bluebooks · June 28, 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)
JUNE 22, 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)
June 22, 2006
MONETARY POLICY ALTERNATIVES
Recent Developments
(1)
Although the decision at the May 10 FOMC meeting to raise the target
federal funds rate 25 basis points to 5 percent was widely expected, the indication in
the accompanying statement that “some further policy firming may yet be needed”
reportedly prompted financial market participants to raise their near-term policy
expectations slightly that afternoon.1 Over the intermeeting period, data releases on
economic activity generally came in soft relative to expectations, while readings on
inflation surprised to the upside, apparently leaving investors less optimistic about
prospects for growth and more concerned about inflation. Those inflation concerns
seemed to be assuaged by the release of the FOMC minutes and speeches by several
Federal Reserve policymakers. The expected federal funds rate at the end of 2007
rose about 25 basis points (Chart 1). As judged from federal funds futures quotes and
the Desk’s survey of primary dealers, market participants appear virtually certain that
the FOMC will hike the target funds rate 25 basis points at its upcoming meeting, and
place high odds on another such increase at the August meeting (see the box
“Probabilities of Alternative Trajectories of Monetary Policy”). The expected policy
path currently peaks near 5½ percent toward the end of this year and then slopes
down gradually thereafter. Policy uncertainty, as measured by volatilities implied by
Eurodollar options, remained low over the intermeeting period, as did the implied
volatility of longer-term Treasury rates.
The effective federal funds rate averaged near its intended level over most of the
intermeeting period, but this morning federal funds are trading a few basis points above the
target in anticipation of tightening at next Thursday’s meeting. During the period, the Desk
purchased $7.5 billion of Treasury coupon securities in the market. The volume of
outstanding long-term RPs declined $4 billion, to $11 billion.
1
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
June 22, 2006
May 9, 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
June
Sept.
2006
Dec.
Mar.
May July
2007
1
Oct.
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
30
6
20
5
4
10
3
2
0
1
1
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
2
3
Apr.
2006
5
7
10
-10
Years Ahead
*Par yields from a smoothed nominal off-the-run Treasury yield curve.
Oil and Commodity Prices
Inflation Compensation*
Percent
FOMC
Daily
Next Five Years
Five-to-Ten Years Ahead
$/barrel
4.0
90
Index(12/31/03=100)
FOMC
Daily
Spot WTI (left scale)
Metals Index* (right scale)
80
3.5
160
70
3.0
60
2.5
50
180
140
40
120
2.0
30
1.5
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
*Estimates based on smoothed nominal and inflation-indexed
Treasury yield curves, and adjusted for the indexation-lag (carry) effect.
20
100
Apr.
Aug.
2004
Dec.
Apr.
*Source. Journal of Commerce.
Note: Vertical lines indicate May 9, 2006. Last daily observations are for June 22, 2006.
Aug.
2005
Dec.
Apr.
2006
Class I FOMC - Restricted Controlled (FR)
Page 3 of 41
Probabilities of Alternative Trajectories of Monetary Policy
On the assumption that at each of its next two meetings the Committee will choose either to
leave the target federal funds rate unchanged or to increase it by 25 basis points, there are
four possible near-term paths for monetary policy. Quotes on federal funds futures and
options can be used to solve for the implied probabilities of each of these possible paths.
The time series of these probabilities since just before the last FOMC meeting are shown in
the chart below.
Around the time of the May FOMC meeting, market participants apparently placed betterthan-even odds on the target federal funds rate being left unchanged at both the June and
August meetings. However, the probability of this outcome subsequently fell substantially,
especially following the Chairman’s comments at the International Monetary Conference,
and it is now close to zero. Early in the intermeeting period, investors had viewed a pause in
June followed by a rate hike in August as possible, but the assessed chance of that outcome
has dwindled to zero. The odds of a rate hike in June followed by a pause in August rose
over most of the intermeeting period, and now stand a bit below 40 percent. The
probability of rate hikes at both the June and August meetings has climbed, especially
following the release of May CPI data, and is now over 60 percent.
Class I FOMC - Restricted Controlled (FR)
(2)
Page 4 of 41
Nominal Treasury yields showed mixed changes, on balance, over the
intermeeting period: Two-year yields rose about 25 basis points, consistent with the
increase in near-term policy expectations. However, forward rates at maturities of
five years and beyond were little changed, leaving ten-year coupon yields up only
about 10 basis points. Inflation compensation calculated from yields on nominal and
indexed Treasury securities fell about 10 basis points across the maturity spectrum.
This drop, which was consistent with a decline in some survey measures of inflation
expectations and reversed most of the increase posted earlier in the spring, appears to
have been a reaction to statements by Federal Reserve officials suggesting a
willingness to tighten policy in order to contain inflation risks, as well as to soft
readings on economic activity and perhaps also to lower commodity prices.
(3)
The expectation of less robust economic performance and more substantial
near-term monetary policy tightening apparently led investors to mark down their
longer-term outlook for corporate earnings and, perhaps, to require more
compensation for risk. Major stock price indexes fell 5 to 9 percent over the
intermeeting period, and a rough measure of the equity premium—the gap between
the twelve-month forward trend earnings-price ratio and the real perpetuity Treasury
yield—widened somewhat (Chart 2). Actual and options-implied volatilities on
equities jumped over the intermeeting period, in contrast to implied volatilities of
interest rates. Spreads over Treasuries on investment-grade corporate bonds rose
about 15 basis points, and those on speculative-grade issues rose around 35 basis
points, but both stayed narrow by the standards of recent years. Broad measures of
corporate credit quality generally continued to be favorable over the intermeeting
period, and expected year-ahead defaults remained very low.
(4)
Investors’ confidence in the strength of the global expansion also flagged
during the intermeeting period, a shift that was associated with substantial fluctuations
in financial markets around the world. Share prices in many industrial countries
Class I FOMC - Restricted Controlled (FR)
Stock Prices
Page 5 of 41
Chart 2
Asset Market Developments
Equity Valuation
Index(12/31/03=100)
Daily
130
FOMC
Wilshire
Nasdaq
Percent
12
Monthly
10
120
8
12-Month Forward
Trend E/P Ratio
110
+ 6
100
4
+
2
90
Real Long-Term Treasury Yield*
0
80
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
1988
Apr.
