
Daily
5
Years Ahead
4.0
$/barrel
FOMC
Daily
Spot WTI
Far-Dated Futures
3.5
3.0
2.5
2.0
1.5
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
Apr.
Aug.
2004
*Estimates based on smoothed nominal and inflation-indexed
Treasury yield curves, and adjusted for the indexation-lag (carry) effect.
Note: Vertical lines indicate March 27, 2006. Last daily observations are for May 4, 2006.
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
80
75
70
65
60
55
50
45
40
35
30
25
20
Class I FOMC - Restricted Controlled (FR)
Page 3 of 41
is now above its level just prior to the onset of the current round of policy tightening.
A rise in distant-horizon forward rates, possibly owing to a modest rebound in term
premiums, accounted importantly for this movement in yields (see box entitled “The
Recent Rise in Distant-Horizon Forward Rates and Term Premiums”). Yields on
TIPS rose less than those on comparable-maturity nominal Treasury securities. The
15 basis point climb in near-term inflation compensation can largely be attributed to
the rise in energy prices. In contrast, with survey measures of long-run inflation
expectations unchanged to 20 basis points higher, the 20 basis point increase in fiveto-ten-year forward inflation compensation appears to reflect both expectations of
higher inflation and an increase in the inflation risk premium.
(3)
Major stock price indexes were up a bit over the intermeeting period, as
positive first-quarter earnings reports more than offset the negative effects of higher
energy prices and interest rates (Chart 2). The implied volatility of equity prices
remained near historical lows. With the rise in long-term real Treasury yields, the
equity premium is estimated to have narrowed a bit, though it remains slightly above
its average level of the past two decades. Measures of the credit quality of
nonfinancial firms remained solid, supported by gains in earnings and by strong and
liquid balance sheets. Spreads of yields on investment-grade bonds over those on
comparable-maturity Treasury securities were about unchanged, while spreads on
speculative-grade bonds declined.
(4)
The trade-weighted exchange value of the dollar against major foreign
currencies fell 4¾ percent on balance over the intermeeting period (Chart 3). The
dollar’s decline came amid fairly widespread signs of stronger global growth that
boosted investors’ expectations of further monetary policy tightening abroad.
Increased focus in public debate on risks posed by the large U.S. external imbalance
also appeared to erode investor support for the dollar. The dollar dropped
3¼ percent versus the yen, about 4¾ percent versus the euro, and nearly 5½ percent
Class I FOMC - Restricted Controlled (FR)
Page 4 of 41
The Recent Rise in Distant-Horizon Forward Rates and Term Premiums
In the Treasury market, the nine-to-ten-year-ahead nominal forward rate climbed 60 basis
points over the intermeeting period, while the comparable indexed forward rate from TIPS
rose about 35 basis points. Thus, distant-horizon forward inflation compensation increased
about 25 basis points. Judging from the staff’s arbitrage-free term structure model, the tenyear instantaneous forward nominal term premium—which includes compensation for
inflation risk—moved up notably over the intermeeting period (lower left panel).
Nonetheless, the estimated term premium remains well below its historical average and is
nearly a percentage point below its level at the beginning of the current tightening cycle.
The recent rise in distant-horizon forward rates appears to be a global phenomenon, with
such rates posting substantial increases in other major industrialized countries (lower right
panel). The correlation between these foreign and domestic forward rates has been
particularly high over the last two years, suggesting that their movements owe predominantly
to international factors. However, over the intermeeting period, forward rates have risen
more in the United States than in foreign countries, and inflation compensation has moved
up more in U.S. markets than in other countries, perhaps in part as a result of the recent
depreciation of the dollar and concerns that more is in store.
The reasons for the apparent backup in U.S. term premiums of late are hard to ascertain, but
may include heightened inflation concerns, some waning of foreign demand for Treasury
securities that has been evident in recent auctions and in custody holdings at the Federal
Reserve Bank of New York, and investors’ reassessment of the appropriate pricing of
interest-rate risk.
Class I FOMC - Restricted Controlled (FR)
Page 5 of 41
Chart 2
Asset Market Developments
Stock Prices
Corporate Earnings Growth
Index(12/31/03=100)
Daily
FOMC
Wilshire
Nasdaq
130
Percent
Quarterly*
30
Q4
120
20
110
Q1e
10
0
100
-10
S&P 500 EPS
NIPA, economic
profits before tax
90
-30
80
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
1989
Apr.
2006
Implied Volatilities
1992
1995
1998
2001
2004
*Change from four quarters earlier.
Source. I/B/E/S for S&P 500 EPS.
e Staff estimate.
Equity Valuation
Percent
40
Daily
-20
Percent
12
Monthly
FOMC
S&P 500
Nasdaq
10
30
8
12-Month Forward
Trend E/P Ratio
20
+
6
4
+
10
2
Real Long-Term Treasury Yield*
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
1992
1996
Expected Defaults of Nonfinancial Companies
and Corporate Bond Default Rate
Corporate Bond Spreads*
Percent of liabilities
Basis points
Percent of outstandings
Monthly
280
6
1.5
2004
5
Basis points
Daily
FOMC
7
Expected Defaults* (left scale)
Bond Default Rate** (right scale)
2000
*Perpetuity Treasury yield minus Philadelphia Fed 10-year expected inflation.
Note. + Denotes the latest observation using daily interest rates and stock
prices and latest earnings data from I/B/E/S.
8
2.0
0
1988
Apr.
2006
Ten-Year BBB (left scale)
Five-Year High-Yield (right scale)
240
625
500
200
4
1.0
3
750
375
160
250
0.5
Mar
2
120
125
1
0.0
0
1999
2000
2001
2002
2003
2004
2005
*Firm-level estimates of year-ahead defaults from KMV corporation, weighted
by firm liabilities as a percent of total liabilities, excluding defaulted firms.
**Six-month moving average, from Moody’s Investors Service
80
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
*Measured relative to an estimated off-the-run Treasury yield curve.
Note: Vertical lines indicate March 27, 2006. Last daily observations are for May 4, 2006.
Class I FOMC - Restricted Controlled (FR)
Page 6 of 41
Chart 3
International Financial Indicators
Ten-Year Government Bond Yields (Nominal)
Nominal Trade-Weighted Dollar Indexes
Index(12/31/03=100)
Daily
Broad
Major Currencies
Other Important Trading Partners
112
6.0
Percent
Daily
UK (left scale)
Germany (left scale)
Japan (right scale)
110
5.5
2.5
108
106
5.0
2.0
104
102
3.0
4.5
1.5
100
4.0
98
96
1.0
3.5
94
0.5
3.0
92
90
Jan.
May Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
2.5
0.0
Jan.
Ten-year Government Bond Yields (Inflation Indexed)
May Aug.
2004
Dec.
Apr.
Daily
Dec.
Apr.
2006
Stock Price Indexes
Percent
3.00
Aug.
2005
Index(12/31/03=100)
Daily
175
170
2.75
165
2.50
160
2.25
155
150
2.00
145
140
1.75
135
1.50
130
UK (FTSE-350)
Euro Area (DJ Euro)
Japan (Topix)
1.25
125
120
1.00
UK
France
Japan
Canada*
115
0.75
110
0.50
105
100
0.25
95
90
0.00
Jan.
May Aug.
2004
* Fifteen-year yields.
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
Jan.
May Aug.
2004
Note: Vertical lines indicate March 27, 2006. Last daily observations are for May 4, 2006.
