greenbooks · June 17, 2014
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 01/10/2020.
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
June 12, 2014
Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System
Authorized for Public Release
(This page is intentionally blank.)
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
The top panel of the first exhibit, “Policy Rules and the Staff Projection,”
provides near-term prescriptions for the federal funds rate from six different policy rules:
the Taylor (1993) rule, the Taylor (1999) rule, the inertial Taylor (1999) rule, the
outcome-based 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 the near term, and they incorporate the staff’s new, lower, estimate of the
long-run equilibrium real federal funds rate.2 (Medium-term prescriptions derived from
dynamic simulations of the rules are discussed below.) As shown in the left-hand
columns, five of the six rules prescribe a federal funds rate above ¼ percent by year-end.
Specifically, the Taylor (1999) rule, the outcome-based rule, and the first-difference rule
prescribe increases in the federal funds rate to values between ½ and ¾ percent in the
third quarter and to about 1¼ percent in the fourth quarter. The Taylor (1993) rule,
which places considerably less weight on the output gap than the other rules, calls for a
federal funds rate near 1¾ percent in the third quarter and slightly above 2 percent in the
fourth quarter. The inertial Taylor (1999) rule prescribes only a very small increase in
the federal funds rate over the next two quarters to a little above the current target range.
The nominal income targeting rule prescribes keeping the federal funds rate at its
effective lower bound over the next two quarters.
The right-hand columns display the rules’ near-term prescriptions in the absence
of the lower-bound constraint on the federal funds rate.3 Most of the rules call for an
immediate increase in the federal funds rate, so the lower-bound is not a binding
1
The appendix to this section provides details on each of the six rules.
As detailed in the box “Changes to the Longer-Run Outlook” in Tealbook, Book A, the staff has
revised its estimate of the long-run value of the real federal funds rate from 2 percent to 1¾ percent,
reflecting its new assessment that the long-run growth rate of the economy is 2 percent compared to its
previous estimate of 2¼ percent. To facilitate comparison, new values of the intercepts of rules, where
applicable, have been applied to both to the “Current Tealbook” and “Previous Tealbook outlook” numbers
displayed in the exhibit. For example, the intercept terms of Taylor (1993) and Taylor (1999) rules are now
1¾ rather than 2.
3
Four of the rules—the inertial Taylor (1999) rule, the outcome-based rule, the first-difference
rule, and the nominal income targeting rule—place substantial weight on the lagged federal funds rate.
Because the rule prescriptions are conditioned on the actual level of the nominal federal funds rate
observed last quarter, the unconstrained prescriptions shown in the table may be indirectly affected by the
presence of the effective lower bound.
2
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Strategies
Monetary Policy Strategies
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Policy Rules and the Staff Projection
Near-Term Prescriptions of Selected Policy Rules
Strategies
Constrained Policy
Unconstrained Policy
2014Q3
2014Q4
2014Q3
2014Q4
Taylor (1993) rule
Previous Tealbook outlook
1.84
1.72
2.12
2.05
1.84
1.72
2.12
2.05
Taylor (1999) rule
Previous Tealbook outlook
0.73
0.52
1.28
1.07
0.73
0.52
1.28
1.07
Inertial Taylor (1999) rule
Previous Tealbook outlook
0.22
0.18
0.37
0.32
0.22
0.18
0.37
0.32
Outcome-based rule
Previous Tealbook outlook
0.54
0.42
1.12
0.89
0.54
0.42
1.12
0.89
First-difference rule
Previous Tealbook outlook
0.77
0.69
1.30
1.23
0.77
0.69
1.30
1.23
Nominal income targeting rule
Previous Tealbook outlook
0.13
0.13
0.13
0.13
−0.49
−0.52
−0.85
−0.89
Memo: Equilibrium and Actual Real Federal Funds Rates
Tealbook-consistent FRB/US r* estimate
Actual real federal funds rate
Current
Tealbook
Previous
Tealbook
−0.64
−1.01
−0.87
−1.02
Note: The lines denoted "Previous Tealbook outlook" report rule prescriptions based on the previous Tealbook’s staff
outlook using the current rule specifications, which have intercept terms that have been adjusted, where applicable,
to reflect the staff’s downward revision to the long-run real federal funds rate. Rules that have the lagged policy rate
as a right-hand-side variable jump off from the average value of the policy rate thus far in the current quarter.
Key Elements of the Staff Projection
GDP Gap
2
PCE Prices ex. Food and Energy
Percent
2
Current Tealbook
Previous Tealbook
1
0
-1
-1
-2
-2
-3
-3
-4
-4
2013
2014
2015
2016
2017
Four-quarter percent change
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
1
0
-5
2.5
2018
2019
2020
-5
0.0
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2013
2014
2015
2016
2017
2018
2019
2020
0.0
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Class I FOMC - Restricted Controlled (FR)
June 12, 2014
constraint. The only exception is the nominal income targeting rule, which calls for
accommodative prescription arises because the rule responds not only to the staff’s
estimates of the output gap and inflation in the current quarter but also to the cumulative
shortfall of inflation from the Committee’s 2 percent longer-run objective since the end
of 2007.
In general, the current versions of the simple rules prescribe somewhat higher
policy rates in the near term under the current staff forecast than under the previous
Tealbook forecast, primarily reflecting the staff’s projection of a narrower output gap
than in the April Tealbook. As the lower-left panel of the exhibit shows, the staff’s
downward revisions to potential output growth in 2014 and 2015 have led to a modestly
narrower output gap in 2015 and 2016, after which real GDP rises about 1 percent above
potential in 2017 compared with ¾ percent in April. The staff’s projection for core
inflation, shown in the lower-right panel of the exhibit, is largely unchanged in the near
term; the medium-term path for inflation is slightly below the path projected in April,
reflecting the staff’s reassessment of where the inflation rate would settle in the absence
of economic slack if the current level of long-run inflation expectations were
maintained.4
The top panel of the first exhibit also reports the Tealbook-consistent estimate of
the equilibrium real federal funds rate, r*, generated using the FRB/US model after
adjusting it to reproduce the staff’s baseline forecast. The estimated r* corresponds to
the real federal funds rate that would, if maintained, return output to potential in
12 quarters. The estimated r*, at about –0.6 percent, is modestly higher than in April
because of the staff’s downward revisions to potential output growth and the consequent
narrowing in the projected output gap, and it is about 0.4 percentage points higher than
the actual real federal funds rate.
The second exhibit, “Policy Rule Simulations,” reports dynamic simulations of
the FRB/US model.5 These simulations reflect the endogenous responses of inflation and
4
A detailed explanation of the reassessment is provided in the memo “Why is Inflation
Persistently Low in the Judgmental Forecast?” by Deb Lindner, which was sent to the Committee on
June 4, 2014. This reassessment has been incorporated into the dynamic simulations of the policy rules.
5
All of the dynamic simulations presented in this section incorporate the staff’s downward
revisions to the longer-run real federal funds rate and the staff’s reassessment of where the inflation rate
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negative policy rates in the near term when the constraint is not imposed. This more
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June 12, 2014
Strategies
Policy Rule Simulations
Effective Nominal Federal Funds Rate
Real Federal Funds Rate
Percent
Taylor (1993) rule
Taylor (1999) rule
Inertial Taylor (1999) rule
Outcome-based rule
Nominal income targeting rule
First-difference rule
Tealbook baseline
6
5
4
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
6
5
4
4
3
3
2
2
1
1
0
0
-2
-1
-3
-1
2013
2014
2015
2016
2017
2018
2019
2020
Unemployment Rate
2013
2014
2015
2016
2017
2018
2019
2020
-3
PCE Inflation
8
Percent
8
7
7
6
2.5
Percent
2.5
Four-quarter average
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
6
5
5
4
4
2013
2014
2015
2016
2017
2018
2019
2020
0.0
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.
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the output gap when the federal funds rate follows the paths implied by the different
lower bound of 12½ basis points.6 For these simulations, no attempt is made to capture
the Committee’s forward guidance, reaffirmed in April, that “it likely will be appropriate
to maintain the current target range for the federal funds rate for a considerable time after
the asset purchase program ends.” Alternative policy rule simulations that take account
of this guidance are discussed below. Each rule is applied under the assumptions that
financial market participants as well as price- and wage-setters believe that the FOMC
will follow that rule, and that agents fully understand and anticipate the implications of
the rule for future real activity, inflation, and interest rates.
The second exhibit also displays the implications of following the baseline policy
assumptions adopted in this Tealbook. In forming the Tealbook baseline, the staff
assumed that the federal funds rate would remain at the effective lower bound for two
quarters after the end of the asset purchase program and then follow the prescriptions of
the inertial Taylor (1999) rule. As in April, the first rate hike under the baseline policy
occurs in the second quarter of 2015. Thereafter, the federal funds rate gradually
increases over the next few years, reaching 2 percent in the second half of 2016 and
4 percent in 2019. Even though the projected output gap is now narrower over the nearterm, the trajectory of the federal funds rate under the Tealbook baseline is somewhat
lower than in April, reflecting the staff’s revisions to the long-run real federal funds rate
and the medium-term path for inflation.
Four of the rules—the Taylor (1993), Taylor (1999), outcome-based, and firstdifference rules—call for policy tightening to have begun already by the third quarter of
this year and are associated with real federal funds rate paths that lie significantly above
the corresponding path in the Tealbook baseline over the next few years, leading to
higher unemployment rates over that period. Nonetheless, these four rules produce paths
for inflation that are similar to the Tealbook baseline because of the low sensitivity of
inflation to slack in the FRB/US model. The inertial Taylor (1999) rule calls for a more
would settle in the absence of economic slack if the current level of long-run inflation expectations were
maintained.
6
The policy rule simulations discussed here and below incorporate the macroeconomic effects of
the FOMC’s large-scale asset purchase programs. For the current program, the simulations embed the
assumption that purchases of longer-term Treasury securities and agency MBS will conclude before the end
of this year, with cumulative purchases since the start of 2013 close to $1.5 trillion.
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policy rules, under the assumption that the federal funds rate is subject to an effective
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June 12, 2014
gradual tightening commencing in the fourth quarter; its prescriptions for the federal
Strategies
funds rate are nearly identical to those under the Tealbook baseline from 2017 onward
and result in very similar macroeconomic outcomes. Only the nominal income targeting
rule implies a later inception of tightening than assumed in the Tealbook baseline. This
rule keeps the federal funds rate within the Committee’s current target range until the
second quarter of 2016 and generates a real federal funds rate that runs persistently below
the baseline path for the rest of the decade, thereby leading to stronger real activity.
