bluebooks · August 7, 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)
AUGUST 3, 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)
August 3, 2006
MONETARY POLICY ALTERNATIVES
Recent Developments
(1)
The FOMC’s decision at its June meeting to increase the federal funds rate
target by 25 basis points to 5¼ percent was widely anticipated, but market participants
apparently read the accompanying statement as indicating that a near-term pause was
more likely than had been foreseen, and the expected path of the nominal funds rate
edged lower. Subsequently, policy expectations jumped in response to the release of
June consumer price data, but dropped following the Chairman’s semiannual
monetary policy testimony and declined further after the release of the minutes of the
June FOMC meeting (Chart 1). Both of these communications were apparently read
as indicating that, while the FOMC was concerned about elevated readings on
inflation, it viewed price pressures as likely to abate over coming quarters. Policy
expectations were also damped by incoming data on economic activity over the
intermeeting period that were somewhat softer than expected.
(2)
Futures quotes suggest that investors now put the likelihood of a quarter-
point increase in the target rate at this meeting at around 35 percent, down from
about 70 percent before the June meeting; the expected path of the funds rate is
essentially flat for the remainder of the year. Further ahead, futures rates now point
to a more pronounced downward tilt to the expected path of policy next year. In
contrast to futures-market investors, respondents to the Desk’s survey of primary
dealers appear to expect a somewhat firmer near-term policy stance, placing a
probability of about 50 percent on a quarter-point action at the August meeting;
almost all respondents expect a tightening at one of the next three meetings. The
primary dealers also expect the August FOMC statement to acknowledge that core
inflation readings are still elevated, to describe economic growth as moderating, and
Class I FOMC - Restricted Controlled (FR)
Page 2 of 39
Chart 1
Interest Rate Developments
Probability of a 25 b.p. Firming at August FOMC meeting*
Percent
90
80
Percent
MPR
CPI testimony
(Senate)
PPI
5-minute intervals
FOMC
statement
ADP
Employment
report
70
90
80
FOMC
minutes
70
60
60
GDP
50
50
40
40
30
30
20
20
June 29
July 4
July 7
July 12
July 17
July 20
July 25
July 28
Aug. 2
*Estimated from federal funds futures, with an allowance for term premia.
Expected Federal Funds Rates*
Nominal Treasury Yields*
Percent
6.0
Percent
7
Daily
August 3, 2006
June 28, 2006
FOMC
Ten-Year
Two-Year
5.5
6
5
4
5.0
3
2
4.5
1
4.0
Aug.
Dec.
2006
Apr.
Aug.
2007
Dec.
Apr.
0
Aug.
2008
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
Aug.
2006
*Estimates from federal funds and Eurodollar futures, with an allowance
for term premiums and other adjustments.
*Par yields from a smoothed nominal off-the-run Treasury yield curve.
Inflation Compensation*
Percent
Implied Volatilities
Percent
FOMC
Daily
Next Five Years
Five-Year Forward, Five Years Ahead
4.0
11
3.5
9
3.0
7
Basis points
220
Daily
Ten-Year Treasury (left scale)
Six-Month Eurodollar (right scale)
FOMC
200
180
160
140
2.5
5
2.0
3
120
100
80
1.5
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
Aug.
2006
1
60
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 June 28, 2006. Last daily observations are for August 3, 2006.
Dec.
Apr.
Aug.
2005
Dec.
Apr.
Aug.
2006
Class I FOMC - Restricted Controlled (FR)
Page 3 of 39
to indicate that, while the Committee expects slower growth to restrain inflation going
forward, it remains concerned about inflation risks. Despite the evident uncertainty
over the outcome of the August meeting, short-term Eurodollar implied volatilities
rose modestly since the June meeting but have remained low.
(3)
The federal funds rate averaged 5.23 percent over the intermeeting period.
The implementation of the Board’s revised Payment System Risk policy on July 20
went smoothly, in part because practices in the federal funds and other money
markets have adjusted in response to the policy change (see the box on page 5).1
(4)
Consistent with the revision to monetary policy expectations, yields on two-
and ten-year nominal Treasury securities fell about 30 basis points over the
intermeeting period. Yields on TIPS declined about in line with those on comparable
nominal Treasury securities, leaving inflation compensation little changed, while some
survey-based measures of inflation expectations ticked down. Monetary policy
communications and the softer growth outlook apparently led investors to believe
that, despite the disappointing recent news on consumer prices and further increases
in energy prices, inflation would be contained going forward even with a lower path
of policy.
(5)
Broad stock price indexes posted modest increases, on net, over the
intermeeting period (Chart 2). Equity prices were buoyed by earnings reports that
were mainly solid and by FOMC communications that were seen as signaling a
possible end to the current phase of policy tightening, but these gains were partly
offset by concerns about turmoil in the Middle East, associated oil price increases, and
negative second-quarter earnings reports from a few high-profile firms. The equity
risk premium rose slightly, and implied volatility of the S&P 500 remained somewhat
Over the intermeeting period, the Desk purchased $1.6 billion of Treasury bills from
foreign customers and $0.5 billion of Treasury coupon securities in the market. The Desk
also redeemed $3.9 billion of Treasury coupon securities. The volume of outstanding longterm RPs increased $1 billion, to $12 billion.
1
Class I FOMC - Restricted Controlled (FR)
Stock Prices
Page 4 of 39
Chart 2
Asset Market Developments
Equity Valuation
Index(12/31/03=100)
Daily
130
FOMC
Wilshire
Dow Jones Technology
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. Aug.
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*
Implied Volatilities
Percent
Basis points
40
Daily
280
FOMC
S&P 500
Nasdaq
30
Basis points
Daily
750
FOMC
Ten-Year BBB (left scale)
Five-Year High-Yield (right scale)
240
625
500
200
20
375
160
250
10
120
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
Aug.
2006
125
80
0
Apr.
Aug.
2004
Dec.
Apr.
Aug.
2005
Dec.
Apr.
Aug.
2006
*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
Bond default rate*
Jun
1
Jun
0.5
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 June 28, 2006. Last daily observations are for August 3, 2006.
Class I FOMC - Restricted Controlled (FR)
Page 5 of 39
above its average over the first four months of the year. Business default rates
remained low. Spreads of yields on investment-grade bonds over those on
comparable-maturity Treasury securities were about unchanged, while spreads on
speculative-grade bonds widened some; both stayed narrow by historical standards.
(6)
Heightened tensions in the Middle East contributed to volatile conditions in
Changes in the Federal Funds Market in Response to the Revised PSR Policy
On July 20, 2006, the Board’s revised Payments System Risk (PSR) policy took effect.