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
Class I FOMC - Restricted Controlled (FR)
Page 7 of 41
versus the Canadian dollar. The Canadian currency, and those of several other smaller
commodity exporters, appeared to be boosted by the sharply higher prices of oil and
some other key primary products. On April 25, the Bank of Canada raised its policy
rate 25 basis points and signaled that further policy tightening was likely. On May 3,
the Reserve Bank of Australia also raised its policy rate 25 basis points. Yields on
long-term government securities in major foreign industrial countries moved up 25 to
30 basis points on balance, somewhat less than increases in comparable U.S. yields
over the period. Based on returns on inflation-indexed securities, the advances in
nominal yields abroad appear to owe mostly to higher real yields. Stock prices in
foreign industrial countries recorded gains of 1 to 3 percent.
(5)
The dollar fell about 1¼ percent against an index of currencies of our other
important trading partners.
3
Upward pressure on Asian currencies
may have been accentuated by the G-7 statement calling for “greater exchange rate
flexibility…in emerging economies with large current account surpluses, especially
China.” Although Chinese authorities allowed only a slight appreciation of the yuan
over the period, they did announce some changes in foreign exchange regulations;
they also raised their benchmark lending rate 27 basis points and issued guidance on
lending to certain sectors intended to slow investment growth. Central banks in
Brazil and Mexico cut their policy rates again, but the Bank of Mexico added that it
saw no room for further easing for the foreseeable future. Both countries continued
to benefit from favorable financial conditions: EMBI+ spreads narrowed, and stock
3
Class I FOMC - Restricted Controlled (FR)
Page 8 of 41
prices recorded increases close to 10 percent. The Brazilian real strengthened
substantially, while the Mexican peso was about unchanged versus the dollar over the
period.
(6)
Domestic nonfinancial sector debt is estimated to have grown at a
9¼ percent annual rate in the first quarter, down only slightly from the brisk pace in
2005 (Chart 4). Business sector debt appears to have expanded at an 8¾ percent rate,
supported by robust net issuance of U.S. corporate bonds and a double-digit
expansion of business loans at commercial banks. Results from the latest Senior Loan
Officer Opinion Survey indicate that banks eased standards and terms for C&I loans
further. In the household sector, consumer credit has continued to expand slowly.
Although only limited data are currently available, growth of household mortgage
debt is projected to have moderated somewhat in the first quarter against a backdrop
of higher mortgage interest rates, some signs of a deceleration in house prices, and
reports in the Senior Loan Officer Opinion Survey indicating lower demand for
residential mortgage loans. Federal debt is estimated to have expanded at nearly a 13
percent rate in the first quarter, a pace roughly in line with first-quarter growth a year
earlier.
(7)
M2 advanced at a 6½ percent pace during the first quarter, somewhat below
the growth rate of nominal GDP, and expanded moderately in April. This recent
growth has been due importantly to increases in small time deposits, which have been
buoyed by favorable offering rates.
Class I FOMC - Restricted Controlled (FR)
Page 9 of 41
Chart 4
Debt and Money
Growth of Nonfinancial Debt
Percent
s.a.a.r.
Changes in Selected Components of
Nonfinancial Business Debt
16
50
Monthly rate
40
14
C&I Loans
Commercial Paper
Bonds
12
10
e
$Billions
30
Sum
20
8
10
6
2004
Q1
Q2
Q3
Q4
2005
4
0
2
-10
0
Q1
2006
-20
2004
Q1
Q2
Q3
Q4
Q1
2006
2005
e Estimated.
Note. Commercial paper and C&I loans are seasonally adjusted,
bonds are not.
Mortgage Rates
Growth of Household Debt
Percent
Percent
21
9
Weekly
Quarterly, s.a.a.r.
18
Consumer
Credit
8
15
30-year
FRM
12
Q1p
Q1p
Home
Mortgage
7
9
6
6
3
5
1-year
ARM
0
4
-3
1991
1993
1995
1997
1999
2001
2003
3
2005
1996
1998
Source. Freddie Mac.
p Projected.
2000
2002
2004
2006
M2 Velocity and Opportunity Cost
Growth of M2
Percent
s.a.a.r.
10
8.00
Percent
Velocity
2.3
Quarterly
8
Opportunity Cost*
(left axis)
4.00
2.2
Q1
6
4
2.1
2.00
2.0
2
0
1.00
Q1
Velocity
(right axis)
1.9
0.50
-2
1.8
0.25
-4
2004
H1
H2
2005
Q1
Apr.
2006
1993
1995
1997
1999
*Two-quarter moving average.
2001
2003
2005
2007
Class I FOMC - Restricted Controlled (FR)
Page 10 of 41
Economic Outlook
(8)
The sharp run-up in energy prices over the intermeeting period, together
with somewhat larger-than-expected increases in core consumer prices, led the staff to
boost its inflation outlook for the near term. News on output and spending also came
in above staff expectations, but little of this additional strength is expected to persist
in the forecast. In view of the intensification of inflation pressures, the staff forecast
now assumes that the Committee will leave the funds rate at 5 percent after this
meeting rather than easing slightly next year, as was the case in the March Greenbook.
In the current forecast, longer-term Treasury yields edge lower as market expectations
for monetary policy come into alignment with the staff assumption, equity prices rise
at a rate sufficient to produce risk-adjusted returns about equal to those on fixedincome instruments, and house price appreciation slows substantially. The real
foreign exchange value of the dollar against a broad basket of currencies is assumed to
decline at an average rate of a little over 2 percent over the forecast period. In line
with futures quotes, the staff forecasts that the price of West Texas intermediate
crude oil will be around $75 per barrel over the projection period, roughly $11 per
barrel higher than in the last forecast. Against this backdrop, the staff projects that
real GDP will expand 3¾ percent in 2006 and 3 percent in 2007, close to the March
Greenbook projection. With output growing a bit less quickly than potential next
year, the unemployment rate is expected to creep up to 5 percent, the staff’s estimate
of the NAIRU. Core PCE inflation is now expected to be 2¼ percent this year,
slightly above the March forecast, but to edge down to 2 percent next year as energy
prices flatten out. Total PCE prices are seen as rising about 2½ percent and 2 percent
in 2006 and 2007, respectively.
Class I FOMC - Restricted Controlled (FR)
Page 11 of 41
Longer-Run Scenarios
(9)
Simulations of the FRB/US model provide a longer-term perspective that
could help inform the Committee’s near-term policy choice. To that end, staff
extended the basic features of the Greenbook outlook through 2010. In that
extension, monetary policy adjusts to hold core PCE inflation at about 2 percent. In
the absence of any significant supply shocks or changes in expectations, the
unemployment rate remains near the 5 percent staff estimate of the NAIRU. The
associated medium-run value of the equilibrium real funds rate is about 2¾ percent,
which implies a modest step-down in the nominal funds rate to roughly 4¾ percent
after 2007. With this as the baseline, the model can be used to simulate the effects of
alternative assumptions for monetary policy over the next few years. In these
simulations, participants in financial markets—including those in the equity, bond,
and foreign exchange markets—are assumed to understand fully the forces shaping
the economic outlook, whereas households and firms are assumed to form their
expectations using more limited information.
(10)
To shed light on the implications of ending the process of policy firming,
the first simulation considers a policy trajectory in which the federal funds rate is held
constant at its current level through 2010 rather than being raised to 5 percent as in
the Greenbook. The policy path beyond 2010 is set using the aggressive Taylor rule
as described below in the explanatory notes for policy rules. As shown in the upper
left panel of Chart 5, the funds rate path in this alternative scenario (the dashed line) is
a bit lower than under the extended baseline (the solid line) over the next two years
and a bit higher thereafter. Under the assumption that this policy path is fully
anticipated by financial market participants, the alternative scenario produces a slightly
lower trajectory for longer-term real interest rates over the next two years relative to
the baseline. This in turn generates a modestly lower path for the unemployment rate
Class I FOMC - Restricted Controlled (FR)
Page 12 of 41
Chart 5
Ending the Policy Firming Process
Federal Funds Rate
Five-Year Real Interest Rate
Percent
5.25
Percent
3.75
5.00
3.25
4.75
2.75
Baseline
Lower near-term funds rate
2006
2007
2008
2009
2010
4.50
4.25
2006
2007
2008
2009
2010
2.25
Civilian Unemployment Rate
Percent
5.25
5.00
4.75
2006
2007
2008
2009
2010
4.50
Core PCE Inflation
Four-quarter average
Percent
2.50
2.25
2.00
2006
2007
2008
2009
2010
1.75
Class I FOMC - Restricted Controlled (FR)
Page 13 of 41
during 2007 and 2008 and slightly higher core inflation through the remainder of the
decade.
