greenbooks · September 20, 2016
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 01/14/2022.
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
September 15, 2016
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)
September 15, 2016
This section considers a selection of monetary policy strategies for setting the
federal funds rate and compares the associated policy paths and macroeconomic
outcomes to those in the Tealbook baseline forecast. The strategies fall into one of two
categories. Under simple policy rules, policymakers set the federal funds rate according
to a reaction function that includes a small number of macroeconomic factors. Under
optimal control policies, policymakers compute a path for the federal funds rate that
minimizes a loss function meant to capture policymakers’ preferences over
macroeconomic outcomes. Both approaches recognize the Federal Reserve’s dual
mandate. Unless otherwise noted, the simulations assume that policymakers will adhere
to the policy strategy in the future and that financial market participants, price setters, and
wage setters not only believe that policymakers will follow through with their strategy
but also fully understand the macroeconomic implications. Such policy strategies are
described as commitment strategies.
The two approaches have different merits and limitations. The parsimony of
simple rules makes them relatively easy to communicate to the public, and because they
respond only to variables that are central to a range of models, proponents argue that they
may be more robust to uncertainty about the structure of the economy. However, simple
rules omit, by construction, other potential influences on policy decisions; thus, strict
adherence to such rules may, at times, lead to unsatisfactory outcomes. By comparison,
optimal control policies respond to a broader set of economic factors; their prescriptions
optimally balance various policy objectives. And although this section focuses on
policies under commitment, optimal control policies can more generally be derived under
various assumptions about the degree to which policymakers can commit. That said,
optimal control policies assume substantial knowledge on the part of policymakers and
are sensitive to the assumed loss function and the specifics of the particular model.
Given the different strengths and weaknesses of the two approaches, they are
probably best considered together, possibly along with others, as a means to assess the
various tradeoffs policymakers may face when pursuing their mandated objectives.
As was the case in the July Tealbook, most of the policy strategies considered
herein, though not all, prescribe a more rapid increase in the federal funds rate than
assumed in the staff forecast. Relative to the July Tealbook, the simple rules and optimal
Page 1 of 60
Strategies
Monetary Policy Strategies
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
control exercises generally call for a slightly less accommodative stance of monetary
Strategies
policy, reflecting a bit more positive output gap in the staff’s projection.
NEAR-TERM PRESCRIPTIONS OF SELECTED SIMPLE POLICY RULES
The top panel of the first exhibit provides near-term prescriptions for the federal
funds rate from four policy rules: the Taylor (1993) rule, the Taylor (1999) rule, an
inertial version of the Taylor (1999) rule, and a first-difference rule.1 These prescriptions
take as given the staff’s baseline projections for the output gap and inflation in the near
term, shown in the middle panels. The top and middle panels also include the staff’s
baseline projection for the federal funds rate.
The Taylor-type rules call for federal funds rates above those in the Tealbook
baseline at the end of 2016.
The Taylor (1993) and Taylor (1999) rules, which feature no interest rate smoothing
term, prescribe substantially higher federal funds rates in the near term than the
inertial Taylor (1999) or the first-difference rules.
All three Taylor-type rules call for slightly higher policy rates than they did in the
July Tealbook (after adjusting previous-Tealbook values to account for the staff’s
new estimate of the real federal funds rate in the long run) because the staff now
projects a modestly higher path for the output gap.2 The prescriptions of the firstdifference rule, which depend on expected changes in the output gap and inflation,
are essentially unchanged.
A MEDIUM-TERM EQUILIBRIUM REAL FEDERAL FUNDS RATE
The bottom panel of the exhibit reports the estimate of a Tealbook-consistent,
medium-term notion of the equilibrium real federal funds rate that is generated using the
FRB/US model. This Tealbook-consistent FRB/US r* corresponds to the level of the real
1
The appendix to this section provides details on each of these four simple rules.
Staff has lowered its estimate of the long-run equilibrium value of the real federal funds rate
¼ percentage point in this Tealbook; see Cristina Fuentes-Albero and Ashley Wang (2016), “Adjustments
to some Long-Term Parameters of the Staff Judgmental Forecast,” memorandum to the Federal Open
Market Committee, Board of Governors of the Federal Reserve System, Division of Research and
Statistics, September 9.
2
Page 2 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Strategies
Policy Rules and the Staff Projection
Near−Term Prescriptions of Selected Simple Policy Rules1
(Percent)
2016:Q4
2017:Q1
Taylor (1993) rule
Previous Tealbook (intercept−adjusted)
2.33
2.21
2.25
2.14
Taylor (1999) rule
Previous Tealbook (intercept−adjusted)
2.44
2.27
2.46
2.25
Inertial Taylor (1999) rule
Previous Tealbook (intercept−adjusted)
0.73
0.70
0.99
0.94
First−difference rule
Previous Tealbook
0.56
0.55
0.75
0.78
Addendum:
Tealbook baseline
0.64
0.84
*
Key Elements of the Staff Projection
GDP Gap
Federal Funds Rate
Percent
Percent
5
3
4
2
3
1
PCE Prices Excluding Food and Energy
Percent
Four−quarter average
3.0
Current Tealbook
Previous Tealbook
2.5
2.0
1.5
2
0
1.0
1
2016 2017 2018 2019 2020 2021 2022
0
−1
2016
2017
2018
2019
2020
2021
2022
−2
0.5
2016 2017 2018 2019 2020 2021 2022
A Medium−Term Equilibrium Real Federal Funds Rate2
(Percent)
Tealbook−consistent FRB/US r*
Average projected real federal funds rate
Current
Tealbook
Previous Tealbook
(intercept−adjusted)
1.03
0.02
0.81
−0.07
*
1. The prescriptions of rules conditional on the previous Tealbook projection reflect, where applicable, the downward
revision to the staff's estimate of the long−run equilibrium real federal funds rate, as implemented in the current Tealbook.
Moreover, the previous−Tealbook prescriptions of rules featuring the lagged policy rate are conditional on the current−
Tealbook value of the lagged policy rate.
2. The "Tealbook−consistent FRB/US r*" is the level of the real federal funds rate that, if maintained over a 12−quarter
period (beginning in the current quarter) in the FRB/US model, sets the output gap equal to zero in the final quarter of that
period. The "average projected real federal funds rate" is calculated under the Tealbook baseline projection over the same
12−quarter period. Statistics for the previous Tealbook are adjusted to reflect the downward revision to the time−varying
intercept of the baseline policy rule implemented in the current Tealbook.
Page 3 of 60
0.0
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
federal funds rate that, if maintained over a 12-quarter period, sets the output gap to zero
Strategies
in the final quarter of that period.
The current estimate of r*, at 1.03 percent, is a bit higher than in the July Tealbook
due to the higher path of the output gap in the current projection.
At 2 basis points, the average level of the real federal funds rate in the staff's forecast
for the same 12-quarter period used to compute r* is about 1 percentage point below
r*. The relatively accommodative stance of policy in the Tealbook baseline
projection reflects policy considerations other than closing the output gap that are
embedded in the policy reaction function assumed by the staff.
SIMPLE POLICY RULES SIMULATIONS
The second exhibit reports dynamic simulations of the FRB/US model under the
Taylor (1993) rule, the Taylor (1999) rule, the inertial Taylor (1999) rule, and the firstdifference rule. These simulations reflect the endogenous responses of the output gap
and inflation when the federal funds rate follows the paths implied by the different policy
rules.3 The intercepts of the Taylor-type rules correspond to the staff’s assumption that
the long-run level of the equilibrium real federal funds rate equals ¾ percent.
The baseline policy path in the staff forecast is based on a version of the inertial
Taylor (1999) rule with a temporary downward adjustment to the intercept.4 In the
Tealbook baseline, the nominal federal funds rate increases about 85 basis points per
year through the final quarter of 2019, when it reaches 3.2 percent. The pace of
tightening subsequently slows, and the federal funds rate peaks at 3½ percent in 2021,
before eventually returning to its longer-run normal level of 2¾ percent.
The inertial Taylor (1999) rule with a constant intercept prescribes a slightly higher
path for the federal funds rate over the next few years than the version with a
judgmental downward intercept adjustment used to construct the Tealbook baseline.
However, the difference in policy rates arising from alternative intercept assumptions
3
Because of these endogenous responses, the near-term prescriptions from the dynamic
simulations can differ from those shown in the top panel of the first exhibit.
4
This temporary downward intercept adjustment was made consistent with the new staff estimate
of the long-run equilibrium value of the real federal funds rate. For a motivation of the adjustment, see
Christopher Erceg, Etienne Gagnon, David López-Salido, Matthias Paustian, and James Trevino (2016),
“Changes to the Interest-Rate Reaction Function Used in the Tealbook,” memorandum to the Federal Open
Market Committee, Board of Governors of the Federal Reserve System, Divisions of International Finance,
Monetary Affairs, and Research and Statistics, June 3.
Page 4 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Unemployment Rate
Nominal Federal Funds Rate
Percent
Percent
8
Taylor (1993) rule
Taylor (1999) rule
Inertial Taylor (1999) rule
First−difference rule
Tealbook baseline
5.5
Staff's estimate of the natural rate
7
6
5.0
5
4
4.5
3
2
1
4.0
2016
2017
2018
2019
2020
2021
Real Federal Funds Rate
2022
0
3.5
Percent
4
3
2016
2
1
0
2017
2018
2019
2020
2021
2022
3.0
PCE Inflation
Percent
Four−quarter average
2.5
−1
2016
2017
2018
2019
2020
2021
2022
−2
2.0
2
1.5
1
1.0
0
0.5
Real 10−year Treasury Yield
Percent
2016
2017
2018
2019
2020
2021
2022
−1
2016
2017
2018
2019
2020
2021
2022
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 a tendency for current and near−term core inflation rates to outperform headline inflation
rates as predictors of the medium−term behavior of headline inflation.
Page 5 of 60
0.0
Strategies
Simple Policy Rule Simulations
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
is small and dissipates too rapidly to have a material effect on the real longer-term
Strategies
interest rates that influence economic activity in FRB/US, so macroeconomic
outcomes under the inertial Taylor (1999) rule are similar to those in the Tealbook
baseline.
The Taylor (1993) and Taylor (1999) rules call for an immediate sharp tightening in
policy and produce paths for the real federal funds rate that lie significantly above the
Tealbook baseline path over the next few years largely because these two policy rules
do not put weight on the lagged policy rate. The Taylor (1999) rule calls for slightly
higher policy rates than the Taylor (1993) rule over the period shown because it
responds more strongly to the projected rise in output above its potential level over
the next several years. As a consequence, the Taylor (1999) rule generates a higher
trajectory of the unemployment rate and a slightly lower trajectory of inflation than
does the Taylor (1993) rule.