Under the revised policy, the Reserve Banks will release principal and interest (P&I)
payments on securities issued by government-sponsored enterprises (GSEs) and certain
international organizations only when the entity’s Federal Reserve account contains
sufficient funds to cover the payments. In the past, the GSEs had routinely incurred very
large daylight overdrafts, especially on days of sizable P&I payments. Nevertheless,
implementation of the policy has resulted in no disruptions to the payment system or the
federal funds market, including on July 25, the first day on which large P&I payments were
made.
The GSEs have reportedly relied on several strategies to comply with the new PSR
policy, including tapping the increasingly active early-return federal funds market. Under
early-return contracts, borrowers are obliged to return funds to the lender at a specified
time, typically between 9:30 and 11:00 a.m., that is earlier than under the regular-return
arrangements. Early-return funds tend to trade about 2 to 4 basis points below regularreturn federal funds. Based on reports from federal funds brokers, early-return federal
funds accounted for as much as one-fifth of the brokered federal funds market on July 25.
The lower rate at which early-return federal funds trade and their increasing share of the
market implies that the effective federal funds rate will tend to understate the average rate
for regular-return federal funds. This effect is particularly pronounced on days when earlyreturn contracts account for a relatively large share of federal funds trades. Desk and
Board staff are studying the implications of the policy change and the early-return market
for the effective rate and the funds market in general.
foreign financial markets over the intermeeting period, with declines in U.S. interest
rates an important common factor in foreign financial developments.2 Yields on
long-term government bonds dropped in almost all industrial countries, though
2
Class I FOMC - Restricted Controlled (FR)
Page 6 of 39
generally by less than their U.S. counterparts (Chart 3). In Canada, yields fell about as
much as in the United States, as the Bank of Canada reiterated on July 13 that it
considered its current policy stance to be consistent with achieving its inflation
objective over the medium term. In contrast, bond yields in Japan and the United
Kingdom were about unchanged on balance as declines early in the intermeeting
period were reversed later when indicators of economic activity came in stronger than
expected. As expected, both the European Central Bank and the Bank of Japan raised
policy interest rates 25 basis points; for Japan, this move marked the end of the zerointerest-rate target. The Bank of England surprised markets this morning with a
25 basis point increase and warned that inflation is likely to stay above its target “for a
while.” The dollar appreciated about 1 percent against the Canadian dollar but fell a
bit more than 2 percent on average against the currencies of other industrial countries.
On balance, the trade-weighted index of the dollar against other major currencies fell
1 percent. As in the United States, broad share price indexes in foreign industrial
countries rose moderately.
(7)
Equity values rebounded vigorously in most emerging markets, partly in
response to the decline in U.S. interest rates. Mexican equity prices were among the
strongest performers, spurred by the apparent victory of Felipe Calderón in Mexico’s
presidential election. EMBI+ spreads declined around 20 and 35 basis points for
Mexico and Brazil, respectively. The dollar fell about 3½ percent against the Mexican
peso and 1 percent against the real. The dollar also fell against most Asian currencies,
including a ¼ percent decline against the Chinese renminbi. Overall, the dollar
depreciated 1¼ percent against an index of currencies of other important U.S. trading
partners.
(8)
Debt of the nonfinancial business sector expanded at an 8¾ percent annual
rate in the second quarter, down only a bit from its rapid first-quarter pace. C&I
loans, commercial paper, and corporate bonds all posted solid gains. In July, business
Class I FOMC - Restricted Controlled (FR)
Page 7 of 39
Chart 3
International Financial Indicators
Ten-Year Government Bond Yields (Nominal)
6.0
Percent
Daily
3.0
Index(12/31/03=100)
Daily
Broad
Major Currencies
Other Important Trading Partners
UK (left scale)
Germany (left scale)
Japan (right scale)
5.5
Nominal Trade-Weighted Dollar Indexes
112
110
2.5
108
106
5.0
2.0
104
4.5
102
1.5
100
4.0
98
1.0
3.5
96
94
0.5
3.0
92
2.5
0.0
Jan.
May Sept.
2004
Jan.
Stock Price Indexes
Industrial Countries
May Sept.
2005
Jan.
May
2006
Index(12/31/03=100)
Daily
90
Jan.
May Sept.
2004
Jan.
May Sept.
2005
Stock Price Indexes
Emerging Market Economies
175
170
Jan.
May
2006
Index(12/31/03=100)
Daily
250
235
165
160
220
155
205
150
190
145
140
175
135
UK (FTSE-350)
Euro Area (DJ Euro)
Japan (Topix)
160
Brazil (Bovespa)
Korea (KOSPI)
Mexico (Bolsa)
130
145
125
120
130
115
110
115
105
100
100
85
95
90
Jan.
May Sept.
2004
Jan.
May Sept.
2005
Jan.
May
2006
70
Jan.
May Sept.
2004
Note: Vertical lines indicate June 28, 2006. Last daily observations are for August 3, 2006.
Jan.
May Sept.
2005
Jan.
May
2006
Class I FOMC - Restricted Controlled (FR)
Page 8 of 39
loan growth is estimated to have stayed robust, but net issuance of corporate bonds
was somewhat soft and commercial paper outstanding contracted (Chart 4).
According to the July Senior Loan Officer Opinion Survey, banks further eased
lending standards and some terms on C&I loans over the previous three months,
largely in response to increased competition from other banks and nonbank lenders.
The limited data in hand for the household sector suggest that debt growth was still
brisk in the second quarter, though below the first quarter’s double-digit pace. While
cash-out refinancing activity remained strong in the second quarter, applications for
mortgages to purchase homes continued to wane, pointing to a modest decline in
overall mortgage borrowing. Consumer loan growth through May remained subdued.
In the federal sector, tax receipts were strong in the second quarter, and Treasury debt
outstanding contracted slightly. State and local governments stepped up borrowing.
Overall, the expansion of domestic nonfinancial sector debt is estimated to have
slowed last quarter to an annual rate of just under 7 percent.
(9)
M2 growth averaged 5¼ percent in June and July, somewhat stronger than
projected at the time of the last FOMC meeting but still consistent with moderate
nominal income growth and high opportunity cost. Retail money funds and small
time deposits, whose yields tend to rise about in line with short-term market interest
rates, expanded rapidly over the two months. By contrast, liquid deposits, whose
yields typically rise much more slowly than market rates, continued to run off.
Currency growth was negative in June and July. Available data indicate that domestic
demand for currency was likely about average while international demand was
unusually weak.
Class I FOMC - Restricted Controlled (FR)
Page 9 of 39
Chart 4
Debt and Money
Changes in Selected Components of
Nonfinancial Business Debt
$Billions
80
Net Percentage of Domestic Respondents Tightening
Standards for C&I Loans
Percent
50
Loans to large and medium-sized firms
Loans to small firms
Monthly rate
40
C&I Loans
Commercial Paper
Bonds
60
30
40
Sum
20
e
10
20
0
0
-10
-20
2004
H1
H2
Q1
Q2
2006
-20
July
1990
2005
e Estimated.