(11)
Because policy paths that merely hold inflation around its current rate might
not be viewed as acceptable by the Committee, the next set of simulations examines
policies that would generate a more rapid decline in core inflation toward an inflation
objective of 1½ percent. In these simulations, the funds rate reaches 5¾ percent later
this year and remains at that rate through at least mid-2008 (Chart 6). Two different
scenarios illustrate the role of inflation expectations in determining the
macroeconomic effects of the additional policy tightening. In one, long-term inflation
expectations respond only sluggishly to inflation outcomes (the dashed lines); in the
other, expectations are assumed to converge to the 1½ percent target by late 2008, as
might be the case if the public became convinced that the Committee had that
inflation goal (the dotted lines). In the first scenario, making significant progress in
reducing inflation involves holding the funds rate at 5¾ percent through the end of
2008 and then cutting it to 4¼ percent over the course of 2009. Under these
conditions, the unemployment rate rises steadily to about 5½ percent over the next
two years and does not start to return to the NAIRU until late in the decade; this slack
helps generate a slow decline in core inflation. In the second scenario, the more rapid
adjustment of long-run inflation expectations brings about a more rapid decline in
actual inflation with less slack in economic activity. As a result, policymakers can
begin cutting the funds rate noticeably earlier, and because investors fully anticipate
the timing of the future policy easing, nominal and real yields on longer-term bonds
rise somewhat less than in the first scenario.
Class I FOMC - Restricted Controlled (FR)
Page 14 of 41
Chart 6
Policy Tightening and the Evolution of Inflation Expectations
Federal Funds Rate
Five-Year Real Interest Rate
Percent
6.0
Percent
4.0
5.5
3.5
5.0
3.0
4.5
2.5
Baseline
Sluggish adjustment of inflation expectations
Rapid adjustment of inflation expectations
2006
2007
2008
2009
4.0
2010
3.5
2006
2007
2008
2009
2010
2.0
Civilian Unemployment Rate
Percent
6.0
5.5
5.0
2006
2007
2008
2009
2010
4.5
Core PCE Inflation
Four-quarter average
Percent
2.5
2.0
1.5
2006
2007
2008
2009
2010
1.0
Class I FOMC - Restricted Controlled (FR)
Page 15 of 41
Short-Run Policy Alternatives
(12)
This Bluebook presents three alternatives for the Committee’s
consideration, summarized by the draft statements in Table 1. Under Alternative A,
the Committee leaves the federal funds rate unchanged at this meeting. It also
indicates a best guess that, if any adjustment to the stance of policy subsequently
proved necessary, it likely would be upward. Under Alternative B, the target for the
federal funds rate is raised another 25 basis points at this meeting, and the risk
assessment suggests that the Committee may pause in June. Under Alternative C, the
target for the funds rate is raised 50 basis points and the risks are described as
balanced without mention of additional policy action. All three alternatives provide a
fuller description of the rationale for policy action and some forward-looking
language about the economic outlook.
(13)
If the Committee believes that the outcome projected by the staff in the
Greenbook forecast is both likely and best balances the Federal Reserve’s dual
objectives, then it may wish to couple another 25 basis point firming at this meeting
with a risk assessment that hints that the tightening cycle may be coming to a close, as
in Alternative B. A quarter-point move at this meeting would bring the cumulative
tightening since June 2004 to 4 percentage points. While a portion of that rise has
been offset by higher inflation, real short-term interest rates have been boosted
appreciably as well, from below zero to around 2¾ percent as measured using trailing
core PCE inflation as a proxy for expected inflation. The real federal funds rate has
been lifted to around the middle of the range of model-based estimates of its shortrun equilibrium (Chart 7) and to a level about equal to the equilibrium rate implicit in
the Greenbook projection. Members may also view the recent backup in longer-term
rates as augmenting the financial restraint imposed by higher short-term interest rates.
Indeed, under the staff forecast, the maintenance of the nominal funds rate at
5 percent through 2007 would foster financial conditions that would slow output
Class I FOMC - Restricted Controlled (FR)
Page 16 of 41
Table 1: Alternative Language for the May FOMC Announcement
Policy
Decision
Rationale
March FOMC
Alternative A
1. The Federal Open Market
Committee decided today to raise
its target for the federal funds
rate by 25 basis points to
4-3/4 percent.
2. The slowing of the growth of
real GDP in the fourth quarter of
2005 seems largely to have
reflected temporary or special
factors. Economic growth has
rebounded strongly in the current
quarter but appears likely to
moderate to a more sustainable
pace.
3. As yet, the run-up in the prices
of energy and other commodities
appears to have had only a
modest effect on core inflation,
ongoing productivity gains have
helped to hold the growth of unit
labor costs in check, and inflation
expectations remain contained.
Still, possible increases in
resource utilization, in
combination with the elevated
prices of energy and other
commodities, have the potential
to add to inflation pressures.
4. The Committee judges that
some further policy firming may
be needed to keep the risks to
the attainment of both
sustainable economic growth and
price stability roughly in balance.
The Federal Open Market Committee
decided today to keep its target for the federal
funds rate unchanged at 4-3/4 percent.
The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 25 basis points to
5 percent.
The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 50 basis points to
5-1/4 percent.
Economic growth rebounded to nearly a
5 percent annual rate in the first quarter. The
Committee sees growth as likely to moderate
to a sustainable pace, partly reflecting a
gradual cooling of the housing market, other
lagged responses to previous rate increases,
and the effects of energy price increases.
Economic growth rebounded to nearly a
5 percent annual rate in the first quarter.
The Committee sees growth as likely to
moderate toward a more sustainable
pace, partly reflecting a gradual cooling
of the housing market, other lagged
responses to previous rate increases, and
the effects of energy price increases.
Economic growth rebounded to nearly
a 5 percent annual rate in the first
quarter. The Committee sees growth as
likely to moderate somewhat in coming
quarters, though data confirming a
slowing in growth have been sparse.
As yet, the run-up in the prices of energy and
other commodities appears to have had only
a modest effect on core inflation, ongoing
productivity gains have helped to hold the
growth of unit labor costs in check, and
inflation expectations remain contained. The
Committee expects core inflation to remain
well contained. Still, possible increases in
resource utilization, in combination with the
elevated prices of energy and other
commodities, have the potential to add to
inflation pressures.
As yet, the run-up in the prices of energy
and other commodities appears to have
had only a modest effect on core
inflation, and ongoing productivity gains
have helped to hold the growth of unit
labor costs in check. The Committee
expects core inflation to remain
contained. However, the recent climb in
energy and other commodity prices, an
apparent slight rise in inflation
expectations, and possible increases in
resource utilization have the potential to
add to inflation pressures.
As yet, the run-up in the prices of
energy and other commodities appears
to have had only a modest effect on
core inflation, and ongoing productivity
gains have helped to hold the growth of
unit labor costs in check. However, the
recent climb in energy and other
commodity prices, an apparent rise in
inflation expectations, and possible
increases in resource utilization have the
potential to add to inflation pressures.