Under this rule, inflation is closer to the Committee’s objective than the Tealbook
baseline through 2017 and runs almost ¼ percentage point above this objective for
several years thereafter.
The results for each rule presented in these and subsequent simulations depend
importantly on the assumptions that policymakers will adhere to that rule in the future
and that the private sector fully understands the policy that will be pursued and its
implications for real activity and inflation. These assumptions play a particularly critical
role in the case of the nominal income targeting rule, which generates outcomes in which
unemployment runs markedly below the natural rate, even after inflation has moved
above the Committee’s longer-run goal.
As noted above, the policy rules in the simulations do not take into account the
Committee’s forward guidance, and most of these rules involve departures from the
effective lower bound that occur about three quarters earlier than the date suggested by
recent FOMC communications. The third exhibit, “Policy Rule Simulations with an
Unemployment Rate Threshold,” reports results obtained when each policy rule is subject
to an unemployment rate threshold of 5.8 percent. The threshold captures the
Committee’s guidance—most recently expressed in its April statement—“that it will be
appropriate to maintain the current target range for the federal funds rate for a
considerable time after the asset purchase program ends” in a data-dependent manner. A
value of 5.8 percent was chosen because in the Tealbook baseline, the unemployment rate
crosses that level in the quarter before firming begins.7 The same unemployment rate
threshold is also adopted in most of the alternative scenarios shown in the Risk and
Uncertainties section of Tealbook, Book A. Financial market participants and price- and
7
The unemployment rate threshold used in April was 6.0 percent because that was the value of the
unemployment rate immediately before the federal funds rate left the effective lower bound in the baseline
projection. The threshold was lowered to 5.8 percent for consistency with the current staff outlook for both
the federal funds rate and the unemployment rate.
Page 6 of 54
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June 12, 2014
Effective Nominal Federal Funds Rate
Real Federal Funds Rate
Percent
Taylor (1993) rule
Taylor (1999) rule
Outcome-based rule
Nominal income targeting rule
First-difference rule
Tealbook baseline
6
5
4
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
6
5
4
4
3
3
2
2
1
1
0
0
-2
-1
-3
-1
2013
2014
2015
2016
2017
2018
2019
2020
Unemployment Rate
2013
2014
2015
2016
2017
2018
2019
2020
-3
PCE Inflation
8
Percent
8
7
7
6
2.5
Percent
2.5
Four-quarter average
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
6
5
5
4
4
2013
2014
2015
2016
2017
2018
2019
2020
0.0
2013
2014
2015
2016
2017
2018
2019
2020
Note: The policy rule simulations in this exhibit keep the federal funds rate at an effective lower bound of 12½ basis
points as long as the unemployment rate is 5.8 percent or more. Thereafter, the federal funds rate follows the
prescriptions of the specified rule. A value of 5.8 percent was chosen because in the Tealbook baseline the
unemployment rate crosses that level just before firming begins. In addition, the simulations are based on rules
that respond to core inflation.
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Strategies
Policy Rule Simulations with an Unemployment Rate Threshold
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wage-setters are assumed to understand that the Committee will switch to the specified
Strategies
rule in the quarter following the observation of an unemployment rate of 5.8 percent, and
to view this switch as permanent and fully credible.
For all of the rules except the nominal income targeting rule, imposing the
unemployment rate threshold results in the federal funds rate leaving the effective lower
bound in the same quarter as in the Tealbook baseline—the second quarter of 2015.
However, the delayed departure from the effective lower bound typically has small
macroeconomic effects because the longer-term real rates that influence economic
activity in the FRB/US model are not appreciably altered by imposing the unemployment
rate threshold. Only for the first-difference rule does the threshold imply significantly
different outcomes. For this rule, imposing the unemployment rate threshold lowers the
path of interest rates over the subsequent few years and results in lower longer-term real
rates, higher inflation, and a lower path for the unemployment rate than otherwise.
The fourth exhibit, “Optimal Control Policy,” compares optimal control
simulations derived using this Tealbook’s baseline forecast with those reported in April.8
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 natural rate of unemployment, and on minimizing changes in the
federal funds rate. The optimal control concept presented here corresponds to a
commitment policy under which policymakers make decisions today that effectively
constrain policy choices in future periods.
Unlike in the previous Tealbook, the effective lower bound no longer imposes a
binding constraint for the federal funds rate path under optimal control. The policy rate
under optimal control rises above the Committee’s current target range in the fourth
quarter of this year, two quarters earlier than the optimal control path in April, largely
reflecting the lower degree of product and labor market slack in the staff projection, and
two quarters earlier than the Tealbook baseline. An important reason that optimal control
8
The optimal control policy simulations incorporate the assumptions about underlying economic
conditions used in the staff’s baseline forecast, as well as the assumptions about balance sheet policies
described in footnote 6. The “current Tealbook” optimal control policy simulation also reflects the staff’s
revision to the long-run equilibrium real federal funds rate and the staff’s reassessment of where the
inflation rate would settle in the absence of economic slack if the current level of long-run inflation
expectations were maintained, while no adjustments for these changes are made to the “previous Tealbook”
simulation of optimal control. The simulated policies do not incorporate the unemployment rate threshold.
Page 8 of 54
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June 12, 2014
Effective Nominal Federal Funds Rate
Real Federal Funds Rate
Percent
Current Tealbook
Previous Tealbook
Tealbook baseline
6
4
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
6
5
5
4
4
3
3
2
2
1
1
0
0
-2
-1
-3
-1
2013
2014
2015
2016
2017
2018
2019
2020
Unemployment Rate
2013
2014
2015
2016
2017
2018
2019
2020
-3
PCE Inflation
8
Percent
8
7
7
2.5
Four-quarter average
Percent
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
6
6
5
5
4
4
2013
2014
2015
2016
2017
2018
2019
2020
0.0
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2013
2014
2015
2016
2017
2018
2019
2020
0.0
Strategies
Optimal Control Policy
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June 12, 2014
policy departs from the effective lower bound before the Tealbook baseline policy is the
Strategies
presence of a penalty on changes in the federal funds rate in the policymakers’ objective
function.9 While the optimal control policy is a little less accommodative than the
baseline policy through 2020, the optimal control policy is a bit more stimulative over the
subsequent several years (not shown). These differences are sufficiently small, however,
that the paths of the unemployment rate and inflation are broadly similar under both
policies.
The optimal control policy discussed above corresponds to a commitment policy
under which policymakers make choices today that effectively constrain policy choices in
future periods. The fifth exhibit, “Optimal Control Policy: Commitment vs. Discretion,”
displays results that use an alternative optimality concept—discretion—under which
policymakers cannot credibly commit to carrying out a plan that requires them to make
future choices that would be suboptimal at future times. The discretion concept limits
policymakers’ ability to influence private-sector expectations regarding the federal funds
rate and other variables. Instead, the private sector knows that future Committees will
always reoptimize without regard for policymakers’ past promises.
The prescribed path for the federal funds rate under discretion is very similar to
the Tealbook baseline path, resulting in nearly identical macroeconomic outcomes.
Under discretion, the macroeconomic outcomes are also similar to those under
commitment, mostly because in current circumstances the effective lower bound is not a
significant constraint on policy. These outcomes under discretion are achieved through
an initially more accommodative policy than under commitment, as the federal funds rate
leaves the lower bound a little later and remains lower until the second half of 2021. For
several years thereafter (not shown), policy is less stimulative under discretion than under
commitment because of the inability to commit to low interest rates very far in the future.
The final two exhibits, “Outcomes under Alternative Policies” and “Outcomes
under Alternative Policies with an Unemployment Rate Threshold,” tabulate the
simulation results for key variables under each of the policy rules described above.
9
The staff has included such a penalty in large part because it helps to keep the simulated
variation and persistence of the federal funds rate close to their observed historical estimates. An objective
function with a substantially smaller interest-rate smoothing term would imply a federal funds rate path
under optimal policy that would still remain constrained by the effective lower bound for a time, but
increase more steeply thereafter.
Page 10 of 54
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Effective Nominal Federal Funds Rate
Real Federal Funds Rate
Percent
Optimal policy: Commitment
Optimal policy: Discretion
Tealbook Baseline
6
4
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
6
5
5
4
4
3
3
2
2
1
1
0
0
-2
-1
-3
-1
2013
2014
2015
2016
2017
2018
2019
2020
Unemployment Rate
2013
2014
2015
2016
2017
2018
2019
2020
-3
PCE Inflation
8
Percent
8
7
7
6
2.5
Percent
2.5
Four-quarter average
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
6
5
5
4
4
2013
2014
2015
2016
2017
2018
2019
2020
0.0
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2013
2014
2015
2016
2017
2018
2019
2020
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Optimal Control Policy: Commitment vs. Discretion
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June 12, 2014
Outcomes under Alternative Policies
Strategies
(Percent change, annual rate, from end of preceding period except as noted)
2013
Measure and policy
H2
2014 2015 2016 2017 2018
Real GDP
Extended Tealbook baseline1
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
3.4
3.4
3.4
3.4
3.4
3.4
3.4
3.4
2.4
2.3
2.3
2.4
2.3
2.3
2.5
2.4
3.0
2.6
2.7
3.0
2.6
2.7
3.6
3.0
3.2
3.2
3.1
3.2
3.1
3.1
3.7
3.2
2.6
2.8
2.7
2.6
2.7
2.7
2.8
2.5
1.7
1.9
1.9
1.7
1.9
2.0
1.6
1.7
Unemployment rate2
Extended Tealbook baseline1
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
7.0
7.0
7.0
7.0
7.0
7.0
7.0
7.0
6.0
6.1
6.0
6.0
6.0
6.0
5.9
6.0
5.4
5.7
5.6
5.4
5.6
5.6
5.1
5.4
5.0
5.2
5.2
5.0
5.2
5.2
4.4
5.0
4.7
4.8
4.9
4.7
4.9
4.9
4.1
4.8
4.8
4.8
4.9
4.8
4.9
4.8
4.3
4.9
Total PCE prices
Extended Tealbook baseline1
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.6
1.5
1.4
1.4
1.4
1.4
1.3
1.4
1.5
1.4
1.5
1.5
1.5
1.6
1.5
1.6
1.8
1.6
1.7
1.7
1.7
1.8
1.6
1.8
2.0
1.8
1.9
1.9
1.9
1.9
1.8
2.0
2.2
1.9
Core PCE prices
Extended Tealbook baseline1
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.6
1.6
1.6
1.6
1.5
1.6
1.7
1.6
1.7
1.7
1.7
1.7
1.6
1.7
1.9
1.7
1.8
1.8
1.7
1.8
1.7
1.8
2.0
1.8
1.9
1.9
1.9
1.9
1.8
2.0
2.1
1.9
Effective nominal federal funds rate2
Extended Tealbook baseline1
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
2.0
1.1
0.4
1.1
1.1
0.1
0.3
1.1
2.6
2.2
1.3
2.3
2.3
0.1
1.2
2.4
3.4
3.5
2.4
3.5
3.8
1.0
2.5
3.4
3.8
4.1
3.4
4.1
4.2
2.1
3.6
3.9
3.9
4.1
3.9
4.0
3.9
2.7
4.0
1. In the Tealbook baseline, the federal funds rate first departs from an effective lower bound of 12½ basis points
two quarters after the end of the asset purchase program. Thereafter, the federal funds rate follows the prescriptions
of the inertial Taylor (1999) rule.