The first-difference rule prescribes a slightly higher path for the federal funds rate
through the first half of 2019 than the Tealbook baseline. Thereafter, the federal
funds rate edges down whereas it keeps rising under the Tealbook baseline. This
divergence occurs because the first-difference rule, which responds to the expected
change in the output gap rather than to its level, reacts to the slower pace of economic
growth projected late in the decade and beyond. The lower path of the federal funds
rate after 2019, in conjunction with expectations of higher price and wage inflation in
the future, implies lower longer-term real rates over the entire projection period, as
well as higher levels of resource utilization and inflation. The first-difference rule
generates outcomes for the unemployment rate that are markedly below the
unemployment rate paths generated under the other policy rules and well below the
staff’s estimate of the natural rate.
OPTIMAL CONTROL SIMULATIONS UNDER COMMITMENT
The third exhibit displays optimal control simulations under various assumptions
about policymakers’ preferences, as captured by four specifications of the loss function.5
The concept of optimal control employed here corresponds to a commitment policy under
which the plans that policymakers make today are assumed to constrain future policy
5
The box “Optimal Control and the Loss Function” in the Monetary Policy Strategies section of
the June 2016 Tealbook B offers motivations for these specifications; the appendix provides technical
details on the optimal control simulations.
Page 6 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Unemployment Rate
Nominal Federal Funds Rate
Percent
Percent
5.5
8
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Tealbook baseline
Staff's estimate of the natural rate
7
6
5.0
5
4
4.5
3
2
1
4.0
2016
2017
2018
2019
2020
2021
Real Federal Funds Rate
2022
0
3.5
Percent
4
3
2016
2
1
0
2017
2018
2019
2020
2021
2022
3.0
PCE Inflation
Percent
Four−quarter average
2.5
−1
2016
2017
2018
2019
2020
2021
2022
−2
2.0
2
1.5
1
1.0
0
0.5
Real 10−year Treasury Yield
Percent
2016
2017
2018
2019
2020
2021
2022
−1
2016
2017
2018
2019
2020
2021
2022
Note: Each set of lines corresponds to an optimal control policy under commitment in which policymakers minimize a
discounted weighted sum of squared deviations of four−quarter headline PCE inflation from the Committee's 2 percent
objective, of squared deviations of the unemployment rate from the staff's estimate of the natural rate, and of squared
changes in the federal funds rate. The weights vary across simulations. See the appendix for technical details and the box
"Optimal Control and the Loss Function" in the June 2016 Tealbook B for a motivation.
Page 7 of 60
0.0
Strategies
Optimal Control Simulations under Commitment
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
choices in a way that improves overall economic outcomes.6 The exhibit also shows the
Strategies
current Tealbook baseline forecast.
The first simulation, labeled “equal weights,” presents the case in which
policymakers are assumed to place the same 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 changes in
the federal funds rate. Under this strategy, the path for the federal funds rate is
significantly higher than the Tealbook baseline policy path. This higher path arises
because, in the current baseline projection, unemployment falls well below the staff’s
estimate of the natural rate over the next several years. Under equal-weight
preferences, policymakers judge this undershooting of the natural rate to be costly (as
would be a similar-sized deviation of the unemployment rate above the natural rate),
leading them to tighten policy appreciably more than in the Tealbook baseline. This
tighter policy results in a path of the unemployment rate that is substantially closer to
the staff’s estimate of the natural rate; headline PCE inflation is somewhat lower than
in the Tealbook baseline over the period shown, consistent with a limited response of
inflation in the model to lower levels of resource utilization.
The second simulation, labeled “asymmetric weight on ugap,” uses a loss function
that assigns no cost to deviations of the unemployment rate from the natural rate
when the unemployment rate is running below the natural rate, but that is identical to
the specification with equal weights when the unemployment rate is above the natural
rate. Under this strategy, the path of the federal funds rate is considerably below both
the Tealbook baseline path and the path for the case of equal weights. Policymakers
choose this relatively accommodative path for the policy rate because their desire to
raise inflation to 2 percent is not tempered by an aversion to the undershooting of the
natural rate of unemployment that helps achieve this outcome. The tighter labor
market causes inflation to reach 2 percent more quickly than in the case of equal
weights; inflation then edges above the Committee’s longer-run objective for the next
decade.7
6
Under the optimal control policies shown in the exhibit, policymakers improve current economic
outcomes by making promises that bind future policymakers’ actions; however, the simulations are not
conditioned on policy commitments that might have been made in the past.
7
The simultaneous overshooting of the long-run inflation objective and undershooting of the
natural rate of unemployment over the medium term is time inconsistent, in the sense that, if given the
Page 8 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
The third simulation, labeled “large weight on inflation gap,” posits a loss function
than under the specification with equal weights. The resulting optimal strategy is
only slightly more accommodative than in the case with equal weights, even though
the losses associated with undershooting the inflation objective in coming years are
larger. The reason is that, in the FRB/US model, policymakers face an unappealing
tradeoff because inflation responds little to resource utilization. Hence, policymakers
would need to engineer a substantial undershooting of the natural rate of
unemployment, which they see as costly, in order to raise inflation in the near term by
a modest amount.
The fourth simulation, labeled “minimal weight on rate adjustments,” uses a loss
function that assigns a very small cost to changes in the federal funds rate but is
otherwise identical to the loss function with equal weights. In the resulting optimal
strategy, the federal funds rate rises faster than under the specification with equal
weights over the next few years in an effort to contain the projected undershooting of
the natural rate of unemployment. The paths for the real federal funds rate and the
real 10-year Treasury yield are also higher for a couple of years than in the case of
equal weights. While this policy leaves the trajectory for inflation almost unaffected,
it keeps unemployment rate close to the staff’s estimate of the natural rate.
NOMINAL INCOME TARGETING
With inflation having run below 2 percent for the past several years, the
Committee may want to explore policy strategies that entail commitments to achieving
inflation outcomes that are, on average, near its longer-run objective by seeking to offset
past deviations from that objective. Moreover, with the federal funds rate still near its
effective lower bound (ELB), the Committee may wish to examine possible ways to
deliver additional monetary stimulus, either in general or in the event of adverse
macroeconomic outcomes. In that spirit, the pair of special exhibits, titled “Nominal
Income Targeting (Tealbook Baseline Scenario)” and “Nominal Income Targeting
(Recession Scenario),” use the FRB/US model to explore the implications of following a
nominal income (NI) targeting rule—in which monetary policy reacts to the gap between
opportunity to reoptimize the path of the federal funds rate without regards to past policy commitments,
policymakers in the future would choose to pursue a tighter monetary policy. When we instead simulate
the model under the assumption of discretion, policy rates and macroeconomic outcomes are roughly
between those under the Tealbook baseline and those under commitment. For the other three specifications
of the loss function, the simulation results under commitment and discretion are similar.
Page 9 of 60
Strategies
that assigns a cost to above-target or below-target inflation that is five times larger
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Strategies
Nominal Income Targeting
(Tealbook Baseline Scenario)
Nominal Income Gap
Nominal Federal Funds Rate
Percent
Percent
3
2011:Q4 NI target
2016:Q4 NI target
Tealbook baseline
5
2
4
1
0
3
−1
−2
2
−3
−4
1
−5
−6
0
2016
2017
2018
2019
2020
2021
2022
−7
Unemployment Rate
2016
2017
2018
2019
2020
2021
2022
PCE Inflation
Percent
9
Percent
Four−quarter average
2.5
Staff's estimate of the natural rate
8
2.0
7
1.5
6
1.0
5
0.5
4
2016
2017
2018
2019
2020
2021
2022
3
2016
2017
2018
2019
2020
2021
2022
0.0
Note: For comparability, the nominal income targeting rule in this exhibit has the same weight on the lagged federal funds
rate and the same temporary adjustment to the intercept as the inertial Taylor (1999) rule in the Tealbook baseline. The
simulation period begins in 2017:Q1. The Tealbook baseline does not include an NI target.
Page 10 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
(Recession Scenario)
Nominal Income Gap
Nominal Federal Funds Rate
Percent
Percent
3
2011:Q4 NI target
2016:Q4 NI target
Recession baseline
5
2
4
1
0
3
−1
−2
2
−3
−4
1
−5
−6
0
2016
2017
2018
2019
2020
2021
2022
−7
Unemployment Rate
2016
2017
2018
2019
2020
2021
2022
PCE Inflation
Percent
9
Percent
Four−quarter average
2.5
Staff's estimate of the natural rate
8
2.0
7
1.5
6
1.0
5
0.5
4
2016
2017
2018
2019
2020
2021
2022
3
2016
2017
2018
2019
2020
2021
2022
0.0
Note: For comparability, the nominal income targeting rule in this exhibit has the same weight on the lagged federal funds
rate and the same temporary adjustment to the intercept as the inertial Taylor (1999) rule in the Tealbook baseline. The
simulation period begins in 2017:Q1 and imposes an immediate fall in the federal funds rate to the effective lower bound. The
Tealbook baseline does not include an NI target.
Page 11 of 60
Strategies
Nominal Income Targeting
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
the level of actual nominal GDP and a target path—under the staff’s baseline outlook and
Strategies
a recession scenario, respectively. In these scenarios, policymakers adopt the NI
targeting rule beginning in the first quarter of 2017, when the simulations begin. And as
in the simulations presented above, it is assumed that economic agents understand the
model and that policymakers can credibly commit to following an NI targeting rule for an
extended period.8
Because the amount of stimulus that NI targeting delivers depends importantly on
the target path for nominal income and, in particular, on the shortfall in nominal income
that policymakers seek to offset, we consider two specifications of the target path. Under
the “2016:Q4 NI target,” policymakers target a path for the level of nominal income that,
in 2016:Q4, equals real potential GDP multiplied by the GDP deflator in that quarter;
subsequently, the target grows 2 percentage points faster than the staff’s baseline
projection for real potential GDP. Under the “2011:Q4 NI target,” policymakers seek to
make up for the shortfall in nominal income relative to a path anchored in 2011:Q4, just
before the Committee announced its 2 percent inflation objective.9
The first special exhibit shows the effects of responding to the 2011:Q4 and 2016:Q4
NI targets conditional on the staff’s current baseline. The pursuit of the 2016:Q4 NI
target leads to paths for the nominal federal funds rate and associated macroeconomic
outcomes that are similar to those under the Tealbook baseline. This similarity arises
because policymakers begin with only a small NI gap to close (shown in the upperleft panel), whereas the output gap and inflation gap entering the Tealbook baseline
rule (shown on the first exhibit) have largely offsetting effects on the prescriptions of
that rule.