Against this backdrop, the Committee
preferred to await additional information
about economic developments before taking
any further action. The Committee sees the
risks to its price stability objective as slightly
to the upside and judges it more likely that its
next policy action will be a tightening rather
than an easing.
The Committee judges that, with this
action, the risks to the attainment of
both sustainable economic growth and
price stability are roughly in balance.
5. In any event, the Committee
will respond to changes in
economic prospects as needed to
foster these objectives.
In any event, the Committee will respond to
changes in the economic outlook, as implied
by incoming information, as needed to foster
its objectives of sustainable economic growth
and price stability.
To keep the risks to the attainment of
both sustainable economic growth and
price stability roughly in balance, some
further policy firming may be needed.
The Committee judges that any
additional firming is likely to be modest.
However, the extent and timing of any
such firming will depend importantly on
the evolution of the economic outlook as
implied by incoming information.
In any event, the Committee will
respond to changes in economic
prospects as needed to support the
attainment of its objectives.
Assessment
of Risk
Alternative B
Alternative C
[Unchanged.]
Class I FOMC - Restricted Controlled (FR)
Page 17 of 41
Chart 7
Equilibrium Real Federal Funds Rate
Short-Run Estimates with Confidence Intervals
Percent
8
Actual real federal funds rate
Range of model-based estimates
70 percent confidence interval
90 percent confidence interval
Greenbook-consistent measure
7
6
5
4
50 b.p. Tightening
25 b.p. Tightening
Current Rate
3
2
1
0
-1
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Short-Run and Medium-Run Measures
Current Estimate
Previous Bluebook
2.2
2.6
3.8
2.1
2.5
3.7
Short-Run Measures
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
Greenbook-consistent measure
(1.2 - 4.4(
(0.3 - 5.4(
2.8
2.8
2.2
2.4
2.1
2.5
Medium-Run Measures
Single-equation model
Small structural model
Confidence intervals for two model-based estimates
70 percent confidence interval
90 percent confidence interval
TIPS-based factor model
(1.4 - 3.2(
(0.7 - 3.8(
2.2
2.1
2.70
2.74
Memo
Actual real federal funds rate
Notes: Confidence intervals reflect uncertainties about model specification, coefficients, and the level of potential output.
The final column indicates the values for the current quarter based on the estimation for the previous Bluebook, except
that the TIPS-consistent measure and the actual real funds rate are the values published in the previous Bluebook.
-2
Class I FOMC - Restricted Controlled (FR)
Page 18 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. For the first three measures listed below, the short-run equilibrium rate is defined as the
rate that would close the output gap in twelve quarters given the corresponding model’s projection of the
economy. For the first two measures, the medium-run concept is the value of the real federal 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 keeps them equal thereafter. The TIPS-based factor model
measure provides an estimate of market expectations for the real federal funds rate seven years ahead. The actual
real federal funds rate is constructed as the difference between the nominal rate and realized inflation, where the
nominal rate is measured as the quarterly average of the observed federal funds rate, and realized inflation is
given by the log difference between the staff’s estimate of the core PCE price index and its lagged value four
quarters earlier. For the current quarter, the nominal rate is specified as the target federal funds rate on the
Bluebook publication date.
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 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
Model
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-based
Factor Model
Yields on TIPS (Treasury Inflation-Protected Securities) reflect investors’ expectations of
the future path of real interest rates, but also include term and liquidity premiums. The
TIPS-based measure of the equilibrium real rate is constructed using the seven-year-ahead
instantaneous real forward rate derived from TIPS yields as of the Bluebook publication
date. This forward rate is adjusted to remove estimates of the term and liquidity
premiums based on a three-factor arbitrage-free term-structure model applied to TIPS
yields, nominal yields, and inflation. Because TIPS indexation is based on the total CPI,
this measure is also adjusted for the medium-term difference—projected at 40 basis
points—between total CPI inflation and core PCE inflation.
Class I FOMC - Restricted Controlled (FR)
Page 19 of 41
growth to a pace a little below that of its potential, slightly easing pressures on
resources and promoting a modest downward tilt in core inflation to rates below
2 percent late in the forecast period and beyond. Even if the Committee is not
convinced that output growth would slow to this extent if the funds rate were
maintained at 5 percent, it might nonetheless believe that the stance of policy is not
far from neutral. If so, a pause in policy firming before long would be unlikely to
jeopardize the Committee’s price stability objective and might be appropriate to allow
a better assessment at a later date of the cumulative effects of its policy actions.
(14)
Under Alternative B, the rationale paragraph could indicate that spending is
likely to slow because of a cooling of the housing market and the restraint imparted by
increases in energy prices and interest rates. The Committee could repeat its analysis
in the March statement of recent factors affecting inflation, but then acknowledge that
a slight rise in inflation expectations could also add to inflation pressures. To treat its
dual objectives symmetrically, row 3 includes the Committee’s expectation that core
inflation will remain contained, just as there is forward-looking language on economic
growth in the previous row. In view of the additional quarter-point firming that
would be implemented under this alternative, the risk assessment might be softened a
little relative to that released after the last meeting by adding “The Committee judges
that any additional firming is likely to be modest” and adopting some of the language
of the Chairman’s recent testimony: “the extent and timing of any such firming will
depend importantly on the evolution of the economic outlook as implied by incoming
information.” Inclusion of the reference to “timing” is intended to suggest that
additional firming would not necessarily take place at the June meeting. If the
Committee saw only a small probability that it would act again in June, it could tune
the message by replacing the second sentence of row 4 with “The Committee judges
that additional firming, if any, is likely to be modest.” In either case, the dependency
Class I FOMC - Restricted Controlled (FR)
Page 20 of 41
of future policy actions on data could be underscored by essentially reiterating the
final sentence from the March announcement.
(15)
Investors seem sure of a 25 basis point hike in the federal funds rate at this
meeting and see only about a one-in-three chance of a similar move in June. The
statement accompanying Alternative B would likely maintain or slightly increase these
odds. Market interest rates could back up a few basis points, and downward pressure
on the dollar might be reduced a bit, at least for a time, and equity prices could
decline.
(16)
The sizable rise over the intermeeting period in long-term nominal interest
rates (which apparently included a significant pickup in compensation for expected
inflation), the weakening of the exchange value of the dollar, and the rise in some
survey measures of inflation expectations could be read by members as evidence of an
erosion in the public’s confidence in the Committee’s commitment to price stability.
If so, the combination of a half-point action at this meeting and the words presented
in Alternative C might be appealing. With energy prices having risen sharply further
in recent weeks, the Committee could be concerned that elevated energy and
commodity prices and relatively high levels of resource utilization may begin to leave a
more distinct imprint on core inflation and inflation expectations. Moreover,
members may believe that core inflation currently is already at or above the upper end
of an acceptable range, inclining them to foster a steeper downward trajectory in
inflation than that forecast in the Greenbook. In that regard, the alternative
simulation provided earlier suggests that the nominal federal funds rate would need to
reach 5¾ percent by year-end to foster a 1½ percent inflation goal over the next few
years.
(17)
The rationale portion of the policy statement associated with Alternative C
could temper the expectation of a moderation in growth with the observation that
“data confirming a slowing in growth have been sparse.” As in March, the inflation
Class I FOMC - Restricted Controlled (FR)
Page 21 of 41
paragraph could cite limited energy-price pass-through and productivity gains as
having helped to hold inflation in check, but would not indicate that the Committee
expected core inflation to remain contained. Reasserting that “inflation expectations
are contained” might be problematic, and, as in Alternative B, rising inflation
expectations could be cited as a factor that could add to inflation pressures. In light
of the size of the policy move, the Committee might want to declare that the risks to
its dual objectives are balanced.