2006
1992
1996
2000
2004
*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.
Corporate Bond Spreads*
Realized and Implied S&P 500 Volatility over Recent
Intermeeting Periods*
Basis points
20
Realized
Implied
280
Basis points
Daily
750
FOMC
Ten-Year BBB (left scale)
Five-Year High-Yield (right scale)
240
15
625
500
200
10
375
160
250
5
120
NovDec
DecJan
JanMar
MarMay
0
MayJun
125
80
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
2006
* Realized volatility is constructed from five-minute returns. Implied
volatility is the period-average of daily implied volatilites calculated
from options prices
*Measured relative to an estimated off-the-run Treasury yield curve.
Bond Default and C&I Loan Delinquency Rates
Expected Year-Ahead Defaults*
Percent of liabilities
Percent of outstandings
7
Monthly
2.0
6
5
1.5
4
C&I loan delinquency rate
(Call Report)
3
1.0
2
Q1
1
Bond default rate*
May
0.5
May
0
1990
1993
1996
1999
2002
*6-month moving average, from Moody’s Investors Service.
2005
1999
2000
2001
2002
2003
2004
2005
0.0
2006
*Firm-level estimates of year-ahead defaults from KMV corporation, weighted
by firm liabilities as a percent of total liabilities, excluding defaulted firms.
Note: Vertical lines indicate May 9, 2006. Last daily observations are for June 22, 2006.
Class I FOMC - Restricted Controlled (FR)
Page 6 of 41
recorded net declines of 6 to 11 percent (Chart 3). Yields on long-term government
securities were little changed on net in most major industrial countries, but in Japan
they dropped 15 basis points. The foreign exchange value of the dollar varied
modestly over the period, declining in late May in reaction to the release of softerthan-expected U.S. economic data but more than recouping that loss this month in
response to changes in relative returns associated partly with expressions of the
FOMC’s resolve against inflationary pressures. BOJ authorities re-emphasized that
any rise in policy rates will be gradual, and the dollar rose 5 percent versus the yen.
Against the euro, the dollar gained about 1¾ percent over the period, as market
participants interpreted ECB officials’ statements associated with the 25 basis point
tightening in June as consistent with a slightly lower path for policy going forward
than had been anticipated. The dollar appreciated 1½ percent against the Canadian
dollar. On balance, the trade-weighted exchange value of the dollar against major
foreign currencies rose about 2¼ percent over the intermeeting period.2
(5)
The cooling in equity markets in industrial countries was accompanied by a
more pronounced chill in many emerging markets. Brazilian and Mexican stock
prices fell 17 percent over the period, and their EMBI+ spreads widened about 30 to
40 basis points. The dollar gained almost 9 percent against the real and about
5 percent against the peso. Stock prices in many Asian emerging markets also
declined sharply during the period. The dollar gained 2 to 7 percent against currencies
of Asian countries with flexible exchange rates. Central banks in a large number of
emerging market economies firmed policy during the period, in some cases by
substantially more than markets had expected. Overall, the dollar rose 2¾ percent
against an index of currencies of our other important trading partners.
2
Class I FOMC - Restricted Controlled (FR)
Page 7 of 41
Chart 3
International Financial Indicators
Stock Price Indexes
Industrial Countries
Ten-Year Government Bond Yields (Nominal)
Index(12/31/03=100)
Daily
175
6.0
170
165
160
Percent
Daily
UK (left scale)
Germany (left scale)
Japan (right scale)
5.5
3.0
2.5
155
150
5.0
2.0
145
140
4.5
135
1.5
130
UK (FTSE-350)
Euro Area (DJ Euro)
Japan (Topix)
125
4.0
120
115
1.0
3.5
110
105
100
0.5
3.0
95
90
Jan.
May
Sept.
2004
Jan.
May
Sept.
2005
Stock Price Indexes
Emerging Market Economies
Jan.
May
2006
2.5
0.0
Jan.
May
Sept.
2004
Jan.
May
Sept.
2005
Jan.
May
2006
Nominal Trade-Weighted Dollar Indexes
Index(12/31/03=100)
Daily
250
Index(12/31/03=100)
Daily
Broad
Major Currencies
Other Important Trading Partners
235
112
110
220
108
205
106
190
104
175
102
160
Brazil (Bovespa)
Korea (KOSPI)
Mexico (Bolsa)
100
145
98
130
96
115
100
94
85
92
70
Jan.
May
Sept.
2004
Jan.
May
Sept.
2005
Jan.
May
2006
90
Jan.
May
Sept.
2004
Note: Vertical lines indicate May 10, 2006. Last daily observations are for June 22, 2006.
Jan.
May
Sept.
2005
Jan.
May
2006
Class I FOMC - Restricted Controlled (FR)
(6)
Page 8 of 41
Growth of the debt of domestic nonfinancial businesses is estimated to
have slowed a little in the second quarter to an 8½ percent annual rate (Chart 4). This
deceleration largely reflected some moderation in cash-financed mergers from the
extraordinary first-quarter pace. Commercial paper issuance has been weak so far in
the current quarter, but growth of business loans has remained brisk. Net issuance of
corporate bonds has continued to be solid. In the household sector, debt growth this
quarter appears to have dropped below the double-digit rate that has prevailed for
some time, as further increases in mortgage rates, the softening in housing activity,
and a more moderate pace of house price appreciation have tempered the volume of
mortgage borrowing. Consumer credit has remained tepid in the current quarter. In
the federal sector, higher-than-anticipated tax payments have reduced the Treasury’s
borrowing needs. Overall, domestic nonfinancial sector debt is estimated to have
decelerated notably to a 6¼ percent rate in the second quarter.