Note. Commercial paper and C&I loans are seasonally adjusted,
bonds are not.
1992
1994
1996
1998
2000
2002
2004
2006
Growth of Nonfinancial Debt
Growth of Household Debt
Percent
21
Percent, s.a.a.r.
Quarterly, s.a.a.r.
18
Consumer
Credit
15
2005
Q1
Q2
Q3
Q4
2006
Q1
Q2
9
6
Q2p
Home
Mortgage
Nonfederal
__________
8.8
8.7
9.8
8.1
9.5
9.4
8.7
9.9
10.5
9.8
10.9
6.9
10.5
9.1
2004
12
Q2p
Total
_____
3
0
p
-3
1991
1993
1995
1997
1999
2001
2003
2005
p Projected.
p Projected.
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
Q2
6
e
4
2.1
2.00
2.0
2
0
1.00
Q2
Velocity
(right axis)
1.9
0.50
-2
1.8
0.25
-4
2004
e Estimated.
H1
H2
2005
Q1
Q2
2006
July
1993
1995
1997
1999
*Two-quarter moving average.
2001
2003
2005
2007
Class I FOMC - Restricted Controlled (FR)
Page 10 of 39
Economic Outlook
(10)
In the staff outlook, the forecasts for aggregate demand and potential
output have both been revised down, leaving expected pressures on resource
utilization about as projected in the June Greenbook. Nonetheless, the outlook for
inflation has deteriorated somewhat, reflecting incoming consumer price data and
higher energy prices. In the forecast, a federal funds rate of 5¼ percent over the
remainder of this year and next—the same path as was assumed in June—engenders
subdued GDP growth and core inflation that edges down slowly from its recent
elevated level. Long-term Treasury yields are about unchanged through the end of
next year. Stock prices are again assumed to rise at about a 6½ percent annual rate,
but from a level that is a somewhat higher than in June, while the foreign exchange
value of the dollar is assumed to depreciate at a 2½ percent annual rate against an
index of major foreign currencies. After rising sharply over the period since the June
Greenbook was completed, oil prices are assumed to remain about flat through 2007,
consistent with quotes in futures markets. Against this backdrop, and with incoming
data confirming that aggregate demand moderated considerably in the second quarter,
the staff projects that real GDP will increase at an average annual rate of about
2¼ percent over the second half of this year and 2007. With output expanding more
slowly than the staff’s estimate of potential GDP growth (which has been revised
down from 3.2 percent to 2.9 percent in light of the annual revision to the National
Income and Product Accounts), the unemployment rate rises steadily, reaching 5¼
percent by the end of 2007 as it did in the June Greenbook. As the pass-through of
increases in energy prices ebbs and pressures on resources ease, core inflation declines
gradually over the projection period. Nonetheless, core PCE inflation is expected to
average 2½ percent this year and 2¼ percent in 2007, slightly above the June
projection for both years. The staff’s forecast for inflation is broadly in line with the
central tendency of the FOMC participants’ projections compiled for the last meeting,
Class I FOMC - Restricted Controlled (FR)
Page 11 of 39
but its forecast for the unemployment rate is notably higher, as was the case in June.
The central tendency for real GDP growth, which was compiled before the annual
revision to the National Income and Product Accounts, was higher than either the
June or the current staff forecast.3
Short-Run Policy Alternatives
(11)
This Bluebook presents four policy alternatives for the Committee’s
consideration, summarized by the draft statements in Table 1. Under Alternatives A
and B, the Committee would leave the federal funds rate unchanged at this meeting,
while under Alternatives C and D it would tighten policy another 25 basis points. In
Alternatives B and D, the accompanying statement would indicate that risks to
inflation remain to the upside and signal that additional tightening might still be
forthcoming, depending on incoming information. In contrast, Alternatives A and C
would imply that the tightening cycle may well have come to a close. For reference,
the June statement is included on the page following Table 1.
(12)
Although recent rates of inflation, if sustained, would presumably be judged
inconsistent with the maintenance of price stability, the Committee might see the
current stance of policy as likely to be sufficient to put core inflation on a downward
track. If so, it might be inclined to keep the federal funds rate unchanged at
5¼ percent at this meeting while indicating in the statement that some additional
firming might prove necessary, as in Alternative B. The Committee may agree with
the staff assessment that core inflation is likely to decline gradually in coming quarters
as the forces that have temporarily boosted inflation begin to unwind and the
moderation in economic growth fosters an easing of resource pressures. Maintaining
The central tendency for core PCE inflation was 2¼ to 2½ percent for 2006 and 2 to 2¼
percent for 2007. For real GDP growth it was 3¼ to 3½ percent for 2006 and 3 to 3¼
percent for 2007, while for the rate of unemployment in the fourth quarter it was 4¾ to 5
percent for both years.
3
Class I FOMC - Restricted Controlled (FR)
Page 12 of 39
Table 1: Alternative Language for the August FOMC Announcement
Alternative A
Policy
Decision
Rationale
Assessment of
Risk
1. The Federal Open Market
Committee decided today to keep its
target for the federal funds rate at
5¼ percent.
2. Economic growth has moderated
from its quite strong pace earlier this
year, partly reflecting a gradual
cooling of the housing market and
the lagged effects of increases in
interest rates and energy prices.
3. Readings on core inflation have
been elevated in recent months,
owing in part to pass-through of
increased energy and other
commodity prices. However,
inflation pressures seem likely to
moderate over time, reflecting the
cumulative effects of monetary
policy actions and other factors
restraining aggregate demand,
ongoing productivity gains, and
contained inflation expectations.
4. In these circumstances, future
policy adjustments will depend on
the evolution of the outlook for
both inflation and economic
growth, as implied by incoming
information.
5.
[None]
Alternative B
The Federal Open Market Committee
decided today to keep its target for the
federal funds rate at 5¼ percent.
[Same as A]
Readings on core inflation have been
elevated in recent months, owing in part
to the pass-through of increased energy
and other commodity prices. However,
inflation pressures seem likely to
moderate over time, reflecting contained
inflation expectations and the cumulative
effects of monetary policy actions and
other factors restraining aggregate
demand.
Although the Committee expects
inflation pressures to diminish gradually,
it judges that some inflation risks remain.
The extent and timing of any additional
firming that may be needed to address
these risks will depend on the evolution
of the outlook for both inflation and
economic growth, as implied by
incoming information.
[None]
Alternative C
The Federal Open Market Committee
decided today to raise its target for the
federal funds rate by 25 basis points to
5½ percent.
[Same as A]
Readings on core inflation have been
elevated in recent months, and the high
levels of resource utilization and of the
prices of energy and other commodities
have the potential to sustain inflation
pressures. However, inflation pressures
seem likely to moderate over time,
reflecting contained inflation
expectations and the cumulative effects
of monetary policy actions and other
factors restraining aggregate demand.