(18)
The policy action and statement associated with Alternative C would catch
market participants unawares. Real bond yields could jump up noticeably; the rise in
nominal yields would be somewhat less if inflation expectations declined—but that
would depend on the extent to which investors took the action as an assertion of the
Committee’s anti-inflation resolve. The recent tendency toward weakness in the
foreign exchange value of the dollar would likely be checked, and stock prices would
decline. Given the size of the policy surprise, volatility, both actual and implied, could
rise.
(19)
The likely reaction in financial markets, which could be sizable, to a 50 basis
point increase in the target for the federal funds rate might diminish the appeal of
Alternative C for the Committee. But some of the rationale language of this
alternative could be used to stiffen the policy statement announcing a quarter-point
increase and thus make it more likely that financial markets would build in high odds
of a like-sized action in June. For instance, the Committee could combine the
rationale paragraphs of Alternative C with the risk assessment of Alternative B. To
make it more likely that market participants price in an additional move, the
Committee could strike the sentence characterizing additional firming as likely to be
“modest” in row 4 of Alternative B. This might be favored if the Committee was
impressed by the resilience of aggregate demand in the face of the substantial increase
in energy prices and concerned that the momentum of spending could push the level
Class I FOMC - Restricted Controlled (FR)
Page 22 of 41
of output well above the economy’s potential. Indeed, if the Committee harbored a
suspicion that economic slack had already been more than eliminated, it might see
increased inflation pressures as a palpable risk. In that vein, members might read the
most recent figures on new and existing home sales as suggesting that the housing
market, while off its peak, is not cooling quickly enough to provide much assurance
that overall economic growth is in the process of slowing to potential. In that regard,
the “domestic boom” alternative simulation in the Greenbook, which puts the funds
rate at 6¼ percent by year-end 2007, may strike some members as an uncomfortably
plausible outcome.
(20)
In contrast, the Committee may believe that further policy tightening at this
meeting is not necessary or desirable and that, at least for now, maintaining the
current stance of policy is appropriate, as in Alternative A. As noted previously, the
cumulative firming of policy to date has been significant, and the real federal funds
rate is now well within the range of model-based estimates of its equilibrium value. In
these circumstances, the Committee may wish to pause to obtain more information
that would be useful in assessing whether further action will be necessary. Put
differently, policy accommodation now appears to have been eliminated, and, with
core inflation remaining contained—and perhaps believed likely to edge lower over
time—despite sharp increases in energy and commodity prices, the Committee may
not feel a need to move from a roughly neutral posture to a restrictive stance. That is
the message of the simulation presented earlier: If the equilibrium real rate is in the
neighborhood of 2¾ percent, a 2 percent inflation goal could be achieved by holding
the nominal funds rate at 4¾ percent. Indeed, estimated monetary policy rules imply
that the existing stance of policy is about appropriate or even a little firmer than
would be predicted by past Committee behavior (Chart 8). Model simulations using a
number of simple policy rules also suggest that further tightening may not be required
at this time (Chart 9). And even if members believe that further tightening could
Class I FOMC - Restricted Controlled (FR)
Page 23 of 41
Chart 8
Information from Estimated Policy Rules and Financial Markets
Estimated Policy Rules
Actual and Greenbook assumption
Outcome-based rule
70 percent confidence interval
90 percent confidence interval
Forecast-based rule
2006
Market Expectations
Percent
8
2007
Actual and Greenbook assumption
Market-based expectations
70 percent confidence interval
90 percent confidence interval
7
6
5
5
4
4
3
3
2
2006
2007
2007
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Outcome-based policy rule
70 percent confidence interval
Lower bound
Upper bound
90 percent confidence interval
Lower bound
Upper bound
4.8
4.9
4.9
4.8
4.7
4.6
4.5
4.7
4.9
4.5
5.2
4.3
5.5
4.0
5.7
3.7
5.7
3.5
5.8
3.3
5.9
4.6
4.9
4.3
5.4
3.9
5.8
3.5
6.1
3.0
6.3
2.7
6.5
2.4
6.6
Forecast-based policy rule
4.8
4.9
4.8
4.7
4.6
4.5
4.5
4.9
5.1
5.2
5.2
5.1
5.0
5.0
4.9
5.0
5.0
5.2
4.9
5.5
4.7
5.6
4.5
5.7
4.4
5.7
4.2
5.8
4.9
5.0
5.0
5.3
4.7
5.7
4.5
5.9
4.2
6.0
4.0
6.2
3.8
6.3
4.9
5.0
5.0
5.0
5.0
5.0
5.0
Estimated Policy Rules
Market Expectations
Memo
Greenbook assumption
7
6
2006
Expected funds rate path
70 percent confidence interval
Lower bound
Upper bound
90 percent confidence interval
Lower bound
Upper bound
Percent
8
2
Class I FOMC - Restricted Controlled (FR)
Page 24 of 41
Chart 9
Policy Paths under Alternative Inflation Objectives
1½ Percent Inflation Objective
Actual and Greenbook assumption
Baseline Taylor rule
Aggressive Taylor rule
First-difference rule
2006
2 Percent Inflation Objective
Percent
8
2007
Actual and Greenbook assumption
Baseline Taylor rule
Aggressive Taylor rule
First-difference rule
7
6
5
5
4
4
3
3
2
2006
2007
2007
Q2
Q3
Q4
Q1
Q2
Q3
Q4
4.6
4.5
4.7
4.5
4.7
4.5
4.7
4.5
4.5
4.4
4.5
4.3
4.4
4.3
4.7
4.5
4.8
4.6
4.7
4.5
4.7
4.6
4.5
4.4
4.5
4.4
4.5
4.4
4.8
4.7
5.1
4.8
5.3
4.8
5.4
4.8
5.5
4.9
5.6
4.9
5.7
4.9
4.9
5.0
5.0
5.0
5.0
5.0
5.0
Simple Policy Rules
Memo
Greenbook assumption
7
6
2006
Baseline Taylor rule
1½ percent inflation objective
2 percent inflation objective
Aggressive Taylor rule
1½ percent inflation objective
2 percent inflation objective
First-difference rule
1½ percent inflation objective
2 percent inflation objective
Percent
8
2
Class I FOMC - Restricted Controlled (FR)
Page 25 of 41
Policy Rule Charts: Explanatory Notes
For the rules described below, it denotes the federal funds rate for quarter t, while the explanatory
variables include the staff’s estimate of trailing four-quarter core PCE inflation (πt), its forecasts
of inflation two and three quarters ahead (πt+2|t and πt+3|t), its assessment of the current output gap
( yt − yt* ), its one-quarter-ahead forecast of the output gap ( yt +1|t − yt*+1|t ), its three-quarter-ahead
forecast of annual average GDP growth relative to potential ( Δ 4 yt +3|t − Δ 4 yt*+3|t ), and the assumed value
of policymakers’ long-run inflation objective ( π * ).
Rule prescriptions are computed using dynamic simulations of the FRB/US model, implemented as
though the rule is followed starting at this FOMC meeting. This quarter’s prescription is a weighted
average of the actual value of the federal funds rate thus far this quarter and the value obtained from the
FRB/US model simulations using the timing of this meeting within the quarter to determine the weights.
Finally, for the forecast-based rule and the first-difference rule, it should be noted that prescriptions near
the end of the Greenbook horizon also depend on an extension of the Greenbook baseline forecast.
Estimated Policy Rules: Estimation is performed using real-time quarterly data taken from the
Greenbook and staff memoranda closest to the middle of each quarter. The specific lag structure of the
outcome-based rule is chosen according to the Bayesian information criterion over the sample period
starting from 1988Q1. The forecast-based rule differs from the outcome-based rule in that it also
permits staff forecasts of inflation and the output gap to be among the explanatory variables.
