greenbooks · October 23, 2012
Greenbook/Tealbook
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 01/05/2018.
Authorized for Public Release
Class I FOMC – Restricted Controlled (FR)
Report to the FOMC
on Economic Conditions
and Monetary Policy
Book B
Monetary Policy:
Strategies and Alternatives
October 18, 2012
Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
The top panel of the first exhibit, “Policy Rules and the Staff Projection,”
provides near-term prescriptions for the federal funds rate from six policy rules: the
Taylor (1993) rule, the Taylor (1999) rule, the inertial Taylor (1999) rule, the outcomebased rule, the first-difference rule, and the nominal income targeting rule.1 These
prescriptions take as given the staff’s baseline projections for real activity and inflation in
2012 and 2013. Medium-term prescriptions derived from dynamic simulations of each
rule are discussed below. As shown in the left-hand columns, all but one of the near-term
prescriptions keep the federal funds rate at the effective lower bound through the first
quarter of 2013. Only the Taylor (1993) rule, which puts relatively less weight on the
output gap, prescribes an increase in the target federal funds rate, to 165 basis points for
the fourth quarter of 2012 and 140 basis points for the first quarter of 2013.
The right-hand columns display the rule prescriptions that arise in the absence of
the lower-bound constraint. The outcome-based rule, the first-difference rule, and the
inertial Taylor (1999) rule prescribe federal funds rates that are near zero for the next two
quarters, while the Taylor (1999) rule and the nominal income targeting rule prescribe
rates further below zero. The more-accommodative prescriptions under the latter two
rules reflect their stronger immediate response of the rules to the staff’s estimate of the
output gap, which remains appreciably negative.2
The Tealbook baseline projections for the output gap and inflation are shown in
the bottom half of the exhibit, titled “Key Elements of the Staff Projection.” Over the
near term, the outlook for inflation is essentially unchanged from the previous Tealbook.
From 2017 through 2019, the staff has revised up its forecast of core inflation from just
under 2 percent to just over 2 percent, consistent with the change in the staff outlook for
the output gap, which is narrower over the medium term than in September and turns
slightly positive in the third quarter of 2016. As described in Book A of the Tealbook,
the projected path of the output gap is narrower than in the September projection
primarily for two reasons. First, the staff has revised down its estimate of the level of
potential GDP at the end of 2012 (but not its growth rate going forward) by nearly
1
Details for each rule appear in Explanatory Note A.
Although the rule prescriptions are not constrained to be at or above the lower bound, the inertial
Taylor (1999) rule, the outcome-based rule, and the nominal income targeting rule all include and place
material weight on the lagged federal funds rate, which was subject to the lower-bound constraint.
2
Page 1 of 53
Strategies
Monetary Policy Strategies
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October 18, 2012
Strategies
Policy Rules and the Staff Projection
Near-Term Prescriptions of Selected Policy Rules
Constrained Policy
Unconstrained Policy
2012Q4
2013Q1
2012Q4
2013Q1
Taylor (1993) rule
Previous Tealbook
1.65
1.53
1.40
1.30
1.65
1.53
1.40
1.30
Taylor (1999) rule
Previous Tealbook
0.13
0.13
0.13
0.13
−0.36
−0.76
−0.63
−0.98
Inertial Taylor (1999) rule
Previous Tealbook
0.13
0.13
0.13
0.13
0.07
0.01
−0.04
−0.14
Outcome-based rule
Previous Tealbook
0.13
0.13
0.13
0.13
0.10
−0.02
−0.05
−0.23
First-difference rule
Previous Tealbook
0.13
0.13
0.23
0.13
0.11
0.03
0.23
0.04
Nominal income targeting rule
Previous Tealbook
0.13
0.13
0.13
0.13
−0.21
−0.41
−0.55
−0.86
Memo: Equilibrium and Actual Real Federal Funds Rate
Tealbook-consistent FRB/US r* estimate
Actual real federal funds rate
Current
Tealbook
Current Quarter Estimate
as of Previous Tealbook
Previous
Tealbook
−1.90
−1.47
−2.11
−2.39
−1.67
Key Elements of the Staff Projection
GDP Gap
3
2
PCE Prices ex. Food and Energy
Percent
3
Current Tealbook
Previous Tealbook
2
1
1
0
0
-1
-1
-2
-2
-3
-3
-4
-4
-5
-5
-6
-6
-7
-7
-8
2012 2013 2014 2015 2016 2017 2018 2019 2020
-8
4.0
Four-quarter percent change
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
2012 2013 2014 2015 2016 2017 2018 2019 2020
0.0
Note: Estimates of r* may change at the beginning of a quarter even when the staff outlook is unchanged because the twelve-quarter horizon covered by
the calculation has rolled forward one quarter. Therefore, whenever the Tealbook is published early in the quarter, the memo includes a third column
labeled "Current Quarter Estimate as of Previous Tealbook."
Page 2 of 53
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October 18, 2012
½ percent, thus narrowing the output gap. Second, over the medium term, economic
September projection, reflecting the policy accommodation provided by the Committee at
the September meeting. Because of the narrowing in the output gap, the near-term
prescriptions from the unconstrained rules have risen a bit compared with those in the
September Tealbook.
The top panel of the first exhibit also reports the Tealbook-consistent estimate of
short-run r*, which is generated by the FRB/US model when conditioned on the staff’s
outlook for the economy. The short-run r* estimate corresponds to the real federal funds
rate that, if maintained, would return output to potential in twelve quarters. Reflecting
the staff’s revision to the output gap, the r* estimate is 20 basis points higher than in the
September Tealbook. However, at 1.9 percent, it remains below the estimated actual
real federal funds rate of about 1½ percent.
The second exhibit, “Policy Rule Simulations,” reports dynamic simulations using
the FRB/US model that incorporate the endogenous responses of inflation and the output
gap to the different paths of the federal funds rate prescribed by the constrained versions
of the six policy rules described above. The model is adjusted to match the staff’s
baseline outlook for the economy and then simulated using each of the policy rules. Each
rule is implemented from the fourth quarter of 2012 onward, under the assumption that
private agents fully understand and anticipate the implications of the rule for future real
activity, inflation, and interest rates.3 For comparison, the exhibit also displays the
Tealbook baseline paths, which are conditioned on the prescriptions of the outcomebased rule, adjusted to be consistent with the Committee’s September 2012 policy
guidance.4
3
The staff’s baseline forecast incorporates the effects of the asset purchase programs that the FOMC
has undertaken in recent years, as well as the effects of the new flow-based asset purchases that the
Committee began in September, the ongoing maturity extension program, and the modifications to the
Federal Reserve’s reinvestment policies that were announced in September 2011. Via this procedure, the
policy rule simulations incorporate the effects of these balance sheet policies; the rules themselves are not
directly adjusted for the effects of balance sheet policies.
4
As discussed in Book A of the Tealbook, the staff projection for the federal funds rate follows the
estimated outcome-based rule, augmented with an intercept adjustment that reflects the Committee’s
forward guidance announcement at the end of its September meeting. The adjustment is calibrated to delay
the first increase in the federal funds rate until the third quarter of 2015 under the economic outlook in the
September Tealbook. Beginning in the third quarter of 2015, this intercept adjustment is steadily reduced
and is zero beginning in the fourth quarter of 2017.
Page 3 of 53
Strategies
activity is now projected to increase at a somewhat faster pace than was the case in the
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October 18, 2012
Strategies
Policy Rule Simulations
Nominal Federal Funds Rate
7
6
5
Real Federal Funds Rate
Percent
7
Taylor (1993) rule
Taylor (1999) rule
Inertial Taylor (1999) rule
Nominal income targeting rule
First-difference rule
Tealbook baseline
6
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
5
4
4
3
3
2
2
1
1
0
0
-1
4
2012 2013 2014 2015 2016 2017 2018 2019 2020
-1
-3
Unemployment Rate
10
-3
PCE Inflation
Percent
10
9
4.0
Four-quarter average
Percent
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
9
8
8
7
7
6
6
5
4
2012 2013 2014 2015 2016 2017 2018 2019 2020
5
2012 2013 2014 2015 2016 2017 2018 2019 2020
4
0.0
2012 2013 2014 2015 2016 2017 2018 2019 2020
Note: The policy rule simulations in this exhibit are based on rules that respond to core inflation. This choice
of rule specification was made in light of the tendency for current and near-term core inflation rates to outperform
headline inflation rates as predictors of the medium-term behavior of headline inflation.
Page 4 of 53
0.0
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October 18, 2012
In the Tealbook baseline, the federal funds rate departs from the effective lower
Reflecting the forward guidance in the September statement, the Tealbook baseline keeps
the interest rate at its effective lower bound longer than what would otherwise be
prescribed.5 The federal funds rate increases to 4¼ percent by the second quarter of
2018, and hovers around that level through the end of the forecast period. The
unemployment rate drops below 7 percent in 2015 and is expected to reach the staff’s
long-term estimate of the natural rate of unemployment by mid-2017.6 Headline inflation
is projected to average about 1.4 percent until the end of 2014, then rise slowly toward
2 percent.
The Taylor (1993) rule initially prescribes a tighter path for the federal funds rate
than the other rules. As noted above, because the Taylor (1993) rule does not respond
very strongly to the level of the output gap, it calls for an immediate increase in the
federal funds rate to 160 basis points. The higher federal funds rate makes real activity
and inflation weaker than in the baseline, prompting a partial reversal of the initial rate
increase. Reflecting the early tightening, however, the rule implies a higher
unemployment rate initially as well as lower levels of inflation over the whole projection
period.
While the first-difference rule does not call for an increase in the federal funds
rate until the first quarter of 2014, it implies policy rates from the fourth quarter of 2015
until the third quarter of 2017 that are higher than under all of the other rules. Because of
the more-elevated average federal funds rate, the unemployment rate is higher and
inflation lower in the near term.
Compared with the Taylor (1993) rule, the Taylor (1999) rule leads to a later
tightening of policy and produces generally lower unemployment rates and slightly
higher inflation rates over the projection period. However, because the policy rate is
higher under the Taylor (1999) rule than in the baseline, the rule produces worse
outcomes. The unemployment rate slowly converges to the staff’s estimate of the
5
Because of this adjustment, the baseline path for the federal funds rate includes a more rapid increase
in the funds rate after liftoff than in past Tealbooks. The extent of the policy tightening implied by the rule
between the third quarter of 2015 and the second quarter of 2018 is roughly comparable to the actual
tightening observed between the second quarter of 2004 and the third quarter of 2006, when the overall
increase in the federal funds rate was 425 basis points.
6
The staff’s estimate of the effective natural rate of unemployment declines from about 6¼ percent in
the fourth quarter of 2012 to 5¼ percent by the end of 2017.
Page 5 of 53
Strategies
bound in the third quarter of 2015, one year later than in the September Tealbook.
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effective natural rate of unemployment while inflation, after declining to 1 percent,
Strategies
gradually increases to the 2 percent goal.
Under the inertial Taylor (1999) rule, the first increase of the federal funds rate
takes place in the second quarter of 2014, one quarter before the Taylor (1999) rule
would initiate tightening. This earlier firming of policy reflects the fact that the inertial
Taylor (1999) rule subsequently prescribes a slower pace of policy tightening with higher
future inflation, thereby generating a lower average path for the real federal funds rate
through the rest of the decade, and so fueling a more rapid pickup in real activity and a
lower path for the unemployment rate. The unemployment gap closes by mid-2017,
when inflation is about 2 percent.