The pursuit of the 2011:Q4 NI target entails closing a nominal income gap that is
initially 2½ percentage points larger than under the 2016:Q4 NI target; accordingly,
policy in this instance is significantly more accommodative. Under the 2011:Q4 NI
8
For increased comparability, the NI targeting rule used herein features the same weight on the
lagged federal funds rate and temporary intercept adjustment as the inertial Taylor (1999) rule used to
construct the Tealbook baseline. In the Monetary Policy Strategies section of the March 2016 Tealbook B
and in earlier memos to the FOMC, the NI targeting rule typically featured a lower degree of inertia and no
temporary intercept adjustment.
9
Under both NI targets, we use the current estimates of the path of real potential GDP and the
GDP deflator to compute the respective NI target paths. Were the Federal Reserve to pursue such targets,
revisions to these estimates could affect the level of the nominal income gap that the rule seeks to close,
thus requiring an adjustment to the stance of policy.
Page 12 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
target, the federal funds rate does not exceed 1 percent until the second half of 2018,
persistently exceeds 2 percent, an outcome that reduces real interest rates and, in turn,
exacerbates the undershooting of the natural rate of unemployment.
The second special exhibit shows the effects of adopting the same 2011:Q4 and
2016:Q4 NI targets under a recession scenario that begins in early 2017. The ensuing
drop in resource utilization and weakening of inflation cause a large shortfall in
nominal income. Both NI targeting policies are notably more accommodative than
the intercept-adjusted inertial Taylor rule policy, with the federal funds rate remaining
at the ELB longer and rising somewhat more gradually after departing from the
ELB.10 Accordingly, the unemployment rate falls somewhat more rapidly than in the
baseline recession scenario; inflation rises back toward 2 percent more quickly and
then stays above this level for an extended period of time, especially under the
2011:Q4 NI target. Because monetary policy works with a lag, the NI policies have
little effect on the severity of the recession but are, nonetheless, more effective than
the Tealbook baseline policy rule at hastening the recovery.
The ability of NI targeting rules to speed the economic recovery relies on the
assumption that policymakers can credibly commit to high levels of resource
utilization and inflation over the medium run to make up for past shortfalls in nominal
income growth.11 However, once that situation arises, policymakers may well find it
preferable to scale back on the amount of accommodation embedded in the rule. To
the extent that the public anticipates such a shift, policymakers’ ability to improve
near-term macroeconomic outcomes would be reduced.
The next four exhibits tabulate the simulation results for key variables under the
policy rule and optimal control simulations described above.
10
In constructing the recession scenario, we assume that policymakers immediately lower the
federal funds rate to the ELB even if the interest rate smoothing term in the NI rule might have called for
doing so gradually.
11
The assumed credibility of monetary policy in the model also guarantees that inflation
expectations will not become unanchored over the medium term as the economy modestly overheats.
Page 13 of 60
Strategies
about one year later than under the 2016:Q4 NI target. As a result, inflation
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Outcomes of Simple Policy Rule Simulations
Strategies
(Percent change, annual rate, from end of preceding period except as noted)
Measure and policy
2016
2017
2018
2019
2020
Nominal federal funds rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
2.3
2.4
0.7
0.6
0.6
2.6
2.8
1.7
1.9
1.5
3.1
3.4
2.6
2.7
2.5
3.3
3.7
3.2
3.1
3.2
3.4
3.7
3.5
2.9
3.5
Real GDP
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.8
1.8
1.8
1.8
1.8
2.1
2.0
2.3
2.5
2.4
2.0
1.8
1.9
2.1
2.0
1.9
1.8
1.7
1.9
1.7
1.6
1.6
1.4
1.6
1.4
Unemployment rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
4.9
4.9
4.9
4.9
4.9
4.7
4.7
4.5
4.5
4.5
4.4
4.5
4.3
4.1
4.3
4.3
4.4
4.2
4.0
4.2
4.3
4.4
4.4
4.0
4.3
Total PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.2
1.2
1.2
1.2
1.2
1.6
1.6
1.6
1.7
1.6
1.9
1.8
1.8
2.0
1.8
2.0
1.9
1.9
2.1
1.9
2.1
2.0
2.0
2.2
2.0
Core PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.7
1.6
1.9
1.8
1.8
2.0
1.8
1.9
1.9
1.9
2.1
1.9
2.0
2.0
2.0
2.2
2.0
1. Percent, average for the final quarter of the period.
Page 14 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Outcomes of Simple Policy Rule Simulations, Quarterly
2016
Measure and policy
Q1
I
Q2
I
2017
Q3
I
Q4
Q1
I
Q2
I
Q3
I
Q4
Nominal federal funds rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
2.3
2.4
0.7
0.6
0.6
2.2
2.3
1.0
1.0
0.8
2.2
2.4
1.2
1.3
1.0
2.4
2.5
1.5
1.7
1.3
2.6
2.8
1.7
1.9
1.5
Real GDP
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.3
1.3
1.3
1.3
1.3
1.5
1.5
1.5
1.5
1.5
1.8
1.8
1.8
1.8
1.8
2.1
2.0
2.2
2.2
2.2
2.2
2.2
2.4
2.5
2.4
2.1
2.0
2.3
2.4
2.3
2.1
2.0
2.3
2.5
2.4
Unemployment rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.8
4.8
4.8
4.9
4.9
4.8
4.7
4.7
4.8
4.8
4.7
4.6
4.6
4.7
4.7
4.5
4.5
4.5
Total PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
0.9
0.9
0.9
0.9
0.9
1.0
1.0
1.0
1.0
1.0
0.9
0.9
0.9
0.9
0.9
1.2
1.2
1.2
1.2
1.2
1.5
1.5
1.5
1.6
1.5
1.5
1.4
1.4
1.5
1.5
1.6
1.6
1.6
1.7
1.6
1.6
1.6
1.6
1.7
1.6
Core PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.5
1.5
1.5
1.6
1.5
1.5
1.5
1.5
1.6
1.5
1.6
1.5
1.5
1.6
1.5
1.6
1.6
1.6
1.7
1.6
1. Percent, average for the quarter.
Page 15 of 60
Strategies
(Four-quarter percent change, except as noted)
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Outcomes of Optimal Control Simulations under Commitment
Strategies
(Percent change, annual rate, from end of preceding period except as noted)
Measure and policy
2016
2017
2018
2019
2020
Nominal federal funds rate¹
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
0.9
0.5
0.9
1.7
0.6
2.8
0.9
2.7
4.0
1.5
4.0
1.3
3.9
4.4
2.5
4.7
1.8
4.4
4.8
3.2
4.7
2.3
4.4
4.8
3.5
Real GDP
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.8
1.8
1.8
1.8
1.8
1.8
2.8
1.9
1.5
2.4
1.5
2.4
1.6
1.4
2.0
1.6
1.9
1.6
1.7
1.7
1.5
1.4
1.5
1.6
1.4
Unemployment rate¹
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
4.9
4.9
4.9
4.9
4.9
4.8
4.3
4.8
5.0
4.5
4.8
3.8
4.7
5.0
4.3
4.8
3.7
4.7
4.9
4.2
4.9
3.8
4.7
4.9
4.3
Total PCE prices
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.2
1.2
1.2
1.2
1.2
1.5
1.7
1.5
1.5
1.6
1.7
1.9
1.8
1.7
1.8
1.8
2.0
1.8
1.8
1.9
1.9
2.1
2.0
1.9
2.0
Core PCE prices
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.5
1.6
1.5
1.4
1.6
1.7
1.9
1.7
1.7
1.8
1.8
2.0
1.8
1.8
1.9
1.9
2.1
1.9
1.9
2.0
1. Percent, average for the final quarter of the period.
Page 16 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Outcomes of Optimal Control Simulations under Commitment, Quarterly
2016
Measure and policy
Q1
2017
I Q2 I Q3 I Q4
Q1
I Q2 I Q3 I Q4
Nominal federal funds rate¹
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.4
0.9
0.5
0.9
1.7
0.6
1.4
0.6
1.4
2.5
0.8
1.9
0.7
1.8
3.1
1.0
2.3
0.8
2.3
3.6
1.3
2.8
0.9
2.7
4.0
1.5
Real GDP
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.3
1.3
1.3
1.3
1.3
1.5
1.5
1.5
1.5
1.5
1.8
1.8
1.8
1.8
1.8
2.1
2.3
2.1
2.0
2.2
2.1
2.6
2.2
2.0
2.4
1.9
2.6
2.0
1.7
2.3
1.8
2.8
1.9
1.5
2.4
Unemployment rate¹
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.9
4.8
4.9
4.9
4.8
4.9
4.7
4.8
5.0
4.7
4.8
4.5
4.8
5.0
4.6
4.8
4.3
4.8
5.0
4.5
Total PCE prices
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
0.9
0.9
0.9
0.9
0.9
1.0
1.0
1.0
1.0
1.0
0.9
0.9
0.9
0.9
0.9
1.2
1.2
1.2
1.2
1.2
1.5
1.5
1.5
1.5
1.5
1.4
1.5
1.4
1.4
1.5
1.5
1.6
1.5
1.5
1.6
1.5
1.7
1.5
1.5
1.6
Core PCE prices
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.6
1.5
1.5
1.5
1.5
1.5
1.4
1.5
1.4
1.4
1.5
1.4
1.6
1.5
1.4
1.5
1.5
1.6
1.5
1.4
1.6
1. Percent, average for the quarter.
Page 17 of 60
Strategies
(Four-quarter percent change, except as noted)
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Strategies
Appendix
POLICY RULES USED IN “MONETARY POLICY STRATEGIES”
The table below gives the expressions for the four simple policy rules reported in
“Monetary Policy Strategies.”
denotes the nominal federal funds rate for quarter t, and 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 ( and
| ), the output gap estimate for the
current period (ygapt), and the forecast of the three-quarter-ahead annual change in the output gap
(4ygapt+3|t). The value of policymakers’ longer-run inflation objective, denoted πLR, is 2 percent.