Confidence intervals, shown only for the outcome-based rule, are based on stochastic simulations of the
FRB/US model, where the shocks are randomly drawn from the set of model equations residuals for the
period 1986-2004. The following table indicates the specification of each rule and its root mean squared
error (RMSE) over the sample 1993:1-2005:4.
Outcome-based Rule
it = 0.27 + 1.14it-1 – 0.36it-2 + 0.32πt
.19
+ 0.60( yt − yt* ) – 0.40( yt −1 − yt*−1 )
Forecast-based Rule
it = 0.24 + 1.14it-1 – 0.35it-2 + 0.31πt+2|t
.18
+ 0.42( yt +1|t − yt*+1|t ) – 0.23( yt −1 − yt*−1 )
Market Expectations: The expected funds rate path is based on quotes from fed funds and Eurodollar
futures, and the confidence intervals are obtained from options on those futures.
Simple Policy Rules: The following table indicates the specification of each rule and its RMSE over
the sample 1993:1-2005:4 for two inflation objectives.
π*=1.5
π*=2
Baseline Taylor Rule
it = 2 + πt + 0.5(πt – π * ) + 0.5( yt − yt* )
.99
.99
Aggressive Taylor Rule
it = 2 + πt + 0.5(πt – π * ) + ( yt − yt* )
.62
.63
First-difference Rule
it = it-1 + 0.5(πt+3|t – π * ) + 0.5( Δ 4 yt +3|t − Δ 4 yt*+3|t )
.51
.44
Class I FOMC - Restricted Controlled (FR)
Page 26 of 41
eventually prove necessary to address upside risks to inflation, they may see no
urgency to implement such restraint. Such an assessment might be importantly
influenced by members’ regional knowledge of the housing situation. With national
data, particularly survey information, pointing to some cooling, the Committee may
put some weight on the “housing slump” alternative simulation in the Greenbook,
which suggests that if significant confidence effects accompany a drop in housing
values, then considerably easier monetary policy would be warranted.
(21)
The rationale section of the Committee’s statement associated with
Alternative A could begin like that in Alternative B but soften the characterization of
the outlook for growth to “likely to moderate to a sustainable pace.” It could use
essentially the same paragraph discussing inflation as that for Alternative B, but retain
the assertion that “inflation expectations remain contained” and emphasize the
expectation that core inflation will remain “well contained.” The risk assessment
might be revised considerably from that employed at recent meetings. In particular, it
could indicate that “Against this backdrop, the Committee preferred to await
additional information about economic developments before taking any further
action. The Committee sees the risks to its price stability objective as slightly to the
upside and judges it more likely that its next policy action will be a tightening rather
than an easing.” To accommodate those changes, the final sentence of the risk
assessment might be modified slightly to read “In any event, the Committee will
respond to changes in the economic outlook, as implied by incoming information, as
needed to foster its objectives of sustainable economic growth and price stability.”
(22)
Both the absence of policy action and the statement associated with
Alternative A would come as a considerable surprise to market participants. Shortterm market rates would probably drop by about 25 basis points as market
participants removed all but a small probability of near-term policy firming. The
effect on bond yields would depend in part on whether inflation expectations were
Class I FOMC - Restricted Controlled (FR)
Page 27 of 41
adversely affected by the lack of tightening at this meeting and the suggestion that
policy could be on hold for some time. If inflation expectations were unperturbed,
bond yields most likely would decline, stock markets rally, and the foreign exchange
value of the dollar weaken.
Money and Debt Forecasts
(23)
Under the Greenbook forecast, M2 growth is projected to expand 5 percent
this year, restrained by a further increase in the opportunity cost of holding M2. As a
result, M2 velocity would rise about 1½ percent, after increases of 1½ and 2½ percent
in 2004 and 2005, respectively. Next year, M2 growth is forecast at 5½ percent, in
line with the expansion in nominal GDP, as opportunity costs are expected to be
about unchanged on balance following the leveling off of short-term market interest
rates.
(24)
Domestic nonfinancial sector debt growth is expected to slow to
7¼ percent this year from last year’s 9½ percent increase. Household debt growth is
likely to fall off fairly sharply, reflecting a deceleration in mortgage debt, but at
8 percent is nonetheless projected to remain relatively brisk. Business sector debt is
seen as expanding 7½ percent, only a little lower than last year’s pace, with the
proceeds of a considerable portion of the borrowing slated to finance equity
retirement. Despite the widening of the federal budget deficit, federal debt growth
slows to 6¾ percent in 2006. Next year, overall debt growth is projected to drop
further, reflecting a noticeable slowdown in the nonfederal components.
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Page 28 of 41
Table 2
Alternative Growth Rates for M2
(percent, annual rate)
No Change
Raise 25 bp/
Greenbook*
Raise 50 bp**
Monthly Growth Rates
Jan-06
Feb-06
Mar-06
Apr-06
May-06
Jun-06
Jul-06
Aug-06
Sep-06
11.2
4.1
3.1
4.4
3.9
6.3
5.8
6.0
6.0
11.2
4.1
3.1
4.4
3.5
5.4
4.6
4.5
4.5
11.2
4.1
3.1
4.4
3.2
4.5
3.4
3.0
3.0
Quarterly Growth Rates
2005 Q2
2005 Q3
2005 Q4
2006 Q1
2006 Q2
2006 Q3
2.5
4.4
5.1
6.6
4.2
5.8
2.5
4.4
5.1
6.6
4.0
4.6
2.5
4.4
5.1
6.6
3.8
3.5
Annual Growth Rates
2004
2005
2006
2007
5.2
3.9
5.7
5.7
5.2
3.9
5.0
5.5
5.2
3.9
4.3
5.3
5.7
4.5
3.4
Growth From
Apr-06
To
Sep-06
* Increase of 25 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.
** Increase of 50 basis points in the target federal funds rate at this meeting and no change
thereafter.
Class I FOMC - Restricted Controlled (FR)
Page 29 of 41
Directive and Balance of Risks Statement
(25)
Draft language for the directive and draft risk assessments identical to those
presented in Table 1 are provided below.
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 ____________ 4¾percent.
Risk Assessments
A. Against this backdrop, the Committee preferred to await additional
information about economic developments before taking any
further action. The Committee sees the risks to its price stability
objective as slightly to the upside and judges it more likely that its
next policy action will be a tightening rather than an easing. In any
event, the Committee will respond to changes in the economic
outlook, as implied by incoming information, as needed to foster its
objectives of sustainable economic growth and price stability.
B. To keep the risks to the attainment of both sustainable economic
growth and price stability roughly in balance, some further policy
firming may be needed. The Committee judges that any additional
firming is likely to be modest. However, the extent and timing of
any such firming will depend importantly on the evolution of the
economic outlook as implied by incoming information. In any
Class I FOMC - Restricted Controlled (FR)
Page 30 of 41
event, the Committee will respond to changes in economic
prospects as needed to support the attainment of its objectives.
C. The Committee judges that, with this action, the risks to the attainment
of both sustainable economic growth and price stability are roughly in
balance. In any event, the Committee will respond to changes in
economic prospects as needed to foster these objectives.
Class I FOMC - Restricted Controlled (FR)
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
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
+ Denotes most recent weekly value.
Note. Blue shaded regions denote NBER−dated recessions.
Treasury Yield Curve*
Percent
6.5
May 4, 2006
March 27, 2006
6.0
5.5
5.0
4.5
4.0
3.5
3.0
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.
Class I FOMC - Restricted Controlled (FR)
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
2003
80
2006
+ Denotes most recent weekly value.
Ratio Scale
March 1973=100
Real
140
Monthly
130
120
Other Important
110
100
Broad
Major
Currencies
90
80
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
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.