Under the nominal income targeting rule, the initial increase in the federal funds
rate occurs in the fourth quarter of 2014, and for several years thereafter policy is
generally more accommodative than under the other rules. In particular, the average
level of the real federal funds rate through the rest of the decade is markedly lower than
in the baseline. This more-accommodative policy is reflected in a more-rapid decline of
the unemployment rate, culminating in a period in which it is below the natural rate,
while inflation is uniformly higher than in the Tealbook baseline and modestly exceeds
its 2 percent longer-run objective for a few years.
The next exhibit, “Constrained vs. Unconstrained Optimal Control Policy,”
compares optimal control simulations derived for this Tealbook with those shown in
September.7 In these simulations, policymakers are assumed to place equal weights on
keeping headline PCE inflation close to the Committee’s 2 percent goal, on keeping the
unemployment rate close to the staff’s estimate of the effective natural rate of
unemployment, and on minimizing changes in the federal funds rate. The simulations
indicate that, with the federal funds rate constrained to remain positive, the optimal
control path for the federal funds rate does not rise above the effective lower bound until
the fourth quarter of 2015, the same as reported in the September Tealbook; the optimal
path is also little revised beyond 2015.8
7
The optimal policy simulations incorporate the assumptions about underlying economic conditions
used in the staff’s baseline forecast, including the assumptions about balance sheet policy described above.
8
Although the loss function uses headline inflation instead of core inflation, the real federal funds rate
shown in the upper right panel of the exhibit is calculated as the difference between the nominal federal
funds rate and a four-quarter moving average of core PCE inflation. Core PCE inflation is used to compute
Page 6 of 53
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Nominal Federal Funds Rate
8
7
6
Real Federal Funds Rate
Percent
8
Current Tealbook: Constrained
Previous Tealbook: Constrained
Current Tealbook: Unconstrained
Tealbook baseline
7
4
Percent
4
3
3
2
2
1
1
6
5
5
4
4
3
3
0
0
2
2
-1
-1
1
1
-2
-2
-3
-3
-4
-4
0
0
-1
-1
-2
-2
-3
2012 2013 2014 2015 2016 2017 2018 2019 2020
-3
-5
Unemployment Rate
10
-5
PCE Inflation
Percent
10
9
Four-quarter average
4.0
Percent
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
9
8
8
7
7
6
6
5
4
2012 2013 2014 2015 2016 2017 2018 2019 2020
5
2012 2013 2014 2015 2016 2017 2018 2019 2020
4
0.0
Page 7 of 53
2012 2013 2014 2015 2016 2017 2018 2019 2020
0.0
Strategies
Constrained vs. Unconstrained Optimal Control Policy
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October 18, 2012
The stability of the optimal policy path across the September and October
Strategies
Tealbooks may seem surprising in light of the staff’s substantial downward revision in its
projection for the unemployment rate in response to favorable incoming data, the
Committee’s decision to continue expanding its securities holdings until the outlook for
the labor market improves substantially, and a lower path for the federal funds rate. The
first two of these factors have caused the FRB/US estimate of r* to rise since the
September Tealbook, and by themselves they would have led to tighter optimal policy as
well. In contrast to r*, however, optimal policy also depends on the outlook for inflation.
As shown in the bottom panel of the first exhibit, the staff has not appreciably changed its
forecast for inflation. From the FRB/US model’s perspective, this stability is surprising:
Given the staff’s projection for stronger real activity, the model would have predicted
noticeably higher inflation in both the near term and the longer run.9 For this reason, it is
necessary to shift down the intercepts of the model’s wage and price equations to match
the staff forecast prior to running the optimal control exercise. These adjustments lower
the underlying outlook for inflation in the matched baseline, which essentially offsets the
upward revision to the underlying outlook for real activity in the baseline, leaving the
optimal path for the federal funds rate little changed, on net.
The constrained optimal control policy would promote a faster pace of economic
recovery than in the staff’s baseline outlook by raising rates more slowly than under any
of the simple rules, while still keeping inflation close to the Committee’s goal of
2 percent over the medium term. In this set of simulations, the gap between the
unemployment rate and the staff’s estimate of the effective natural rate of unemployment
is closed by the fourth quarter of 2015, and the unemployment rate subsequently runs
below the natural rate for a few years. Inflation initially exhibits a smaller decline than in
the Tealbook baseline, after which it increases to the 2 percent objective by the third
quarter of 2016 and then overshoots slightly, peaking at about 2¼ percent in 2018 and
gradually returning to the 2 percent objective thereafter. The more-rapid convergence to
the Committee’s assumed objectives than in the Tealbook baseline, and the subsequent
temporary overshooting, occur because policymakers respond to the lower bound
the real rate for this illustrative purpose because it provides a less volatile measure of inflation expectations
than does a four-quarter moving average of headline inflation.
9
In many respects, the staff’s view of inflation dynamics is similar to that generated by the model’s
New Keynesian Phillips curve. However, the staff generally views inflation as being much less sensitive to
expected future economic conditions than is the case in the FRB/US model when run under rational
expectations (as is the case in the optimal control exercise). In general, future economic conditions
influence the staff inflation forecast only to the extent that they affect the survey measures of expected
long-run inflation that underpin the staff’s forecast.
Page 8 of 53
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October 18, 2012
constraint by promising to keep interest rates low for an extended period of time. As this
real interest rates during the initial years of the simulation.
If the nominal federal funds rate could fall below zero, the funds rate, under the
optimal unconstrained policy, would decrease to 2.4 percent in the third quarter of 2013
and return to positive territory by the second quarter of 2015. Under these conditions, the
unemployment rate would decline more rapidly than under the optimal constrained
policy. Inflation would return to 2 percent by the second quarter of 2016, a pattern much
like that in the constrained simulation. In subsequent years, inflation would slightly
exceed the 2 percent objective—but less persistently than in the constrained case.
The fourth exhibit, “Outcomes under Alternative Policies,” tabulates the
simulation results for key variables under the selected policy rules described above.
Page 9 of 53
Strategies
policy is assumed to be completely credible, it boosts inflation expectations and reduces
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October 18, 2012
Outcomes under Alternative Policies
Strategies
(Percent change, annual rate, from end of preceding period except as noted)
Measure and scenario
2012
H1
2013 2014 2015 2016
H2
Real GDP
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
1.6
1.6
1.6
1.6
1.6
1.6
1.6
2.0
2.0
2.0
2.0
2.0
2.0
2.2
2.6
1.6
2.2
2.5
2.0
2.8
3.0
3.5
2.8
3.1
3.3
2.9
3.7
3.8
3.7
3.5
3.4
3.6
3.3
3.8
4.0
3.1
3.5
3.2
3.2
3.2
3.3
3.2
Unemployment rate1
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
8.2
8.2
8.2
8.2
8.2
8.2
8.2
8.0
8.0
8.0
8.0
8.0
8.0
8.0
7.8
8.1
7.9
7.8
8.0
7.7
7.6
7.2
7.9
7.5
7.3
7.7
7.0
6.8
6.2
7.2
6.8
6.4
7.0
6.0
5.7
5.5
6.3
6.0
5.7
6.3
5.2
5.0
Total PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.9
1.7
1.8
1.9
1.8
2.1
2.2
1.3
0.9
1.0
1.3
1.0
1.6
1.6
1.4
1.0
1.1
1.4
1.1
1.7
1.7
1.5
1.0
1.2
1.5
1.2
1.8
1.8
1.8
1.3
1.4
1.8
1.5
2.1
2.1
Core PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
2.0
2.0
2.0
2.0
2.0
2.0
2.0
1.3
1.1
1.1
1.3
1.1
1.4
1.5
1.6
1.3
1.3
1.6
1.3
1.9
1.9
1.7
1.2
1.4
1.7
1.4
2.0
2.0
1.7
1.2
1.4
1.8
1.4
2.1
2.0
1.9
1.4
1.5
1.9
1.6
2.2
2.2
Federal funds rate1
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.1
1.6
0.1
0.1
0.1
0.1
0.1
0.1
1.1
0.1
0.1
0.2
0.1
0.1
0.1
1.4
0.6
0.6
0.9
0.3
0.1
0.7
2.1
1.8
1.5
2.2
1.3
0.4
2.6
2.9
3.0
2.6
3.2
2.4
2.0
1. Percent, average for the final quarter of the period.
Page 10 of 53
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Monetary Policy Alternatives
This Tealbook presents three policy alternatives—labeled A, B, and C—for the
Committee’s consideration. As always, the Committee could blend elements of the draft
statements to construct its desired statement.
The draft statement for Alternative B is largely unchanged from the September
statement. In particular, it begins by observing that economic activity has continued to
expand at a moderate pace in recent months, that growth in employment has been slow,
and that the unemployment rate remains elevated—all as in the September statement. It
business fixed investment has slowed.” Alternative A contains much the same language
except that it describes consumer spending with the words of the September statement:
“household spending has continued to advance.” Alternative C offers a somewhat more
positive characterization of the data by noting that economic activity has expanded
moderately “despite the adverse effects of the drought on agricultural production” and
that “private domestic demand has continued to advance.” Moreover, Alternative C says
that “employment has increased further” and that “the unemployment rate, though still
elevated, has declined.” Alternatives A and B again note “some further signs of
improvement” in the housing sector, “albeit from a depressed level,” while Alternative C
notes the improvement but not the depressed level. With respect to inflation, Alternatives
A and B say that it “recently picked up somewhat, reflecting higher energy prices.”
Alternative C suggests greater concern by stating that inflation “recently picked up,
mainly reflecting higher energy prices.” Each alternative indicates that longer-term
inflation expectations have remained stable.
Alternatives A and B also differ from Alternative C in how they communicate the
outlook for real activity and employment. The language in Alternatives A and B is
essentially the same as in the September statement, reiterating the Committee’s concern
that economic growth might not, on its own, be strong enough to generate sustained
improvement in labor market conditions. Alternative B says that growth might not be
strong enough unless there is “sufficient” policy accommodation, while the September
statement said “further” policy accommodation. Alternative A retains “further,” which
some market participants might read as a signal that the Committee sees a need for more
stimulus than will be provided by the flow-based asset purchases that it announced in
Page 11 of 53
Alternatives
then notes that household spending “has advanced a bit more quickly, but growth in
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October 18, 2012
September. Alternative C indicates that the Committee expects economic growth to pick
up gradually and consequently anticipates that the unemployment rate will continue to
decline; this observation sets the stage for ending asset purchases upon completion of the
maturity extension program (MEP) and for moving closer the projected start of policy
normalization. All of the draft statements continue to highlight the significant downside
risks to the outlook from strains in global financial markets. With respect to inflation,
Alternatives A and B say, as in the September statement, that the Committee anticipates
that inflation over the medium term “likely would run at or below its 2 percent
objective.” Alternative C says the Committee anticipates that inflation over the medium
term “will run near its 2 percent objective.”
Alternatives
The alternatives also offer different approaches to balance sheet policy.
Alternative B maintains both the asset purchases and the language the Committee
adopted in September: Purchases of agency MBS would continue at a pace of $40 billion
per month and the MEP would run through year-end; the statement would again indicate
that the Committee “will continue its purchases of agency mortgage-backed securities,
undertake additional asset purchases, and employ its other policy tools as appropriate” if
it does not observe substantial improvement in the outlook for labor market conditions in
coming months. Alternative A would state explicitly that purchases of agency MBS will
continue at a pace of $40 billion per month beyond the turn of the year and that the
Committee will buy longer-term Treasury securities at a pace of $45 billion per month
after completing the MEP. Alternative A also offers new language that is intended to
give the public additional information about the factors the Committee will consider in
deciding how long to continue asset purchases. In contrast, Alternative C implies that
purchases of both MBS and Treasury securities will stop at year-end. All three
alternatives envision that the Committee will continue to reinvest principal payments on
its holdings of agency MBS and agency debt into MBS.