(7)
M2 growth in the second quarter, at 2¾ percent, has been weak, as nominal
income growth has apparently slowed and the lagged cumulative effects of increases
in opportunity costs have continued to sap M2 demand. Liquid deposits have
remained particularly soft, as rates on these instruments adjust only slowly to rising
short-term rates. Overall, M2 velocity is estimated to have increased at an annual rate
of about 3 percent in the second quarter.
Class I FOMC - Restricted Controlled (FR)
Page 9 of 41
Chart 4
Debt and Money
Growth of Household Debt
Changes in Selected Components of
Nonfinancial Business Debt
Percent
$Billions
50
18
Monthly rate
Consumer
Credit
40
C&I Loans
Commercial Paper
Bonds
15
30
Sum
12
20
Q2p
10
H1
H2
9
6
Q2p
Home
Mortgage
0
2004
21
Quarterly, s.a.a.r.
3
-10
0
-20
-3
Q1
Apr. May
2005
2006
Note. Commercial paper and C&I loans are seasonally adjusted,
bonds are not.
1991
1993
1995
1997
1999
2001
2003
2005
p Projected.
Growth of Nonfinancial Debt
Growth of House Prices
Percent
Quarterly
12
Percent, s.a.a.r.
Total
_____
Nonfederal
__________
8.8
8.7
9.8
8.1
9.5
9.4
8.7
9.9
10.5
9.8
10.9
6.2
10.4
8.3
10
Q1
2004
8
2005
Q1
Q2
Q3
Q4
2006
Q1
Q2
6
4
OFHEO Purchase
Only Index (s.a.)
1991
1993
1995
1997
1999
2001
2
2003
2005
p
p Projected.
Note: Four-quarter growth rate.
Growth of M2
M2 Velocity and Opportunity Cost
Percent
s.a.a.r.
10
8.00
Percent
Velocity
2.3
Quarterly
8
Opportunity Cost*
(left axis)
4.00
2.2
Q2p
6
4
2.1
2.00
2.0
2
p
0
1.00
Q2p
Velocity
(right axis)
1.9
0.50
-2
1.8
0.25
-4
2004
H1
H2
2005
p Preliminary.
Q1
Apr.
2006
May
1993
1995
1997
1999
*Two-quarter moving average.
p Projected.
2001
2003
2005
2007
Class I FOMC - Restricted Controlled (FR)
Page 10 of 41
Economic Outlook
(8)
The staff’s reading of incoming data over the intermeeting period implies a
less favorable starting point for the Greenbook forecast, with real GDP growth
notably lower in the current quarter and inflation higher. In particular, the bulge in
core inflation is expected to be a bit larger and to last longer than in the May
projection. The staff forecast is now predicated on the federal funds rate moving up
to 5¼ percent in June and staying there over the next one-and-one-half years, up
¼ percentage point from the previous Greenbook. The assumed policy path keeps
longer-term Treasury yields at around current levels over the forecast period. In the
staff outlook, stock prices again rise at about a 6½ percent annual rate, but from a
level that is 7 percent lower than in May, and the foreign exchange value of the dollar
is again assumed to decline 2 percent per year, albeit from a somewhat higher point.
In line with futures quotes, the price of WTI crude oil rises $2.50 by the end of this
year and then is little changed in 2007, a path $4 to $6 lower than in the last forecast.
Against this backdrop, the staff projects real GDP to increase at a 2¾ percent pace
over the next six quarters, somewhat slower than in the May Greenbook. With
output expanding more slowly than its potential, the unemployment rate rises to
5¼ percent by the end of the forecast horizon, a little above the staff’s estimate of the
NAIRU. This slack offsets only part of the impetus from the upside surprises in
recent inflation releases, and the staff has increased its forecast of total and core PCE
inflation to 2½ percent in 2006 and 2¼ percent in 2007.
Class I FOMC - Restricted Controlled (FR)
Page 11 of 41
Longer-Run Scenarios
(9)
Longer-run aspects of monetary policy strategies—including the selection of
an inflation goal and the relative weight placed on different stabilization objectives—
can be informed by simulations of the FRB/US model. This analysis starts by
constructing an illustrative extension of the current Greenbook projection through
2012, in which the natural rate of unemployment is assumed to hold steady at
5 percent and the equilibrium real funds rate has a medium-run value of about
2¾ percent. The optimal policy balances three objectives: keeping core PCE
inflation close to a long-run goal; keeping unemployment close to its natural rate; and
avoiding abrupt changes in the federal funds rate.3 The optimal path of the funds rate
is determined in part by the weights assigned to these three policy objectives as well as
by the goal for long-run inflation; it also depends importantly on the characteristics of
the extended outlook and the structure of the FRB/US model. In this analysis,
policymakers and 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 get a sense of the recent evolution of the economic outlook, the first set
of simulations, shown in Chart 5, compares the policy that best accomplishes the
assumed objectives and macroeconomic outcomes implied by the current outlook
(solid lines) with those implied by the extended outlook at the time of the January
Bluebook (dashed lines). In each of these simulations, policymakers are assumed to
have a long-run inflation goal of 1½ percent and to place equal weights on the three
Specifically, policy aims to minimize the weighted sum of squared deviations in fourquarter average core PCE inflation from a long-run goal, squared deviations in
unemployment from its natural rate, and squared changes in the federal funds rate (all
measured in percent). For further information regarding the specification and characteristics
of optimal policy in the FRB/US model, see the memo to the Committee, “Optimal-Control
Monetary Policies” by Michael Kiley, Thomas Laubach, and Robert Tetlow, June 20, 2006.