[Same as A]
[None]
Alternative D
The Federal Open Market
Committee decided today to raise its
target for the federal funds rate by
25 basis points to 5½ percent.
[Same as A]
Readings on core inflation have
been elevated in recent months.
The moderation in the growth of
aggregate demand and anchored
inflation expectations should help to
contain inflation in coming quarters.
However, the high levels of resource
utilization and of the prices of
energy and other commodities have
the potential to sustain inflation
pressures.
The extent and timing of any
additional firming that may be
needed to foster a moderation in
inflation pressures will depend on
the evolution of the outlook for
both inflation and economic
growth, as implied by incoming
information.
[None]
Class I FOMC - Restricted Controlled (FR)
Page 13 of 39
June FOMC Statement
1. The Federal Open Market Committee decided today to raise its target for
the federal funds rate by 25 basis points to 5-1/4 percent.
2. Recent indicators suggest that economic growth is moderating from its quite
strong pace earlier this year, partly reflecting a gradual cooling of the housing
market and the lagged effects of increases in interest rates and energy prices.
3. 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.
4. Although the moderation in the growth of aggregate demand should help to
limit inflation pressures over time, the Committee judges that some inflation
risks remain. The extent and timing of any additional firming that may be
needed to address these risks will depend on the evolution of the outlook for
both inflation and economic growth, as implied by incoming information.
5. In any event, the Committee will respond to changes in economic prospects
as needed to support the attainment of its objectives.
Class I FOMC - Restricted Controlled (FR)
Page 14 of 39
the current policy stance would be consistent with prescriptions from the estimated
forecast-based policy rule (Chart 5) as well as the first-difference rule with a long-run
inflation objective of 2 percent (Chart 6). (See the box “Intercept Shifts in Empirical
Taylor Rules.”) A pause at this meeting, after seventeen consecutive actions, might be
seen as desirable in order to limit the risk of over-tightening and the adverse
consequences for employment and growth. With the real federal funds rate in the
range of model-based estimates of its equilibrium value (Chart 8), the risk that
deferring action for a brief time might significantly worsen underlying inflationary
trends would seem to be modest. Nonetheless, the Committee may feel that elevated
energy and commodity prices, possible further increases in these prices, and high
levels of resource utilization imply that the upside risks to inflation remain substantial
and perceive only limited downside risks to the economic expansion, and so see
Intercept Shifts in Empirical Policy Rules
Chart 5 shows the projections of two empirical policy rules—specified in terms of
either outcomes or forecasts of the output gap and core inflation—that have been
estimated using quarterly data from 1988Q1 to 2005Q4. In previous Bluebooks,
both of these rules involved a time-invariant intercept, essentially implying that
the medium-run equilibrium real rate (r*) and the implicit inflation objective (π*)
remained constant throughout the sample period. However, recent staff analysis
indicates that a significant upward shift in the intercept of each empirical rule
occurred in the late 1990s. Such a shift could arise from either a 75 basis point
rise in r*, a 1 percentage point decline in π*, or some combination of the two.
The funds rate projections and confidence intervals shown in Chart 5 incorporate
these intercept shifts. The projections generated by the forecast-based rule are
broadly similar to the expectations of market participants, while the outcome-based
rule points to some additional firming.
Reflecting the possibility of an upward shift in the value of r*, this Bluebook
introduces an additional simple policy rule in Chart 6. For each specified value
of π* (either 1½ or 2 percent), the new rule follows Taylor (1999) with respect
to the policy coefficients—which determine the responsiveness of the funds rate
to movements in the output gap and core inflation—but specifies the value of r*
at 2.75 percent instead of 2 percent.
Class I FOMC - Restricted Controlled (FR)
Page 15 of 39
Chart 5
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
9
2007
Actual and Greenbook assumption
Market-based expectations
70 percent confidence interval
90 percent confidence interval
8
7
6
6
5
5
4
4
3
2006
2007
2007
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
5.3
5.7
5.8
5.8
5.7
5.4
5.1
5.5
5.2
6.1
5.1
6.6
4.9
6.9
4.6
6.9
4.3
6.8
5.0
5.6
4.9
6.4
4.7
7.0
4.3
7.4
3.9
7.6
3.4
7.6
Forecast-based policy rule
5.2
5.3
5.2
5.0
4.9
4.8
5.3
5.4
5.3
5.2
5.1
4.9
5.2
5.4
5.2
5.6
5.0
5.6
4.7
5.7
4.4
5.7
4.2
5.7
5.2
5.4
5.1
5.7
4.8
5.9
4.5
6.0
4.1
6.1
3.9
6.2
5.3
5.3
5.3
5.3
5.3
5.3
Estimated Policy Rules
Market Expectations
Memo
Greenbook assumption
8
7
2006
Expected funds rate path
70 percent confidence interval
Lower bound
Upper bound
90 percent confidence interval
Lower bound
Upper bound
Percent
9
3
Class I FOMC - Restricted Controlled (FR)
Page 16 of 39
Chart 6
Policy Implications of Simple Rules
1½ Percent Inflation Objective
Actual and Greenbook assumption
Taylor (1993) rule
Taylor (1999) rule
Taylor (1999) rule with higher r*
First-difference rule
2006
2 Percent Inflation Objective
Percent
8
2007
Actual and Greenbook assumption
Taylor (1993) rule
Taylor (1999) rule
Taylor (1999) rule with higher r*
First-difference rule
7
6
5
5
4
4
3
3
2
2006
2007
2007
Q3
Q4
Q1
Q2
Q3
Q4
5.2
5.1
5.0
4.8
5.1
4.9
4.8
4.7
4.7
4.6
4.6
4.5
5.3
5.2
5.1
4.9
5.1
4.9
4.8
4.6
4.6
4.5
4.5
4.4
5.7
5.6
5.8
5.6
5.6
5.4
5.2
5.0
4.9
4.8
4.7
4.7
5.3
5.2
5.6
5.3
5.7
5.3
6.0
5.4
6.2
5.5
6.3
5.5
5.3
5.3
5.3
5.3
5.3
5.3
Simple Policy Rules
Memo
Greenbook assumption
7
6
2006
Taylor (1993) rule
1½ percent inflation objective
2 percent inflation objective
Taylor (1999) rule
1½ percent inflation objective
2 percent inflation objective
Taylor (1999) rule with higher r*
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 17 of 39
Chart 7
Optimal Policy Paths Under Two Inflation Objectives
1½ Percent Inflation Objective
2 Percent Inflation Objective
Percent
Federal Funds Rate
6.5
Equal Weights
Less Weight On Unemployment Objective
6.0
2006
2007
2008
2009
2010
2006
2007
2008
2009
2010
2006
2007
2008
2009
2010
Core PCE Inflation
2006
2007
2008
2009
5.0
5.0
4.5
4.5
4.0
2006
2010
2007
2008
2009
2010
4.0
Percent
4.5
Five-Year Real Interest Rate
4.0
4.0
3.5
3.5
3.0
3.0
2.5
2006
2007
2008
2009
2010
2.5
Percent
6.5
Civilian Unemployment Rate
6.0
6.0
5.5
5.5
5.0
5.0
4.5
Percent
2.75
Four-quarter average
6.0
5.5
Percent
6.5
Civilian Unemployment Rate
6.5
5.5
Percent
4.5
Five-Year Real Interest Rate
Percent
Federal Funds Rate
2006
2007
2008
2009
2010
Core PCE Inflation
4.5
Percent
2.75
Four-quarter average
2.50
2.50
2.25
2.25
2.00
2.00
1.75
1.75
1.50
1.50
1.25
2006
2007
2008
2009
2010
1.25
Class I FOMC - Restricted Controlled (FR)
Page 18 of 39
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.