Under each alternative, the Committee would maintain the 0 to ¼ percent target
range for the federal funds rate. Alternatives A and B indicate that the Committee
anticipates maintaining exceptionally low levels of the funds rate “at least through mid2015,” as in the September statement. Both alternatives also retain the language that says
“the Committee expects that a highly accommodative stance of monetary policy will
remain appropriate for a considerable time after the economic recovery strengthens.”
Alternative C offers the choice of retaining the words “for a considerable time” or
replacing them with “for some time”; it also offers a choice between specifying an earlier
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anticipated date for the first increase in the federal funds rate or replacing the current
forward guidance with new language that describes factors the Committee will consider
in deciding when to raise its target for the funds rate but does not include a date.
The following table summarizes key elements of the alternative statements. The
table is followed by complete draft statements and then by a summary of the arguments
Alternatives
for each alternative.
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Table 1: Overview of Policy Alternatives for the October 24 FOMC Statement
Selected
Elements
September
Statement
October Alternatives
A
B
C
Economic Outlook
Alternatives
Outlook
. . . expects economic growth to be
moderate over coming quarters and
. . . without further policy
. . . remains concerned . . . remains concerned then to pick up gradually,
accommodation, economic
that, without further
that, without sufficient supported in part by the highly
growth might not be strong
policy accommodation, policy accommodation, accommodative stance of monetary
enough to generate sustained
economic growth might economic growth might policy, and consequently
improvement in labor market
not be strong enough to not be strong enough to anticipates that the unemployment
conditions.
generate sustained
generate sustained
rate will continue to decline toward
improvement in labor
improvement in labor
levels the Committee judges
. . . anticipates that inflation
market conditions.
market conditions.
consistent with its dual mandate.
over the medium term likely
would run at or below its
Unchanged
Unchanged
. . . anticipates that inflation over
2 percent objective.
the medium term will run near its
2 percent objective.
Balance Sheet
Continue its program as
announced in June
Ends in December
Additional
Asset
Purchases
$40 billion per month
additional MBS
Continue MBS
purchases at $40 billion
per month after the end
of the year; purchase
Unchanged
longer-term Treasury
securities at $45 billion
per month after MEP
ends.
Continue MBS purchases at $40
billion per month through the end
of the year.
Reinvestment
Policies
Reinvest principal payments
from agency debt and MBS
into agency MBS.
Unchanged
Unchanged
Guidance
If the outlook for the labor
market does not improve
substantially, the Committee
will continue its purchases
of agency mortgage-backed
securities, undertake
additional asset purchases,
and employ its other policy
tools as appropriate until
such improvement is
achieved in a context of
price stability.
The Committee will
continue purchases of
agency MBS and
Treasury securities until
it judges that data on
economic activity and
Unchanged
labor market conditions
are consistent with an
outlook for sustained
progress toward
maximum employment
and price stability.
MEP
Continues to year-end
Unchanged
Continues to year-end
The Committee is prepared to take
further action as needed to promote
sustained improvement in labor
market conditions in a context of
price stability.
Forward Rate Guidance
Guidance
Committee expects that a
highly accommodative
stance of monetary policy
will remain appropriate for a
considerable time after the
recovery strengthens;
Unchanged
. . . currently anticipates that
exceptionally low levels for
the federal funds rate are
likely warranted at least
through mid-2015.
Unchanged
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for [ a considerable | some ] time;
…at least through [ late 2014 |
mid-2014 | late 2013 ]
OR
In determining the appropriate time
to increase its target, the
Committee will consider actual and
projected labor market conditions,
medium-term outlook for inflation,
and risks to achievement of
Committee’s objectives.
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SEPTEMBER FOMC STATEMENT
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee is concerned that, without further policy
accommodation, economic growth might not be strong enough to generate sustained
improvement in labor market conditions. Furthermore, strains in global financial markets
continue to pose significant downside risks to the economic outlook. The Committee
also anticipates that inflation over the medium term likely would run at or below its 2
percent objective.
3. To support a stronger economic recovery and to help ensure that inflation, over time, is at
the rate most consistent with its dual mandate, the Committee agreed today to increase
policy accommodation by purchasing additional agency mortgage-backed securities at a
pace of $40 billion per month. The Committee also will continue through the end of the
year its program to extend the average maturity of its holdings of securities as announced
in June, and it is maintaining its existing policy of reinvesting principal payments from its
holdings of agency debt and agency mortgage-backed securities in agency mortgagebacked securities. These actions, which together will increase the Committee’s holdings
of longer-term securities by about $85 billion each month through the end of the year,
should put downward pressure on longer-term interest rates, support mortgage markets,
and help to make broader financial conditions more accommodative.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months. If the outlook for the labor market does not improve
substantially, the Committee will continue its purchases of agency mortgage-backed
securities, undertake additional asset purchases, and employ its other policy tools as
appropriate until such improvement is achieved in a context of price stability. In
determining the size, pace, and composition of its asset purchases, the Committee will, as
always, take appropriate account of the likely efficacy and costs of such purchases.
5. To support continued progress toward maximum employment and price stability, the
Committee expects that a highly accommodative stance of monetary policy will remain
appropriate for a considerable time after the economic recovery strengthens. In
particular, the Committee also decided today to keep the target range for the federal funds
rate at 0 to ¼ percent and currently anticipates that exceptionally low levels for the
federal funds rate are likely to be warranted at least through mid-2015.
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Alternatives
1. Information received since the Federal Open Market Committee met in August suggests
that economic activity has continued to expand at a moderate pace in recent months.
Growth in employment has been slow, and the unemployment rate remains elevated.
Household spending has continued to advance, but growth in business fixed investment
appears to have slowed. The housing sector has shown some further signs of
improvement, albeit from a depressed level. Inflation has been subdued, although the
prices of some key commodities have increased recently. Longer-term inflation
expectations have remained stable.
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OCTOBER FOMC STATEMENT—ALTERNATIVE A
Alternatives
1. Information received since the Federal Open Market Committee met in August
September suggests that economic activity has continued to expand at a moderate pace
in recent months. Growth in employment has been slow, and the unemployment rate
remains elevated. Household spending has continued to advance, but growth in business
fixed investment appears to have has slowed. The housing sector has shown some
further signs of improvement, albeit from a depressed level. Inflation has been subdued,
although the prices of some key commodities have increased recently picked up
somewhat, reflecting higher energy prices. Longer-term inflation expectations have
remained stable.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee is remains concerned that, without
further policy accommodation, economic growth might not be strong enough to generate
sustained improvement in labor market conditions. Furthermore, strains in global
financial markets continue to pose significant downside risks to the economic outlook.
The Committee also anticipates that inflation over the medium term likely would run at
or below its 2 percent objective.
3. To support a stronger economic recovery and to help ensure that inflation, over time, is at
the rate most consistent with its dual mandate, the Committee agreed today to increase
policy accommodation by continue purchasing additional agency mortgage-backed
securities at a pace of $40 billion per month after the end of the year. The Committee
also will continue through the end of the year agreed to purchase longer-term
Treasury securities at a pace of $45 billion per month after its program to extend the
average maturity of its holdings of Treasury securities as announced in June, and it ends
in December. The Committee is maintaining its existing policy of reinvesting principal
payments from its holdings of agency debt and agency mortgage-backed securities in
agency mortgage-backed securities. These actions, which together will increase the
Committee’s holdings of longer-term securities by about $85 billion each month through
the end of the year, should put downward pressure on longer-term interest rates, support
mortgage markets, and help to make broader financial conditions more accommodative.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months. If the outlook for the labor market does not improve
substantially, The Committee will continue its purchases of agency mortgage-backed
securities and Treasury securities, undertake additional asset purchases, and employ its
other policy tools as appropriate, until such improvement is achieved it judges that data
on economic activity and labor market conditions are consistent with an outlook for
sustained progress toward maximum employment in a context of price stability. In
determining the size, pace, and composition of its asset purchases, the Committee will, as
always, take appropriate account of the likely efficacy and costs of such purchases.
5. To support continued progress toward maximum employment and price stability, the
Committee expects that a highly accommodative stance of monetary policy will remain
appropriate for a considerable time after the economic recovery strengthens. In
particular, the Committee also decided today to keep the target range for the federal funds
rate at 0 to ¼ percent and currently anticipates that exceptionally low levels for the
federal funds rate are likely to be warranted at least through mid-2015.
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OCTOBER FOMC STATEMENT—ALTERNATIVE B
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee is remains concerned that, without
further sufficient policy accommodation, economic growth might not be strong enough
to generate sustained improvement in labor market conditions. Furthermore, strains in
global financial markets continue to pose significant downside risks to the economic
outlook. The Committee also anticipates that inflation over the medium term likely
would run at or below its 2 percent objective.
3. To support a stronger economic recovery and to help ensure that inflation, over time, is at
the rate most consistent with its dual mandate, the Committee agreed today to increase
policy accommodation by will continue purchasing additional agency mortgage-backed
securities at a pace of $40 billion per month. The Committee also will continue through
the end of the year its program to extend the average maturity of its holdings of Treasury
securities as announced in June, and it is maintaining its existing policy of reinvesting
principal payments from its holdings of agency debt and agency mortgage-backed
securities in agency mortgage-backed securities. These actions, which together will
increase the Committee’s holdings of longer-term securities by about $85 billion each
month through the end of the year, should put downward pressure on longer-term interest
rates, support mortgage markets, and help to make broader financial conditions more
accommodative.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months. If the outlook for the labor market does not improve
substantially, the Committee will continue its purchases of agency mortgage-backed
securities, undertake additional asset purchases, and employ its other policy tools as
appropriate until such improvement is achieved in a context of price stability. In
determining the size, pace, and composition of its asset purchases, the Committee will, as
always, take appropriate account of the likely efficacy and costs of such purchases.
5. To support continued progress toward maximum employment and price stability, the
Committee expects that a highly accommodative stance of monetary policy will remain
appropriate for a considerable time after the economic recovery strengthens. In
particular, the Committee also decided today to keep the target range for the federal funds
rate at 0 to ¼ percent and currently anticipates that exceptionally low levels for the
federal funds rate are likely to be warranted at least through mid-2015.
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Alternatives
1. Information received since the Federal Open Market Committee met in August
September suggests that economic activity has continued to expand at a moderate pace
in recent months. Growth in employment has been slow, and the unemployment rate
remains elevated. Household spending has continued to advanced a bit more quickly,
but growth in business fixed investment appears to have has slowed. The housing sector
has shown some further signs of improvement, albeit from a depressed level. Inflation
has been subdued, although the prices of some key commodities have increased recently
picked up somewhat, reflecting higher energy prices. Longer-term inflation
expectations have remained stable.