2. Percent, average for the final quarter of the period.
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(Percent change, annual rate, from end of preceding period except as noted)
2013
Measure and policy
H2
2014 2015 2016 2017 2018
Real GDP
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
3.4
3.4
3.4
3.4
3.4
3.4
3.4
2.4
2.4
2.4
2.4
2.4
2.5
2.4
3.0
2.7
2.7
2.9
3.1
3.6
3.0
3.2
3.0
3.0
3.0
3.2
3.7
3.2
2.6
2.7
2.6
2.5
2.7
2.8
2.5
1.7
1.9
1.9
1.9
1.9
1.6
1.7
Unemployment rate2
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
7.0
7.0
7.0
7.0
7.0
7.0
7.0
6.0
6.0
6.0
6.0
6.0
5.9
6.0
5.4
5.6
5.6
5.5
5.4
5.1
5.4
5.0
5.2
5.2
5.2
5.0
4.4
5.0
4.7
4.8
4.9
4.9
4.6
4.1
4.8
4.8
4.9
4.9
4.9
4.6
4.3
4.9
Total PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.6
1.5
1.4
1.4
1.4
1.3
1.5
1.5
1.4
1.5
1.5
1.5
1.5
1.7
1.8
1.6
1.7
1.7
1.7
1.7
1.9
2.0
1.8
1.9
1.9
1.9
1.8
2.1
2.2
1.9
Core PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.6
1.6
1.6
1.5
1.7
1.7
1.6
1.7
1.7
1.7
1.6
1.8
1.9
1.7
1.8
1.8
1.7
1.7
1.9
2.0
1.8
1.9
1.9
1.9
1.8
2.1
2.1
1.9
Effective nominal federal funds rate2
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
Outcome-based
First-difference
Nominal income targeting
Optimal control
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.3
1.1
2.7
2.3
1.5
1.5
0.1
1.2
2.4
3.4
3.5
3.6
3.3
1.0
2.5
3.4
3.8
4.1
4.1
3.7
2.1
3.6
3.9
3.9
4.0
4.0
3.4
2.7
4.0
1. With the exception of optimal control, monetary policy is specified to keep the federal funds rate
at an effective lower bound of 12½ basis points as long as the unemployment rate is 5.8 percent or more. Once
the threshold is crossed, the federal funds rate follows the prescriptions of the specified rule.
2. Percent, average for the final quarter of the period.
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Outcomes under Alternative Policies
with an Unemployment Rate Threshold1
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Appendix
POLICY RULES USED IN “MONETARY POLICY STRATEGIES”
The table below gives the expressions for the selected policy rules used in “Monetary
Policy Strategies.” In the table, [math] denotes the effective 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 [math] the output gap estimate
for the current period as well as its one-quarter-ahead forecast [math], and the forecast
of the three-quarter-ahead annual change in the output gap [math]. The value of
policymakers' long-run inflation objective, denoted n*, is 2 percent. The nominal income
targeting rule responds to the nominal income gap, which is defined as the difference between
nominal income [math] (100 times the log of the level of nominal GDP) and a target value [math]
(100 times the log of target nominal GDP). Target nominal GDP in 2007:Q4 is set equal to the
staff's current estimate of 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 the
staff's estimate of potential GDP.
Taylor (1993) rule
[math]
Taylor (1999) rule
[math]
Inertial Taylor (1999) rule
[math]
Outcome-based rule
[math]
First-difference rule
[math]
Nominal income targeting rule
[math]
The first two of the selected rules were studied by Taylor (1993, 1999), while the inertial
Taylor (1999) rule has been featured prominently in recent analysis by Board staff.1 The
outcome-based rule uses policy reactions estimated using real-time data over the sample
1988:Q1-2006: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 real interest rate of 1 3/4 percent, a
value used in the FRB/US model.2 The intercepts of the Taylor (1993, 1999) rules and the long1 See Erceg and others (2012).
2 For the June 2014 Tealbook, the staff revised the long-run value of the real interest rate from 2
percent to 1% percent. The FRB/US model, as well as the intercepts of the different policy rules, have been
adjusted to reflect this change.
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run intercept of the inertial Taylor (1999) rule are set at 1¾ percent for the same reason. The 1¾
percent real rate estimate also enters the long-run intercept of the nominal income targeting rule.
The prescriptions of the first-difference rule do not depend on the level of the output gap or the
long-run real interest rate; see Orphanides (2003).
Near-term prescriptions from the different policy rules are calculated using Tealbook
projections for inflation and the output gap. For the rules that include the lagged policy rate as a
right-hand-side variable—the inertial Taylor (1999) rule, the first-difference rule, the estimated
outcome-based rule, and the nominal income targeting rule—the lines denoted “Previous
Tealbook outlook” report prescriptions derived from the previous Tealbook projections for
inflation and the output gap, while using the same lagged funds rate value as in the prescriptions
computed for the current Tealbook. When the Tealbook is published early in the quarter, this
lagged funds rate value is set equal to the actual value of the lagged funds rate in the previous
quarter, and prescriptions are shown for the current quarter. When the Tealbook is published late
in the quarter, the prescriptions are shown for the next quarter, and the lagged policy rate, for
each of these rules, including those that use the “Previous Tealbook outlook,” is set equal to the
average value for the policy rate thus far in the quarter. For the subsequent quarter, these rules
use the lagged values from their simulated, unconstrained prescriptions.
References
Erceg, Christopher, Jon Faust, Michael Kiley, Jean-Philippe Laforte, David López-Salido,
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.
McCallum, Bennett T., and Edward Nelson (1999). “Nominal Income Targeting in an OpenEconomy 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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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 12 quarters using an output projection from 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 memo item in the exhibit reports 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.
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.
FRB/US MODEL SIMULATIONS
The exhibits of “Monetary Policy Strategies” that report results from simulations of
alternative policies are derived from dynamic simulations of the FRB/US model. Each 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.
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ESTIMATES OF THE EQUILIBRIUM AND ACTUAL REAL RATES
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Monetary Policy Alternatives
This Tealbook presents three policy alternatives—labeled A, B, and C—for the
Committee’s consideration. With respect to balance sheet policy, Alternative B reduces
monthly purchases of agency MBS and Treasury securities by another $5 billion each and
signals that further reductions of that size are likely at future meetings. Under
Alternative C, the Committee would reduce purchases of agency MBS and Treasury
securities by $10 billion each and indicate that the pace of purchases is likely to be
reduced further. Under Alternative A, the Committee would maintain the current pace of
labor market conditions, and inflation.”
All of the alternatives retain the April statement’s forward guidance for the
federal funds rate. Alternative A adds an inflation floor, under which the Committee
would maintain the current target range for the federal funds rate “at least as long as
inflation between one and two years ahead is projected to be below 2 percent, provided
that longer-term inflation expectations remain well anchored.” Moreover, under each
alternative, the Committee would repeat its intention to take a “balanced approach” when
it begins to remove policy accommodation. The Committee would also reiterate that it
“currently anticipates that, even after employment and inflation are near mandateconsistent levels, economic conditions may, for some time, warrant keeping the target
federal funds rate below levels the Committee views as normal in the longer run.”
In characterizing current conditions and the economic outlook, Alternative B
indicates that growth in economic activity “has rebounded in recent months,” without
explicit reference to the decline in output during the first quarter or to adverse weather
conditions during the winter. Alternative B also observes that household spending
“appears to be rising moderately,” and retains the language on housing from April that
“the recovery in the housing sector remained slow.” Alternative C parses the recent data
similarly to Alternative B, except that it is more positive on business fixed investment,
saying it “accelerated.” Alternative A offers a less upbeat characterization of the data,
noting that economic activity “declined earlier in the year,” even while acknowledging
that it “has picked up in recent months.” Alternative A is also less sanguine about the
housing market, stating “the recovery in the housing sector slowed further.”
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Alternatives
asset purchases “while awaiting further information concerning the economic outlook,
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Alternative B differs significantly from the April statement with regard to labor
market conditions, dropping the depiction of relevant data as “mixed” in favor of a
statement saying that “labor market indicators generally showed further improvement,”
and noting that “the unemployment rate, though lower, remains elevated.” Alternative A
retains more of April's characterization of labor market news, saying “indicators were
mixed but generally showed further improvement.” Alternative C offers a more
expansive summary of labor market conditions, consistent with the idea, first introduced
in the March statement, that the Committee “will take into account a wide range of
information.” The text of Alternative C includes: “Payroll employment has strengthened
and the unemployment rate has declined, but these and other measures, taken together,
Alternatives
indicate that [substantial] underutilization of labor resources remains.”
The references to inflation in Alternative B are unchanged from April, stating that
“inflation has been running below the Committee’s longer-run objective, but longer-term
inflation expectations have remained stable.” Alternative A adds an element of
dissatisfaction to this description, arguing that inflation “continues to run well below”
target “even though” long-term inflation expectations have been stable. Alternative C
simply says that inflation “appears to be moving gradually toward” 2 percent.
All three of the Alternatives affirm the Committee’s modal forecast that, with
appropriate policy accommodation, economic activity will expand at a moderate pace and
labor market conditions will continue to improve gradually. Under each alternative the
Committee would state that it recognizes the risks associated with inflation running
persistently below 2 percent and is monitoring inflation developments carefully for
evidence that inflation will move back toward 2 percent. Alternative A notes that “The
Committee anticipates that inflation will return to 2 percent, but only gradually.”