3
Class I FOMC - Restricted Controlled (FR)
Page 12 of 41
Chart 5
Optimal Policy Implications of Recent Changes in the Staff Outlook
Federal Funds Rate
Five-Year Real Interest Rate
Percent
Percent
4.0
6.0
3.5
5.5
5.0
3.0
4.5
2.5
June Outlook
January Outlook
2006
2007
2008
4.0
2009
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
2.50
2.25
2.00
1.75
2006
2007
2008
2009
2010
1.50
Class I FOMC - Restricted Controlled (FR)
Page 13 of 41
stabilization objectives.4 As shown in the upper-left panel, the current outlook
implies a funds rate path that peaks a bit above 5½ percent in mid-2007 and then
declines gradually to about 4½ percent by 2010. This policy keeps the five-year real
Treasury rate (upper-right panel) above its equilibrium value, thereby helping to
restrain aggregate demand and pushing the unemployment rate (center panel) nearly
½ percentage point above its natural rate later in the decade. Although core PCE
inflation (bottom panel) exhibits a near-term bulge related to transitory effects of the
increase in energy prices, the persistent mild economic slack subsequently causes
inflation to decline very slowly towards the long-run goal of 1½ percent. Chart 5 also
illustrates the implications of recent unfavorable price developments, with the implied
funds rate path through the end of next year having shifted up about a percentage
point since January. Furthermore, because the staff sees recent inflation surprises as
only partly transitory, the medium-run policy tradeoff is less favorable now: In these
simulations, both the unemployment rate and core inflation beyond 2007 are higher
than in the January outlook.
(11)
The next set of simulations, shown in Chart 6, explores the implications of
alternative long-run inflation goals. The solid lines replicate those of Chart 5, in which
policymakers have an inflation goal of 1½ percent, while the dashed lines depict an
alternative in which policy pursues an inflation goal of 2 percent. Both paths are
computed using the current Greenbook projection and put equal weight on the three
policy objectives. Under a 2 percent goal, the funds rate remains near 5 percent
throughout the remainder of the decade. This flat trajectory largely reflects the extent
to which core inflation is already close to the specified goal of 2 percent, looking
beyond the transitory effects of recent energy price increases. Accordingly, the stance
of policy is set to keep the unemployment rate near its natural rate.
In conducting this analysis, the January Greenbook projection is extended using the same
set of procedures employed for the current Greenbook extension.
4
Class I FOMC - Restricted Controlled (FR)
Page 14 of 41
Chart 6
Alternative Long-Run Inflation Objectives
Federal Funds Rate
Five-Year Real Interest Rate
Percent
Percent
4.0
6.0
3.5
5.5
5.0
3.0
4.5
2.5
1.5 Percent Objective
2 Percent Objective
2006
2007
2008
4.0
2009
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
2.50
2.25
2.00
1.75
2006
2007
2008
2009
2010
1.50
Class I FOMC - Restricted Controlled (FR)
(12)
Page 15 of 41
Chart 7 depicts the consequences of alternative choices regarding the
relative weights assigned to the three policy objectives. The solid lines replicate those
of Chart 5, in which policymakers have an inflation goal of 1½ percent and place
equal weights on the objectives. A potentially unattractive implication of this
specification is that attainment of the inflation objective is a long time coming, with
actual inflation at the end of the decade still nearly ½ percentage point above the goal.
The alternative scenario (dashed lines) depicts the outcome when policymakers place
greater emphasis on the inflation objective, perhaps because of concerns—not
explicitly considered in the model—that a persistent deviation of inflation from its
goal could damage the Federal Reserve’s credibility.5 In this case, the federal funds
rate climbs more steeply to 6 percent by the end of next year. This policy generates
higher real interest rates that damp real activity more than under the baseline policy; as
a result, the unemployment rate rises above 5½ percent late next year and remains
above that level through 2010. With this additional economic slack, actual inflation
exhibits a more distinct downward trajectory and approaches the long-run goal by the
end of the decade.
In particular, the weight on unemployment gaps was lowered from 1.0 to 0.05, while the
weights on the inflation objective and changes in the funds rate were maintained at 1.0.
5
Class I FOMC - Restricted Controlled (FR)
Page 16 of 41
Chart 7
Placing Greater Relative Weight on the Inflation Objective
Federal Funds Rate
Five-Year Real Interest Rate
Percent
Percent
4.0
6.0
3.5
5.5
5.0
3.0
4.5
2.5
Equal Weights
More Weight on Inflation Objective
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
2.50
2.25
2.00
1.75
2006
2007
2008
2009
2010
1.50
Class I FOMC - Restricted Controlled (FR)
Page 17 of 41
Short-Run Policy Alternatives
(13)
This Bluebook presents three alternatives for the Committee’s
consideration, summarized by the draft statements in Table 1. Under Alternative A,
the Committee would leave the federal funds rate unchanged at this meeting and
indicate that it would likely stay its hand for at least one more meeting before deciding
whether further tightening was necessary. Under Alternative B, the Committee would
tighten 25 basis points and signal that an additional tightening in August was possible.
Alternative C combines a 50 basis point increase in the target with a statement
suggesting that additional firming was likely.
(14)
If the Committee finds the staff forecast both probable and as desirable as
can be achieved in current circumstances, it may choose to tighten policy 25 basis
points at this meeting, as in Alternative B. A 25 basis point firming would raise the
real federal funds rate somewhat above most of the staff’s estimates of the
equilibrium federal funds rate (Chart 8), a moderately restraining stance of policy that
might be viewed as appropriate given the worsening of the inflation outlook. Such a
firming might also be seen as necessary to contain the risk that the near-term bulge in
inflation could become entrenched in expectations. In that regard, members might be
heartened by the fact that the building market expectation of additional policy firming
in recent weeks was associated with some apparent decline in inflation expectations—
progress that they might be loathe to surrender by surprising investors with an easierthan-anticipated policy action. The current configuration of asset prices, however,
might be judged as embedding too great a likelihood of policy tightening at the
August meeting. If so, the Committee would presumably seek to craft its statement to
convey an assessment that an additional move in August was possible but perhaps not
as likely as currently anticipated in financial markets.
(15)
Under Alternative B, the rationale paragraph could indicate that economic
growth appears to be moderating. The Committee could list the developments adding
Class I FOMC - Restricted Controlled (FR)
Page 18 of 41
Table 1: Alternative Language for the June FOMC Announcement
Policy
Decision
Rationale
May FOMC
Alternative A
Alternative B
Alternative C
1. The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 25 basis points to 5
percent.