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OCTOBER FOMC STATEMENT—ALTERNATIVE C
Alternatives
1. Information received since the Federal Open Market Committee met in August
September suggests that economic activity has continued to expand at a moderate pace
in recent months despite the adverse effects of the drought on agricultural
production. Growth in Employment has increased further been slow, and the
unemployment rate, remains though still elevated, has declined. Household spending
Private domestic demand has continued to advance, but growth in business fixed
investment appears to have slowed. The housing sector has shown some further signs of
improvement, albeit from a depressed level. Inflation has been subdued, although the
prices of some key commodities have increased recently picked up, mainly reflecting
higher energy prices; however, longer-term inflation expectations have remained stable.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee is concerned that, without further policy
accommodation, economic growth might not be strong enough to generate sustained
improvement in labor market conditions expects economic growth to be moderate over
coming quarters and then to pick up gradually, supported in part by the highly
accommodative stance of monetary policy, and consequently anticipates that the
unemployment rate will continue to decline toward levels that the Committee judges
consistent with its dual mandate. Furthermore However, strains in global financial
markets continue to pose significant downside risks to the economic outlook. The
Committee also anticipates that inflation over the medium term likely would will run at
or below near its 2 percent objective.
3. To support a stronger economic recovery and to help ensure that inflation, over time, is at
the rate most consistent with its dual mandate, the Committee agreed today to increase
policy accommodation by continue purchasing additional agency mortgage-backed
securities at a pace of $40 billion per month through the end of the year. The
Committee also will continue through the end of the year its program to extend the
average maturity of its holdings of Treasury securities as announced in June, and it is
maintaining its existing policy of reinvesting principal payments from its holdings of
agency debt and agency mortgage-backed securities in agency mortgage-backed
securities. These actions, which together will increase the Committee’s holdings of
longer-term securities by about $85 billion each month through the end of the year,
should put downward pressure on longer-term interest rates, support mortgage markets,
and help to make broader financial conditions more accommodative.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months. If the outlook for the labor market does not improve
substantially, the Committee will continue its purchases of agency mortgage-backed
securities, undertake additional asset purchases, and employ its other policy tools as
appropriate until such improvement is achieved and is prepared to take further action
as needed to promote sustained improvement in labor market conditions in a context
of price stability. In determining the size, pace, and composition of its asset purchases,
the Committee will, as always, take appropriate account of the likely efficacy and costs of
such purchases.
5. To support continued progress toward maximum employment and price stability, the
Committee expects that a highly accommodative stance of monetary policy will remain
appropriate for [ a considerable | some ] time after the economic recovery strengthens. In
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particular, the Committee also decided today to keep the target range for the federal funds
rate at 0 to ¼ percent and currently anticipates that exceptionally low levels for the
federal funds rate are likely to be warranted at least through mid-2015 [ late 2014 | mid2014 | late 2013 ].
5'. To support continued progress toward maximum employment and in a context of price
stability, the Committee expects that a highly accommodative stance of monetary policy
will remain appropriate for [ a considerable | some ] time after the economic recovery
strengthens. In particular, the Committee also decided today to keep the target range for
the federal funds rate at 0 to ¼ percent and currently anticipates that exceptionally low
levels for the federal funds rate are likely to be warranted at least through mid-2015.
As rates of resource utilization rise toward levels consistent with maximum
employment, the Committee will need to make monetary policy less accommodative
in order to foster sustained economic expansion with inflation at its longer-run
objective. In determining the appropriate time to increase its target for the federal
funds rate, the Committee will consider a range of factors, including actual and
projected labor market conditions, the medium-term outlook for inflation, and the
risks to the achievement of the Committee’s objectives.
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Alternatives
OR
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THE CASE FOR ALTERNATIVE B
The Committee, like the staff, might judge that the near-term outlook for
economic activity now appears only modestly better than it did in mid-September and
that the medium-term outlook, while a little stronger, has improved primarily because the
policy steps the Committee took at its last meeting have made broader financial
conditions more accommodative. Participants might think that the outsized gain in
household employment reported for September, and the accompanying sharp drop in the
unemployment rate, probably overstate the recent gains in labor market conditions and
the improvement in the outlook for the labor market; policymakers may judge that the
more moderate gain in payrolls is the more reliable measure. If so, the Committee may
Alternatives
remain concerned that economic growth would not be adequate to return the
unemployment rate to its mandate-consistent level over the next several years without an
exceptionally accommodative monetary policy that includes continued asset purchases.
Policymakers might also see the inflationary pressure from increases in oil prices as
temporary and as likely to abate in the near future. Moreover, participants might note
that measures of medium- and longer-run inflation compensation remain within the
ranges seen during the past two years, that the median of longer-run expected inflation
from the Michigan survey has declined in recent months and is now a bit below its
average since 2005, and that the mean and median of the primary dealers’ forecasts for
inflation are essentially unchanged from their values ahead of the September FOMC
meeting. Accordingly, they might judge that inflation expectations remain well
anchored. For all these reasons, the Committee may consider it appropriate to stay on the
course it set in September.
Moreover, policymakers may judge that downside risks to the outlook for growth
in economic activity—particularly from the euro area crisis and unresolved U.S. fiscal
policy decisions—remain quite elevated. Specifically, they may see non-trivial odds that
the euro area crisis could deepen and impose a very substantial drag on the U.S. recovery.
Some policymakers may also see a sizable probability that the Congress and the
Administration will be unable to settle contentious fiscal issues in an orderly and timely
manner, and that fiscal policy could consequently tighten sharply at the turn of the year.
If so, they may judge it appropriate to keep policy unchanged for the time being while
retaining the option to adjust the pace and composition of the Committee’s asset
purchases.
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In light of the positive tone of some recent economic indicators and improved
market sentiment toward Europe, other policymakers may view the economic outlook as
somewhat brighter and see the risks to the outlook as having diminished since the
Committee last met. Even so, with the unemployment rate still well above participants’
estimates of its longer-run normal level and inflation for items other than energy prices
subdued, these participants might think it prudent to postpone a decision about whether to
continue asset purchases into 2013 until late this year, when they will have additional
information about the underlying strength of the economic recovery and the outlook for
fiscal policy.
Some participants may anticipate that labor market conditions will not improve
whether MBS purchases alone will be sufficient or whether purchases of longer-term
Treasury securities will prove necessary as well. Yet policymakers may also be uncertain
whether the benefits of an ongoing expansion of the Committee’s securities holdings will
outweigh the associated costs and risks. In either case, these participants may favor
making no change to the flow of asset purchases for the time being, because waiting will
allow them to learn more about the efficacy and costs of the flow-based program before
deciding whether to continue it beyond the turn of the year and, if so, whether to adjust
its pace and composition.
With respect to the forward guidance for the federal funds rate, some
policymakers may judge that explicit thresholds for unemployment and inflation would
more clearly communicate the Committee’s policy intentions than the language in the
September statement.1 But they might also think that the FOMC should explore the
implications of quantitative thresholds more fully before deciding whether to include
them in its statement. They also may judge that it would be better to introduce new
forward guidance at a meeting that will be followed by a press conference.
Accordingly, the Committee might agree that it is best to continue the current
pace and composition of its flow-based asset purchases at least until the end of the year
and to maintain both the target and forward guidance for the federal funds rate, as in
Alternative B.
1
For a detailed analysis of quantitative thresholds, see the memo by E. Engen, J.P. Laforte, D. LópezSalido, E. Nelson, W. Nelson, D. Reifschneider, and R. Tetlow, titled “Using Thresholds to Clarify the
Conditionality in the Committee’s Forward Guidance for the Federal Funds Rate,” which was distributed to
the Committee on October 16, 2012.
Page 21 of 53
Alternatives
substantially unless asset purchases continue well into next year but may be unsure
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The Desk’s latest survey of the primary dealers indicates that the median dealer
expects flow-based asset purchases to continue into the first quarter of 2014; no dealer
expects purchases to end before mid-2013. The survey also indicates that the dealers
expect the Committee to continue acquiring longer-term Treasury securities at a pace of
$45 billion per month after the MEP comes to a close. Thus the dealers appear to expect
the flow-based asset purchases to end later, and so to cumulate to a larger total, than
assumed in the baseline staff forecast.2 The results of the dealer survey also indicate that
the dealers expect no more than minor updating to the language of the statement and no
change in the forward guidance at this meeting. Thus, the survey suggests that a
statement along the lines of the draft for Alternative B would be in line with market
Alternatives
expectations, so it probably would result in little change in interest rates, equity prices, or
exchange rates.
THE CASE FOR ALTERNATIVE A
Members may instead conclude that the medium-term outlook remains
sufficiently weak to warrant making clear to the public that purchases of both agency
MBS and longer-term Treasury securities will continue well into next year, particularly
given that both core and headline inflation are running close to 1½ percent on a 12-month
basis. Moreover, they, like the staff, might project that inflation will continue to run well
below the Committee’s 2 percent longer-run objective for the next several years even
with asset purchases continuing to mid-2013. They also might judge that announcing in
the October FOMC statement that purchases of MBS and Treasury securities will
continue into next year would complement the forward guidance for the federal funds
rate that the Committee adopted in September. Moreover, policymakers may think that
continuing to purchase agency MBS at a pace of $40 billion per month would help
strengthen the emerging recovery in the housing sector, a development that they might
see as generating ancillary benefits such as raising consumer confidence, boosting
household wealth, and increasing access to credit. In addition, participants may see the
new language in paragraph 4 of the draft statement for Alternative A as desirable,
because it signals that the Committee will not end asset purchases at the first signs of
improvement in labor market conditions.
2
The staff forecast is conditioned on the assumption that asset purchases proceed at a rate of $85
billion per month until they end in mid-2013, and cumulate to about $750 billion. Of course, the
Committee has not fixed an end date or specified precisely the conditions that might warrant ending
purchases or adjusting their pace.
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Some members may judge that risks to the outlook stemming from U.S. fiscal
policy, the euro area crisis, and slowing growth in China are heavily weighted to the
downside. Moreover, members may view the consequences of a new adverse shock
while the economy remains weak as significantly more costly than the consequences of
some delay in tightening policy should economic performance or inflation surprise to the
upside. If so, they may see the degree of uncertainty about the outlook and the
asymmetry in risks and potential costs as arguing for providing clarity about future
monetary policy by announcing now that asset purchases will continue into next year.
These policymakers may want to adopt a statement such as the one presented in
Alternative A, which says explicitly that the Committee will continue to acquire both
The Desk’s latest survey shows that most dealers already predict that the FOMC
will continue to purchase both MBS and Treasury securities well beyond year-end and
expect an announcement to that effect after the December FOMC meeting, but they
anticipate little change in the Committee’s statement at this meeting. Thus, while the
content of a statement along the lines of Alternative A should not greatly surprise
investors, the Committee’s decision to make substantial changes in statement language
would be a surprise. Investors might take the new wording of Alternative A, including
the revisions to the language about the conditions that would lead the Committee to end
those purchases, as a signal that asset purchases will last longer and cumulate to a larger
total than they had projected, in which case longer-term real interest rates likely would
decline somewhat, inflation compensation and equity prices might rise, and the dollar
could depreciate. Or investors might read the statement of Alternative A, with its earlierthan-expected announcement that asset purchases will continue into 2013, as indicating
that the FOMC has a relatively gloomy outlook for growth and employment. If so, equity
prices could decline.
THE CASE FOR ALTERNATIVE C
The Committee might see the recent data as suggesting that, adjusting for the
effects of drought on agricultural production, the underlying pace of economic recovery
and rate of employment gains have improved in recent months. Policymakers might
point not only to recent labor market reports but also to stronger-than-expected growth in
consumer spending and housing starts. Indeed, smoothing through the month-to-month
fluctuations in this year’s data, policymakers may see the economic recovery as finally on
Page 23 of 53
Alternatives
agency MBS and longer-term Treasury securities after year-end.
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a sustainable course that will generate ongoing improvements in labor market conditions.