Taylor (1993) rule
0.5
Taylor (1999) rule
0.5
Inertial Taylor (1999) rule
First-difference rule
0.85
0.5
0.15
0.5
|
0.5Δ
0.5
|
The first two of the selected rules were studied by Taylor (1993, 1999), while the inertial
version of the Taylor (1999) rule has been featured prominently in analysis by Board staff.1 The
, are constant and chosen so that they are consistent with a
intercepts of these rules, denoted
2 percent longer-run inflation objective and a longer-run real federal funds rate of ¾ percent, a
value used in the FRB/US model.2 The prescriptions of the first-difference rule do not depend on
the level of the output gap or the longer-run real interest rate; see Orphanides (2003).
Near-term prescriptions from the four policy rules are calculated taking as given the
Tealbook projections for inflation and the output gap. When the Tealbook is published early in a
quarter, the prescriptions are shown for the current and next quarters. When the Tealbook is
published late in a quarter, the prescriptions are shown for the next two quarters. Rules that
include a lagged policy rate as a right-hand-side variable are conditioned on the lagged federal
funds rate in the Tealbook projection for the first quarter shown, and then conditioned on their
simulated lagged federal funds rate for the second quarter shown. To isolate the effects of
changes in the macroeconomic projections on the prescriptions of these inertial rules, the lines
labeled “Previous Tealbook projection” report prescriptions conditional on the previous Tealbook
1
See, for example, Erceg and others (2012).
All nominal and real federal funds rates reported in the Monetary Policy Strategies section are
expressed on the same 360-day basis as the published federal funds rate. Consistent with the methodology
in the FRB/US model, the simple rules are first implemented on a fully-compounded, 365-day basis and
then converted to a 360-day basis.
2
Page 18 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
REAL FEDERAL FUNDS RATE ESTIMATES
The bottom panel of the exhibit titled “Policy Rules and the Staff Projection” provides an
estimate of one notion of the equilibrium real federal funds rate, r*. This measure is an estimate
of the real federal funds rate that, if maintained over a 12-quarter period (beginning in the current
quarter), makes the output gap equal to zero in the final quarter of that period using the output
projection from FRB/US, the staff’s large-scale econometric model of the U.S. economy. This
“Tealbook-consistent FRB/US r*” depends on a broad array of economic factors, some of which
take the form of projected values of the model’s exogenous variables. It 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 “average projected real federal funds rate” reported in the panel is the average of the
real federal funds rate under the Tealbook baseline projection calculated over the same 12-quarter
period as the Tealbook-consistent FRB/US r*. The average projected real federal funds rate and
r* need not be associated with the same macroeconomic outcomes even when their values are
identical. The reason is that, in the r* simulations, the real federal funds rate is held constant over
the entire 12-quarter period to close the output gap at the end of this timeframe whereas, in the
Tealbook baseline, the real federal funds rate can vary over time. Distinct paths of real short-term
rates can, in turn, generate different paths for inflation and economic activity.
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; this period
extends several decades beyond the time horizon shown in the exhibits. The simulations are
conducted under the assumption that market participants as well as price and wage setters have
perfect foresight, and are predicated on the staff’s extended Tealbook projection, which includes
the macroeconomic effects of the Committee’s large-scale asset purchase programs. When the
Tealbook is published early in a quarter, all of the simulations begin in that quarter; when the
Tealbook is published late in a quarter, all of the simulations begin in the subsequent quarter.
COMPUTATION OF THE OPTIMAL CONTROL POLICY UNDER COMMITMENT
The optimal control simulations posit that policymakers minimize a discounted weighted
sum of squared inflation gaps (measured as the difference between four-quarter headline PCE
, and the Committee’s 2 percent objective), squared unemployment gaps (
,
inflation,
measured as the difference between the unemployment rate and the staff’s estimate of the natural
Page 19 of 60
Strategies
projections for inflation and the output gap but using the value of the lagged federal funds rate in
the current Tealbook for the first quarter shown.
Authorized for Public Release
Strategies
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
rate), and squared changes in the federal funds rate. The resulting loss function, shown below,
embeds the assumption that policymakers discount the future using a quarterly discount factor
0.9963:
.
,
The exhibit “Optimal Control Simulations under Commitment” considers four
specifications of the weights on the inflation gap, the unemployment gap, and the rate change
components of the loss function. The box “Optimal Control and the Loss Function” in the
Monetary Policy Strategies section of the June 2016 Tealbook B provides motivations for the four
specifications of the loss function.
The first specification, titled “equal weights,” assigns equal weights to all three
components at all times. The second specification, titled “asymmetric weight on ugap,” uses the
same weights as the equal-weights specification whenever the unemployment rate is above the
staff’s estimate of the natural rate but it assigns no penalty to the unemployment rate falling
below the natural rate. The third specification, titled “large weight on inflation gap,” attaches a
relatively large weight to inflation gaps. The fourth specification, titled “minimal weight on rate
adjustments,” places almost no weight on changes in the federal funds rate.3 The table below
shows the weights used in the four specifications. The optimal control policy and associated
outcomes depend on the relative (rather than the absolute) values of the weights.
,
0
Equal weights
Asymmetric weight
on ugap
Large weight
on inflation gap
Minimal weight on
rate adjustment
0
1
1
1
1
1
0
1
1
5
1
1
1
1
1
1
0.01
For each of these four specifications of the loss function, the optimal control policy is the
path for the federal funds rate that minimizes the loss function in the FRB/US model, subject to
the effective lower bound constraint on nominal interest rates, under the assumption of perfect
foresight, and conditional on the staff’s extended Tealbook projection. Policy tools other than the
federal funds rate are taken as given and subsumed within the Tealbook baseline. The path
chosen by policymakers today is assumed to be credible, meaning that decision makers in the
3
The inclusion of a minimal but strictly positive weight on changes in the federal funds rate helps
ensure a well-behaved numerical solution.
Page 20 of 60
Authorized for Public Release
September 15, 2016
model see this path as being a binding commitment on future Committee decisions; the optimal
control policy takes as given the initial lagged value of the federal funds rate but is otherwise
unconstrained by policy decisions made prior to the simulation period. The discounted losses are
calculated over a period that ends sufficiently far in the future that extending that period farther
would not affect the policy prescriptions shown in the exhibits.
NOMINAL INCOME TARGETING RULE
The nominal income targeting rule used in the pair of special exhibits titled “Nominal
Income Targeting (Tealbook Baseline Scenario)” and “Nominal Income Targeting (Recession
Scenario)” is expressed as
0.85
0.15
∗
∗
.4
The prescriptions of this rule depend on the lagged federal funds rate, a time-varying intercept
( ∗ ), four-quarter core PCE inflation, and a nominal income gap defined as the difference
and calculated as 100 times the log of the level of nominal
between nominal income (denoted
GDP) and a time-varying target (denoted ∗ and calculated as 100 times the log of target
nominal GDP). The target ∗ grows 2 percentage points faster per year than the staff’s estimate
of real potential GDP growth.5 In the special exhibit, the level of ∗ is calibrated in two ways.
In the first calibration, the initial target value is set so that policymakers address only nominal
income shortfalls since 2016:Q4. In the second calibration, the initial value for ∗ is set so that
the rule seeks to offset the cumulative nominal income gap since 2011:Q4. In both cases, the
resulting nominal income gap can be expressed as the sum of the current estimate of the output
gap and the shortfall of the GDP deflator from the level it would have attained had it grown at a
2 percent annual pace since the date associated with the calibration.6
To emphasize the role of the nominal income gap, the nominal income rule used in this
Tealbook puts the same weight on the lagged federal funds rate and features the same timevarying intercept as the inertial Taylor (1999) rule used to construct the Tealbook baseline. In
past Tealbooks and staff analysis (such as Erceg and others (2012)), the weight on the lagged
federal funds rate was typically set to 0.75 and the intercept was held constant at rLR.
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
4
The nominal income targeting rule is also called “nominal GDP targeting rule.”
This assumption implies that, as with many other simple policy rules, revisions to the estimate of
potential GDP would change the prescription of the nominal income rule.
6
For a discussion of the properties of nominal income targeting regimes, see Erceg and others
(2011) and McCallum and others (1999).
5
Page 21 of 60
Strategies
Class I FOMC - Restricted Controlled (FR)
Authorized for Public Release
Strategies
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Under Current Conditions,” memorandum to the Federal Open Market Committee, Board
of Governors of the Federal Reserve System, Divisions of International Finance,
Monetary Affairs, and Research and Statistics, July 18.
Erceg, Christopher, Michael Kiley, and David López-Salido (2011). “Alternative Monetary
Frameworks,” memorandum to the Federal Open Market Committee, Board of Governors
of the Federal Reserve System, Divisions of International Finance, Monetary Affairs, and
Research and Statistics, October 6.
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.
Page 22 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Monetary Policy Alternatives
During the first half of the year, the outlook for economic activity and inflation
had become clouded: Output growth in the first and second quarters appeared sluggish,
payroll gains in May were quite weak, and policymakers were confronted by increases in
some near-term global risks. Consequently, the Committee elected to hold off on further
increases in the target range for the federal funds rate. More recently, those global risks
appear to have abated and incoming economic data—including the available readings on
spending in the third quarter—have generally supported the view that growth has picked
up. Nevertheless, while recent job gains have, on average, been solid—suggesting that
utilization, including the unemployment rate, have shown little or no change since the
beginning of this year. Meanwhile, both headline and core PCE inflation, measured on a
12-month basis, have continued to run below 2 percent and have shown no further
increase since stepping up at the start of the year.
The key question for policymakers is whether, given the currently available
information, an increase in the federal funds rate is warranted at this meeting, or whether,
at least for the time being, it is appropriate to maintain the current target range (and
possibly update the Committee’s communications about future policy) in order to ensure
continued progress toward the Committee’s objectives. While the three alternative policy
statements provide similar descriptions of the incoming data and the economic outlook,
they offer different settings of the policy rate in the near term as well as different signals
about the likely stance of policy going forward.
In characterizing the recent data, all three alternatives highlight a pickup in growth of
economic activity “from the modest pace seen in the first half of this year,” and
acknowledge strength in household spending as well as remaining softness in
business fixed investment. While all three alternatives note that the labor market “has
continued to strengthen,” the statements differ somewhat in their characterization of
the details of labor market conditions.
o Alternatives B and C point to solid job gains, while cautioning that “the
unemployment rate is little changed in recent months.”
Page 23 of 60
Alternatives
the very weak growth in payrolls in May was an aberration—many measures of labor
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
o
September 15, 2016
While also noting that job gains “have been solid” on average, Alternative A
emphasizes “little change in labor utilization” based on labor market
indicators other than payrolls, “including the unemployment rate.”