Alternative C is more optimistic, indicating that inflation “will continue to move back
toward” the Committee’s objective.
Subsequent pages present complete drafts of the statements and arguments for
each alternative.
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Alternatives
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APRIL FOMC STATEMENT
Alternatives
1. Information received since the Federal Open Market Committee met in March
indicates that growth in economic activity has picked up recently, after having slowed
sharply during the winter in part because of adverse weather conditions. Labor
market indicators were mixed but on balance showed further improvement. The
unemployment rate, however, remains elevated. Household spending appears to be
rising more quickly. Business fixed investment edged down, while the recovery in
the housing sector remained slow. Fiscal policy is restraining economic growth,
although the extent of restraint is diminishing. Inflation has been running below the
Committee’s longer-run objective, but 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 expects that, with appropriate policy
accommodation, economic activity will expand at a moderate pace and labor market
conditions will continue to improve gradually, moving toward those the Committee
judges consistent with its dual mandate. The Committee sees the risks to the outlook
for the economy and the labor market as nearly balanced. The Committee recognizes
that inflation persistently below its 2 percent objective could pose risks to economic
performance, and it is monitoring inflation developments carefully for evidence that
inflation will move back toward its objective over the medium term.
3. The Committee currently judges that there is sufficient underlying strength in the
broader economy to support ongoing improvement in labor market conditions. In
light of the cumulative progress toward maximum employment and the improvement
in the outlook for labor market conditions since the inception of the current asset
purchase program, the Committee decided to make a further measured reduction in
the pace of its asset purchases. Beginning in May, the Committee will add to its
holdings of agency mortgage-backed securities at a pace of $20 billion per month
rather than $25 billion per month, and will add to its holdings of longer-term Treasury
securities at a pace of $25 billion per month rather than $30 billion per month. 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 and of rolling over maturing Treasury securities at
auction. The Committee’s sizable and still-increasing holdings of longer-term
securities should maintain downward pressure on longer-term interest rates, support
mortgage markets, and help to make broader financial conditions more
accommodative, which in turn should promote a stronger economic recovery and help
to ensure that inflation, over time, is at the rate most consistent with the Committee’s
dual mandate.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months and will continue its purchases of Treasury and
agency mortgage-backed securities, and employ its other policy tools as appropriate,
until the outlook for the labor market has improved substantially in a context of price
stability. If incoming information broadly supports the Committee’s expectation of
ongoing improvement in labor market conditions and inflation moving back toward
its longer-run objective, the Committee will likely reduce the pace of asset purchases
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5. To support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that a highly accommodative stance of monetary
policy remains appropriate. In determining how long to maintain the current 0 to ¼
percent target range for the federal funds rate, the Committee will assess progress—
both realized and expected—toward its objectives of maximum employment and 2
percent inflation. This assessment will take into account a wide range of information,
including measures of labor market conditions, indicators of inflation pressures and
inflation expectations, and readings on financial developments. The Committee
continues to anticipate, based on its assessment of these factors, that it likely will be
appropriate to maintain the current target range for the federal funds rate for a
considerable time after the asset purchase program ends, especially if projected
inflation continues to run below the Committee’s 2 percent longer-run goal, and
provided that longer-term inflation expectations remain well anchored.
6. When the Committee decides to begin to remove policy accommodation, it will take a
balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent. The Committee currently anticipates that, even after
employment and inflation are near mandate-consistent levels, economic conditions
may, for some time, warrant keeping the target federal funds rate below levels the
Committee views as normal in the longer run.
Page 23 of 54
Alternatives
in further measured steps at future meetings. However, asset purchases are not on a
preset course, and the Committee’s decisions about their pace will remain contingent
on the Committee’s outlook for the labor market and inflation as well as its
assessment of the likely efficacy and costs of such purchases.
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June 12, 2014
FOMC STATEMENT—JUNE 2014 ALTERNATIVE A
Alternatives
1. Information received since the Federal Open Market Committee met in March April
indicates that growth in economic activity has picked up in recently months, after
having slowed sharply declined during the winter earlier in the year in part because
of adverse weather conditions. Labor market indicators were mixed but on balance
generally showed further improvement. The unemployment rate, however, remains
elevated. Household spending appears to be rising moderately more quickly. and
business fixed investment edged down is advancing, while but the recovery in the
housing sector remained slowed further. Fiscal policy is restraining economic
growth, although the extent of restraint is diminishing. Inflation has been continues
to running well below the Committee’s longer-run objective, but even though longerterm inflation expectations have remained stable.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with appropriate policy
accommodation, economic activity will expand at a moderate pace and labor market
conditions will continue to improve gradually, moving toward those the Committee
judges consistent with its dual mandate. The Committee sees the risks to the outlook
for the economy and the labor market as nearly balanced. The Committee
anticipates that inflation will return to 2 percent, but only gradually; it
recognizes that inflation persistently below its 2 percent objective could pose risks to
economic performance, and it is monitoring inflation developments carefully for
evidence that inflation will move back toward its objective over the medium term.
3. The Committee currently judges that there is sufficient underlying strength in the
broader economy to support ongoing improvement in labor market conditions.
However, in light of the cumulative progress toward maximum employment and the
improvement in the outlook for labor market conditions since the inception of the
current asset purchase program, the Committee decided to make a further measured
reduction in the pace of its asset purchases. Beginning in May, surprisingly large
fluctuations in economic growth in recent quarters and the resulting increase in
uncertainty about the economic outlook, the Committee decided to maintain the
current pace of its asset purchases while awaiting further information
concerning the economic outlook, labor market conditions, and inflation. Thus,
the Committee will continue to add to its holdings of agency mortgage-backed
securities at a pace of $20 billion per month rather than $25 billion per month, and
will add to its holdings of longer-term Treasury securities at a pace of $25 billion per
month rather than $30 billion per month. 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 and of rolling over
maturing Treasury securities at auction. The Committee’s sizable and still-increasing
holdings of longer-term securities should maintain downward pressure on longer-term
interest rates, support mortgage markets, and help to make broader financial
conditions more accommodative, which in turn should promote a stronger economic
recovery and help to ensure that inflation, over time, is at the rate most consistent
with the Committee’s dual mandate.
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5. To support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that a highly accommodative stance of monetary
policy remains appropriate. In determining how long to maintain the current 0 to ¼
percent target range for the federal funds rate, the Committee will assess progress—
both realized and expected—toward its objectives of maximum employment and 2
percent inflation. This assessment will take into account a wide range of information,
including measures of labor market conditions, indicators of inflation pressures and
inflation expectations, and readings on financial developments. The Committee
continues to anticipates, based on its assessment of these factors, that it likely will be
appropriate to maintain the current target range for the federal funds rate for a
considerable time after the asset purchase program ends, especially if projected
inflation continues to run below the Committee’s 2 percent longer-run goal, and at
least as long as inflation between one and two years ahead is projected to be
below 2 percent, provided that longer-term inflation expectations remain well
anchored.
6. When the Committee decides to begin to remove policy accommodation, it will take a
balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent. The Committee currently anticipates that, even after
employment and inflation are near mandate-consistent levels, economic conditions
may, for some time, warrant keeping the target federal funds rate below levels the
Committee views as normal in the longer run.
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Alternatives
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months and will continue its purchases of Treasury and
agency mortgage-backed securities, and employ its other policy tools as appropriate,
until the outlook for the labor market has improved substantially in a context of price
stability. If incoming information broadly more clearly supports the Committee’s
expectation of ongoing improvement in labor market conditions and inflation moving
back toward its longer-run objective, the Committee will likely reduce the pace of
asset purchases in further measured steps at future meetings. However, asset
purchases are not on a preset course, and the Committee’s decisions about their pace
will remain contingent on the Committee’s outlook for the labor market and inflation
as well as its assessment of the likely efficacy and costs of such purchases.
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June 12, 2014
FOMC STATEMENT—JUNE 2014 ALTERNATIVE B
Alternatives
1. Information received since the Federal Open Market Committee met in March April
indicates that growth in economic activity has picked up rebounded in recently
months, after having slowed sharply during the winter in part because of adverse
weather conditions. Labor market indicators were mixed but on balance generally
showed further improvement. The unemployment rate, however though lower,
remains elevated. Household spending appears to be rising more quickly.
moderately and business fixed investment edged down resumed its advance, while
the recovery in the housing sector remained slow. Fiscal policy is restraining
economic growth, although the extent of restraint is diminishing. Inflation has been
running below the Committee’s longer-run objective, but 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 expects that, with appropriate policy
accommodation, economic activity will expand at a moderate pace and labor market
conditions will continue to improve gradually, moving toward those the Committee
judges consistent with its dual mandate. The Committee sees the risks to the outlook
for the economy and the labor market as nearly balanced. The Committee recognizes
that inflation persistently below its 2 percent objective could pose risks to economic
performance, and it is monitoring inflation developments carefully for evidence that
inflation will move back toward its objective over the medium term.
3. The Committee currently judges that there is sufficient underlying strength in the
broader economy to support ongoing improvement in labor market conditions. In
light of the cumulative progress toward maximum employment and the improvement
in the outlook for labor market conditions since the inception of the current asset
purchase program, the Committee decided to make a further measured reduction in
the pace of its asset purchases. Beginning in May July, the Committee will add to its
holdings of agency mortgage-backed securities at a pace of $20 $15 billion per month
rather than $25 $20 billion per month, and will add to its holdings of longer-term
Treasury securities at a pace of $25 $20 billion per month rather than $30 $25 billion
per month. 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 and of rolling over maturing Treasury securities at
auction. The Committee’s sizable and still-increasing holdings of longer-term
securities should maintain downward pressure on longer-term interest rates, support
mortgage markets, and help to make broader financial conditions more
accommodative, which in turn should promote a stronger economic recovery and help
to ensure that inflation, over time, is at the rate most consistent with the Committee’s
dual mandate.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months and will continue its purchases of Treasury and
agency mortgage-backed securities, and employ its other policy tools as appropriate,
until the outlook for the labor market has improved substantially in a context of price
stability. If incoming information broadly supports the Committee’s expectation of
ongoing improvement in labor market conditions and inflation moving back toward
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5. To support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that a highly accommodative stance of monetary
policy remains appropriate. In determining how long to maintain the current 0 to ¼
percent target range for the federal funds rate, the Committee will assess progress—
both realized and expected—toward its objectives of maximum employment and 2
percent inflation. This assessment will take into account a wide range of information,
including measures of labor market conditions, indicators of inflation pressures and
inflation expectations, and readings on financial developments. The Committee
continues to anticipate, based on its assessment of these factors, that it likely will be
appropriate to maintain the current target range for the federal funds rate for a
considerable time after the asset purchase program ends, especially if projected
inflation continues to run below the Committee’s 2 percent longer-run goal, and
provided that longer-term inflation expectations remain well anchored.