Furthermore, they may view financial strains in Europe—and therefore the downside
risks to the U.S. economy—as having eased of late and see the Committee’s action in
September as having made overall financial conditions in the United States even more
highly accommodative. Moreover, in the current environment policymakers may see the
potential benefits of additional asset purchases as likely to be small. Participants may be
concerned that inflation has picked up recently, even though largely in response to
increased energy prices, and they might note that ten-year inflation compensation
temporarily rose to the upper end of its recent range immediately after the Committee’s
September announcement and remains in the upper part of the range in which it has
Alternatives
varied in recent years. Thus, they may agree that longer-term inflation expectations
remain well anchored for the time being but see upside risks to the inflation outlook in
both the near term and the medium run unless asset purchases end fairly soon. Some
members may also be concerned that continuing asset purchases beyond the end of this
year could put the Federal Reserve in the position of having to realize large losses when it
eventually sells the MBS it has acquired.3 Others may worry that substantial further
purchases of safe assets when longer-term interest rates are already quite low could lead
to imbalances in financial markets that might undermine financial stability. In light of
these concerns, policymakers may prefer to adopt a statement such as that for Alternative
C to indicate that the Committee is unlikely to continue expanding the Federal Reserve’s
balance sheet beyond the end of this year.
If policymakers see the recovery as now on a course that will generate continuing
reductions in unemployment and also see upside risks to inflation, or if they are
concerned that continuing to hold the federal funds rate near zero until mid-2015 or later
would pose increasing risks to financial stability, they might consider it appropriate to
begin scaling back the public’s expectations of how long the federal funds rate will
remain at its current exceptionally low level. If so, they might favor a statement like the
version of Alternative C that includes paragraph C.5. Alternatively, as in paragraph C.5',
they might prefer to eliminate the calendar date from the Committee’s forward guidance
and replace it with new language that describes in somewhat greater detail the key
3
For a broader discussion of the potential effects of additional asset purchases on the Federal
Reserve’s balance sheet and income see the memo by staff in the Division of Monetary Affairs at the Board
of Governors and in the Markets Group at the Federal Reserve Bank of New York titled “Options for an
Additional LSAP Program,” sent to the Committee on August 28, 2012.
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economic factors that the Committee will consider in deciding when and how quickly to
increase its target for the federal funds rate.
A statement along the lines of Alternative C would greatly surprise market
participants and would be interpreted as signaling a significantly faster removal of policy
accommodation than investors had expected. According to the Desk’s survey, the
primary dealers anticipate no changes in the Committee’s forward guidance at this
meeting. Moving the projected date of the first increase closer to the present, as in
paragraph 5 of Alternative C, would cause a sizable upward shift in market participants’
expectations of the likely path for the federal funds rate, leaving interest rates
significantly higher at maturities beyond a year or so. Equity prices would probably fall,
guidance without providing a clear indication of the specific economic conditions that
would cause the Committee to begin raising the target rate, as in paragraph 5' of
Alternative C, investors might become uncertain about the Committee’s intentions, and
interest rate volatility could increase.
Page 25 of 53
Alternatives
and the dollar might appreciate. If the Committee were to drop the date from its forward
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LONG-RUN PROJECTIONS OF THE BALANCE SHEET AND MONETARY BASE
The staff has prepared three scenarios for the Federal Reserve’s balance sheet that
correspond to the policy alternatives A, B, and C. Alternatives A and B include asset
purchases that continue beyond the end of the maturity extension program (MEP) and
assume that the Committee maintains an exceptionally low federal funds rate until
August 2015. In contrast, Alternative C ends purchases of MBS at the same time as the
MEP, at the end of this year, and has the federal funds rate lift off from its lower bound in
August 2014. Projections under each scenario are based on assumptions about the
trajectory of various components of the balance sheet. Details of these assumptions, as
well as projections for each major component of the balance sheet, can be found in
Alternatives
Explanatory Note D.
For the balance sheet scenario that corresponds to Alternative B, the Committee is
assumed to continue its current purchases of MBS through the end of the year, when the
MEP concludes, and then both continue MBS purchases and make additional purchases
of Treasury securities through June 2013. These purchases from October 2012 through
June 2013 expand the SOMA portfolio’s holdings of longer-term securities by about
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$750 billion.4 This scenario is roughly consistent with the descriptions of the asset
purchases detailed in the Alternative B statement if purchases last for about nine months.5
After the end of the MEP, the Committee is assumed to reinstitute its policy of
reinvesting principal payments from Treasury securities at auction, it is also assumed to
continue reinvesting principal payments from agency MBS and agency debt securities
into agency MBS. Overall, under this scenario, SOMA securities holdings increase to
about $3.3 trillion by late-2013.
In the Alternative B scenario, consistent with the statement language that the
federal funds rate is expected to be at exceptionally low levels “at least through mid2015,” we assume that the first increase in the target federal funds rate is in August
February 2015, six months before the first increase in the target federal funds rate, all
reinvestment is assumed to cease, and the SOMA portfolio begins to contract. In
February 2016, six months after the initial increase in the target federal funds rate, the
Committee begins to sell its holdings of agency securities at a pace that reduces the
amount of these securities in the portfolio to zero in five years, that is, by January 2021.
Through these redemptions and sales, the size of the portfolio is normalized by February
2019.7, 8 The balance sheet then begins to expand, with increases in SOMA holdings
4
This amount does not include purchases conducted in September. If the current pace of purchases
continues at about $45 billion per month in Treasury securities and $40 billion per month in MBS, total
purchases from October 2012 through June 2013 will be $763 billion. In addition, although the SOMA
portfolio’s holdings of longer-term securities increases by $763 billion, total securities holdings increase by
less because of the asset sales under the MEP.
5
The statement indicates that the Committee will continue asset purchases until a substantial
improvement in the outlook for the labor market is achieved in a context of price stability. In the staff
economic outlook, by mid-2013 there will be accumulating evidence of a pickup in economic growth and
an outlook for substantial improvement in the unemployment rate, which is projected to decline from 8
percent in mid-2013 to 7½ percent in mid-2014 and to 7¼ percent in late 2014.
6
This liftoff date for the federal funds rate is two months later than that assumed in the balance sheet
projections from the September Tealbook Book B Alternative B’ and is consistent with the current staff
forecast in Tealbook Book A.
7
The tools to drain reserve balances (reverse repurchase agreements and term deposits) are not
modeled in any of the scenarios presented. Use of these tools would result in a shift in the composition of
Federal Reserve liabilities—a decline in reserve balances and a corresponding increase in reverse
repurchase agreements or term deposits—but would not produce an overall change in the size of the
balance sheet.
8
The projected timing of the normalization of the size of the balance sheet depends importantly on the
level of reserve balances that is assumed to be necessary to conduct monetary policy; currently, we assume
that level of reserve balances to be $25 billion. A higher demand for reserve balances would, all else equal,
lead to an earlier normalization of the size of the balance sheet.
Page 27 of 53
Alternatives
2015.6 The date of liftoff is a key determinant of the trajectory of the balance sheet. In
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essentially matching the growth of Federal Reserve Bank capital and currency in
circulation. Total assets are $2 trillion at the end of 2020.
The additional purchases of securities in this scenario substantially boost the
volume of reserve balances. As the federal funds rate increases rapidly in 2016 and 2017,
the interest expense on reserve balances rises quickly. This expense, combined with the
realized losses on sales of agency MBS, imply that the Federal Reserve has an operating
loss, and, as a result, remittances to Treasury cease and a small deferred asset is recorded
on the balance sheet at year-end in 2017, 2018 and 2019, peaking at about $8 billion
in 2018.9,10
Alternatives
In the scenario for Alternative A, the Committee is assumed to continue its
current purchases of MBS through the end of the year, when the MEP is completed, and
then continue MBS purchases and additional purchases of Treasury securities through the
end of 2013. These purchases from October 2012 through December 2013 ultimately
expand the SOMA portfolio’s holdings of longer-term securities by about $1.25 trillion.11
This scenario is roughly consistent with the descriptions of the asset purchases detailed in
the Alternative A statement if purchases last for about fifteen months.12 The Committee
continues reinvesting principal payments from agency MBS and agency debt securities
into agency MBS, and, after the MEP is complete, reinstitutes its policy of reinvesting
principal payments from Treasury securities at auction. In this scenario, total assets
increase to $4.1 trillion in 2014. In February 2015, six months prior to the assumed first
increase in the federal funds rate in August 2015, all reinvestment is assumed to cease
9
Under Reserve Bank accounting, losses and gains on securities held by the SOMA portfolio are only
realized when securities are sold.
10
Alternative B is similar to the $750 billion LSAP scenario presented in the September FOMC memo
"Options for an Additional LSAP Program" by Board and FRBNY staff. In the memo, however, as in the
September Tealbook’s Alternative B’, remittances to the Treasury remained positive and there was no
deferred asset. Remittances are lower, and a deferred asset is accumulated, in the current projection for
Alternative B because the federal funds rate is assumed to rise more steeply than in the previous Tealbook
and because a larger fraction of the projected purchases are assumed to be agency MBS, which are
subsequently sold during exit.
11
This amount does not include purchases conducted in September.
12
The statement indicates that the Committee will continue its purchases of MBS and Treasury
securities until “it judged that data on economic activity and labor market conditions are consistent with an
outlook for sustained progress toward maximum employment in a context of price stability.” Under the
staff baseline forecast, by late 2013 payrolls will have been increasing at a pace of close to 200,000 per
month for a few months, the unemployment rate will have fallen some, and real GDP will be expanding at
about 3 percent. The outlook for labor market conditions as of late 2013 would include a half percentage
point decline in the unemployment rate through late 2014 and a one and a half percentage point decline
through late 2015.
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and the SOMA portfolio begins to contract. Six months after the lift off of the federal
funds rate, sales of agency securities begin and continue for five years.13 The size of the
portfolio is normalized by August 2019. As in Alternative B, increased interest expense
and realized losses on sales of agency MBS cause a deferred asset to be recorded on the
balance sheet; under this alternative, there is a deferred asset from 2017 through the end
of the projection period.
For the scenario that corresponds to Alternative C, the Committee is assumed to
purchase MBS only through the completion of the MEP at the end of this year, after
which no additional asset purchases are assumed. In this scenario, the federal funds rate
is assumed to lift off in August 2014, one year earlier than in Alternatives B and A.
from maturing or prepaying securities ends in February 2014, and the portfolio begins to
contract. Sales of agency securities commence in February 2015 and last for five years.
Total assets in this scenario peak at $3 trillion, and the size of the balance sheet is
normalized in March 2018, 11 months earlier than under Alternative B.
Across scenarios, the volume of reserve balances is directly related to the
assumed asset purchases. Under Alternative A, reserve balances peak at about
$2.7 trillion, while under Alternative B, reserve balances peak at $2.2 trillion. Under
Alternative C, reserve balances rise only slightly from their current level to $1.7 trillion.
For the scenarios corresponding to Alternatives B and A, reserve balances are $2 trillion
and $2.5 trillion, respectively, when the federal funds rate lifts off from its lower bound
in August 2015. For the scenario corresponding to Alternatives C, reserve balances are
$1.5 trillion when the federal funds rate lifts off from its lower bound in August 2014.