The three alternatives largely agree in their interpretations of the incoming price data.
o All three retain language used in recent statements acknowledging that
inflation “has continued to run below” the Committee’s 2 percent longer-run
objective, and note that this situation either “partly” reflects (in the case of
Alternatives B and C) or “only partly” reflects (in the case of Alternative A)
earlier declines in energy prices and in prices of non-energy imports.
Alternatives
o Furthermore, all three alternatives indicate, as in the July statement, that
measures of inflation compensation “remain low” and that most survey-based
measures of longer-term inflation expectations are “little changed.”
With respect to the outlook for economic activity and inflation and its implications
for monetary policy:
o Alternatives B and C retain the July statement language affirming the
Committee’s expectation that, “with gradual adjustments in the stance of
monetary policy, economic activity will expand at a moderate pace” while
adding that labor market conditions will strengthen “somewhat further”
(instead of “labor market indicators will strengthen” as in July). The addition
of “somewhat further” signals that the Committee does not expect labor
market conditions to strengthen indefinitely.
o By contrast, Alternative A expresses the Committee’s expectation that
economic activity will expand at a moderate pace “with the appropriate stance
of monetary policy” rather than “with gradual adjustments.” (Like
Alternatives B and C, Alternative A replaces labor market “indicators” with
“conditions,” but omits “somewhat” in characterizing how they will
strengthen further.)
o All three alternatives reaffirm the Committee’s expectation that inflation will
“remain low in the near term,” in part because of earlier declines in energy
prices, but that inflation will rise to 2 percent over the medium term as the
transitory effects of those earlier declines dissipate and the labor market
strengthens further. Alternative A, however, qualifies that forecast by noting
that inflation will rise “gradually” to 2 percent.
Page 24 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Alternatives B and C offer different ways of updating the Committee’s assessment of
risks to the economic outlook, whereas Alternative A removes from the statement any
characterization of risks:
o In light of the incoming data on spending and the labor market, Alternative B
characterizes near-term risks to the economic outlook as appearing “roughly
balanced” rather than as having “diminished” (as in July). The
characterization of risks is limited to the near term. This is because certain
risks—such as those stemming from yet-to-be-started Brexit negotiations or
from the limited ability of monetary policy to stabilize the economy in
response to adverse developments while short-term interest rates remain near
o Reflecting a more optimistic assessment and foreshadowing its policy
decision, Alternative C describes the near-term risks to the economic outlook
as appearing “balanced.”
o Alternative A, in contrast, merely drops the previous assertion that “near-term
risks to the economic outlook have diminished,” thereby suggesting there has
been no change in the Committee’s assessment of risks since July.
Turning to the policy decision, Alternatives A and B maintain the current target range
for the federal funds rate but offer very different signals about the Committee’s likely
next steps; Alternative C raises the target range.
o While noting that “the case for an increase in the federal funds rate has
strengthened,” Alternative B adds that the Committee “decided, for the time
being, to wait for further evidence of continued progress toward its
objectives.” With these words, Alternative B acknowledges past progress in
labor market conditions and inflation, indicates that the Committee is adopting
a wait-and-see posture, but signals that, if the economy evolves about as
expected, it may not take long for the Committee to see sufficient evidence to
warrant raising rates.
o Alternative C raises the target range by 25 basis points; it notes that, even
after that increase, monetary policy remains accommodative and thus will
support further (or “some further”) strengthening in labor market conditions
and inflation returning to 2 percent, consistent with the economic outlook
summarized in paragraph 2 of the statement.
Page 25 of 60
Alternatives
zero—may remain tilted to the downside at horizons beyond the near-term.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
o Alternative A communicates a judgment that the outlook and associated risks
warrant deferring an increase in the target range “until inflation moves closer
to 2 percent on a sustained basis.” If the staff’s forecast proves correct, the
Alternatives
inflation condition will not be met in short order.
Page 26 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
JULY 2016 FOMC STATEMENT
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market indicators will strengthen. Inflation is expected to
remain low in the near term, in part because of earlier declines in energy prices, but to
rise to 2 percent over the medium term as the transitory effects of past declines in
energy and import prices dissipate and the labor market strengthens further. Nearterm risks to the economic outlook have diminished. The Committee continues to
closely monitor inflation indicators and global economic and financial developments.
3. Against this backdrop, the Committee decided to maintain the target range for the
federal funds rate at ¼ to ½ percent. The stance of monetary policy remains
accommodative, thereby supporting further improvement in labor market conditions
and a return to 2 percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to 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 and international developments. In light of
the current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
5. 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
Page 27 of 60
Alternatives
1. Information received since the Federal Open Market Committee met in June indicates
that the labor market strengthened and that economic activity has been expanding at a
moderate rate. Job gains were strong in June following weak growth in May. On
balance, payrolls and other labor market indicators point to some increase in labor
utilization in recent months. Household spending has been growing strongly but
business fixed investment has been soft. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting earlier declines in
energy prices and in prices of non-energy imports. Market-based measures of
inflation compensation remain low; most survey-based measures of longer-term
inflation expectations are little changed, on balance, in recent months.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Alternatives
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 28 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
1. Information received since the Federal Open Market Committee met in June July
indicates that the labor market strengthened has continued to strengthen and that
growth of economic activity has been expanding at a moderate rate has picked up
from the modest pace seen in the first half of this year. Job gains were strong in
June following weak growth in May. On balance, payrolls and have been solid in
recent months, on average, but other labor market indicators, including the
unemployment rate, point to some increase little change in labor utilization in
recent months. Household spending has been growing strongly but business fixed
investment has been remained soft. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, only partly reflecting earlier declines in
energy prices and in prices of non-energy imports. Market-based measures of
inflation compensation remain low; most survey-based measures of longer-term
inflation expectations are little changed, on balance, in recent months.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the appropriate stance of monetary policy, economic activity will
expand at a moderate pace and labor market indicators conditions will strengthen
further. Inflation is expected to remain low in the near term, in part because of
earlier declines in energy prices, but to rise gradually to 2 percent over the medium
term as the transitory effects of past declines in energy and import prices dissipate
and the labor market strengthens further. Near-term risks to the economic outlook
have diminished. The Committee continues to closely monitor inflation indicators
and global economic and financial developments.
3. Against this backdrop, the Committee decided to maintain the target range for the
federal funds rate at ¼ to ½ percent. The stance of monetary policy remains
accommodative, thereby supporting further improvement in labor market conditions
and a return to 2 percent inflation. The Committee judges that an increase in the
target range will not be warranted until inflation moves closer to 2 percent on a
sustained basis.
4. In determining the timing and size of future when adjustments to the target range for
the federal funds rate might become appropriate, the Committee will assess realized
and expected economic conditions relative to its objectives of maximum employment
and 2 percent inflation, along with risks to the economic outlook. 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 and international developments. In light of the current shortfall
of inflation from 2 percent, the Committee will carefully monitor actual and expected
progress toward its inflation goal. The Committee expects that economic conditions
will evolve in a manner that will warrant only gradual increases in the federal funds
rate; the federal funds rate is likely to remaining, for some time, below levels that are
Page 29 of 60
Alternatives
SEPTEMBER 2016 ALTERNATIVE A
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
expected to prevail in the longer run. However, the actual path of the federal funds
rate will depend on the economic outlook as informed by incoming data.
Alternatives
5. 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 30 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
SEPTEMBER 2016 ALTERNATIVE B
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market indicators conditions will strengthen somewhat
further. Inflation is expected to remain low in the near term, in part because of
earlier declines in energy prices, but to rise to 2 percent over the medium term as the
transitory effects of past declines in energy and import prices dissipate and the labor
market strengthens further. Near-term risks to the economic outlook have diminished
appear roughly balanced. The Committee continues to closely monitor inflation
indicators and global economic and financial developments.
3. Against this backdrop, the Committee decided to maintain the target range for the
federal funds rate at ¼ to ½ percent. The Committee judges that the case for an
increase in the federal funds rate has strengthened but decided, for the time
being, to wait for further evidence of continued progress toward its objectives.
The stance of monetary policy remains accommodative, thereby supporting further
improvement in labor market conditions and a return to 2 percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to 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 and international developments. In light of
the current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
Page 31 of 60
Alternatives
1. Information received since the Federal Open Market Committee met in June July
indicates that the labor market strengthened has continued to strengthen and that
growth of economic activity has been expanding at a moderate rate has picked up
from the modest pace seen in the first half of this year. Although the
unemployment rate is little changed in recent months, job gains were strong in
June following weak growth in May have been solid, on average. On balance,
payrolls and other labor market indicators point to some increase in labor utilization
in recent months. Household spending has been growing strongly but business fixed
investment has been remained soft. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting earlier declines in
energy prices and in prices of non-energy imports. Market-based measures of
inflation compensation remain low; most survey-based measures of longer-term
inflation expectations are little changed, on balance, in recent months.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Alternatives
5. 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 32 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
SEPTEMBER 2016 ALTERNATIVE C
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market indicators conditions will strengthen somewhat
further. Inflation is expected to remain low in the near term, in part because of
earlier declines in energy prices, but to rise to 2 percent over the medium term as the
transitory effects of past declines in energy and import prices dissipate and the labor
market strengthens further. Near-term risks to the economic outlook have diminished
appear balanced. The Committee continues to closely monitor inflation indicators
and global economic and financial developments.
3. Against this backdrop In view of realized and projected progress toward
maximum employment and 2 percent inflation, the Committee decided to maintain
raise the target range for the federal funds rate at ¼ to ½ to ¾ percent. The stance of
monetary policy remains accommodative after this increase, thereby supporting
[ some ] further improvement strengthening in labor market conditions and a return
to 2 percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to its objectives of maximum employment and 2 percent inflation,
along with risks to the outlook. 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 and international
developments. In light of the current shortfall of inflation from 2 percent, the
Committee will carefully monitor actual and expected progress toward its inflation
goal. The Committee expects that economic conditions will evolve in a manner that
will warrant only gradual increases in the federal funds rate; the federal funds rate is
likely to remain, for some time, below levels that are expected to prevail in the longer
run. However, the actual path of the federal funds rate will depend on the economic
outlook as informed by incoming data.