2. Economic growth has been quite
strong so far this year. The Committee
sees growth as likely to moderate to a
more sustainable pace, partly reflecting a
gradual cooling of the housing market
and the lagged effects of increases in
interest rates and energy prices.
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 yet be needed
to address inflation risks but emphasizes
that the extent and timing of any such
firming will depend importantly on the
evolution of the economic outlook as
implied by incoming information.
The Federal Open Market Committee
decided today to leave its target for the
federal funds rate unchanged at 5
percent.
Recent indicators suggest that
economic growth is moderating
considerably from its quite strong pace
earlier this year.
The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 25 basis points to
5¼ percent.
Recent indicators suggest that
economic growth is moderating from
its quite strong pace earlier this year.
The Federal Open Market
Committee decided today to raise its
target for the federal funds rate by
50 basis points to 5½ percent.
Recent indicators suggest that
economic growth is moderating
from its quite strong pace earlier
this year, but the level of resource
utilization remains relatively high.
The Committee views the pickup in
core inflation this spring as
unwelcome but likely to be transitory.
Ongoing productivity gains, anchored
inflation expectations, and moderate
economic growth should reduce
inflation in coming quarters.
Readings on core inflation have been
elevated in recent months. Ongoing
productivity gains have held down the
rise in unit labor costs, and inflation
expectations remain contained.
However, the high levels of resource
utilization and of the prices of energy
and other commodities have the
potential to sustain inflation pressures.
Ongoing productivity gains and
contained inflation expectations
should restrain inflation going
forward. However, recent readings
on core inflation have been
elevated, which the Committee
views as unwelcome.
The Committee judges that the risks to
the attainment of price stability remain
tilted to the upside but recognizes that
the moderation in the growth of
aggregate demand, along with other
forces, should work to contain
inflation going forward. While the
Committee judges that some further
policy firming may yet be needed to
address inflation risks, considerable
uncertainty attends the outlook,
making it prudent to await the
accumulation of additional
information.
Although the moderation in the
growth of aggregate demand should
help to contain inflation pressures, the
Committee judges that the risks to the
attainment of price stability remain
tilted to the upside. The extent and
timing of any further policy action will
depend importantly on the evolution
of the economic outlook as implied by
incoming information.
In order to foster price stability and
sustainable economic growth, the
Committee seeks a medium-term
decline in core inflation from its
recent elevated levels. The
Committee judges that some further
policy firming may yet be needed to
accomplish this outcome. The
extent and timing of any such
firming will depend importantly on
the evolution of the economic
outlook as implied by incoming
information.
Assessment of
Risk
5. In any event, the Committee will
respond to changes in economic
prospects as needed to support the
attainment of its objectives.
[None]
In any event, the Committee will
respond to changes in economic
prospects as needed to support the
attainment of sustainable economic
growth and price stability.
[None]
Class I FOMC - Restricted Controlled (FR)
Page 19 of 41
Chart 8
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
2.3
2.6
3.9
2.2
2.6
3.8
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
(1.3 - 4.6(
(0.3 - 5.5(
2.6
2.8
2.2
2.4
2.2
2.4
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
2.2
2.83
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 20 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 21 of 41
to inflation pressure, including taut resource markets and elevated oil and commodity
prices, and acknowledge the recent pickup in core inflation. The rationale could also
note the forces acting to reduce inflation pressures, such as the subdued increases in
unit labor costs and the continued containment of inflation expectations. To indicate
that further tightening was possible but not certain, the assessment of risk could note
that, while forces that should restrain inflation were at work, the risks to inflation
continued to be on the upside. The Committee could again note that any further
policy action will depend on the evolution of the economic outlook.
(16)
Market participants are somewhat more confident that the Committee will
tighten at its August meeting than the wording of Alternative B suggests. As a result,
investors would trim back their near-term policy expectations, and short-term interest
rates would probably decline slightly. The policy surprise might add to expected
volatility, as market participants became a little less sure of the predictability of the
Committee’s behavior. The downward revision to expectations would tend to lower
longer-term yields, but some of that decline might be offset by a backup in term
premiums. Stock prices would likely rally some, and downward pressure on the
foreign exchange value of the dollar could emerge.
(17)
The Committee might instead desire a more forceful policy response to the
deterioration in the inflation outlook and find some appeal in the 50 basis point
tightening of Alternative C. Although measures of inflation expectations have edged
lower on balance in recent weeks, they have risen since earlier this year, potentially
adding momentum to actual inflation. Moreover, resource utilization appears to be
relatively high, and some policymakers have noted that inflation is already above a
range they see as consistent with price stability. In these circumstances, the
Committee might be concerned by the risk that the recently higher readings on
inflation could get embedded in inflation expectations along the lines of the “rising
inflation expectations” alternative simulation in the Greenbook. The Committee may
Class I FOMC - Restricted Controlled (FR)
Page 22 of 41
also favor a more sizable move now so as to make more rapid progress toward
moving inflation lower. In the alternative policy simulation presented earlier, the
pursuit of a 1½ percent inflation target requires additional tightening in the near term,
especially so if inflation deviations receive a higher relative weight in the FOMC’s
objective function. If policymakers believed that additional firming, beyond a 50 basis
point policy move at this meeting, probably would be necessary, they may find it
appropriate to indicate a fairly high likelihood that further tightening was in train.
Such an indication may be particularly appealing if firmer financial conditions were
judged to be desirable to make satisfactory progress toward the Committee’s
objectives.
(18)
The rationale paragraph under Alternative C could place more emphasis on
the recent unwelcome pickup in inflation while noting that productivity gains and
contained inflation expectations are restraining inflation. To signal that further
tightening is likely, the risk assessment could indicate that additional policy action may
be needed to reduce core inflation to a more desirable level. So that the Committee
would not become locked into additional tightening even if there were additional
elevated monthly readings on core inflation, the assessment could specify that the
reduction in core inflation was sought in the medium term and repeat that the extent
and timing of firming would depend on the evolution of the economic outlook.