6. When the Committee decides to begin to remove policy accommodation, it will take a
balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent. The Committee currently anticipates that, even after
employment and inflation are near mandate-consistent levels, economic conditions
may, for some time, warrant keeping the target federal funds rate below levels the
Committee views as normal in the longer run.
Page 27 of 54
Alternatives
its longer-run objective, the Committee will likely reduce the pace of asset purchases
in further measured steps at future meetings. However, asset purchases are not on a
preset course, and the Committee’s decisions about their pace will remain contingent
on the Committee’s outlook for the labor market and inflation as well as its
assessment of the likely efficacy and costs of such purchases.
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Alternatives
FOMC STATEMENT—JUNE 2014 ALTERNATIVE C
1. Information received since the Federal Open Market Committee met in March April
indicates that growth in economic activity has picked up rebounded in recently
months, after having slowed sharply during the winter in part because of adverse
weather conditions. Labor market indicators were mixed but on balance showed
broad further improvement. The unemployment rate, however, remains elevated.
Payroll employment has strengthened and the unemployment rate has declined,
but these and other measures, taken together, indicate that [ substantial ]
underutilization of labor resources remains. Household spending appears to be
has been rising more quickly. moderately and business fixed investment edged
down accelerated, while the recovery in the housing sector remained slow. Fiscal
policy is restraining economic growth, although the extent of restraint is diminishing.
Inflation has been running below appears to be moving gradually toward the
Committee’s longer-run objective, but and 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 expects that, with appropriate policy
accommodation, economic activity will expand at a moderate pace and labor market
conditions will continue to improve gradually, moving toward those the Committee
judges consistent with its dual mandate. The Committee sees the risks to the outlook
for the economy and the labor market as nearly balanced. The Committee recognizes
that inflation persistently below its 2 percent objective could pose risks to economic
performance, and it is monitoring inflation developments carefully for evidence that
inflation will continue to move back toward its objective over the medium term.
3. The Committee currently judges that there is sufficient underlying strength in the
broader economy to support ongoing improvement in labor market conditions. In
light of the cumulative progress toward maximum employment and the improvement
in the outlook for labor market conditions since the inception of the current asset
purchase program, the Committee decided to make a further measured reduction in
the pace of its asset purchases. Beginning in May July, the Committee will add to its
holdings of agency mortgage-backed securities at a pace of $20 $10 billion per month
rather than $25 $20 billion per month, and will add to its holdings of longer-term
Treasury securities at a pace of $25 $15 billion per month rather than $30 $25 billion
per month. 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 and of rolling over maturing Treasury securities at
auction. The Committee’s sizable and still-increasing holdings of longer-term
securities should maintain downward pressure on longer-term interest rates, support
mortgage markets, and help to make broader financial conditions more
accommodative, which in turn should promote a stronger economic recovery and help
to ensure that inflation, over time, is at the rate most consistent with the Committee’s
dual mandate.
4. The Committee will closely monitor incoming information on economic and financial
developments in coming months and will continue its purchases of Treasury and
agency mortgage-backed securities, and employ its other policy tools as appropriate,
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5. To support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that a highly accommodative stance of monetary
policy remains appropriate. In determining how long to maintain the current 0 to ¼
percent target range for the federal funds rate, the Committee will assess progress—
both realized and expected—toward its objectives of maximum employment and 2
percent inflation. This assessment will take into account a wide range of information,
including measures of labor market conditions, indicators of inflation pressures and
inflation expectations, and readings on financial developments. The Committee
continues to anticipate, based on its assessment of these factors, that it likely will be
appropriate to maintain the current target range for the federal funds rate for a
considerable time after the asset purchase program ends, especially if projected
inflation continues to run below the Committee’s 2 percent longer-run goal, and
provided that longer-term inflation expectations remain well anchored.
6. When the Committee decides to begin to remove policy accommodation, it will take a
balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent. The Committee currently anticipates that, even after
employment and inflation are near mandate-consistent levels, economic conditions
may, for some time, warrant keeping the target federal funds rate below levels the
Committee views as normal in the longer run.
Page 29 of 54
Alternatives
until the outlook for the labor market has improved substantially in a context of price
stability. If incoming information broadly supports the Committee’s expectation of
ongoing improvement in labor market conditions and inflation moving back toward
its longer-run objective, the Committee will likely reduce the pace of asset purchases
in further measured steps at future meetings. However, asset purchases are not on a
preset course, and the Committee’s decisions about their pace will remain contingent
on the Committee’s outlook for the labor market and inflation as well as its
assessment of the likely efficacy and costs of such purchases.
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THE CASE FOR ALTERNATIVE B
The Committee may judge it appropriate to maintain its recent pattern of adjusting
policy by reducing the monthly pace of asset purchases another $10 billion and issuing a
postmeeting statement with very few changes, as in Alternative B. They might see the
information received during the intermeeting period as confirming the rebound in
economic growth that they anticipated when they met in April, and as indicating that
there continues to be sufficient underlying strength in the broader economy to support
ongoing improvement in labor market conditions. Policymakers may judge that the bulk
of the weakness in real activity observed early in the year reflected transitory phenomena,
including unusually severe winter weather and may see the more recent data as
Alternatives
suggesting that those effects have largely or entirely passed. In particular, policymakers
may view recent indicators of consumer spending and business fixed investment as
consistent with their earlier expectation that the economic recovery would regain
momentum during the current quarter. And they might see a high likelihood that
sustained employment gains, in conjunction with higher house and equity prices and
diminishing restraint from fiscal policy, will support continued solid growth in private
domestic final purchases in coming quarters.
At the same time, policymakers may judge that considerable slack remains in
labor markets. The unemployment rate, while having come down in recent months,
remains appreciably above the upper bound of the central tendency of participants’
projections for the unemployment rate in the long run. In addition, policymakers may
regard the recent large decline in the labor force participation rate, the still-high share of
unemployed workers who have been out of work for six months or more, and the elevated
number of part-time workers who would prefer a full-time job as supporting the judgment
that there is still considerable slack in labor markets. Moreover, inflation continues to
run below the Committee’s 2 percent objective and policymakers may agree with the
staff’s assessment that inflation is likely to move toward 2 percent only slowly,
particularly given that evidence showing inflation moving back up remains sparse.
Policymakers might also observe that the paths for unemployment and inflation in the
staff’s current baseline forecast (which reflects policy settings consistent with Alternative
B, including continued gradual reductions in the pace of asset purchases) are quite similar
to the paths generated by the optimal control exercises summarized in the “Monetary
Policy Strategies” section of Tealbook, Book B. Accordingly, they might decide that a
highly accommodative monetary policy remains appropriate in order to promote
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continued improvement in the labor market and return inflation to 2 percent over the
medium run. Nonetheless, given the cumulative improvement in the labor market and
their expectation that progress toward their objectives will continue, policymakers may
judge it appropriate to make another measured reduction in the pace of asset purchases,
while maintaining the current target range for the federal funds rate and the current
forward guidance.
Some policymakers may read the economic news since April as providing
insufficient assurance that a lasting bounce back from the first quarter’s weakness is
underway and thus may be inclined to halt, for a time, reductions in the pace of asset
signal a deviation from the announced baseline for asset purchases would send, it would
be risky to pause the taper in the absence of additional evidence indicating that the
economy is diverging substantially from the path the Committee anticipated in April.
Other policymakers may be concerned that continuing to buy assets and expand
the balance sheet until the fall of this year, and maintaining near-zero rates for a
considerably longer period, risks an increase in longer-term inflation expectations and an
undesirably large increase in inflation as the economy strengthens over the medium run.
Policymakers also may point to the low levels of actual and expected volatility in
financial markets and worry that maintaining highly accommodative policy for such a
long span could lead to excessive risk-taking in the financial sector. Still, inflation
continues to run below 2 percent, expected inflation shows no sign of drifting up, and
indicators of leverage and reliance on short-term wholesale funding in the financial
system remain well below pre-crisis levels, so policymakers may judge that the sequence
of modest reductions in the pace of asset purchases and subsequent gradual rise in the
federal funds rate that market participants now anticipate will be enough to contain
inflation and financial market risks. They may also see the language in paragraph B.5
that says the Committee will consider a wide range of information including readings on
financial developments and inflation pressures in determining how long to maintain a
highly accommodative stance of monetary policy as providing the Committee with
sufficient flexibility to adjust policy in response to off-baseline scenarios in which their
concerns about inflation or financial stability risks begin to be realized.
Market participants are unlikely to be surprised by a statement along the lines of
Alternative B. According to the Desk’s latest survey, all 22 of the primary dealers, and
Page 31 of 54
Alternatives
purchases. However, those same policymakers might conclude that, given how strong a
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all but one of the 27 buy-side respondents, expect the Committee to announce another
$10 billion cut in the pace of asset purchases next week and are nearly certain that will be
the outcome. Most dealers also anticipate a largely unchanged statement, though with a
somewhat more positive characterization of current economic growth or labor market
conditions. Dealers expect the SEP to show declines in FOMC participants’ projections
of both GDP growth in 2014 and the unemployment rate, and some dealers predict a
modest upward revision in participants’ inflation forecast for this year. All told, a
statement like Alternative B is likely to generate little adjustment in asset prices or yields.