In the scenario corresponding to Alternative B, the monetary base increases from
2012 to 2013 because of the purchase program. Once exit begins, the monetary base
shrinks at a notable pace through the second quarter of 2019, primarily reflecting a
decline in reserve balances as securities are redeemed or sold. Starting in the third
quarter of 2019, after reserve balances are assumed to have stabilized at $25 billion, the
monetary base begins to expand again, in line with the growth of Federal Reserve notes
13
In Alternative A, MBS are sold over a five-year period, and the size of the portfolio normalizes
about three and a half years after sales begin—somewhat longer than the timeframe anticipated in the exit
strategy principles. If sales were assumed to be completed over about three and a half years, the portfolio
would normalize in three years; however, for consistency, we have maintained the same assumption about
the timeframe of sales—five years—as in Alternative B.
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Alternatives
Corresponding to this earlier increase in the federal funds rate, reinvestment of principal
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in circulation. Under Alternative A, the monetary base increases from 2012 to 2014
because of the purchase program and then contracts during exit until after the size of the
portfolio is normalized. Under Alternative C, the monetary base increases a bit from
2012 to 2013 — rising with delayed settlement of MBS purchases —and then contracts,
Alternatives
on net, until after the size of the portfolio is normalized.
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Date
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2010
2011
2012
2013
2014
2015
2016
2017
2018
Memo:
Alternative B Alternative A Alternative C September Alt
B'
Percent, annual rate
Monthly
-12.3
-12.3
-12.3
-12.2
-8.7
-8.7
-8.7
-8.7
-5.1
-5.1
-5.1
-5.1
7.7
7.7
7.7
7.7
7.7
7.7
7.7
18.7
-12.4
-12.4
-12.4
6.0
1.1
1.2
-0.1
-1.1
28.9
29.1
27.6
16.0
23.1
23.1
23.6
17.3
21.0
-5.9
5.5
-3.9
0.8
7.5
28.3
30.1
Quarterly
21.0
-5.9
5.5
-3.9
0.8
7.6
28.3
30.3
21.0
-5.9
5.5
-3.9
0.8
6.9
15.9
-4.8
21.0
-5.9
5.5
-3.9
5.3
8.6
22.8
25.3
0.9
32.9
2.5
25.1
-0.6
-2.4
-14.3
-16.9
-23.9
Annual - Q4 to Q4
0.9
32.9
2.5
37.4
4.9
-2.5
-13.5
-15.7
-22.6
0.9
32.9
2.3
4.9
-2.2
-7.7
-17.2
-18.9
-6.7
0.9
32.9
3.9
23.6
-0.7
-3.2
-14.5
-16.7
-23.9
Note: Not seasonally adjusted.
Page 31 of 53
Alternatives
Growth Rates for the Monetary Base
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DEBT, BANK CREDIT, AND MONEY FORECASTS
Domestic nonfinancial sector debt is projected to expand at an annual rate of
about 4¾ percent in the fourth quarter of 2012, and then slow slightly to 4 percent in
2013 and 3¾ percent in 2014. The expected slowing is almost entirely the result of
smaller projected increases in federal government debt, from an annual rate of 10 percent
in the fourth quarter of 2012 to 7 percent in 2013 and 5¾ percent in 2014. We forecast
nonfinancial business debt to increase at a moderate pace over the projection period,
reflecting favorable financing conditions in the near term and a rise in capital
expenditures in the medium term. The level of home mortgage debt is projected to hit
bottom by the end of the year and to rise slowly thereafter at an annual rate of around
Alternatives
1 percent, in line with the expectation that financing conditions will remain relatively
tight and that housing demand and house prices will increase only gradually. Meanwhile,
the rise in consumer credit is projected to pickup from an annual rate of 6 percent in the
fourth quarter of 2012 to 7½ percent in 2014, driven by further increases in demand for
student loans, lending to finance consumer durables expenditures, and a gradual easing in
credit conditions.
We expect commercial bank credit to increase at an annual rate of about
3½ percent in the fourth quarter of 2012, 4 percent in 2013, and 4¾ percent in 2014.
Core loans—the sum of commercial and industrial (C&I), real estate, and consumer
loans—are projected to increase modestly for the remainder of 2012 and to pick up
somewhat in 2013 and 2014. After having expanded robustly for most of 2012, C&I
loans are expected to rise at a more moderate rate over the forecast period, in part
reflecting low expected interest rates on alternatives to bank borrowing. We anticipate
that growth in both residential real estate and consumer loans will pick up somewhat
from their currently weak paces, reflecting improvements in borrowers’ credit quality and
further gradual easing of standards and terms on such loans. We also expect residential
real estate lending to be supported by gradual increases in residential investment.
Commercial real estate loans are projected to increase slowly over the forecast period, as
high vacancy rates, depressed prices for commercial properties, and the poor credit
quality of existing loans are likely to suppress activity in this sector. Banks’ securities
holdings are expected to rise at a moderate pace, with smaller increases in 2013 and 2014
than were posted in 2012, as deposit growth ebbs and bank loans strengthen.
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We project that M2 will increase faster than nominal income through the
remainder of 2012, as investors continue to respond to uncertainty about global economic
and financial conditions by adding to their already elevated deposit balances. We expect
a significant portion of these elevated balances to unwind in early 2013 due to the
expiration of the unlimited FDIC insurance on noninterest-bearing transaction deposits,
leading M2 to rise at a slower pace than nominal income.14 M2 growth is forecast to
remain below that of nominal income after this unwinding, as improvements in financial
and economic conditions encourage investors to reallocate their portfolios towards riskier
assets.
Turning to the components of M2, liquid deposits are expected to expand at a
forecast period. In contrast, retail money market funds and small time deposits are
projected to decline through late 2014. We project that currency growth will gradually
decline to a pace consistent with its long-term average of 6 percent, and then continue at
that rate through the end of the forecast period.
14
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 provides unlimited
deposit insurance coverage for noninterest-bearing transaction accounts in excess of $250,000 from
December 31, 2010, through December 31, 2012.
Page 33 of 53
Alternatives
brisk pace for the remainder of 2012, and then to slow somewhat over the rest of the
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Growth Rates for M2
Alternatives
(Percent, seasonally adjusted annual rate)
Monthly Growth Rates
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Tealbook Forecast*
16.2
3.7
4.2
5.5
3.9
5.1
9.0
4.5
10.1
6.6
4.0
3.6
Quarterly Growth Rates
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
2014 Q1
2014 Q2
2014 Q3
2014 Q4
8.7
4.6
6.7
6.3
-0.4
1.9
2.2
2.2
2.6
2.7
2.7
2.8
Annual Growth Rates
2012
2013
2014
6.7
1.5
2.7
* This forecast is consistent with nominal GDP and interest rates in the
Tealbook A forecast. Actual data through October 8, 2012; projections
thereafter.
Page 34 of 53
October 18, 2012
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October 18, 2012
DIRECTIVE
The directive that was issued in September appears on the next page, followed by
drafts for an October directive that correspond to each of the policy alternatives.
The draft directives for all three Alternatives instruct the Desk to take appropriate
steps to complete, by the end of December 2012, the MEP of $267 billion that was
announced in June. The draft directives for Alternatives A and B also tell the Desk to
continue purchasing additional agency MBS at a pace of about $40 billion per month;
they do not specify an end date. The directive for Alternative C instructs the Desk to
continue purchasing additional agency MBS at a pace of $40 billion per month “until the
current practice of reinvesting principal payments on all agency debt and agency MBS in
agency MBS.
If the Committee were to decide to continue purchasing longer-term Treasury
securities after the MEP concludes, that decision would be reflected in the December
directive.
Page 35 of 53
Alternatives
end of the year.” Each of the draft directives would also instruct the Desk to continue the
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September 2012 Directive
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 seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it announced in June to purchase Treasury
securities with remaining maturities of 6 years to 30 years with a total face value of about
$267 billion by the end of December 2012, and to sell or redeem Treasury securities with
remaining maturities of approximately 3 years or less with a total face value of about
Alternatives
$267 billion. For the duration of this program, the Committee directs the Desk to
suspend its policy of rolling over maturing Treasury securities into new issues. The
Committee directs the Desk to maintain its existing policy of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities. The Desk is also directed to
begin purchasing agency mortgage-backed securities at a pace of about $40 billion per
month. The Committee directs the Desk to engage in dollar roll and coupon swap
transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS
transactions. The System Open Market Account Manager and the Secretary will keep the
Committee informed of ongoing developments regarding the System's balance sheet that
could affect the attainment over time of the Committee's objectives of maximum
employment and price stability.
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October 2012 Directive—Alternative A
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 seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it announced in June to purchase Treasury
securities with remaining maturities of 6 years to 30 years with a total face value of about
$267 billion by the end of December 2012, and to sell or redeem Treasury securities with
remaining maturities of approximately 3 years or less with a total face value of about
suspend its policy of rolling over maturing Treasury securities into new issues. The
Committee directs the Desk to maintain its existing policy of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities. The Desk is also directed to
begin continue purchasing agency mortgage-backed securities at a pace of about $40
billion per month. The Committee directs the Desk to engage in dollar roll and coupon
swap transactions as necessary to facilitate settlement of the Federal Reserve's agency
MBS transactions. The System Open Market Account Manager and the Secretary will
keep the Committee informed of ongoing developments regarding the System's balance
sheet that could affect the attainment over time of the Committee's objectives of
maximum employment and price stability.
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Alternatives
$267 billion. For the duration of this program, the Committee directs the Desk to
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October 18, 2012
October 2012 Directive—Alternative B
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 seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it announced in June to purchase Treasury
securities with remaining maturities of 6 years to 30 years with a total face value of about
$267 billion by the end of December 2012, and to sell or redeem Treasury securities with
remaining maturities of approximately 3 years or less with a total face value of about
Alternatives
$267 billion. For the duration of this program, the Committee directs the Desk to
suspend its policy of rolling over maturing Treasury securities into new issues. The
Committee directs the Desk to maintain its existing policy of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities. The Desk is also directed to
begin continue purchasing agency mortgage-backed securities at a pace of about $40
billion per month. The Committee directs the Desk to engage in dollar roll and coupon
swap transactions as necessary to facilitate settlement of the Federal Reserve's agency
MBS transactions. The System Open Market Account Manager and the Secretary will
keep the Committee informed of ongoing developments regarding the System's balance
sheet that could affect the attainment over time of the Committee's objectives of
maximum employment and price stability.
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October 2012 Directive—Alternative C
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 seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it announced in June to purchase Treasury
securities with remaining maturities of 6 years to 30 years with a total face value of about
$267 billion by the end of December 2012, and to sell or redeem Treasury securities with
remaining maturities of approximately 3 years or less with a total face value of about
suspend its policy of rolling over maturing Treasury securities into new issues. The
Committee directs the Desk to maintain its existing policy of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities. The Desk is also directed to
begin continue purchasing agency mortgage-backed securities at a pace of about
$40 billion per month until the end of 2012. The Committee directs the Desk to engage
in dollar roll and coupon swap transactions as necessary to facilitate settlement of the
Federal Reserve's agency MBS transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System's balance sheet that could affect the attainment over time of the
Committee's objectives of maximum employment and price stability.