(19)
The announcement of Alternative C would lead market participants to
revise upward their outlook for the path for policy, and short- and intermediate-term
interest rates would rise as a result. Longer-term interest rates could also rise,
especially if investors concluded that the FOMC was much more worried about
underlying inflation than previously thought. Stock prices would fall substantially, and
the foreign exchange value of the dollar would increase.
(20)
If, in contrast, the Committee is particularly concerned by the soft tone to
the incoming data on spending, it might feel that the best course of action at this
Class I FOMC - Restricted Controlled (FR)
Page 23 of 41
meeting would be to leave the stance of policy unchanged, as in Alternative A. With
news on spending and prices pointing in different directions, the Committee could
combine such a policy move with statement language implying that policy would likely
be on hold in the near term to await additional information, although policy firming
was likely at some point down the road. Leaving policy unchanged at the current
meeting would be consistent with the prescriptions from a number of simple and
estimated policy rules (Charts 9 and 10). Indeed, most of those rules call for an easier
policy than currently priced into financial markets, suggesting that the level of the
federal funds rate may have already been brought up enough to prevent an
unsustainable spurt in economic growth. Staff estimates of equilibrium real interest
rates indicate that cumulative tightening to date has effectively removed policy
accommodation. Given the lags in policy, the easing of pressures on resources
expected to result from this prior tightening, together with the anticipated flattening
out of energy prices, may be seen as likely to be sufficient to point inflation down
toward an acceptable range. Moreover, the Committee may see significant downside
risk to the outlook if it views the recent marked declines of indicators of housing
activity as possible harbingers of a prolonged and sizable reduction in housing
construction and household spending along the lines of the “housing slump”
Greenbook scenario.
(21)
To explain a choice to leave policy unchanged, the rationale paragraph
could emphasize the considerable slowdown in economic activity. That slowing,
anchored inflation expectations, and subdued advances in labor costs could be cited
as reasons why the recently elevated readings on core inflation, while unwelcome,
should prove transitory. The risk assessment could reflect the Committee’s concerns
by indicating downside risks to growth and upside risks to inflation, which would
justify a pause in policy to await additional information bearing on the outlook.
Class I FOMC - Restricted Controlled (FR)
Page 24 of 41
Chart 9
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
4.9
4.9
4.9
4.7
4.6
4.5
4.4
4.8
4.9
4.6
5.2
4.3
5.4
4.0
5.6
3.6
5.7
3.4
5.7
3.2
5.8
4.8
4.9
4.4
5.4
3.9
5.7
3.5
6.0
3.0
6.2
2.7
6.4
2.4
6.6
Forecast-based policy rule
4.9
4.9
4.8
4.6
4.5
4.5
4.5
4.9
5.4
5.5
5.5
5.4
5.3
5.3
4.9
4.9
5.2
5.5
5.2
5.8
5.1
5.9
4.9
6.0
4.7
6.0
4.5
6.1
4.9
4.9
5.2
5.6
5.0
5.9
4.8
6.2
4.6
6.4
4.3
6.5
4.1
6.6
4.9
5.3
5.3
5.3
5.3
5.3
5.3
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 25 of 41
Chart 10
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
4.9
4.8
4.8
4.5
4.7
4.5
4.8
4.6
4.5
4.3
4.5
4.4
4.5
4.4
4.9
4.8
4.7
4.5
4.6
4.4
4.7
4.5
4.4
4.3
4.5
4.4
4.5
4.5
4.9
4.9
5.2
5.0
5.5
5.1
5.6
5.1
5.8
5.2
6.0
5.3
6.1
5.3
4.9
5.3
5.3
5.3
5.3
5.3
5.3
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 26 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)
(22)
Page 27 of 41
Markets would be surprised, to say the least, if the Committee left the stance
of policy unchanged, and short-term interest rates would drop. Longer-term interest
rates could rise if market participants concluded that the FOMC was willing to
tolerate a higher level of inflation over time than had previously been thought and so
marked up inflation compensation. The foreign exchange value of the dollar would
probably fall. Stock prices likely would rise, given the lower real interest rates.
Money and Debt Forecasts
(23)
Under the Greenbook forecast, M2 is expected to expand just 4 percent in
2006, reflecting the moderate growth in nominal income and the restraining effects of
past policy tightenings (Table 2). With short-term interest rates unchanged after the
June meeting, opportunity costs gradually level out, and M2 growth picks up to
5 percent in 2007, matching the growth in nominal income.
(24)
Growth of domestic nonfinancial sector debt is projected to drop from
9½ percent last year to 8 percent in 2006 and 6½ percent in 2007. The slowdown
reflects the contours of the staff outlook for nominal GDP and, in the near term, a
reduction in federal debt growth owing to the surprisingly strong tax receipts this
spring. In addition, merger and acquisition activity is expected to moderate next year,
contributing to a decline in business borrowing. Moreover, past increases in home
mortgage rates and the projected deceleration of home prices restrain household debt
growth over the forecast horizon.
Class I FOMC - Restricted Controlled (FR)
Page 28 of 41
Table 2
Alternative Growth Rates for M2
(percent, annual rate)
Raise 25 bp/
No Change*
Greenbook**
Monthly Growth Rates
Jan-06
11.2
11.2
Feb-06
4.1
4.1
Mar-06
3.1
3.1
Apr-06
3.6
3.6
May-06
-0.3
-0.3
Jun-06
4.6
4.6
Jul-06
3.9
3.5
Aug-06
4.2
3.4
Sep-06
4.1
3.3
Raise 50 bp***
11.2
4.1
3.1
3.6
-0.3
4.6
3.1
2.6
2.5
Quarterly Growth Rates
2005 Q2
2005 Q3
2005 Q4
2006 Q1
2006 Q2
2006 Q3
2.5
4.4
5.1
6.6
2.8
3.7
2.5
4.4
5.1
6.6
2.8
3.3
2.5
4.4
5.1
6.6
2.8
2.9
Annual Growth Rates
2004
2005
2006
2007
5.2
3.9
4.4
5.1
5.2
3.9
4.1
5.0
5.2
3.9
3.8
4.8
4.2
3.7
3.2
Growth From
May-06
To
Sep-06
* No change in in the target federal funds rate at this meeting and no change thereafter.