THE CASE FOR ALTERNATIVE C
Alternatives
Policymakers may be convinced that the recent weakness in measures of output
growth was entirely caused by temporary factors and judge that there is a solid
underlying expansion in economic activity under way—an expansion that is likely to
reduce the amount of slack in labor markets relatively quickly. Moreover, they may think
that the unemployment rate, while still high relative to its likely longer-run equilibrium
level, is high because of labor market frictions that are unlikely to diminish quickly and
so may see little labor market slack currently. They might also consider the recent uptick
in inflation as more consequential than does the staff, increasing their confidence that
inflation is likely to move back toward 2 percent in a reasonably timely fashion. In
addition, they may worry that, given the current trajectory for policy, the risks are
increasing that inflation will eventually exceed the Committee’s longer-run goal. Or they
may view high stock market valuations, low credit spreads, and very low levels of
implied volatility, as suggesting that continuing asset purchases for as long as envisioned
under Alternative B could pose risks to financial stability. Hence they may see little
justification for continuing asset purchases and perceive the potential costs of doing so as
building, tipping the balance of efficacy and costs in favor of a larger cut in asset
purchases and an early end to the purchase program, as under Alternative C.
Policymakers may view the post-winter strengthening in the pace of consumer
spending, the waning of fiscal restraint, and the 230,000 average monthly gain in
nonfarm private payrolls over the last three months as reasons to be confident that the
economy and the labor market have sufficient momentum to maintain good progress
towards maximum employment, even if the Committee quickly winds down asset
purchases. Moreover, they might see this momentum as making it likely that real GDP
will approach potential in relatively short order, particularly given the further downward
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adjustment to potential output growth adopted in the staff forecast. Their confidence in
this view might be buttressed to the extent that they subscribe to the even more
pessimistic outlook for potential output exemplified by the “No Room to Grow”
alternative simulation in Tealbook, Book A. As a consequence, policymakers may
anticipate that inflation will move back up toward 2 percent fairly quickly and be
concerned that inflation expectations could become unanchored if the Committee
continues to maintain accommodation for much longer. For all of these reasons,
policymakers may see an early transition to a less accommodative stance of monetary
policy as an attractive option.
decision to adopt a statement like Alternative C would surprise market participants, as all
dealers and all buy-side respondents but one expect another $10 billion cut in the pace of
asset purchases. A $20 billion reduction in the pace of purchases likely would be read by
investors as a signal that the Committee is moving to taper the asset purchase program
more quickly, and end it sooner, than previously anticipated. In combination with the
solidly positive characterization of the economy in the first paragraph of the draft
statement for Alternative C, a larger-than-expected cut in the pace of purchases would
probably lead market participants to pull forward their forecasts of the date on which the
Committee will first increase its target for the federal funds rate, and perhaps also lead
them to anticipate a steeper path for the funds rate once policy firming begins. In
response, longer-term real interest rates likely would rise, equity prices and inflation
compensation fall, and the dollar appreciate. However, to the extent that the statement
instead leads investors to become more positive and more confident about the economic
outlook, equity prices and inflation compensation would likely decline less than
otherwise while medium- and longer-term interest rates would rise more. Finally,
adopting Alternative C could increase market participants’ uncertainty regarding the
Committee’s reaction function and thereby increase financial market volatility.
THE CASE FOR ALTERNATIVE A
Though temporary factors likely accounted for much of the decline in economic
activity during the winter, the sequence of downward revisions to first-quarter GDP may
raise doubts that the current rebound in economic growth will persist; moreover,
policymakers might note that average growth in the first half will likely be sub-par even
with a substantial rebound in the second quarter. Taking into account the string of
Page 33 of 54
Alternatives
Based on the Desk’s latest surveys of primary dealers and buy-side firms, a
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disappointing data on the pace of activity in the housing market and readings on inflation
that have continued to run consistently below the Committee’s longer-run objective,
participants may judge that ending the asset purchase program later this year could prove
premature, especially if they fear that the Committee would consider resuming purchases
only if the unemployment rate were trending up. Although policymakers may be
encouraged by the continuing rise in private payroll employment in recent months, they
might remain skeptical that significant gains in employment can be sustained in the
absence of a broader pickup in economic activity, or they may see the low and declining
labor force participation rate as indicative of weaker underlying labor market conditions
than is evident from the unemployment rate and payroll employment figures.
Alternatives
Policymakers might also observe that, while the prescribed path for federal funds rate in
the staff’s current baseline forecast is quite similar to the path in the optimal control
exercise summarized in the “Monetary Policy Strategies” section of the Tealbook, those
paths essentially ignore any labor market conditions that are not captured by the deviation
of the unemployment rate from the natural rate. For any of these reasons, participants
may believe that it would be appropriate to adopt a more accommodative stance of policy
than market participants currently anticipate, as in Alternative A.
Some policymakers may also regard the outlook as less certain than they
previously thought and may be less confident that there is sufficient underlying strength
in the economy to support ongoing improvement in labor market conditions and to return
inflation to 2 percent over the medium run. For example, they may see an appreciable
risk of an outcome such as that in the “Weaker Household Demand” alternative scenario
in Tealbook, Book A. Such policymakers would presumably find Alternative A
particularly appealing.
In addition, participants may share the staff’s revised assessment that inflation is
not likely to return to the Committee’s longer-run objective for a long time, absent easier
monetary conditions than are shown in the Tealbook baseline, and they may judge not
only that the modal outlook for inflation is unsatisfactory but also that downside risks to
that outlook remain substantial enough to be a concern. Some policymakers may be
particularly concerned about the possibility that persistently low inflation could produce
lower longer-run inflation expectations, resulting in mutually-reinforcing downward
dynamics for inflation and economic activity, as suggested by the “Low Inflation”
alternative simulation in Tealbook, Book A. If so, they may see a statement like that in
Alternative A as desirable because it not only maintains the current pace of asset
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purchases but also explicitly introduces an inflation floor. They may view such a floor as
appropriate in order to strengthen the credibility of the Committee’s 2 percent inflation
target and create additional downward pressure on longer-term real interest rates, thus
helping to ensure that the economic recovery gains traction and that inflation moves up
toward the Committee’s longer-run goal.
An announcement like Alternative A would come as a considerable surprise to
market participants. Investors likely would mark up their expectations for total asset
purchases and push back the date of the first hike in the federal funds rate, perhaps by a
considerable amount, with a flattening of the expected path for the federal funds rate
inflation compensation and equity prices might rise, and the dollar could depreciate.
However, to the extent that investors read the statement in Alternative A as reflecting a
more downbeat assessment of the outlook for economic growth and inflation, equity
prices would not rise as much or could even decline, and inflation compensation would
likely fall. As with Alternative C, the announcement of Alternative A could engender
greater uncertainty on the part of market participants regarding the Committee’s reaction
function and thereby increase financial market volatility
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Alternatives
thereafter also likely. Therefore, longer-term real interest rates likely would decline,
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DIRECTIVE
The directive that was issued after the April meeting appears on the next page,
followed by drafts for a June directive that correspond to each of the three policy
alternatives. Each draft includes changes to make it consistent with the corresponding
postmeeting statement.
The directive for Alternative A instructs the Desk to continue purchasing
additional longer-term Treasury securities at a pace of about $25 billion per month and to
continue purchasing agency mortgage-backed securities at a pace of about $20 billion per
month. The draft directive for Alternative B instructs the Desk to purchase longer-term
Alternatives
Treasury securities at a pace of about $20 billion per month, beginning in July, and to
purchase agency mortgage-backed securities at a pace of about $15 billion per month.
The draft directive for Alternative C instructs the Desk to purchase longer-term Treasury
securities at a pace of about $15 billion per month, also beginning in July, and to
purchase agency mortgage-backed securities at a pace of about $10 billion per month.
All three of the draft directives direct the Desk to maintain the current policy of
reinvesting principal payments from its holdings of agency debt and agency mortgagebacked securities in agency mortgage-backed securities and of rolling over maturing
Treasury securities into new issues.
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April 2014 Directive
Consistent with its statutory mandate, the Federal Open Market Committee seeks
monetary and financial conditions that will foster maximum employment and price
stability. In particular, 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
undertake open market operations as necessary to maintain such conditions. Beginning
in May, the Desk is directed to purchase longer-term Treasury securities at a pace of
about $25 billion per month and to purchase agency mortgage-backed securities at a pace
of about $20 billion per month. The Committee also directs the Desk to engage in dollar
roll and coupon swap transactions as necessary to facilitate settlement of the Federal
Desk to maintain its policy of rolling over maturing Treasury securities into new issues
and its policy of reinvesting principal payments on all agency debt and agency mortgagebacked securities in agency mortgage-backed securities. 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
Reserve’s agency mortgage-backed securities transactions. The Committee directs the
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Directive for April June 2014 Alternative A
Consistent with its statutory mandate, the Federal Open Market Committee seeks
monetary and financial conditions that will foster maximum employment and price
stability. In particular, 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
undertake open market operations as necessary to maintain such conditions. Beginning
in April, The Desk is directed to purchase continue purchasing longer-term Treasury
securities at a pace of about $25 billion per month and to purchase continue purchasing
agency mortgage-backed securities at a pace of about $20 billion per month. The
Committee also directs the Desk to engage in dollar roll and coupon swap transactions as
Alternatives
necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed
securities transactions. The Committee directs the Desk to maintain its policy of rolling
over maturing Treasury securities into new issues and its policy of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in agency mortgagebacked securities. 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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Directive for April June 2014 Alternative B
Consistent with its statutory mandate, the Federal Open Market Committee seeks
monetary and financial conditions that will foster maximum employment and price
stability. In particular, 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
undertake open market operations as necessary to maintain such conditions. Beginning
in May July, the Desk is directed to purchase longer-term Treasury securities at a pace of
about $25 $20 billion per month and to purchase agency mortgage-backed securities at a
pace of about $20 $15 billion per month. The Committee also directs the Desk to engage
in dollar roll and coupon swap transactions as necessary to facilitate settlement of the
directs the Desk to maintain its policy of rolling over maturing Treasury securities into
new issues and its policy of reinvesting principal payments on all agency debt and agency
mortgage-backed securities in agency mortgage-backed securities. 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
Federal Reserve’s agency mortgage-backed securities transactions. The Committee
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Directive for April June 2014 Alternative C
Consistent with its statutory mandate, the Federal Open Market Committee seeks
monetary and financial conditions that will foster maximum employment and price
stability. In particular, 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
undertake open market operations as necessary to maintain such conditions. Beginning
in May July, the Desk is directed to purchase longer-term Treasury securities at a pace of
about $25 $15 billion per month and to purchase agency mortgage-backed securities at a
pace of about $20 $10 billion per month. The Committee also directs the Desk to engage
in dollar roll and coupon swap transactions as necessary to facilitate settlement of the
Alternatives
Federal Reserve’s agency mortgage-backed securities transactions. The Committee
directs the Desk to maintain its policy of rolling over maturing Treasury securities into
new issues and its policy of reinvesting principal payments on all agency debt and agency
mortgage-backed securities in agency mortgage-backed securities. 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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Projections
BALANCE SHEET, INCOME, AND MONETARY BASE
The staff has prepared three scenarios for the Federal Reserve’s balance sheet,
corresponding to Alternatives A, B, and C. The pace, ending date, and cumulative
amount of asset purchases differ across the three alternatives. Projections under each
scenario are based on the staff’s assumptions about the trajectory of various components
of the balance sheet and the balance sheet normalization strategy.1 The projections
assume that when the time comes to begin normalizing the size of the balance sheet, the
SOMA portfolio will shrink only through redemptions of Treasury securities and agency
debt and through paydowns of principal from agency MBS; consistent with the
discussion in the minutes of the June 2013 FOMC meeting, no sales of agency MBS are
included.