Page 33 of 60
Alternatives
1. Information received since the Federal Open Market Committee met in June July
indicates that the labor market strengthened has continued to strengthen and that
growth of economic activity has been expanding at a moderate rate has picked up
from the modest pace seen in the first half of this year. Although the
unemployment rate is little changed in recent months, job gains were strong in
June following weak growth in May have been solid, on average. On balance,
payrolls and other labor market indicators point to some increase in labor utilization
in recent months. Household spending has been growing strongly but business fixed
investment has been remained soft. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting earlier declines in
energy prices and in prices of non-energy imports. Market-based measures of
inflation compensation remain low; most survey-based measures of longer-term
inflation expectations are little changed, on balance, in recent months.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Alternatives
5. 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 34 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
THE CASE FOR ALTERNATIVE B
Policymakers may view the information they have received so far about the labor
market and real activity as consistent, on balance, with earlier expectations for stronger
output growth and continued improvement in labor markets. They might also conclude
that developments with regard to inflation have proceeded about as expected. While
these developments may have strengthened the case for raising the target range for the
federal funds rate, policymakers may prefer to wait for additional evidence supporting
their expectations of continued progress in labor markets and inflation returning to 2
percent before committing to the next rate rise. Moreover, policymakers may judge that
not much additional evidence may be needed to warrant a rate hike and might wish to
Economic Conditions and Outlook
The solid average gain in payroll employment over recent months has exceeded most
estimates of longer-run labor force growth, indicating further increases in labor
utilization.1 However, since the beginning of the year, the unemployment rate has, on
net, remained unchanged at 4.9 percent, suggesting little increase in resource
utilization (an impression supported also by other labor market indicators, such as the
share of employees working part-time for economic reasons, and the long-term
unemployment share).
While recent data on inventories, business fixed investment, and residential
construction continued to show weakness, generally strong readings on consumer
spending have led the staff to mark up its outlook for 2016:H2 real GDP growth to
about 2.6 percent.
Policymakers may judge that, in light of incoming data that largely confirm their
earlier outlook, downside risks, including those from abroad, have diminished further
since July, and may see near-term risks to the U.S. economic outlook as roughly
balanced.
Twelve-month core and headline inflation stepped up at the beginning of the year but
have not increased since, and headline inflation continues to run below the
Committee’s 2 percent objective. Policymakers may have expected inflation to return
1
See, for example, the discussion provided by the box “The Neutral Pace of Payroll Employment
Gains” shown in Tealbook A.
Page 35 of 60
Alternatives
indicate so in the statement.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
only slowly to 2 percent all along, as in the staff forecast. But historically low levels
of longer-term inflation compensation and survey measures of longer-run inflation
expectations might still be tempering policymakers’ confidence in this outlook.
Policy Strategy
Policymakers may judge it prudent to wait for more evidence that domestic demand
will continue to grow at a moderate pace and that the labor market will strengthen
somewhat further before taking their next step in adjusting the stance of monetary
policy.
o While job gains have rebounded since May, the unemployment rate and
several other measures of resource utilization have changed little since the
Alternatives
beginning of the year. Waiting somewhat longer before raising the federal
funds rate could allow the Committee to better assess underlying trends in
employment, productivity, and inflation.
o In light of mostly favorable economic and financial developments in recent
months, policymakers may be leaning toward removing some policy
accommodation. However, the combination of slow-to-moderate output
growth, little changed labor utilization, and persistently low wage and price
inflation since the start of the year—while policy rates have remained low—
may have tempered somewhat policymakers’ confidence in their estimates of
the amount of accommodation provided by current policy settings. As a
result, policymakers may judge it appropriate to take a wait-and-see posture.
o In addition, policymakers may prefer to postpone a rate hike, for the time
being, in light of risk management considerations related to the proximity of
nominal rates to the effective lower bound, which limits the ability of
monetary policy to respond to negative shocks.
A decision to maintain the current target range for the federal funds rate would be in
line with the expectations of financial market participants.
o The probability of an increase in the federal funds rate target range at the
September meeting derived from federal funds futures quotes is
approximately 15 percent. Similarly, respondents to the Desk’s latest Survey
of Primary Dealers and Survey of Market Participants perceive only a modest
probability that the Committee will alter the target range at this meeting.
Page 36 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
o The Desk’s surveys suggest that market participants will not be surprised by
the changes in paragraph 1 of Alternative B. In contrast, few respondents
expect the Committee to upgrade its assessment of risks to the outlook,
suggesting that many market participants may be surprised by the sentence
indicating that near-term risks to the economic outlook “appear roughly
balanced” in paragraph 2 of Alternative B.
o The majority of respondents to both surveys see the December meeting as the
most likely timing of the next increase in the target range for the federal funds
rate, and the new language in paragraph 3 of Alternative B could reinforce
such expectations. While the new language may still surprise market
Chair to reiterate at her press conference earlier remarks (made at the Jackson
Hole conference in August) that “the case for an increase in the federal funds
rate has strengthened.”
o Of course, the market reaction to alternative B could also be influenced by the
economic and policy outlook reported in the Committee’s Summary of
Economic Projections (SEP) that will also be released at the conclusion of this
meeting. Respondents to the Desk’s surveys generally expect the median of
FOMC participants’ federal funds rate projections in the SEP for year-end
2016 to reflect just one rate hike this year, down from two hikes in the June
SEP; they continue to expect an implied pace of tightening of three hikes per
year for 2017 and 2018.
THE CASE FOR ALTERNATIVE C
Based on continued readings of the unemployment rate at a level within the
central tendency of the Committee’s long-run projections of this measure (as published in
the June 2016 SEP), policymakers may see the real economy as operating near levels
consistent with its longer-run capacity and close to maximum sustainable employment.
Moreover, with core PCE inflation averaging above 1.5 percent and trimmed mean PCE
inflation near 2 percent, policymakers may judge that inflation is not so low as to warrant
concern—particularly if they expect inflation to rise as output growth and resource
utilization pick up in the second half of the year. Furthermore, policymakers may see
financial stability risks arising from excessive risk taking behavior in a low interest rate
environment. Accordingly, policymakers may judge that an increase in the target range
for the federal funds rate is called for at this meeting.
Page 37 of 60
Alternatives
participants to some extent, at least several survey respondents expected the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Economic Conditions and Outlook
Policymakers might view the solid average pace of job growth coupled with the
strong increase in consumer spending in recent months as confirmation that both the
slowdown in employment growth in May and the modest output growth in the first
half of the year were transitory.
Gains in real disposable income have been solid—reflecting both rising employment
and the earlier period of very low headline inflation—and household balance sheets
have improved further. Policymakers may see economic conditions as favorable for
solid consumption growth going forward.
Policymakers might see the average pace of job gains in recent months, though less
Alternatives
rapid than last year and early this year, as nonetheless faster than their projections of
trend growth in the labor force.
Policymakers may project that aggregate demand will grow more rapidly than the
economy’s potential output, absent further increases in the target range for the federal
funds rate in the near term, and they may view resource utilization as already tight.
o Policymakers might anticipate that further tightening of labor market
conditions, combined with mediocre productivity growth, will put increasing
upward pressure on wages and on prices of goods and services—possibly
going beyond what is captured by the “Temporarily Weaker Productivity”
scenario described in the “Risks and Uncertainty” section of Tealbook A—
unless policy accommodation was removed soon.
o Moreover, with oil prices apparently having stabilized in a fairly narrow
range, policymakers may conclude that the restraint on inflation from
transitory factors is already subsiding.
Policymakers might see the news received since the last meeting as consistent with
describing the near-term risks to the outlook as “balanced,” rather than “roughly
balanced” (as in Alternative B). In addition to the incoming data on employment and
spending, they may view developments in financial markets, which seem more
favorable than in the first half of the year, as supporting their new assessment of the
balance of risks.
Page 38 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Policy Strategy
Policymakers may judge that current conditions and the outlook warrant an increase
in the target range for the federal funds rate of 25 basis points at this meeting.
o Policymakers may see a higher chance of growth picking up much more
forcefully than anticipated, for example, under the staff’s baseline forecast,
calling for much quicker increases in the federal funds rate in the future that
could eventually contribute to another recession. Accordingly, policymakers
may deem a tightening of the stance of monetary policy at this meeting as
appropriate to reduce the risk that an undesirably rapid pace of increases will
become necessary in the future.
o Policymakers might worry that not raising the target range for the federal
funds rate at this meeting could lead the public to question the credibility of
the Committee’s earlier communications. In particular, if the Committee
indicates that incoming data have roughly been in line with its projections for
the labor market and inflation, the public may see the decision to further delay
an increase in the policy rate as inconsistent with earlier communications.
o Policymakers may be concerned that leaving policy rates unchanged in the
face of an unemployment rate that is at or below estimates of its longer-run
normal level would foster expectations that monetary policy will be
insufficiently responsive to evolving economic conditions. If the public were
to begin doubting policymakers’ commitment to maintaining low and stable
inflation, longer-term inflation expectations could rise too much.
o In addition, policymakers might be worried that maintaining the federal funds
rate at its current low level will induce further “reach for yield” and other
excessive risk-taking behavior in financial markets. For example, they may
point to elevated valuations in commercial real estate as indicative of rising
risks to financial stability that should be countered by reduced monetary
policy accommodation.
o Policymakers may note that, even after a 25 basis point increase, the stance of
monetary policy remains accommodative. Consistent with such an
assessment, the real federal funds rate would still lie well below the
prescriptions from most simple policy rules and optimal control exercises
shown in the “Monetary Policy Strategies” section of Tealbook B.
Page 39 of 60
Alternatives
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
o Policymakers may see little difference in the direct effects on the economy
between raising the federal funds rate now rather than later. However, they
might point to good momentum in incoming data as supporting raising rates
now rather than later, when fresh but noisy readings on incoming data or some
transitory financial turbulence may complicate the communication of an
otherwise appropriate rate increase.
Respondents to the Desk’s latest surveys perceive there to be a roughly 15 percent
probability that the Committee will change the target range at this meeting, and so a
decision to increase the target range would be very surprising.
o If market participants infer that the Committee intends to pursue a less
accommodative stance of policy going forward than they had expected, for
Alternatives
any given outlook, then it is likely that medium- and longer-term real interest
rates will rise, that equity prices and inflation compensation will decline, and
that the dollar will appreciate.
o Nonetheless, if investors see a statement like Alternative C as primarily
reflecting an upbeat assessment of the strength of the U.S. expansion—
supported by a continuation of only gradual increases in the federal funds
rate—then equity prices and inflation compensation might fall less than
otherwise, or even rise.
THE CASE FOR ALTERNATIVE A
While economic growth appears to have picked up from its modest pace in the
first half of the year, and job growth has rebounded since May, policymakers may be
concerned that their stated expectation of moderate growth could again prove overly
optimistic. In addition, they might be worried that this year’s small uptick in core
inflation will prove transitory. In light of such concerns, policymakers may judge it
appropriate to signal that any further removal of policy accommodation is off until a
more sustained increase in inflation has been observed.