Except for backward-looking rules, it should be noted that prescriptions near the end of the Greenbook
horizon also depend on extended baselines.
Estimated Rules: Estimation is performed using real-time data over the sample 1988:1-2005:4, and the
specifications are chosen according to the Bayesian information criterion. Each rule incorporates a 75
basis point shift in the intercept, specified as a sequence of 25 basis point increments that occurred
during the first three quarters of 1998. Confidence intervals, shown only for the outcome-based rule, are
based on stochastic simulations of the FRB/US model. The following table indicates the specification of
each rule used for dynamic simulations and its root mean squared error over the sample 1993:1-2005:4.
Outcome-based rule
it = 1.17it-1 – 0.37it-2
+ 0.20 [1.04 + 1.77 πt + 3.32( yt − yt* ) – 2.37( yt −1 − yt*−1 )]
Forecast-based rule
it = 1.16it-1 – 0.36it-2
+ 0.20 [0.89 + 1.75 πt+2|t + 2.32( yt +1|t − yt*+1|t ) – 1.40( yt −1 − yt*−1 )]
.17
.16
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 Rules: The following table indicates the specification of each rule.
Taylor (1993) rule
it = 2 + πt + 0.5(πt – π * ) + 0.5( yt − yt* )
Taylor (1999) rule
it = 2 + πt + 0.5(πt – π * ) + ( yt − yt* )
Taylor (1999) rule
with a higher r*
it = 2.75 + πt + 0.5(πt – π * ) + ( yt − yt* )
First-difference rule
it = it-1 + 0.5(πt+3|t – π * ) + 0.5( Δ 4 yt +3|t − Δ 4 yt*+3|t )
Optimal-Control Policies: Policymakers are assumed to minimize the weighted sum of squared
deviations in inflation from the long-run objective, squared deviations in the unemployment from its
natural rate, and squared changes in the federal funds rate. Financial market participants are assumed to
understand fully the model of the economy, the baseline economic projection, and the policy
formulation process, implying model-consistent asset-price responses to policymaker actions. In
contrast, households and firms are assumed to form their expectations using more limited information.
For further information, see the memo to the Committee, “Optimal-Control Monetary Policies” by
Michael Kiley, Thomas Laubach, and Robert Tetlow, June 20, 2006.
Class I FOMC - Restricted Controlled (FR)
Page 19 of 39
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
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
2.4
2.1
3.1
2.1
2.4
3.2
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
(1.0 - 4.1(
(0.1 - 4.9(
2.7
2.6
2.2
2.2
2.2
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
(1.3 - 3.1(
(0.7 - 3.7(
2.1
2.1
2.78
2.83
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 actual real funds rate is the value published in the previous Bluebook. This Bluebook introduces methodological
changes in the computation of the TIPS-based estimate, and these changes account for a 10 basis point difference in the
final column relative to the corresponding measure published in the last Bluebook.
-2
Class I FOMC - Restricted Controlled (FR)
Page 20 of 39
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 39
additional firming as more likely than easing in coming months. The Committee may
find communicating this posture particularly important if it were concerned that
inaction at this meeting might lead investors to question its vigilance against inflation.
(13)
Under Alternative B, the rationale paragraph in the statement would
indicate that economic growth has moderated, noting the role of the lagged effects of
increases in interest rates and energy prices and of the continuing cooling of the
housing market. While acknowledging the elevated readings on core inflation, it
would also cite the reasons to expect inflation to decline in coming quarters:
contained inflation expectations, the cumulative effects of past policy firmings, and
other factors restraining aggregate demand. In its assessment of risks, the Committee
would reiterate its judgment that some upside inflation risks remain and point to the
possibility of additional firming should incoming information warrant such action.
(14)
Investors see about a one-third chance of a policy firming at this meeting
and appear to anticipate a statement similar to that under Alternative B. As a result,
the market reaction to implementation of this alternative would likely be fairly small.
While short-term interest rates would decline somewhat, intermediate- and long-term
rates, stock prices, and the foreign exchange value of the dollar probably would
change little.
(15)
If the Committee judges that the risks to the attainment of its objectives are
now roughly in balance, it may be attracted to the policy choice and wording of
Alternative A. The Committee may see greater downside risks to economic growth
than it did in June. Among other developments, the incoming information on the
housing sector may be viewed as suggesting the possibility of a more prolonged and
sizable reduction in residential construction and spending than is currently anticipated
by the staff, along the lines of the “housing slump” alternative Greenbook scenario.
The incoming data pointing to a slowing in economic growth may also have increased
the Committee’s confidence that the recent elevated inflation readings are unlikely to
Class I FOMC - Restricted Controlled (FR)
Page 22 of 39
be sustained. Keeping the federal funds rate at 5¼ percent for some time would be
roughly consistent with an optimal policy path suggested by a simulation of the
FRB/US model with a long-run inflation objective of 2 percent (Chart 7).
(16)
The rationale presented for Alternative A in the post-meeting statement
could be similar to that for Alternative B, since both alternatives would keep the
federal funds rate unchanged at this meeting. However, the assessment of risks could
simply point to the dependence of future policy adjustments on incoming
information. Against the backdrop of its statements over the previous two years, in
which the Committee either provided explicit rate guidance or pointed to upside
inflation risks, such an announcement would likely suggest to market participants that
the Committee was not predisposed to raising rates or lowering them going forward.
(17)
As in Alternative B, shorter-term interest rates would fall a little in response
to an announcement along the lines of Alternative A. However, longer-term yields
might edge higher if market participants became concerned that the Committee was
underestimating inflation risks or was willing to tolerate somewhat higher rates of
inflation going forward than earlier anticipated.