Page 39 of 53
Alternatives
$267 billion. For the duration of this program, the Committee directs the Desk to
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Alternatives
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October 18, 2012
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Explanatory Notes
A. Policy Rules Used in “Monetary Policy Strategies”
Taylor (1993) rule
ܴ௧ ൌ 2.25 ߨ௧ 0.5ሺߨ௧ െ ߨ כሻ 0.5݃ܽ௧
Taylor (1999) rule
ܴ௧ ൌ 2.25 ߨ௧ 0.5ሺߨ௧ െ ߨ כሻ ݃ܽ௧
Inertial Taylor (1999) rule
ܴ௧ ൌ 0.85ܴ௧ିଵ 0.15ሺ2.25 ߨ௧ 0.5ሺߨ௧ െ ߨ כሻ ݃ܽ௧ ሻ
Outcome-based rule
ܴ௧ ൌ 1.2ܴ௧ିଵ െ 0.39ܴ௧ିଶ 0.19ሾ0.79 1.73ߨ௧
3.66݃ܽ௧ െ 2.72݃ܽ௧ିଵ ሿ
First-difference rule
ܴ௧ ൌ ܴ௧ିଵ 0.5൫ߨ௧ାଷ|௧ െ ߨ כ൯ 0.5Δସ ݃ܽ௧ାଷ|௧
Nominal income targeting rule
ܴ௧ ൌ 0.75ܴ௧ିଵ 0.25ሺ2.25 ߨ כ ݊ݕ௧ െ ݊ݕ௧ כሻ
The first two of the selected rules were studied by Taylor (1993, 1999), while the inertial
Taylor (1999) rule has featured prominently in recent analysis by Board staff.1 The outcomebased rule uses policy reactions estimated using real-time data over the sample
1988:Q12006:Q4. The intercept of the outcome-based rule was chosen so that it is consistent
with a 2 percent long-run inflation objective and a long-run, quarterly real interest rate of
2¼ percent, a value used in the FRB/US model. The intercepts of the Taylor (1993, 1999) rules,
and the long-run intercept of the inertial Taylor (1999) rule, are set at 2¼ percent—instead of
Taylor’s original value of 2 percent—for the same reason. The 2¼ percent real rate estimate also
enters the long-run intercept of the nominal income targeting rule. The prescriptions of the first
1
See Erceg and others (2012).
Page 41 of 53
Explanatory Notes
The table below gives the expressions for the selected policy rules used in “Monetary
Policy Strategies.” In the table, ܴ௧ denotes the nominal federal funds rate for quarter t, while the
right-hand-side variables include the staff’s projection of trailing four-quarter core PCE inflation
for the current quarter and three quarters ahead (ߨ௧ and ߨ௧ାଷ|௧ ), the output gap estimate for the
current period as well as its one-quarter-ahead forecast (gapt and gapt+1|t), and the forecast of the
three-quarter-ahead annual change in the output gap (4gapt+3|t). The value of policymakers’
long-run inflation objective, denoted π*, is 2 percent. The nominal income targeting rule
responds to the nominal income gap, which is defined as the difference between nominal income
݊ݕ௧ (100 times the log of the level of nominal GDP) and a target value ݊ݕ௧( כ100 times the log of
potential nominal GDP). Target nominal GDP in 2007:Q4 is set equal to potential real GDP in
that quarter multiplied by the GDP deflator in that quarter; subsequently, target nominal GDP
grows 2 percentage points per year faster than potential GDP.
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difference rule do not depend on the level of the output gap or the long-run, quarterly real interest
rate; see Orphanides (2003).
Near-term prescriptions from these rules are calculated using Tealbook projections for
inflation and the output gap. The inertial Taylor (1999) rule, the first-difference rule, the
estimated outcome-based rule, and the nominal income targeting rule include the lagged policy
rate as a right-hand-side variable. When the Tealbook is published early in the quarter, the lines
denoted “Previous Tealbook” report rule prescriptions based on the previous Tealbook’s staff
outlook, jumping off from the actual value of the lagged funds rate in the previous quarter. When
the Tealbook is published late in the quarter, the lines denoted “Previous Tealbook Outlook”
report rule prescriptions based on the previous Tealbook’s staff outlook, but jumping off from the
average value for the policy rate thus far this quarter.
REFERENCES
Erceg, Christopher, Jon Faust, Michael Kiley, Jean-Philippe Laforte, David LópezSalido, Stephen Meyer, Edward Nelson, David Reifschneider, and Robert Tetlow (2012). “An
Overview of Simple Policy Rules and Their Use in Policymaking in Normal Times and Under
Current Conditions.” Memo sent to the Committee on July 18, 2012.
Erceg, Christopher, Michael Kiley, and David López-Salido (2011). “Alternative
Monetary Policy Frameworks.” Memo sent to the Committee on October 6, 2011.
Explanatory Notes
McCallum, Bennett T., and Edward Nelson (1999). “Nominal Income Targeting in an
Open-Economy Optimizing Model,” Journal of Monetary Economics, Vol. 43 (June), pp. 553–
578.
Orphanides, Athanasios (2003). “Historical Monetary Policy Analysis and the Taylor
Rule,” Journal of Monetary Economics, Vol. 50 (July), pp. 9831022.
Taylor, John B. (1993). “Discretion versus Policy Rules in Practice,” Carnegie-Rochester
Conference Series on Public Policy, Vol. 39 (December), pp. 195214.
Taylor, John B. (1999). “A Historical Analysis of Monetary Policy Rules,” in John B.
Taylor, ed., Monetary Policy Rules. University of Chicago Press, pp. 319341.
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B. Estimates of the Equilibrium and Actual Real Rates
An estimate of the equilibrium real rate appears as a memo item in the first exhibit,
“Policy Rules and the Staff Projection.” The concept of the short-run equilibrium real rate
underlying the estimate corresponds to the level of the real federal funds rate that is consistent
with output reaching potential in twelve quarters using the projection for the economy of
FRB/US, the staff’s large-scale econometric model of the U.S. economy. This estimate depends
on a very broad array of economic factors, some of which take the form of projected values of the
model’s exogenous variables. The estimate reported is the “Tealbook-consistent” estimate of r*,
which is generated after the paths of exogenous variables in the FRB/US model are adjusted so
that they match those in the extended Tealbook forecast. Model simulations then determine the
value of the real federal funds rate that closes the output gap conditional on the exogenous
variables in the extended baseline forecast.
Explanatory Notes
The estimated actual real federal funds rate reported in the exhibit is constructed as the
difference between the federal funds rate and the trailing four-quarter change in the core PCE
price index. The federal funds rate is specified as the midpoint of the target range for the federal
funds rate on the Tealbook Book B publication date.
Page 43 of 53
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
C. FRB/US Model Simulations
Explanatory Notes
The exhibits of “Monetary Policy Strategies” that report results from simulations of
alternative policies are derived from dynamic simulations of the FRB/US model. The simulated
policy rule is assumed to be in force over the whole period covered by the simulation. For the
optimal control simulations, the dotted line labeled “Previous Tealbook” is derived from the
optimal control simulations, when applied to the previous Tealbook projection.
Page 44 of 53
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
D. Long-Run Projections of the Balance Sheet and Monetary Base
This explanatory note presents the assumptions underlying the projections provided in the
section titled “Long-Run Projections of the Balance Sheet and Monetary Base,” as well as
projections for each major component of the balance sheet.
GENERAL ASSUMPTIONS
The balance sheet projections are constructed at a monthly frequency from October 2012
to December 2020. The few balance sheet items that are not discussed below are assumed to be
constant over the projection period at the level observed on September 30, 2012. The projections
for all major asset and liability categories under each scenario are summarized in the tables that
follow the bullet points.
Explanatory Notes
The Tealbook projections for the scenarios corresponding to Alternatives B and A
assume that the target federal funds rate begins to increase in August 2015, consistent with the
forward guidance in the FOMC’s statement that the target federal funds rate is expected to be at
exceptionally low levels “at least through mid-2015.” This date of liftoff is consistent with the
current staff economic forecast but is two months later than assumed in the balance sheet
projections for Alternative B in the September Tealbook. The projection for the scenario
corresponding to Alternative C assumes the target federal funds rate lifts off in August 2014,
consistent with the draft statement language “at least through [late 2014 | mid-2014 | late 2013]”
and a year earlier than in Alternative B. In each case, the balance sheet projections assume that
no use of short-term draining tools is necessary to achieve the projected path for the target federal
funds rate.2
2
If term deposits or reverse repurchase agreements were used to drain reserves prior to raising the
federal funds rate, the composition of liabilities would change: Increases in term deposits and reverse
repurchase agreements would be matched by corresponding declines in reserve balances. Presumably,
these draining tools would be wound down as the balance sheet returns to its steady state growth path, so
that the projected paths for Treasury securities presented in the Tealbook remain valid.
Page 45 of 53
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
ASSETS
Explanatory Notes
Treasury Securities, Agency Mortgage-Backed Securities (MBS), and Agency Debt
Securities
The assumptions under Alternative B are:
o The Committee is assumed to continue its current purchases of MBS through the end
of the year, when the MEP concludes, and then continue MBS purchases and
additional purchases of Treasury securities through June 2013. Purchases of
Treasury securities will continue at a pace of about $45 billion per month and
purchases of MBS securities will continue at a pace of $40 billion per month. The
Treasury securities purchased after the conclusion of the MEP are assumed to have
an average duration of about nine years, roughly the net duration of purchases and
sales under the MEP. The purchases between October 2012 and June 2013 expand
the SOMA portfolio’s holdings of longer-term securities by $763 billion.
o The FOMC continues to reinvest the proceeds from principal payments on its agency
securities holdings in agency MBS.
o Starting in February 2015—six months prior to the assumed increase in the target
federal funds rate—all securities are allowed to roll off the portfolio as they mature
or prepay.
o The Federal Reserve begins to sell agency MBS and agency debt securities in
February 2016, six months after the assumed date of the first increase in the target
federal funds rate. Holdings of agency securities are reduced over five years and
reach zero by January 2021.
o For agency MBS, the rate of prepayment is based on staff models using estimates of
housing market factors from one of the Desk’s analytical providers, long-run average
prepayment speeds of MBS, and interest rate projections from the Tealbook.3 The
projected rate of prepayment is sensitive to these underlying assumptions.
In the scenario corresponding to Alternative A, the Committee is assumed to continue its
current purchases of MBS through the end of the year, when the MEP concludes, and
then continue MBS purchases and additional purchases of Treasury securities through
December 2013. Purchases of Treasury securities will continue at a pace of about $45
billion per month and purchases of MBS securities will continue at a pace of $40 billion
per month. The Treasury securities purchased after the conclusion of the MEP are
assumed to have an average duration of about nine years. The purchases between
October 2012 and December 2013 expand the SOMA portfolio’s holdings of longer-term
securities by $1.28 trillion. In addition, the Committee is assumed to maintain its
existing policy of reinvesting principal payments from its holdings of agency debt and
agency MBS in agency MBS. In February 2015, six months prior to the assumed
increase in the federal funds rate in August 2015, principal payments from all securities
3
Projected prepayments of agency MBS reflect interest rate projections as of October 15, 2012.
Page 46 of 53
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
In the scenario corresponding to Alternative C, the Committee is assumed to purchase
MBS only through the completion of the MEP at the end of this year; no additional asset
purchases are assumed. The FOMC continues to reinvest the proceeds from principal
payments on its agency securities holdings in agency MBS until February 2014—six
months prior to the assumed increase in the target federal funds rate. Starting in February
2014, all securities are allowed to roll off the portfolio as they mature or prepay. The
Federal Reserve begins to sell agency MBS and agency debt securities in February 2015.
Holdings of agency securities are reduced over five years and reach zero by January
2020.
Because current and expected interest rates in the near term are below the average coupon
rate on outstanding Treasury securities, the market value at which these securities are
purchased will generally exceed their face value, with a larger premium for longermaturity securities. As a result, each alternative will add premiums to the balance sheet.