For the balance sheet scenario that corresponds to Alternative B, monthly
purchases of longer-term Treasury securities and agency MBS continue to be reduced by
$5 billion each following each FOMC meeting until purchases wind down to zero in the
fourth quarter of 2014. Under this assumption, which is the same as the policy
assumption in the staff baseline forecast presented in Tealbook A, purchases total a bit
B and the staff forecast in the April Tealbook.
As shown in the exhibit “Total Assets and Selected Balance Sheet Items,” under
the purchase program assumed for Alternative B, total assets would peak at about
$4.5 trillion in the first quarter of 2015, with $2.5 trillion in Treasury securities holdings
and $1.7 trillion in agency MBS holdings.2 We assume that the first increase in the target
federal funds rate is in the second quarter of 2015, consistent with the staff forecast and
unchanged from Alternative B of the April Tealbook. At the time of liftoff, all
reinvestments and rollovers of securities are assumed to cease, and the SOMA portfolio
1
Further information on the assumptions regarding asset and liability categories not discussed
here can be referenced in the appendix of the December 2013 Tealbook, Book B. Of note, this round, we
have increased the level of reserve balances that is assumed to be necessary to conduct monetary policy in
the long run from $25 billion to $100 billion. (See footnote 5 for a discussion.)
2
Total assets peak after the end of the purchase program because of delayed settlement of agency
MBS purchases.
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Projections
less than $1.5 trillion over 2013 and 2014, an amount that is unchanged from Alternative
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Total Assets and Selected Balance Sheet Items
Alternative B
Alternative C
Total Assets
Billions of dollars
Monthly
Alternative A
April Tealbook Alternative B
Reserve Balances
6000
Billions of dollars
Monthly
5500
3500
5000
4500
3000
4000
2500
3500
3000
2000
2500
1500
2000
1500
1000
1000
500
500
2024
2022
2020
2018
2016
2014
2012
2010
0
2024
2022
Billions of dollars
Monthly
SOMA Agency MBS Holdings
3500
Billions of dollars
Monthly
2400
2200
3000
2000
1800
2500
1600
1400
2000
1200
1500
1000
800
1000
600
400
500
200
0
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2024
2022
2020
2018
2016
2014
2012
2010
2024
2022
2020
2018
2016
2014
2012
0
2010
Projections
2020
2018
2016
2014
2012
2010
0
SOMA Treasury Holdings
4000
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begins to contract.3,4 The size of the portfolio is normalized by the third quarter of 2021,
one quarter earlier than assumed in the April Tealbook.5 The balance sheet then begins to
expand, with increases in SOMA holdings essentially matching the growth of currency in
circulation and Federal Reserve Bank capital. Total assets are $2.5 trillion at the end of
2025, with about $610 billion in agency MBS holdings remaining in the SOMA portfolio.
The second exhibit, “Income Projections,” shows the implications of balance
sheet developments for Federal Reserve income. Under Alternative B, interest income
rises while purchases are ongoing; it subsequently declines for a number of years as the
SOMA portfolio contracts through redemptions and paydowns of principal. Although
interest expense is quite small in the near term, interest expense climbs when the federal
funds rate increases and reserve balances are still quite elevated.6 As a result, Federal
Reserve remittances to the Treasury remain robust in the near term but then decline
markedly over the period from 2016 to 2018; nevertheless, remittances are projected to
remain positive over the entire projection period. Annual remittances peak at about $95
Temporary reserve draining tools—reverse repurchase agreements (RRPs) and term deposits—
are not modeled in any of the scenarios presented, although the projections do assume that the use of
overnight RRPs will wind down from current levels to zero in the first quarter of 2015 and term deposits
are zero for the projection period. 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.
The projections also assume that RRPs associated with foreign official and international accounts will
remain around $110 billion throughout the forecast period. For a discussion of the possible effects of the
use of reserve draining tools on Federal Reserve income and remittances, see the staff memo to the FOMC,
“Income Projections Associated with Alternative Normalization Scenarios,” June 4, 2014.
4
Projected prepayments of agency MBS reflect interest rate projections as of June 6, 2014.
5
The size of the balance sheet is assumed to be normalized when the securities portfolio reverts to
its longer-run trend level, which is determined largely by currency in circulation plus Federal Reserve
capital and a projected steady-state level of reserve balances. 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 in the long run. In this Tealbook, we revised up our assumption of
the steady-state level of reserve balances from $25 billion to $100 billion, reflecting the staff’s assessment
that required reserve balances will likely be higher at that time based on the historical relationship between
required reserves and economic activity and because of the effects of the payment of interest on reserve
balances on the demand for such balances. A $100 billion steady-state level of reserve balances could be
consistent with different operating regimes for monetary policy, including either a floor system or a
corridor system. The earlier projected date of normalization in the current Tealbook relative to the previous
Tealbook owes mostly to this revision to the assumed longer-run level of reserve balances.
6
For the projection period, we assume the interest rate paid on excess reserve balances equals the
federal funds rate.
Page 43 of 54
Projections
3
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
Income Projections
Alternative B
Alternative C
20
0
0
Remittances to Treasury
140
Billions of dollars
Annual
140
120
40
40
20
20
0
0
−20
−20
2024
60
2022
60
2020
80
2018
80
2016
100
2012
100
Memo: Unrealized Gains/Losses
Billions of dollars
End of year
Page 44 of 54
400
300
200
100
0
−100
−200
−300
2024
2022
2020
2018
−400
2016
120
110
100
90
80
70
60
50
40
30
20
10
0
2024
2022
2020
2018
2016
2014
2024
20
2022
40
2020
40
2018
60
2016
60
2014
80
2012
Billions of dollars
End of year
2012
80
2024
2022
2020
2018
2016
Deferred Asset
120
100
120
2014
2012
Annual
140
100
2012
Billions of dollars
Billions of dollars
Annual
2024
2022
2020
2018
2016
Realized Capital Gains
Projections
140
120
2014
2012
Annual
Interest Expense
2014
Billions of dollars
2014
Interest Income
Alternative A
April Tealbook Alternative B
−500
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
billion in 2015 and trough at about $20 billion in 2018, and no deferred asset is recorded.7
The Federal Reserve’s cumulative remittances from 2009 through 2025 are about $950
billion, well above the level that would have been observed in the absence of the asset
purchase programs.
The unrealized gain/loss position of the SOMA portfolio is influenced importantly
by the level of interest rates. The staff estimates that the portfolio was in an unrealized
gain position of about $100 billion as of the end of May 2014.8 Reflecting the assumed
rise in interest rates over the projection period, the position—under Alternative B—shifts
to an unrealized loss in the near term and reaches a peak unrealized loss of about $300
billion at the end of 2017. The unrealized loss position narrows through the remainder of
the forecast period, as securities mature and new securities are added to the portfolio at
par.
Under Alternative C, the monthly pace of purchases of longer-term Treasury
securities and agency MBS are both reduced by $10 billion in July; subsequently,
purchases cease in August, bringing the program to a close.9 Under this scenario,
purchases total about $1.4 trillion over 2013 and 2014, and total assets peak at about $4.4
trillion at the end of 2014. The federal funds rate is assumed to lift off in late 2014, at
which time reinvestment of principal from maturing or prepaying securities ends and
redemptions begin. The size of the balance sheet is normalized in the first half of 2021,
Treasury are projected to remain positive throughout the projection period, and no
deferred asset is recorded. Cumulative remittances from 2009 to 2025 are slightly lower
than under the projection for Alternative B.
7
In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to cover
its operating costs, pay dividends, and equate surplus to capital paid-in, a deferred asset would be recorded.
In this Tealbook, none of the alternatives results in a deferred asset.
8
The Federal Reserve reports the level and the change in the quarter-end net unrealized gain/loss
position of the SOMA portfolio to the public with a lag in the “Federal Reserve Banks Combined Quarterly
Financial Report,” available on the Board’s website at
http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm#quarterly.
9
The assumption that purchases will end this summer is consistent with a view that there is a solid
underlying expansion in economic activity under way, which is likely to reduce the amount of slack in
labor markets more quickly than in the staff forecast or that inflation is likely to move back toward 2
percent more rapidly. It is also consistent with a view that there is little benefit from continuing asset
purchases or that the potential costs of such purchases are relatively high.
Page 45 of 54
Projections
roughly one quarter earlier than under Alternative B. Federal Reserve remittances to the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative B
Billions of dollars
May 31, 2014
2015
2017
2019
2021
2023
2025
4,327
4,345
3,576
2,618
2,132
2,323
2,538
2
0
0
0
0
0
0
4,067
4,106
3,376
2,448
1,984
2,190
2,419
2,375
2,448
2,038
1,342
1,070
1,440
1,808
44
33
4
2
2
2
2
1,648
1,625
1,333
1,104
912
749
608
Unamortized premiums
209
187
145
111
87
71
56
Unamortized discounts
-18
-17
-14
-11
-9
-7
-6
67
69
69
69
69
69
69
4,271
4,284
3,500
2,521
2,009
2,168
2,342
1,236
1,359
1,514
1,645
1,788
1,948
2,123
277
112
112
112
112
112
112
2,750
2,808
1,872
765
113
113
113
2,665
2,795
1,859
752
100
100
100
U.S. Treasury, General Account
29
5
5
5
5
5
5
Other Deposits
56
8
8
8
8
8
8
3
0
0
0
0
0
0
56
61
77
97
123
155
197
Total assets
Selected assets
Loans and other credit extensions*
Securities held outright
U.S. Treasury securities
Agency debt securities
Agency mortgage-backed securities
Total other assets
Projections
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.