** 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 ________________ 5 percent.
Risk Assessments
A. The Committee judges that the risks to the attainment of price stability
remain tilted to the upside but recognizes that the moderation in the
growth of aggregate demand, along with other forces, should work to
contain inflation going forward. While the Committee judges that some
further policy firming may yet be needed to address inflation risks,
considerable uncertainty attends the outlook, making it prudent to await
the accumulation of additional information.
B. Although the moderation in the growth of aggregate demand should
help to contain inflation pressures, the Committee judges that the risks
to the attainment of price stability remain tilted to the upside. The
extent and timing of any further policy action 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 sustainable
economic growth and price stability.
Class I FOMC - Restricted Controlled (FR)
Page 30 of 41
C. In order to foster price stability and sustainable economic growth, the
Committee seeks a medium-term decline in core inflation from its recent
elevated levels. The Committee judges that some further policy firming
may yet be needed to accomplish this outcome. The extent and timing
of any such firming will depend importantly on the evolution of the
economic outlook as implied by incoming information.
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
June 22, 2006
May 9, 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
1500
40
+
S&P 500
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
+
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
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)
450
Weekly
400
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.
Appendix Table 1
Class I FOMC - Restricted Controlled (FR)
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
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
Jun 05
Jul
05
Aug 05
Sep 05
Oct 05
Nov 05
Dec 05
5.05
4.22
4.80
3.91
4.94
4.17
5.25
4.37
5.42
4.50
5.16
4.22
5.27
4.34
5.15
4.28
5.27
4.42
5.45
4.59
2.53
1.82
2.63
1.94
6.84
6.17
5.25
5.04
6.71
6.10
5.75
5.15
3.04
3.26
3.50
3.62
3.78
4.00
4.16
2.82
3.09
3.33
3.21
3.49
3.91
3.67
3.03
3.29
3.52
3.50
3.79
3.97
3.98
3.22
3.53
3.78
3.80
4.13
4.30
4.33
3.38
3.57
3.77
3.87
4.13
4.31
4.45
3.11
3.27
3.47
3.64
3.84
4.01
4.23
3.65
3.90
4.06
3.96
4.31
4.44
4.43
3.76
3.98
4.12
4.01
4.34
4.46
4.39
4.07
4.25
4.34
4.28
4.56
4.66
4.57
4.38
4.50
4.56
4.55
4.77
4.85
4.76
1.37
1.64
1.69
1.40
1.69
1.96
2.07
1.67
1.88
1.89
1.70
1.94
2.09
2.15
5.86
5.95
5.96
6.03
6.30
6.39
6.32
4.77
4.85
4.90
4.94
5.13
5.22
5.18
5.58
5.70
5.82
5.77
6.07
6.33
6.27
4.24
4.40
4.55
4.51
4.86
5.14
5.17
Jan
Feb
Mar
Apr
May
Weekly
Apr
Apr
May
May
May
May
Jun
Jun
Jun
Jun
Daily
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
Jun
4.29
4.49
4.59
4.79
4.94
4.10
4.38
4.55
4.60
4.69
4.34
4.54
4.63
4.72
4.84
4.47
4.69
4.79
4.90
5.01
4.56
4.72
4.88
5.03
5.15
4.36
4.47
4.61
4.80
4.95
4.42
4.69
4.77
4.92
5.00
4.35
4.60
4.72
4.90
4.98
4.50
4.66
4.82
5.07
5.19
4.67
4.75
4.93
5.24
5.36
1.92
1.97
2.08
2.25
2.26
2.03
2.06
2.21
2.41
2.45
6.24
6.27
6.41
6.68
6.75
5.11
5.12
5.10
5.19
5.24
6.15
6.25
6.32
6.51
6.60
5.17
5.34
5.42
5.62
5.63
06
06
06
06
06
21
28
5
12
19
26
2
9
16
23
06
06
06
06
06
06
06
06
06
06
4.75
4.77
4.83
4.89
5.00
4.98
5.00
4.99
5.00
--
4.55
4.62
4.62
4.65
4.73
4.74
4.75
4.78
4.67
4.64
4.73
4.78
4.81
4.86
4.83
4.83
4.84
4.86
4.89
4.93
4.91
4.94
4.99
5.02
5.00
5.01
5.05
5.06
5.16
5.24
5.05
5.09
5.11
5.13
5.14
5.18
5.22
5.24
5.33
5.41
4.79
4.87
4.91
4.94
4.96
4.98
4.99
5.02
5.10
5.14
4.91
4.95
4.98
5.02
4.99
4.97
5.02
5.02
5.11
5.23
4.90
4.94
4.99
5.02
4.98
4.94
4.97
4.93
4.99
5.12
5.10
5.14
5.21
5.21
5.19
5.13
5.16
5.08
5.12
5.24
5.28
5.31
5.38
5.38
5.37
5.31
5.33
5.22
5.24
5.35
2.20
2.28
2.26
2.25
2.26
2.26
2.26
2.31
2.37
2.49
2.40
2.43
2.45
2.44
2.45
2.44
2.44
2.46
2.50
2.59
6.72
6.73
6.75
6.74
6.76
6.72
6.75
6.67
6.71
--
5.20
5.22
5.24
5.25
5.24
5.22
5.23
5.18
5.20
--