Class I FOMC - Restricted Controlled (FR)
Page 33 of 41
Appendix Chart 3
Stock Indexes
Nominal
Ratio Scale
1941−43=10
Ratio
45
2000
Monthly
+
40
S&P 500
1500
1000
35
30
500
25
P/E Ratio*
20
+
15
10
5
0
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
* 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
1964
1968
1972
1976
1980
* Deflated by the CPI.
+ Denotes most recent weekly value.
Note. Blue shaded regions denote NBER−dated recessions.
1984
1988
1992
1996
2000
2004
Class I FOMC - Restricted Controlled (FR)
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
2003
+ Denotes most recent weekly Treasury constant maturity yield less most recent inflation expectation.
Note. Blue shaded regions denote NBER−dated recessions.
2005
Class I FOMC - Restricted Controlled (FR)
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
+
+
2
Real rate using
Michigan Survey
+
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
Real rate using
Philadelphia Fed Survey
8
+
+
Real rate using
Michigan Survey
6
4
+
2
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.
Class I FOMC - Restricted Controlled (FR)
Page 36 of 41
Appendix Chart 6
Commodity Price Measures
Journal of Commerce Index
Ratio scale, index (1980=100)
180
Weekly
160
140
120
Metals
100
Total
80
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
CRB Spot Industrials
Ratio scale, index (1967=100)
450
Weekly
400
350
300
250
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
CRB Futures
Ratio scale, index (1967=100)
400
Weekly
350
300
250
200
1985
1987
1989
1991
1993
1995
Note. Blue shaded regions denote NBER−dated recessions.
1997
1999
2001
2003
2005
Class I FOMC - Restricted Controlled (FR)
Page 37 of 41
Appendix Chart 7
Growth of M2
Nominal M2
Percent
14
Quarterly
12
10
8
6
4
2
0
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
Real M2
Percent
10
Quarterly
5
0
−5
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
Note. Four−quarter moving average. Blue shaded regions denote NBER−dated recessions. Gray areas denote
projection period. Real M2 is deflated by CPI.
2008
Class I FOMC - Restricted Controlled (FR)
Page 38 of 41
Appendix Chart 8
Inflation Indicator Based on M2
Price Level
Ratio Scale
140
Quarterly
120
100
Implicit GDP
price deflator (P)
80
Long-run equilibrium
price level (P*)
60
40
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
Inflation 1
2007
Percent
12
Quarterly
10
8
6
4
2
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
1. Change in the implicit GDP price deflator over the previous four quarters.
Note: P* is defined to equal M2 times V* divided by potential GDP. V*, or long-run velocity, is estimated
using average velocity over the 1959:Q1-to-1989:Q4 period and then, after a break, over the interval from
1993:Q1 to the present. For the forecast period, P* is based on the staff M2 forecast and P is simulated using a
short-run dynamic model relating P to P*. Blue areas indicate periods in which P* is notably less than P.
Gray areas denote the projection period.
Class I FOMC - Restricted Controlled (FR)
Page 39 of 41
Appendix Table 1
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
05 -- High
-- Low
4.30
2.19
4.01
1.86
4.08
2.31
4.37
2.63
4.49
2.50
4.30
2.24
4.52
3.11
4.59
3.58
4.79
3.97
5.04
4.28
2.11
0.98
2.22
1.50
6.48
5.64
5.24
4.72
6.37
5.53
5.22
4.10
06 -- High
-- Low
Monthly
May 05
Jun 05
Jul
05
Aug 05
Sep 05
Oct 05
Nov 05
Dec 05
5.00
4.22
4.71
3.91
4.82
4.17
5.01
4.37
5.12
4.50
4.95
4.22
5.02
4.34
5.02
4.28
5.23
4.42
5.40
4.59
2.35
1.82
2.49
1.94
6.77
6.17
5.24
4.22
6.59
6.10
5.68
5.15
3.00
3.04
3.26
3.50
3.62
3.78
4.00
4.16
2.62
2.82
3.09
3.33
3.21
3.49
3.91
3.67
2.90
3.03
3.29
3.52
3.50
3.79
3.97
3.98
3.17
3.22
3.53
3.78
3.80
4.13
4.30
4.33
3.22
3.38
3.57
3.77
3.87
4.13
4.31
4.45
2.97
3.11
3.27
3.47
3.64
3.84
4.01
4.23
3.65
3.65
3.90
4.06
3.96
4.31
4.44
4.43
3.84
3.76
3.98
4.12
4.01
4.34
4.46
4.39
4.22
4.07
4.25
4.34
4.28
4.56
4.66
4.57
4.59
4.38
4.50
4.56
4.55
4.77
4.85
4.76
1.25
1.37
1.64
1.69
1.40
1.69
1.96
2.07
1.65
1.67
1.88
1.89
1.70
1.94
2.09
2.15
6.01
5.86
5.95
5.96
6.03
6.30
6.39
6.32
4.83
4.77
4.85
4.90
4.94
5.13
5.22
5.18
5.72
5.58
5.70
5.82
5.77
6.07
6.33
6.27
4.23
4.24
4.40
4.55
4.51
4.86
5.14
5.17
Jan
Feb
Mar
Apr
Weekly
Mar
Mar
Mar
Mar
Mar
Apr
Apr
Apr
Apr
May
Daily
Apr
Apr
Apr
Apr
Apr
Apr
Apr
Apr
Apr
May
May
May
May
4.29
4.49
4.59
4.79
4.10
4.38
4.55
4.60
4.34
4.54
4.63
4.72
4.47
4.69
4.79
4.90
4.56
4.72
4.88
5.03
4.36
4.47
4.61
4.80
4.42
4.69
4.77
4.92
4.35
4.60
4.72
4.90
4.50
4.66
4.82
5.07
4.67
4.75
4.93
5.24
1.92
1.97
2.08
2.25
2.03
2.06
2.21
2.41
6.24
6.27
6.41
6.68
5.11
5.12
5.10
4.94
6.15
6.25
6.32
6.51
5.17
5.34
5.42
5.62
06
06
06
06
3
10
17
24
31
7
14
21
28
5
06
06
06
06
06
06
06
06
06
06
4.50
4.51
4.52
4.60
4.76
4.84
4.78
4.75
4.77
--
4.45
4.44
4.48
4.64
4.68
4.64
4.61
4.55
4.62
4.62
4.62
4.60
4.61
4.67
4.63
4.68
4.70
4.73
4.78
4.81
4.75
4.77
4.80
4.80
4.82
4.85
4.91
4.91
4.94
4.99
4.80
4.84
4.89
4.91
4.94
4.98
5.02
5.05
5.09
5.11
4.47
4.53
4.62
4.68
4.72
4.75
4.73
4.79
4.87
4.92
4.74
4.80
4.73
4.74
4.84
4.88
4.94
4.91
4.95
4.98
4.66
4.76
4.68
4.68
4.78
4.84
4.90
4.90
4.94
4.99
4.71
4.85
4.80
4.79
4.90
4.99
5.07
5.10
5.14
5.21
4.78
4.93
4.92
4.91
5.02
5.13
5.23
5.28
5.31
5.38
1.92
2.08
2.05
2.10
2.20
2.26
2.26
2.20
2.28
2.26
2.05
2.20
2.18
2.22
2.32
2.39
2.43
2.40
2.43
2.45
6.27
6.41
6.41
6.39
6.50
6.59
6.69
6.72
6.73
--
5.07
5.11
5.08
5.08
5.14
5.16
5.18
5.20
4.22
5.24
6.24
6.37
6.34
6.32
6.35
6.43
6.49
6.53
6.58
6.59
5.34
5.45
5.37
5.41
5.51
5.57
5.61
5.63
5.68
5.67
18
19
20
21
24
25
26
27
28
1
2
3
4
06
06
06
06
06
06
06
06
06
06
06
06
06
4.72
4.70
4.73
4.74
4.77
4.74
4.73
4.79
4.86
4.84
4.79
4.81
4.83
4.54
4.54
4.55
4.57
4.57
4.63
4.65
4.64
4.59
4.59
4.66
4.64
4.60
4.73
4.73
4.73
4.75
4.76
4.79
4.79
4.78
4.77
4.82
4.81
4.82
4.80
4.90
4.90
4.90
4.90
4.93
4.96
4.98
4.93
4.91
4.98
4.98
5.00
5.01
5.05
5.04
5.05
5.06
5.07
5.07
5.09
5.11
5.09
5.09
5.11
5.11
5.12
4.76
-4.85
4.80
4.81
4.80
4.90
4.91
4.92
4.92
4.94
4.85
4.95
4.88
4.90
4.92
4.93
4.91
4.97
5.02
4.94
4.90
4.96
4.96
4.98
5.01
4.87
4.90
4.92
4.90
4.89
4.96
5.00
4.95
4.91
4.98
4.97
5.00
5.02
5.07
5.12
5.12
5.09
5.06
5.15
5.18
5.16
5.14
5.21
5.19
5.22
5.23
5.25
5.31
5.31
5.27
5.23
5.32
5.35
5.34
5.33
5.39
5.37
5.40
5.40
2.18
2.16
2.22
2.20
2.23
2.33
2.35
2.27
2.21
2.23
2.23
2.28
2.30
2.38
2.38
2.42
2.38
2.39
2.47
2.48
2.43
2.38
2.42
2.42
2.47
2.49
6.69
6.74
6.74
6.71
6.66
6.75
6.76
6.76
6.74
6.77
6.73
6.76
6.76
--------------
--------------
--------------
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
Class I FOMC - Restricted Controlled (FR)
Page 40 of 41
Appendix Table 2
Money Aggregates
Seasonally Adjusted
Period
M2
1
2
Nontransactions
Components in M2
3
Annual growth rates (%):
Annually (Q4 to Q4)
2003
2004
2005
7.4
5.4
0.0
5.5
5.2
3.9
5.0
5.2
5.0
Quarterly (average)
2005-Q2
Q3
Q4
2006-Q1
-0.3
-0.6
0.8
3.6
2.5
4.4
5.1
6.6
3.2
5.7
6.2
7.4
Monthly
2005-Apr.