* Loans and other credit extensions includes primary, secondary, and seasonal credit; central bank liquidity swaps; Term Asset-Backed Securities Loan
Facility (TALF); net portfolio holdings of Maiden Lane LLC, Maiden Lane II LLC, and Maiden Lane III LLC; and net portfolio holdings of TALF LLC.
Page 46 of 54
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
Under the scenario for Alternative A, the current pace of purchases of longer-term
Treasury securities and agency MBS is maintained in the near term and then is reduced
gradually, with purchases ending in early 2015.10 Under these assumptions, purchases
total about $1.6 trillion from 2013 to 2015. In this scenario, total assets rise to a peak of
about $4.6 trillion in the first quarter of 2015. The first increase in the target federal
funds rate is assumed to occur in the fourth quarter of 2016, consistent with the
expectation that inflation one to two years ahead will be projected to be below 2 percent
until this time. All reinvestments are assumed to cease at the time of the first increase in
the federal funds rate, and the SOMA portfolio then begins to contract. The size of the
portfolio is normalized nearly a year later than under the scenario corresponding to
Alternative B, reflecting the larger amount of asset purchases and the later end of
reinvestment. Federal Reserve remittances to the Treasury are projected to remain
positive over the entire projection period, and no deferred asset is recorded. Cumulative
remittances from 2009 through 2025 are slightly higher than under the projection for
Alternative B.
As shown in the exhibit, “Alternative Projections for the 10-Year Treasury Term
Premium Effect,” under Alternative B, the effect of the Federal Reserve’s cumulative
increase in asset holdings on the term premium embedded in the 10-year Treasury yield
in the second quarter of 2014 is negative 121 basis points, about the same as under
term premium effect converges slowly toward zero, reflecting the actual and anticipated
normalization of the portfolio. Under Alternative C, the term premium effect in the
second quarter of 2014 is negative 117 basis points. In absolute terms, the effect is
smaller than under Alternative B because fewer securities are purchased than under
Alternative B, and the balance sheet begins to contract sooner. Under Alternative A, the
term premium effect is negative 138 basis points in the current quarter. In absolute
terms, the effect is larger than under Alternative B because more securities are purchased,
and the balance sheet begins to contract later than under Alternative B.
The differences across the scenarios regarding the projected peak amount of
reserve balances and the level of reserve balances at liftoff are directly related to the
10
Compared with the baseline, the later end to asset purchases is consistent with a view that the
downside risks to the economic outlook are more pronounced than previously thought, raising questions
about whether there is sufficient underlying strength in the economy to support ongoing improvement in
labor market conditions and to return inflation to 2 percent over the medium run.
Page 47 of 54
Projections
Alternative B in the April Tealbook. Over the remainder of the projection period, the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
Alternative Projections for the 10-Year Treasury Term Premium Effect
Date
Alternative B Alternative C Alternative A
April
Alternative B
Projections
Basis Points
Quarterly Averages
2014: Q2
Q3
Q4
2015: Q1
Q2
Q3
Q4
2016: Q1
Q2
Q3
Q4
–121
–116
–110
–105
–100
–95
–90
–85
–81
–76
–72
–117
–111
–106
–101
–96
–91
–86
–81
–77
–73
–69
–138
–134
–129
–124
–119
–114
–109
–104
–99
–95
–90
–122
–117
–112
–106
–101
–96
–91
–86
–82
–77
–73
2017: Q4
2018: Q4
2019: Q4
2020: Q4
2021: Q4
2022: Q4
2023: Q4
2024: Q4
2025: Q4
–58
–47
–37
–30
–25
–21
–17
–13
–9
–55
–44
–36
–29
–24
–20
–16
–12
–9
–72
–58
–46
–36
–29
–22
–18
–13
–10
–59
–47
–37
–30
–24
–19
–15
–12
–8
Page 48 of 54
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
magnitude of assumed asset purchases and the timing of the liftoff of the federal funds
rate; importantly, the level of reserve balances is also contingent on the evolution of other
balance sheet items. Reserve balances peak at about $3.0 trillion early in the second
quarter of 2015 under Alternative B and at about $2.9 trillion in the first quarter of 2015
under Alternative C. Under Alternative A, reserve balances peak at around $3.1 trillion
in the second quarter of 2015.
As shown in the final exhibit, “Alternative Projections for the Monetary Base,”
under the scenario corresponding to Alternative B, the monetary base increases, on
balance, through the middle of 2015 because the purchase program is accompanied by an
increase in reserve balances. Once the normalization process begins, the monetary base
shrinks, on net, through 2021, primarily because redemptions of securities cause
corresponding reductions in reserve balances. Starting around mid-2022, after reserve
balances are assumed to have stabilized at $100 billion, the monetary base begins to
expand in line with the growth of currency in circulation. Because the contours of the
balance sheet are similar across the alternatives, the growth rates of the monetary base
Projections
under Alternatives C and A are broadly similar to those under Alternative B.11
11
The projections for the monetary base depend critically on the FOMC’s choice of tools during
normalization. If, for example, the FOMC employs reverse repurchase agreements or term deposits
extensively during normalization, the projected level of reserve balances and the monetary base could
decline quite markedly in the out years of the projection.
Page 49 of 54
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
Alternative Projections for the Monetary Base
Percent change, annual rate; not seasonally adjusted
Date
Alternative B Alternative C Alternative A
April
Alternative B
Quarterly
Projections
2014: Q2
Q3
Q4
2015: Q1
Q2
Q3
Q4
2016: Q1
Q2
Q3
Q4
Annual
2017
2018
2019
2020
2021
2022
2023
2024
2025
14.0
12.7
5.5
5.7
10.6
-2.5
-5.1
-7.1
-13.1
-10.2
-8.5
14.0
11.2
3.5
8.8
-0.7
-5.1
-4.9
-7.1
-13.2
-10.2
-8.5
14.0
13.6
10.0
11.4
5.7
1.9
-0.6
-0.5
-1.2
1.5
2.4
39.9
21.3
6.5
-0.3
5.4
-1.6
-4.2
-6.2
-11.9
-9.2
-7.7
-9.7
-14.7
-16.1
-14.9
-9.6
4.1
4.1
4.2
4.2
-9.8
-15.0
-16.3
-15.1
-5.5
4.1
4.1
4.2
4.2
-8.3
-14.2
-15.8
-13.9
-14.3
-8.0
4.1
4.2
4.2
-8.9
-13.5
-14.6
-13.6
-11.7
2.5
4.3
4.3
4.3
Note: For years, Q4 to Q4; for quarters, calculated from corresponding
average levels.
Page 50 of 54
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
MONEY
In recent years, M2 has grown considerably faster than would be anticipated
based on its historical relationship with nominal GDP and the opportunity cost of holding
money. In part, the elevated level of M2 may reflect strong investor demand for safe and
liquid assets in the wake of the financial crisis and during the long economic recovery.
Over the forecast period, the staff projects that M2 growth will slow markedly relative to
its pace in recent years.12 In part, the projected deceleration in M2 reflects an assumption
that investors will reallocate a portion of their elevated M2 balances to riskier
investments as the economic recovery progresses; however, the timing and magnitude of
this unwind is highly uncertain. In addition, the increase in the opportunity cost of
holding M2 balances that occurs due to the projected tightening of monetary policy acts
M2 Monetary Aggregate Projections
(Percent change, annual rate; seasonally adjusted)*
Quarterly
2014: Q2
6.3
Q3
5.7
Q4
5.4
2015: Q1
1.0
Q2
-2.4
Q3
-3.0
Q4
-2.8
2016: Q1
-1.2
Q2
0.5
Q3
1.2
Q4
1.4
Annual
2014
6.1
2015
-1.8
2016
0.5
Note: Actual data through June 2, 2014; projections thereafter.
* Quarterly growth rates are computed from quarter averages. Annual
growth rates are fourth quarter over fourth quarter.
12
Since the last Tealbook, the staff’s money demand models have been reestimated using data
over a more recent time period (1994:Q3 to 2007:Q2); however, the contour of the projected path for M2
growth is broadly similar to that implied by the models prior to the reestimation.
13
The three-month Treasury bill rate is assumed to begin rising in 2015:Q1, causing M2
opportunity cost to rise one quarter earlier than the projected increase in the federal funds rate.
Page 51 of 54
Projections
as an additional restraint on M2 growth in 2015 and 2016.13
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
Projections
(This page is intentionally blank.)
Page 52 of 54
June 12, 2014
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
Abbreviations
ABS
asset-backed securities
AFE
advanced foreign economy
BEA
Bureau of Economic Analysis, Department of Commerce
BHC
bank holding company
CDS
credit default swaps
C&I
commercial and industrial
CLO
collateralized loan obligation
CMBS
commercial mortgage-backed securities
CPI
consumer price index
CRE
commercial real estate
Desk
Open Market Desk
ECB
European Central Bank
EME
emerging market economy
FDIC
Federal Deposit Insurance Corporation
FOMC
Federal Open Market Committee; also, the Committee
GCF
general collateral finance
GDP
gross domestic product
LIBOR
London interbank offered rate
LSAP
large-scale asset purchase
MBS
mortgage-backed securities
NIPA
national income and product accounts
OIS
overnight index swap
ON RRP
overnight reverse repurchase agreement
PCE
personal consumption expenditures
repo
repurchase agreement
RMBS
residential mortgage-backed securities
RRP
reverse repurchase agreement
Page 53 of 54
June 12, 2014
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
June 12, 2014
SCOOS
Senior Credit Officer Opinion Survey on Dealer Financing Terms
SFA
Supplemental Financing Account
SLOOS
Senior Loan Officer Opinion Survey on Bank Lending Practices
SOMA
System Open Market Account
S&P
Standard & Poor’s
TALF
Term Asset-Backed Securities Loan Facility
TBA
to be announced (for example, TBA market)
TGA
U.S. Treasury’s General Account
TIPS
Treasury inflation-protected securities
TPE
Term premium effects
Page 54 of 54
Cite this document
APA
Federal Reserve (2014, June 17). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_20140618_part2
BibTeX
@misc{wtfs_greenbook_20140618_part2,
author = {Federal Reserve},
title = {Greenbook/Tealbook},
year = {2014},
month = {Jun},
howpublished = {Greenbooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/greenbook_20140618_part2},
note = {Retrieved via When the Fed Speaks corpus}
}