(18)
The Committee may judge instead that an additional 25 basis point increase
in the federal funds rate at this meeting, as in Alternative C, is needed to bring the
risks to the outlook for inflation and economic growth into better balance. A firming
at this meeting might be appropriate if the staff’s inflation forecast were seen as likely
and generally acceptable but the Committee wished to have slightly greater assurance
that inflation would diminish in coming quarters. Members might worry that inflation
pressures could turn out to be a little greater than projected in the Greenbook. The
economy has proved quite resilient in the face of higher oil prices and tighter
monetary policy over the past two years, and members may see economic growth as
most likely to rebound from its sharply slower pace in the second quarter. In light of
the recent upside surprises in price data, raising the federal funds rate at this meeting
Class I FOMC - Restricted Controlled (FR)
Page 23 of 39
might also seem desirable as a signal of the Committee’s resolve to foster a decline in
inflation. Even with the firming action under this alternative, the Committee may
judge that significant upside risks to inflation remain. However, some members may
see the slowing in the expansion of aggregate demand of late as suggesting that the
downside risks to growth have increased since the last meeting. The Committee
might see Alternative C as bringing the risks to the attainment of its growth and price
stability objectives roughly in balance and believe that, after implementation of such a
policy choice, an easing and a tightening of policy are about equally probable.
(19)
Under Alternative C, the paragraph on economic activity in the rationale
section could be identical to that proposed for Alternatives A and B. The
announcement could then acknowledge the elevated readings on core inflation and
cite the potential for high levels of resource utilization and of the prices of energy and
other commodities to sustain inflation pressures, but it could also point to the factors
likely to reduce inflation over coming quarters. In the risk assessment sentence of the
announcement, the Committee could merely point to the dependence of future policy
adjustments on incoming information, as in the assessment proposed for
Alternative A. Market participants would likely interpret such an announcement as
suggesting that the Committee no longer had a significant inclination to continue
firming policy.
(20)
With market participants placing less than fifty-fifty odds on a policy move
at this meeting, short-term interest rates would likely jump in response to
implementation of Alternative C. However, the effect on intermediate-term interest
rates would be considerably more muted, and long-term rates could even decline a
little should the announcement persuade investors that inflation pressures were less
intense than they had appreciated or that the Committee was seeking a slightly lower
long-term rate of inflation than they had previously perceived. Despite the rise in
short-term interest rates, with policy tightening evidently having drawn to a close,
Class I FOMC - Restricted Controlled (FR)
Page 24 of 39
equity prices might rally. The foreign exchange value of the dollar might be little
affected.
(21)
If members were dissatisfied with the gradual and limited reduction in
inflation in the staff forecast and favored a trajectory of policy that would foster a
steeper decline, they might wish to adopt the action and language of Alternative D.
The optimal policy path simulations of the FRB/US model (Chart 7) and the firstdifference rule (Chart 6), with a long-term inflation objective equal to 1½ percent,
would both call for additional firming of policy even following a 25 basis point
tightening at the August meeting. The Committee may also find Alternative D
attractive if it deems the outlook for employment and growth to be more favorable
than the staff projection. Moreover, members may be concerned that the staff has
underestimated the persistence of the forces that have boosted inflation, possible
consequences of which are illustrated by the “persistent inflation” alternative
Greenbook scenario. Indeed, the optimal policy path suggested by a simulation of the
FRB/US model under perfect foresight in this scenario would call for considerable
additional policy firming in coming months. However, the policy response would be
tempered in the more realistic circumstance that the persistence of the inflationary
forces became clear only gradually over time (see box on next page). Even if the
Committee saw the staff inflation forecast as the most likely outcome, and one that
would be satisfactory, it might find this alternative appealing if it were persuaded by
recent price data that the upside risks to inflation, and the potential costs should these
risks be realized, continued to predominate despite an additional 25 basis points
increase in the federal funds rate at this meeting. The potential for further increases
in energy prices, for example as a result of mounting geopolitical tensions, could be a
reason for such worries.
(22)
While acknowledging the moderation in economic growth and other forces
that are expected to contain inflation in coming quarters, the rationale paragraph
Class I FOMC - Restricted Controlled (FR)
Page 25 of 39
Persistent Inflation: Implications of Alternative Policy Assumptions
The policy path implied by a simple rule—such as the empirical outcome-based rule
shown in Chart 5 and used in analyzing the alternative scenarios in the Greenbook—
often differs from the optimal policy when policymakers fully understand the forces
affecting the real economy and inflation, but may well yield prescriptions close to
those under the optimal policy when these forces become evident only gradually.
For example, the chart below compares these alternative policy assumptions in the
context of the Greenbook’s ‘Persistent Inflation’ scenario, in which the recent rise
in core inflation is much more persistent than in the staff’s current projection. The
solid lines depict the optimal policy and associated macroeconomic outcomes (as
deviations from baseline) when policymakers have perfect foresight about the persistence
of the inflation pressures and place equal weight on the objectives of stabilizing
inflation, stabilizing unemployment, and avoiding sharp funds rate changes. In this
case, the optimal policy involves a 75 basis point funds rate hike by the end of 2006.
In contrast, if the persistence of the shock does not become apparent until mid-2007,
the optimal policy with gradual learning (dashed lines) generates a funds rate trajectory
over the next six quarters that lies between the path obtained under perfect foresight
and the path associated with the empirical outcome-based rule (dotted lines), in which
policy responds to contemporaneous four-quarter average core inflation and to
contemporaneous and lagged output gaps. All three policy paths generate fairly
similar trajectories for inflation, reflecting the relatively sluggish inflation dynamics
in the FRB/US model.
Deviations from Baseline (in percentage points)
Federal Funds Rate
Five-Year Real Interest Rate
1.00
0.50
0.75
0.25
0.50
0.25
0.00
0.00
2006
2007
2008
2009
2010
-0.25
2006
Civilian Unemployment Rate
2007
2008
2009
2010
-0.25
Core PCE Inflation
0.50
Four-quarter average
0.75
0.50
0.25
0.25
2006
2007
2008
2009
Optimal Policy With Perfect Foresight
2010
0.00
2006
2007
Optimal Policy With Gradual Learning
2008
2009
2010
0.00
Empirical Outcome-Based Rule
Class I FOMC - Restricted Controlled (FR)
Page 26 of 39
under Alternative D could emphasize that several factors have the potential to sustain
inflation pressures. The risk assessment could be similar to the Committee’s
statement in June, indicating that additional firming may be needed, but reference an
intention to foster a moderation in inflation pressures.
(23)
The policy choice and announcement of Alternative D would come as a
considerable surprise to market participants and lead to an upward revision of their
outlook for the path of policy. Short- and intermediate-term interest rates would
climb significantly. Longer-term rates probably would also rise, especially if investors
read the statement as suggesting that they should be more concerned about inflation
prospects, but the increase would be limited if market participants also revised
downward their perceptions of the Committee’s long-term inflation objective. Equity
prices would likely fall, while the foreign exchange value of the dollar might rise.