May
June
July
Aug.
Sep.
Oct.
Nov.
Dec.
-6.3
4.4
-1.1
-6.2
7.0
-2.5
1.6
0.7
-1.2
1.1
1.6
4.9
3.7
5.6
5.5
5.3
4.0
5.1
3.1
0.8
6.5
6.3
5.2
7.7
6.3
4.8
6.7
12.4
-5.3
7.3
7.9
11.2
4.1
3.1
4.4
10.9
6.6
2.0
3.4
1370.2
1368.8
1383.0
1376.9
1385.3
6647.6
6675.7
6737.9
6761.2
6778.4
5277.3
5306.9
5354.9
5384.3
5393.1
6
13
20
27
1377.1
1360.0
1382.9
1388.8
6783.2
6757.1
6782.9
6776.5
5406.2
5397.1
5400.1
5387.6
3
10
17p
24p
1424.3
1374.2
1384.7
1402.9
6799.9
6776.2
6806.7
6810.0
5375.7
5402.0
5422.0
5407.1
2006-Jan.
Feb.
Mar.
Apr. e
Levels ($billions):
Monthly
2005-Nov.
Dec.
2006-Jan.
Feb.
Mar.
Weekly
2006-Mar.
Apr.
p
e
M1
preliminar y
estimated
Class I FOMC - Restricted Controlled (FR)
Page 41 of 41
Appendix Table 3
Changes in System Holdings of Securities 1
(Millions of dollars, not seasonally adjusted)
May 4, 2006
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
2003
2004
18,150
18,138
-----
18,150
18,138
6,565
7,994
7,814
17,249
4,107
5,763
220
1,364
-----
18,706
32,370
10
---
36,846
50,507
2,223
-2,522
1,036
-331
3,259
-2,853
2005
8,300
---
8,300
2,894
11,309
3,626
2,007
2,795
17,041
---
25,341
-2,415
-192
-2,607
2005 QI
35
---
35
---
---
---
---
544
-544
---
-509
1,653
-3,454
-1,801
QII
QIII
2,010
4,743
-----
2,010
4,743
--1,298
3,495
5,025
1,708
1,118
1,015
90
1,305
757
4,914
6,774
-----
6,923
11,517
1,082
964
1,361
1,538
2,443
2,502
QIV
1,512
---
1,512
1,596
2,789
800
902
189
5,897
---
7,410
-1,202
-1,293
-2,496
2006 QI
4,099
---
4,099
1,200
7,443
1,704
1,219
1,321
10,245
---
14,345
793
1,839
2,631
2005 Sep
Oct
1,992
1,023
-----
1,992
1,023
--500
3,635
1,693
130
---
90
902
-----
3,855
3,095
-----
5,847
4,118
283
-1,468
-599
-5,369
-316
-6,837
Nov
Dec
489
---
-----
489
---
1,096
---
1,096
---
800
---
-----
189
---
2,802
---
-----
3,292
---
-627
1,322
3,635
6,719
3,008
8,042
2006 Jan
Feb
1,563
1,308
-----
1,563
1,308
--1,200
2,809
2,498
1,505
25
205
924
1,321
---
3,198
4,647
-----
4,761
5,955
252
-396
-1,355
-3,672
-1,103
-4,068
Mar
Apr
1,228
---
-----
1,228
---
-----
2,136
1,096
174
---
90
---
-----
2,400
1,096
-----
3,628
1,096
393
626
-232
-3,995
162
-3,368
2006 Feb 8
Feb 15
14
1,274
-----
14
1,274
-----
--1,250
-----
-----
-----
--1,250
-----
14
2,524
-2,824
4,204
-2,000
1,000
-4,824
5,204
Feb 22
Mar 1
-----
-----
-----
--1,200
1,248
---
--25
--924
-----
1,248
2,149
-----
1,248
2,149
-1,211
-362
3,000
1,000
1,789
638
Mar 8
Mar 15
-----
-----
-----
-----
676
1,460
174
---
--90
-----
850
1,550
-----
850
1,550
-1,927
2,475
-1,000
---
-2,927
2,475
Mar 22
Mar 29
--1,228
-----
--1,228
-----
-----
-----
-----
-----
-----
-----
--1,228
-56
-24
---6,000
-56
-6,024
Apr 5
Apr 12
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
3,105
-4,143
-2,000
1,000
1,105
-3,143
Apr 19
Apr 26
-----
-----
-----
-----
--1,096
-----
-----
-----
--1,096
-----
--1,096
4,093
-5,428
1,000
2,000
5,093
-3,428
May 3
---
---
---
---
---
---
---
---
---
---
---
3,218
---
3,218
2006 May 4
---
---
---
---
---
---
---
---
---
---
---
92
-1,000
-908
---
---
---
---
1,096
---
---
---
1,096
---
1,096
606
1,000
1,606
275.4
132.7
216.2
55.4
80.0
484.3
---
759.7
-14.6
15.0
0.4
Intermeeting Period
Mar 28-May 4
Memo: LEVEL (bil. $)
May 4
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.
4.
5.
6.
7.
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:SPS
Cite this document
APA
Federal Reserve (2006, May 9). Bluebook. Bluebooks, Federal Reserve. https://whenthefedspeaks.com/doc/bluebook_20060510
BibTeX
@misc{wtfs_bluebook_20060510,
author = {Federal Reserve},
title = {Bluebook},
year = {2006},
month = {May},
howpublished = {Bluebooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/bluebook_20060510},
note = {Retrieved via When the Fed Speaks corpus}
}