In Alternative C, premiums net of amortization will increase $5 billion. In Alternatives B
and A, premiums are boosted by roughly $40 billion and $50 billion, respectively, by the
time asset purchases end. The increase in premiums is reflected in higher total assets and
in higher reserve balances.
The asset purchases in all three alternatives put downward pressure on market interest
rates, in particular primary and secondary mortgage rates.
The current and near-term market value of agency MBS is assumed to be four percent
above face value. As a result, for Alternatives B, A, and C, the $360 billion, $600 billion,
and $120 billion of agency MBS purchases, respectively, will cause unamortized
premiums on the Federal Reserve’s balance sheet to rise by roughly $14 billion, $24
billion, and $5 billion, respectively, relative to a scenario without these MBS purchases.
The increase in premiums is reflected in higher total assets and in higher reserve
balances.
The level of central bank liquidity swaps is assumed to decline gradually, as the recent
foreign central bank swap auctions mature, and then return to zero in 2013.
In all scenarios, once reserve balances drop to $25 billion, the Desk begins to purchase
Treasury bills to maintain this level of reserve balances going forward. Purchases of bills
continue until such securities comprise one-third of the Federal Reserve’s total Treasury
securities holdings—about the average share prior to the crisis. Once this share is
reached, the Federal Reserve buys coupon securities in addition to bills to maintain an
approximate composition of the portfolio of one-third bills and two-thirds coupon
securities.
Liquidity Programs and Credit Facilities
Credit through the Term Asset-Backed Securities Loan Facility (TALF) declines to zero
by the end of 2015, reflecting loan maturities and prepayments.
Page 47 of 53
Explanatory Notes
are allowed to roll off the portfolio. Sales of agency securities begin in February 2016
and continue for five years.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
The assets held by TALF LLC remain at about $1 billion through 2014 before declining
to zero the following year. Assets held by TALF LLC consist of investments of
commitment fees collected by the LLC and the U.S. Treasury’s initial funding. In this
projection, the LLC does not purchase any asset-backed securities received by the
Federal Reserve Bank of New York in connection with a decision of a borrower not to
repay a TALF loan.
The assets held by Maiden Lane LLC decline to zero in 2016.
Explanatory Notes
LIABILITIES AND CAPITAL
Federal Reserve notes in circulation grow in line with the staff forecast for money stock
currency through 2015. Afterwards, Federal Reserve notes in circulation grow at the
same rate as nominal GDP in the extended Tealbook projection.
The level of reverse repurchase agreements (RRPs) is assumed to remain around $70
billion, about the average level of RRPs associated with foreign official and international
accounts observed over the past three years.
Balances held in the U.S. Treasury’s General Account (TGA) follow recent patterns until
the assumed initial increase in the target federal funds rate in each alternative. At that
point, the TGA slowly drops back to its historical target level of $5 billion as it is
assumed that the Treasury will implement a new cash management system and invest
funds in excess of $5 billion. The TGA remains constant at $5 billion over the remainder
of the forecast period.
We maintain the Supplementary Financing Account (SFA) balance at its current level of
zero throughout the forecast.
Federal Reserve capital grows 15 percent per year, in line with the average rate of the
past ten years.4
In general, increases in the level of Federal Reserve assets are matched by higher levels
of reserve balances. All else equal, increases in the levels of liability items, such as
Federal Reserve notes in circulation or other liabilities, or increases in the level of
Reserve Bank capital, drain reserve balances. When increases in these liability or capital
items would otherwise cause reserve balances to fall below $25 billion, purchases of
Treasury securities are assumed in order to maintain that level of reserve balances.
In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to
cover operating costs, pay dividends, and equate surplus to capital paid-in, a deferred
asset would be recorded. This deferred asset is recorded in lieu of reducing the Reserve
Bank’s capital and is reported on the liability side of the balance sheet as “Interest on
4
The annual growth rate of capital affects the date of normalization of the size of the balance sheet and
the size of the SOMA portfolio. Growth in Reserve Bank capital has been modest over the past two years;
however, even if Federal Reserve capital were assumed to be constant, normalization only would be pushed
later by about a quarter.
Page 48 of 53
Class I FOMC - Restricted Controlled (FR)
Authorized for Public Release
October 18, 2012 (Corrected)
Federal Reserve notes due to U.S. Treasury.” This liability takes on a positive value
when weekly cumulative earnings have not yet been distributed to the Treasury and takes
on a negative value when earnings fall short of the expenses listed above. In Alternative
B, a small deferred asset – peaking at about 8 billion in 2018 – is recorded on the balance
sheet at year-end in 2017, 2018 and 2019. In Alternative A, a deferred asset is recorded
from 2017 through the end of the projection horizon, with a peak year-end value of about
$36 billion in 2019.
TERM PREMIUM EFFECTS
4
•
Under Alternative B, the current staff estimates of the contemporaneous term premium
effect on the yield of the ten-year Treasury note is negative 93 basis points. Based on the
projection for the balance sheet, that term premium effect converges slowly toward zero
over the forecast period as the portfolio normalizes. The term premium is about the same
as it was in September Alternative B’.
•
Under Alternative A, the term premium effect is negative 114 basis points. The effect is
more negative than in Alternative B because of the larger assumed securities purchases.
•
Under Alternative C, the term premium effect is negative 66 basis points. The effect is
less negative than in Alternative B because there are no additional securities purchases in
2013 and the liftoff date is earlier so asset sales begin sooner than under Alternative B.
4
Staff estimates include all current and projected asset purchases and use the model outlined in the
appendix of the January 18, 2012, memo “Possible MBS Large-Scale Asset Purchase Program” written by
staff at the Federal Reserve Bank of New York and the Board of Governors. More details of the model can
be found in “Term Structure Modeling with Supply Factors and the Federal Reserve’s Large Scale Asset
Purchase Programs” by Li and Wei, FEDS working paper #37, 2012.
49 of 53
Class I FOMC - Restricted Controlled (FR)
Authorized for Public Release
October 18, 2012 (Corrected)
10-Year Treasury Term Premium Effect
Date
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
2014 Q1
2014 Q2
2014 Q3
2014 Q4
2015 Q1
2015 Q2
2015 Q3
2015 Q4
2016 Q1
2016 Q2
2016 Q3
2016 Q4
2017 Q1
2017 Q2
2017 Q3
2017 Q4
2018 Q1
2018 Q2
2018 Q3
2018 Q4
2019 Q1
2019 Q2
2019 Q3
2019 Q4
2020 Q1
2020 Q2
2020 Q3
2020 Q4
Alternative B
-93
-90
-86
-81
-76
-72
-67
-62
-57
-53
-49
-44
-40
-37
-33
-30
-27
-24
-21
-19
-17
-15
-13
-12
-10
-9
-8
-8
-7
-6
-6
-6
-5
Alternative A
Alternative C
Basis Points
Quarterly Averages
-114
-111
-107
-103
-98
-93
-87
-81
-75
-70
-64
-59
-54
-49
-44
-40
-36
-32
-29
-25
-23
-20
-17
-15
-13
-12
-10
-9
-8
-7
-6
-6
-5
Page 50 of 53
-66
-62
-58
-54
-50
-46
-42
-38
-35
-32
-29
-26
-23
-20
-18
-16
-14
-13
-11
-10
-9
-8
-7
-7
-6
-6
-6
-6
-5
-5
-5
-4
-4
Memo: September
Alt B'
-93
-89
-86
-81
-76
-71
-66
-61
-57
-52
-48
-43
-39
-35
-32
-29
-25
-23
-20
-17
-15
-13
-12
-10
-9
-8
-7
-6
-6
-5
-5
-5
-4
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative B
Billions of dollars
Sep 30, 2012
2012
2014
2016
2018
2020
2,802
2,908
3,511
2,891
1,873
1,976
13
13
0
0
0
0
0
0
0
0
0
0
13
13
0
0
0
0
Term Asset-Backed Securities Loan Facility (TALF)
2
2
0
0
0
0
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
2
1
0
0
0
0
2,564
2,650
3,258
2,685
1,710
1,848
1,645
1,657
1,927
1,707
1,218
1,828
83
77
39
16
2
0
Agency mortgage-backed securities
835
916
1,292
961
490
20
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
221
241
252
206
162
128
2,747
2,846
3,430
2,783
1,730
1,787
1,086
1,108
1,249
1,402
1,530
1,671
70
70
70
70
70
70
1,578
1,658
2,099
1,300
127
36
1,464
1,607
2,048
1,290
116
25
U.S. Treasury, General Account
85
45
45
5
5
5
Other Deposits
29
6
6
6
6
6
2
0
0
0
-8
0
55
62
82
108
143
189
Total assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Securities held outright
U.S. Treasury securities
Agency debt securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
Page 51 of 53
Explanatory Notes
Selected assets
Class I FOMC - Restricted Controlled (FR)
Authorized for Public Release
October 18, 2012 (Corrected)
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative A
Billions of dollars
Sep 30, 2012
2012
2014
2016
2018
2020
2,802
2,909
4,043
3,359
2,213
1,943
13
13
0
0
0
0
0
0
0
0
0
0
13
13
0
0
0
0
Term Asset-Backed Securities Loan Facility (TALF)
2
2
0
0
0
0
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
2
1
0
0
0
0
2,564
2,649
3,765
3,134
2,038
1,808
1,645
1,657
2,197
1,977
1,454
1,784
83
77
39
16
2
0
Agency mortgage-backed securities
835
915
1,530
1,141
582
23
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
221
243
276
224
175
135
2,747
2,847
3,961
3,251
2,070
1,754
1,086
1,108
1,249
1,402
1,530
1,671
70
70
70
70
70
70
1,578
1,658
2,626
1,764
483
36
1,464
1,608
2,575
1,754
473
25
U.S. Treasury, General Account
85
45
45
5
5
5
Other Deposits
29
6
6
6
6
6
2
0
0
0
-31
-34
55
62
82
108
143
189
Total assets
Selected assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Securities held outright
U.S. Treasury securities
Agency debt securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
Page 52 of 53
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
October 18, 2012
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative C
Billions of dollars
Sep 30, 2012
2012
2014
2016
2018
2020
2,802
2,907
2,862
2,206
1,790
1,976
13
13
0
0
0
0
0
0
0
0
0
0
13
13
0
0
0
0
Term Asset-Backed Securities Loan Facility (TALF)
2
2
0
0
0
0
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
2
1
0
0
0
0
2,564
2,661
2,655
2,040
1,656
1,863
1,645
1,657
1,657
1,437
1,448
1,863
83
77
39
16
2
0
Agency mortgage-backed securities
835
927
959
586
206
0
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
221
230
206
166
134
112
2,747
2,845
2,780
2,098
1,647
1,786
1,086
1,108
1,249
1,402
1,530
1,671
70
70
70
70
70
70
1,578
1,655
1,449
615
36
36
1,464
1,604
1,438
605
25
25
U.S. Treasury, General Account
85
45
5
5
5
5
Other Deposits
29
6
6
6
6
6
2
0
0
0
0
0
55
62
82
108
143
189
Total assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Securities held outright
U.S. Treasury securities
Agency debt securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
Page 53 of 53
Explanatory Notes
Selected assets
Cite this document
APA
Federal Reserve (2012, October 23). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_20121024_part1
BibTeX
@misc{wtfs_greenbook_20121024_part1,
author = {Federal Reserve},
title = {Greenbook/Tealbook},
year = {2012},
month = {Oct},
howpublished = {Greenbooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/greenbook_20121024_part1},
note = {Retrieved via When the Fed Speaks corpus}
}