Money and Debt Forecasts
(24)
Under the Greenbook forecast, M2 is expected to grow about 4 percent in
2006, reflecting the restraining effects of past policy tightenings and rising opportunity
costs, and the velocity of M2 is forecast to increase about 2 percent. With short-term
interest rates unchanged, however, opportunity cost is forecast to level out in coming
months and subsequently decline a little. Consequently, M2 growth is expected to pick
up in coming quarters and, in 2007, to about match the growth in nominal income of
approximately 4¾ percent. Debt growth of the domestic nonfinancial sector is
projected to drop from 9½ percent last year to 8¼ percent in 2006 and to 6½ percent
in 2007. Federal debt growth, which was depressed by unexpectedly strong tax
receipts this spring, is expected to pick up over the forecast horizon. However, with
the expected further deceleration in house prices, mortgage borrowing is projected to
slow considerably from its recent strong pace.
Class I FOMC - Restricted Controlled (FR)
Page 27 of 39
Table 2
Alternative Growth Rates for M2
(percent, annual rate)
No change/
Greenbook*
Raise 25 bp
Monthly Growth Rates
Apr-06
May-06
Jun-06
Jul-06
Aug-06
Sep-06
Oct-06
Nov-06
Dec-06
4.0
1.1
5.9
4.7
3.3
2.7
2.6
2.7
2.8
4.0
1.1
5.9
4.7
3.0
2.0
1.8
2.0
2.2
Quarterly Growth Rates
2005 Q3
2005 Q4
2006 Q1
2006 Q2
2006 Q3
2006 Q4
4.5
5.0
6.3
3.2
4.1
2.8
4.5
5.0
6.3
3.2
3.9
2.1
Annual Growth Rates
2005
2006
2007
2008
4.0
4.1
4.6
5.0
4.0
3.9
4.4
5.0
2.8
2.2
Growth From
Jul-06
To
Dec-06
* No change in the target federal funds rate at this meeting. This forecast
is consistent with nominal GDP and interest rates in the Greenbook forecast.
Class I FOMC - Restricted Controlled (FR)
Page 28 of 39
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 ________________ 5¼ percent.
Risk Assessments
A. In these circumstances, future policy adjustments will depend on the
evolution of the outlook for both inflation and economic growth, as
implied by incoming information.
B. Although the Committee expects inflation pressures to diminish
gradually, it judges that some inflation risks remain. The extent and
timing of any additional firming that may be needed to address these
risks will depend on the evolution of the outlook for both inflation and
economic growth, as implied by incoming information.
C. Same as A.
D. The extent and timing of any additional firming that may be needed to
foster a moderation in inflation pressures will depend on the evolution
of the outlook for both inflation and economic growth, as implied by
incoming information.
Class I FOMC - Restricted Controlled (FR)
Page 29 of 39
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
August 3, 2006
June 28, 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 30 of 39
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 31 of 39
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 32 of 39
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 33 of 39
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 34 of 39
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 35 of 39
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 36 of 39
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 37 of 39
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
Aug 05
Sep 05
Oct 05
Nov 05
Dec 05
5.31
4.22
5.20
3.91
5.13
4.17
5.33
4.37
5.50
4.50
5.30
4.22
5.32
4.34
5.20
4.28
5.32
4.42
5.45
4.59
2.60
1.82
2.68
1.94
6.94
6.17
5.31
5.04
6.80
6.10
5.83
5.15
3.50
3.62
3.78
4.00
4.16
3.33
3.21
3.49
3.91
3.67
3.52
3.50
3.79
3.97
3.98
3.78
3.80
4.13
4.30
4.33
3.77
3.87
4.13
4.31
4.45
3.47
3.64
3.84
4.01
4.23
4.06
3.96
4.31
4.44
4.43
4.12
4.01
4.34
4.46
4.39
4.34
4.28
4.56
4.66
4.57
4.56
4.55
4.77
4.85
4.76
1.69
1.40
1.69
1.96
2.07
1.89
1.70
1.94
2.09
2.15
5.96
6.03
6.30
6.39
6.32
4.90
4.94
5.13
5.22
5.18
5.82
5.77
6.07
6.33
6.27
4.55
4.51
4.86
5.14
5.17
Jan
Feb
Mar
Apr
May
Jun
Jul
Weekly
Jun
Jun
Jun
Jun
Jun
Jul
Jul
Jul
Jul
Aug
Daily
Jul
Jul
Jul
Jul
Jul
Jul
Jul
Jul
Jul
Jul
Aug
Aug
Aug
4.29
4.49
4.59
4.79
4.94
4.99
5.24
4.10
4.38
4.55
4.60
4.69
4.71
4.89
4.34
4.54
4.63
4.72
4.84
4.92
5.08
4.47
4.69
4.79
4.90
5.01
5.18
5.27
4.56
4.72
4.88
5.03
5.15
5.35
5.46
4.36
4.47
4.61
4.80
4.95
5.12
5.24
4.42
4.69
4.77
4.92
5.00
5.15
5.15
4.35
4.60
4.72
4.90
4.98
5.04
5.02
4.50
4.66
4.82
5.07
5.19
5.18
5.15
4.67
4.75
4.93
5.24
5.36
5.30
5.26
1.92
1.97
2.08
2.25
2.26
2.41
2.43
2.03
2.06
2.21
2.41
2.45
2.54
2.52
6.24
6.27
6.41
6.68
6.75
6.78
6.76
5.11
5.12
5.10
5.19
5.24
5.24
5.21
6.15
6.25
6.32
6.51
6.60
6.68
6.76
5.17
5.34
5.42
5.62
5.63
5.71
5.79
06
06
06
06
06
06
06
2
9
16
23
30
7
14
21
28
4
06
06
06
06
06
06
06
06
06
06
5.00
4.99
5.00
4.95
5.03
5.19
5.25
5.25
5.24
--
4.75
4.78
4.67
4.63
4.73