Economic Conditions and Outlook
Both headline and core inflation continue to run noticeably below the Committee’s 2
percent objective and market-based measures of inflation compensation are at or near
historical lows. In particular, policymakers might worry that the failure of inflation to
rise to 2 percent over the past several years has become ingrained in longer-term
Page 40 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
inflation expectations and that the persistent weakness in inflation compensation
measures suggests that the inflation expectations relevant for wage and price setting
have declined.
Though payroll growth over recent months allayed some concerns raised by the
disappointing numbers for May, the average pace of payroll growth has stepped down
markedly since the beginning of the year. In addition, the unemployment rate, the
share of employees working part-time for economic reasons, and the long-term
unemployment share have changed little over the past three quarters.
Moreover, continued weakness in inventories and business fixed investment suggests
that firms may not expect aggregate demand to grow as much as policymakers have
Policymakers may judge that the risks to the economic outlook are still tilted to the
downside.
o So far, the Brexit vote has resulted in minimal disruptions to global financial
markets. Nevertheless, the outcome of the vote could ultimately lead to
renewed financial stress in Europe and beyond because of contentious future
Brexit negotiations, the possibility of other EU breakaway movements, or
increased market scrutiny of the vulnerabilities in the European banking
system.
o Furthermore, policymakers might see the volatility in financial markets during
the past week as an indication that markets remain fragile.
o Policymakers might also point to downside risk associated with persistently
low readings on realized inflation and measures of longer-run inflation
expectations. Indeed, policymakers may view developments as outlined, for
example, in the alternative scenarios “Weak Business Investment” in the
“Risks and Uncertainty” section of Tealbook A as increasingly likely.
Policy Strategy
Policymakers may believe that risk management considerations call for signaling that
any further removal of policy accommodation is some time off.
o Policymakers might observe that, given the proximity to the effective lower
bound, the scope for conventional policy measures to support the economy
would be limited in the event that adverse shocks were to hit the economy.
Page 41 of 60
Alternatives
been projecting.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Moreover, unconventional monetary policies provide imperfect substitutes for
conventional policy.
o Policymakers might judge that the neutral rate of interest is low, relative to its
longer-run level, due to restraint on U.S. economic activity from economic
and financial developments abroad, subdued household formation, or meager
productivity growth. They may see the neutral rate as likely to remain low for
quite some time, thus exacerbating the risk that conventional policy could be
constrained going forward.
Some policymakers might argue that the chronic failure of policy to raise inflation to
2 percent is eroding the credibility of the FOMC’s commitment to achieving that
Alternatives
objective and calling into question its statement that positive and negative deviations
from this objective are treated symmetrically.
Policymakers may believe that the natural rate of unemployment is lower than the
current unemployment rate. Alternatively, they may see virtues in allowing the
unemployment rate to undershoot temporarily its natural rate as a way of repairing the
damage to the labor market that resulted from the prolonged period of weak labor
demand following the financial crisis. Accordingly, they may see increases in the
federal funds rate, at least over the near-term, as counterproductive for achieving the
Committee’s statutory goals.
Most respondents to the Desk’s latest surveys expect the Committee to continue to
emphasize the gradual nature of its normalization approach, but a large majority of
respondents expects the FOMC to raise rates this year. A postmeeting statement like
Alternative A would therefore be surprising to financial market participants.
o Investors would likely push further into the future the expected date of the
next rate increase, and the expected path for the federal funds rate would
likely flatten further and longer-term yields would likely decline.
o If the statement is primarily seen as more accommodative, equity prices and
inflation compensation would likely rise, and the dollar would depreciate.
o Conversely, if investors interpret the statement as reflecting an unexpectedly
downbeat assessment of global economic conditions and greater-thananticipated concerns about the downside risks to the outlook, equity prices and
inflation compensation could fall.
Page 42 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
IMPLEMENTATION NOTE
If the Committee decides to maintain the current target range for the federal funds
rate, an implementation note that indicates no change in the Federal Reserve’s
administered rates—the interest rates on required and excess reserves, the offering rate on
overnight reverse repurchase agreements, and the discount rate—would be issued. If the
Committee instead decides to raise the target range for the federal funds rate, an
implementation note that communicates the changes the Federal Reserve decided to make
to these three policy tools would be issued.
On the following pages, struck-out text indicates language deleted from the July
and blue underlined text indicates text that links to websites.
Page 43 of 60
Alternatives
directive and implementation note, bold red underlined text indicates added language,
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Implementation Note if the Committee maintains the current target range
Release Date: July 27 September 21, 2016
Decisions Regarding Monetary Policy Implementation
The Federal Reserve has made the following decisions to implement the monetary policy stance
announced by the Federal Open Market Committee in its statement on July 27 September 21,
2016:
The Board of Governors of the Federal Reserve System left unchanged the interest rate
paid on required and excess reserve balances at 0.50 percent.
As part of its policy decision, the Federal Open Market Committee voted to authorize and
direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed
otherwise, to execute transactions in the System Open Market Account in accordance
with the following domestic policy directive:
Alternatives
“Effective July 28 September 22, 2016, the Federal Open Market Committee directs
the Desk to undertake open market operations as necessary to maintain the federal
funds rate in a target range of ¼ to ½ percent, including overnight reverse repurchase
operations (and reverse repurchase operations with maturities of more than one day
when necessary to accommodate weekend, holiday, or similar trading conventions) at
an offering rate of 0.25 percent, in amounts limited only by the value of Treasury
securities held outright in the System Open Market Account that are available for
such operations and by a per-counterparty limit of $30 billion per day.
The Committee directs the Desk to continue rolling over maturing Treasury securities
at auction and to continue reinvesting principal payments on all agency debt and
agency mortgage-backed securities in agency mortgage-backed securities. The
Committee also directs the Desk to engage in dollar roll and coupon swap
transactions as necessary to facilitate settlement of the Federal Reserve’s agency
mortgage-backed securities transactions.”
More information regarding open market operations may be found on the Federal
Reserve Bank of New York’s website.
The Board of Governors of the Federal Reserve System took no action to change the
discount rate (the primary credit rate), which remains at 1.00 percent.
This information will be updated as appropriate to reflect decisions of the Federal Open Market
Committee or the Board of Governors regarding details of the Federal Reserve’s operational
tools and approach used to implement monetary policy.
Page 44 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Implementation Note if the Committee raises the target range to ½ to ¾ percent
Release Date: July 27 September 21, 2016
Decisions Regarding Monetary Policy Implementation
The Board of Governors of the Federal Reserve System left unchanged voted
[ unanimously ] to raise the interest rate paid on required and excess reserve balances at
0.50 to 0.75 percent, effective September 22, 2016.
As part of its policy decision, the Federal Open Market Committee voted to authorize and
direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed
otherwise, to execute transactions in the System Open Market Account in accordance
with the following domestic policy directive:
“Effective July 28 September 22, 2016, the Federal Open Market Committee directs
the Desk to undertake open market operations as necessary to maintain the federal
funds rate in a target range of ¼ to ½ to ¾ percent, including overnight reverse
repurchase operations (and reverse repurchase operations with maturities of more
than one day when necessary to accommodate weekend, holiday, or similar trading
conventions) at an offering rate of 0.25 0.50 percent, in amounts limited only by the
value of Treasury securities held outright in the System Open Market Account that
are available for such operations and by a per-counterparty limit of $30 billion per
day.
The Committee directs the Desk to continue rolling over maturing Treasury securities
at auction and to continue reinvesting principal payments on all agency debt and
agency mortgage-backed securities in agency mortgage-backed securities. The
Committee also directs the Desk to engage in dollar roll and coupon swap
transactions as necessary to facilitate settlement of the Federal Reserve’s agency
mortgage-backed securities transactions.”
More information regarding open market operations may be found on the Federal
Reserve Bank of New York’s website.
In a related action, the Board of Governors of the Federal Reserve System took no
action to change voted [ unanimously ] to approve a ¼ percentage point increase in
the discount rate (the primary credit rate) , which remains at 1.00 to 1.25 percent,
effective September 22, 2016. In taking this action, the Board approved requests
submitted by the Boards of Directors of the Federal Reserve Banks of …
Page 45 of 60
Alternatives
The Federal Reserve has made the following decisions to implement the monetary policy stance
announced by the Federal Open Market Committee in its statement on July 27 September 21,
2016:
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Alternatives
This information will be updated as appropriate to reflect decisions of the Federal Open Market
Committee or the Board of Governors regarding details of the Federal Reserve’s operational
tools and approach used to implement monetary policy.
Page 46 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Projections
BALANCE SHEET AND INCOME
The staff has prepared projections of the Federal Reserve’s balance sheet, and of
key elements of the associated income statement, under two scenarios for the paths of
monetary policy and longer-term interest rates.
The “September Tealbook baseline” scenario is consistent with the monetary policy
assumptions incorporated in the staff’s baseline forecast presented in Tealbook A. In
this scenario, the federal funds rate path is projected to rise to about 3½ percent by the
end of 2020, with a corresponding increase in longer-term interest rates.
The “Greenspan conundrum” scenario incorporates a flat path for longer-term interest
rates in the near term, as assumed in the scenario of the same name in the Risks and
Uncertainty section of Tealbook A.1 Under this scenario, longer-term interest rates
remain fixed at their levels as of the third quarter of 2016 over the next six quarters
despite the projected rise in the policy rate as prescribed by the inertial Taylor (1999)
rule. Thereafter, the conundrum slowly unwinds. In the meantime, lower longerterm rates spur a faster pace of economic expansion and, consequently, a steeper path
The key policy assumptions associated with these scenarios are highlighted below.
Reinvestment policy: We continue to assume that the FOMC will cease
reinvestments of maturing Treasury securities and agency debt as well as principal
received on agency MBS when the target range for the federal funds rate reaches 1¼
and 1½ percent, which occurs in the third quarter of 2017 under both scenarios. Once
reinvestments cease, the SOMA portfolio shrinks through redemptions of maturing
Treasury and agency debt securities as well as paydowns of principal on agency MBS
until reserve balances reach a level of $100 billion.
Use of policy normalization tools: The scenarios assume that take-up of overnight
reverse repurchase agreements (RRPs) runs at a level of $100 billion through the end
1
The alternative view box titled “A Return to the Greenspan Conundrum” in the DEDO section of
Tealbook A details possible mechanisms behind this phenomenon.
Page 47 of 60
Projections
for the policy rate relative to the baseline scenario.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
of 2018 before declining to zero by the end of 2019, and that term deposits and term
RRPs are not used.2
Other features of these scenarios are described below.