6.53
6.58
6.59
6.58
6.60
6.62
6.67
6.62
6.63
6.71
5.63
5.68
5.67
5.62
5.62
5.61
5.68
5.63
5.66
5.75
6
7
8
9
12
13
14
15
16
19
20
21
22
06
06
06
06
06
06
06
06
06
06
06
06
06
4.99
4.99
5.02
5.00
5.01
5.00
5.00
5.02
4.94
4.95
4.92
4.91
5.01 p
4.80
4.80
4.78
4.78
4.76
4.72
4.68
4.59
4.62
4.65
4.70
4.66
4.54
4.86
4.86
4.86
4.87
4.94
4.90
4.90
4.84
4.87
4.94
4.93
4.92
4.92
5.05
5.06
5.06
5.07
5.13
5.13
5.17
5.16
5.19
5.25
5.24
5.23
5.24
5.23
5.25
5.27
5.27
5.28
5.29
5.32
5.37
5.38
5.39
5.40
5.41
5.42
--5.04
5.06
5.09
5.01
5.10
5.12
5.16
5.13
5.15
---
5.01
5.04
5.03
5.02
5.04
5.02
5.12
5.17
5.19
5.21
5.23
5.23
5.27
4.92
4.95
4.92
4.91
4.93
4.91
5.00
5.04
5.07
5.09
5.10
5.11
5.15
5.08
5.11
5.08
5.06
5.06
5.04
5.13
5.17
5.20
5.22
5.23
5.23
5.27
5.23
5.24
5.21
5.18
5.18
5.16
5.24
5.28
5.32
5.33
5.34
5.34
5.38
2.29
2.35
2.33
2.31
2.32
2.34
2.38
2.40
2.43
2.47
2.49
2.49
2.53
2.45
2.50
2.47
2.46
2.46
2.45
2.50
2.52
2.55
2.58
2.59
2.60
2.63
6.66
6.69
6.66
6.64
6.64
6.64
6.72
6.77
6.80
6.81
6.82
6.84
--
--------------
--------------
--------------
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
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-May
June
July
Aug.
Sep.
Oct.
Nov.
Dec.
4.4
-1.1
-6.2
7.0
-2.5
1.7
0.7
-1.2
1.6
4.9
3.7
5.6
5.5
5.3
4.0
5.1
0.8
6.5
6.3
5.2
7.7
6.3
4.8
6.7
12.4
-5.3
7.3
5.0
2.6
11.2
4.1
3.1
3.6
-0.3
10.8
6.6
2.0
3.3
-1.1
1383.0
1376.9
1385.3
1391.1
1394.1
6738.0
6761.3
6778.5
6798.9
6797.1
5354.9
5384.4
5393.2
5407.9
5402.9
1
8
15
22
29
1388.3
1382.8
1386.6
1397.8
1404.9
6795.3
6771.6
6781.8
6807.1
6810.5
5407.0
5388.8
5395.2
5409.3
5405.6
5p
12p
1383.3
1357.1
6807.1
6806.4
5423.8
5449.3
2006-Jan.
Feb.
Mar.
Apr.
May p
Levels ($billions):
Monthly
2006-Jan.
Feb.
Mar.
Apr.
May p
Weekly
2006-May
June
p
M1
preliminar y
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)
June 22, 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 Oct
Nov
1,023
489
-----
1,023
489
500
1,096
1,693
1,096
--800
902
---
--189
3,095
2,802
-----
4,118
3,292
-1,468
-627
-5,369
3,635
-6,837
3,008
Dec
---
---
---
---
---
---
---
---
---
---
---
1,322
6,719
8,042
2006 Jan
1,563
---
1,563
---
2,809
1,505
205
1,321
3,198
---
4,761
252
-1,355
-1,103
Feb
Mar
1,308
1,228
-----
1,308
1,228
1,200
---
2,498
2,136
25
174
924
90
-----
4,647
2,400
-----
5,955
3,628
-396
393
-3,672
-232
-4,068
162
Apr
May
-----
-----
-----
--1,375
1,096
2,317
--101
-----
--1,217
1,096
2,576
-----
1,096
2,576
626
-756
-3,995
2,511
-3,368
1,755
2006 Mar 29
Apr 5
1,228
---
-----
1,228
---
-----
-----
-----
-----
-----
-----
-----
1,228
---
-24
3,105
-6,000
-2,000
-6,024
1,105
Apr 12
Apr 19
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-4,143
4,093
1,000
1,000
-3,143
5,093
Apr 26
May 3
-----
-----
-----
-----
1,096
---
-----
-----
-----
1,096
---
-----
1,096
---
-5,428
3,218
2,000
---
-3,428
3,218
May 10
May 17
-----
-----
-----
-----
--1,098
-----
-----
--1,217
---119
-----
---119
-2,177
569
-1,000
2,000
-3,177
2,569
May 24
May 31
-----
-----
-----
1,375
---
1,219
---
101
---
-----
-----
2,695
---
-----
2,695
---
-453
2,206
--1,000
-453
3,206
Jun 7
Jun 14
-----
-----
-----
-----
1,334
1,316
1,080
---
-----
-----
2,414
1,316
-----
2,414
1,316
-1,091
-3,350
---3,000
-1,091
-6,350
Jun 21
---
---
---
---
---
---
---
---
---
---
---
-2,352
-1,000
-3,352
2006 Jun 22
---
---
---
---
---
---
---
---
---
---
---
2,867
-3,000
-133
---
---
---
1,375
4,967
1,181
---
1,217
6,306
---
6,306
3,497
-4,000
-503
275.4
135.9
216.0
60.7
78.4
491.0
---
766.3
-14.6
11.0
-3.6
Intermeeting Period
May 10-Jun 22
Memo: LEVEL (bil. $)
Jun 22
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:BEW
Cite this document
APA
Federal Reserve (2006, June 28). Bluebook. Bluebooks, Federal Reserve. https://whenthefedspeaks.com/doc/bluebook_20060629
BibTeX
@misc{wtfs_bluebook_20060629,
author = {Federal Reserve},
title = {Bluebook},
year = {2006},
month = {Jun},
howpublished = {Bluebooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/bluebook_20060629},
note = {Retrieved via When the Fed Speaks corpus}
}