4.76
4.87
4.89
4.98
5.15
4.84
4.86
4.89
4.94
5.04
5.03
5.06
5.10
5.10
5.11
5.05
5.06
5.16
5.25
5.30
5.31
5.29
5.28
5.22
5.18
5.22
5.24
5.33
5.41
5.46
5.46
5.48
5.48
5.45
5.44
4.99
5.02
5.10
5.19
5.24
5.25
5.22
5.23
5.25
5.26
5.02
5.02
5.11
5.25
5.27
5.24
5.18
5.14
5.09
4.99
4.97
4.93
4.99
5.13
5.16
5.12
5.05
5.01
4.97
4.88
5.16
5.08
5.12
5.25
5.29
5.25
5.16
5.13
5.10
5.03
5.33
5.22
5.24
5.36
5.39
5.35
5.26
5.24
5.23
5.17
2.26
2.31
2.37
2.50
2.53
2.48
2.44
2.42
2.39
2.32
2.44
2.46
2.50
2.61
2.63
2.60
2.54
2.51
2.47
2.42
6.75
6.67
6.71
6.86
6.90
6.85
6.76
6.75
6.72
--
5.23
5.18
5.20
5.27
5.31
5.31
5.21
5.19
5.13
--
6.67
6.62
6.63
6.71
6.78
6.79
6.74
6.80
6.72
6.63
5.68
5.63
5.66
5.75
5.82
5.83
5.75
5.80
5.78
5.69
18
19
20
21
24
25
26
27
28
31
1
2
3
06
06
06
06
06
06
06
06
06
06
06
06
06
5.22
5.23
5.24
5.23
5.24
5.24
5.24
5.27
5.26
5.31
5.27
5.25
5.25 p
4.94
4.91
4.85
4.86
4.88
5.01
5.00
5.02
4.97
5.01
5.20
5.20
5.19
5.13
5.11
5.08
5.09
5.10
5.13
5.11
5.10
5.07
5.10
5.12
5.10
5.11
5.33
5.28
5.24
5.25
5.26
5.25
5.21
5.20
5.16
5.18
5.18
5.18
5.19
5.47
5.50
5.49
5.45
5.45
5.46
5.46
5.45
5.45
5.43
5.43
5.44
5.44
5.23
5.26
5.22
5.22
5.23
5.29
5.24
5.25
5.24
5.27
5.26
5.25
--
5.22
5.14
5.10
5.11
5.11
5.13
5.09
5.08
5.01
5.00
4.99
4.98
5.00
5.09
5.00
4.96
4.98
4.98
5.01
4.97
4.97
4.91
4.89
4.88
4.86
4.87
5.20
5.12
5.09
5.11
5.11
5.13
5.10
5.11
5.05
5.05
5.04
5.02
5.01
5.30
5.23
5.21
5.22
5.23
5.25
5.23
5.23
5.19
5.19
5.18
5.16
5.15
2.49
2.41
2.38
2.40
2.42
2.42
2.38
2.38
2.35
2.35
2.32
2.28
2.30
2.58
2.50
2.47
2.50
2.51
2.49
2.46
2.47
2.43
2.44
2.42
2.39
2.38
6.81
6.75
6.72
6.74
6.74
6.75
6.72
6.72
6.67
6.67
6.68
6.65
--
--------------
--------------
--------------
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 38 of 39
Appendix Table 2
Money Aggregates
Seasonally Adjusted
Period
Annual growth rates (%):
Annually (Q4 to Q4)
2003
2004
2005
M2
1
2
Nontransactions
Components in M2
3
7.4
5.4
0.3
5.5
5.3
4.0
5.0
5.3
5.1
Quarterly (average)
2005-Q3
Q4
2006-Q1
Q2
0.8
-0.3
2.4
1.1
4.5
5.0
6.3
3.2
5.5
6.4
7.3
3.8
Monthly
2005-July
Aug.
Sep.
Oct.
Nov.
Dec.
-4.9
6.7
-3.0
0.3
0.6
-5.7
3.9
5.7
5.6
5.3
3.5
5.0
6.2
5.5
7.9
6.7
4.3
7.8
11.8
-5.5
7.8
4.9
2.6
-20.4
1.7
11.0
3.4
2.7
4.0
1.1
5.9
4.7
10.8
5.7
1.4
3.7
0.8
12.7
5.5
1375.9
1384.9
1390.6
1393.6
1369.9
6752.2
6767.5
6790.0
6796.5
6829.9
5376.4
5382.6
5399.4
5403.0
5460.0
5
12
19
26
1382.7
1356.3
1357.2
1373.5
6808.3
6806.7
6838.6
6849.4
5425.5
5450.4
5481.5
5475.9
3
10
17p
24p
1402.6
1373.3
1352.9
1372.4
6870.2
6860.4
6860.5
6855.6
5467.6
5487.1
5507.6
5483.2
2006-Jan.
Feb.
Mar.
Apr.
May
June
July e
Levels ($billions):
Monthly
2006-Feb.
Mar.
Apr.
May
June
Weekly
2006-June
July
p
e
M1
preliminar y
estimated
Class I FOMC - Restricted Controlled (FR)
Page 39 of 39
Appendix Table 3
Changes in System Holdings of Securities 1
(Millions of dollars, not seasonally adjusted)
August 3, 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 QII
QIII
QIV
2006 QI
QII
2005 Dec
2,010
---
2,010
---
3,495
1,708
1,015
1,305
4,914
---
6,923
1,082
1,361
2,443
4,743
1,512
-----
4,743
1,512
1,298
1,596
5,025
2,789
1,118
800
90
902
757
189
6,774
5,897
-----
11,517
7,410
964
-1,202
1,538
-1,293
2,502
-2,496
4,099
---
-----
4,099
---
1,200
1,375
7,443
6,063
1,704
1,181
1,219
---
1,321
1,217
10,245
7,402
-----
14,345
7,402
793
-627
1,839
-4,413
2,631
-5,040
---
---
---
---
---
---
---
---
---
---
---
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
Jun
Jul
--1,649
-----
--1,649
-----
2,650
549
1,080
---
-----
--3,931
3,730
-3,382
-----
3,730
-1,733
-2,633
-909
-2,077
110
-4,710
-800
2006 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
Jun 28
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-2,352
2,334
-1,000
-3,000
-3,352
-666
Jul 5
Jul 12
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
-----
3,395
-6,958
5,000
---
8,395
-6,958
Jul 19
Jul 26
1,649
---
-----
1,649
---
-----
549
---
-----
-----
3,931
---
-3,382
---
-----
-1,733
---
6,023
-6,472
-4,000
3,000
2,023
-3,472
Aug 2
---
---
---
---
---
---
---
---
---
---
---
5,587
---
5,587
2006 Aug 3
---
---
---
---
---
---
---
---
---
---
---
-2,255
-3,000
-5,255
1,649
---
1,649
---
549
---
---
3,931
-3,382
---
-1,733
597
1,000
1,597
277.0
128.2
218.6
61.4
79.7
487.9
---
764.8
-18.3
12.0
-6.3
Intermeeting Period
Jun 29-Aug 3
Memo: LEVEL (bil. $)
Aug 3
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, August 7). Bluebook. Bluebooks, Federal Reserve. https://whenthefedspeaks.com/doc/bluebook_20060808
BibTeX
@misc{wtfs_bluebook_20060808,
author = {Federal Reserve},
title = {Bluebook},
year = {2006},
month = {Aug},
howpublished = {Bluebooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/bluebook_20060808},
note = {Retrieved via When the Fed Speaks corpus}
}