Balance sheet. Under the baseline scenario, the size of the portfolio is normalized in
the fourth quarter of 2021, unchanged from the July Tealbook (see the solid black
lines in the exhibit titled “Total Assets and Selected Balance Sheet Items” and the
table that follows).3 At that time, total assets are projected to stand at roughly $2.4
trillion, with about $2.3 trillion in total SOMA securities holdings. Total assets and
SOMA Treasury holdings rise thereafter, keeping pace with the increases in both
Federal Reserve notes in circulation and Federal Reserve Bank capital.
Under the conundrum scenario, relatively lower interest rates on longer-dated
Treasury securities through the medium term put downward pressure on mortgage
rates, causing the trajectory of MBS prepayments to be higher during this period.
Therefore, after reinvestments cease, SOMA holdings of agency MBS are projected
to be lower than in the baseline scenario. As a result, the size of the portfolio is
normalized in the third quarter of 2021, one quarter earlier than in the baseline
Projections
scenario.4
2
Use of term RRPs or term deposits would result in a shift in the composition of Federal Reserve
liabilities—a decline in reserve balances and an equal increase in term RRPs or term deposits—but would
not produce a change in the overall size of the balance sheet. We assume that RRPs associated with foreign
official and international accounts remain near their August 31, 2016 level of $251 billion throughout the
projection period.
3
The size of the balance sheet is assumed to be normalized when the securities portfolio reverts to
the level consistent with its longer-run trend; this trend is determined largely by currency in circulation and
a projected long-run 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 deemed necessary to conduct monetary
policy. Currently, we assume that level of reserve balances to be $100 billion; however, policymakers’
choice of a long-run operating framework, as well as ongoing regulatory and structural changes, could
result in a higher long-run level of reserve balances. In turn, a higher long-run level of reserve balances
would, all else equal, imply an earlier normalization of the size of the balance sheet. For instance, with a
$500 billion long-run level of reserve balances, the balance sheet would likely normalize at the beginning
of 2021, roughly three quarters earlier than in the baseline scenario.
4
The lower level of MBS in the conundrum scenario implies a need to resume purchases of
Treasury securities somewhat sooner that in the baseline scenario in order to accommodate rising currency
demand. Consequently, at the end of the projection period, the share of Treasury holdings relative to MBS
is larger in the conundrum scenario than in the baseline.
Page 48 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Total Assets and Selected Balance Sheet Items
September Tealbook baseline
July Tealbook
Total Assets
Greenspan Conundrum
Reserve Balances
Billions of dollars
Monthly
Billions of dollars
5500
Monthly
3500
5000
3000
4500
4000
2500
3500
2000
3000
2500
1500
2000
1000
1500
1000
500
500
0
2024
2022
2020
2018
2016
2014
SOMA Agency MBS Holdings
Billions of dollars
Monthly
3000
Billions of dollars
Monthly
2400
2200
2000
2500
1800
1600
2000
1400
1200
1500
1000
800
1000
600
400
500
200
0
Page 49 of 60
2024
2022
2020
2018
2016
2014
2012
2010
2024
2022
2020
2018
2016
2014
2012
2010
0
Projections
SOMA Treasury Holdings
2012
2010
2024
2022
2020
2018
2016
2014
2012
2010
0
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Federal Reserve Balance Sheet
End-of-Year Projections -- September Tealbook Baseline
(Billions of dollars)
Aug 31, 2016
Total assets
4,458
2017
2019
2021
2023
2025
4,342 3,120 2,390 2,525 2,679
Selected assets
Loans and other credit extensions*
Securities held outright
U.S. Treasury securities
3
0
0
0
0
4,230
4,153 2,964 2,256 2,404 2,566
2,464
2,422 1,611
Agency debt securities
Agency mortgage-backed securities
0
22
1,744
4
2
1,167 1,515 1,821
2
2
2
1,726 1,351 1,086
887
742
Unamortized premiums
178
154
118
93
79
70
Unamortized discounts
-16
-14
-11
-9
-7
-7
41
42
42
42
42
42
Total other assets
Total liabilities
4,418
4,300 3,075 2,340 2,471 2,620
1,423
1,550 1,708 1,828 1,959 2,108
Projections
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
U.S. Treasury, General Account
423
251
251
251
251
2,565
2,393 1,109
255
255
255
2,231
2,237
954
100
100
100
289
150
150
150
150
150
46
5
5
5
5
5
1
0
0
0
0
0
40
42
45
49
54
59
Other deposits
Earnings remittances due to the U.S. Treasury
Total capital**
351
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; and net portfolio holdings of Maiden Lane LLC.
**Total capital includes capital paid-in and capital surplus accounts.
Page 50 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Federal Reserve Balance Sheet
End-of-Year Projections -- Greenspan Conundrum
(Billions of dollars)
Aug 31, 2016
Total assets
4,458
2017
2019
2021
2023
2025
4,327 3,001 2,402 2,520 2,667
Selected assets
Loans and other credit extensions*
Securities held outright
U.S. Treasury securities
3
0
0
0
0
4,230
4,132 2,843 2,266 2,396 2,551
2,464
2,422 1,611
Agency debt securities
Agency mortgage-backed securities
0
22
1,744
4
1,274 1,578 1,864
2
2
2
2
1,705 1,230
990
816
685
Unamortized premiums
178
160
119
94
81
72
Unamortized discounts
-16
-13
-10
-8
-7
-6
41
42
42
42
42
42
Total other assets
Total liabilities
4,418
4,286 2,956 2,352 2,466 2,608
1,423
1,550 1,722 1,840 1,954 2,096
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
U.S. Treasury, General Account
423
351
251
251
251
251
2,565
2,378
976
255
255
255
2,231
2,223
821
100
100
100
289
150
150
150
150
150
46
5
5
5
5
5
1
0
0
0
0
0
40
42
45
49
54
59
Other deposits
Earnings remittances due to the 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; and net portfolio holdings of Maiden Lane LLC.
**Total capital includes capital paid-in and capital surplus accounts.
Page 51 of 60
Projections
Selected liabilities
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Federal Reserve earnings remittances. Under the baseline scenario, annual
remittances are projected to decline from $98 billion in 2015 to about $93 billion this
year (see the solid black lines in the “Income Projections” exhibit).5 The step-down
primarily reflects increased interest expense on reserves resulting from the decision to
increase the target range for the federal funds rate, and thus the IOER rate, in
December 2015.6 Annual remittances are projected to continue to decline, reaching a
low of roughly $35 billion in 2019, with no deferred asset being recorded.7 Under the
baseline scenario, the Federal Reserve’s projected remittances from 2009 through
2025 total about $1.1 trillion.
Under the conundrum scenario, cumulative remittances over the 2009 to 2025 period
are projected to be about $58 billion lower than in the baseline projection, reflecting
the combination of lower interest income and higher interest expense throughout the
projection period (see the dotted red line in the “Income Projections” exhibit).
Regarding interest income, the higher path for MBS prepayments results in lower
MBS coupon income, especially in the medium term. Regarding interest expense,
flat longer-term rates in the near term lead to a more rapid increase in the pace of
economic expansion and, in turn, to a steeper path for the policy target and for the
Projections
IOER rate, which translates into higher interest expense.8
5
Earnings remittances for 2015 exclude a one-time transfer of $19 billion in Federal Reserve
surplus associated with the FAST Act.
6
We assume that the interest rate paid on excess reserve balances will average 12.5 basis points
above the effective federal funds rate and the ON RRP rate will average 12.5 basis points below the
effective federal funds rate. The effective federal funds rate has averaged 40 basis points over the
intermeeting period.
7
In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to cover
its operating costs and pay dividends, a deferred asset would be recorded as a claim against future earnings
remittances due to the U.S. Treasury.
8
This feature arises even as reserve balances are somewhat lower than in the baseline scenario
until the balance sheet is normalized.
Page 52 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Income Projections
September Tealbook baseline
July Tealbook
Interest Income
Interest Expense
40
20
20
0
0
Memo: Unrealized Gains/Losses
Billions of dollars
Page 53 of 60
2024
2022
2020
2018
2016
End of year
2014
2024
2022
2020
2018
End of year
120
110
100
90
80
70
60
50
40
30
20
10
0
2012
Billions of dollars
400
300
200
100
0
−100
−200
−300
−400
−500
Projections
140
120
100
80
60
40
20
0
−20
2024
2022
2020
2018
2016
2014
2012
Annual
2024
2022
2020
2018
Billions of dollars
140
120
100
80
60
40
20
0
−20
Deferred Asset
2016
2024
40
2022
60
2020
60
2018
80
2016
80
2012
100
2024
2022
2020
2018
2016
2016
Annual
2014
120
Earnings Remittances to Treasury
Billions of dollars
2014
140
100
Realized Capital Gains
2012
Annual
120
2014
2012
Annual
Billions of dollars
140
2014
Billions of dollars
2012
Greenspan Conundrum
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Unrealized gains or losses. The staff estimates that the SOMA portfolio was in a net
unrealized gain position of $265 billion at the end of August.9 Going forward, the net
unrealized gain or loss position of the portfolio will depend importantly on the path of
longer-term interest rates. Under the baseline scenario, because of the rise in longerterm interest rates assumed over the next several years, the portfolio is projected to
shift to an unrealized loss position in the second quarter of 2018. The portfolio is
expected to record a peak unrealized loss of approximately $118 billion in 2019.
About $28 billion of that peak unrealized loss is attributable to losses on holdings of
Treasury securities and $90 billion to losses on holdings of agency MBS. The
unrealized loss position contracts from 2020 through 2025, as the value of Treasury
and agency debt securities previously acquired under the large-scale asset purchase
programs return to par as they approach maturity and new securities are added to the
portfolio at prevailing market yields.
Under the conundrum scenario, the portfolio is projected to shift to a position of
unrealized loss about one year later than in the baseline scenario, as the assumed sixquarter period of unchanged longer-term interest rates leads to higher valuations for
SOMA Treasury and MBS holdings. The mark-to-market value of the portfolio
decreases at a steeper pace than in the baseline scenario in the medium term, and
records a peak unrealized loss of about $127 billion in 2022 before trending toward
Projections
the baseline scenario by the end of 2025.
Term premium effects. As shown in the table “Projections for the 10-Year Treasury
Term Premium Effect,” the Federal Reserve’s elevated holdings of longer-term
securities is estimated to be reducing the term premium embedded in the 10-year
Treasury yield by 91 basis points in the current quarter. Over the next couple of
years, the estimated term premium effect diminishes at a pace of about 4 basis points
per quarter, in large part reflecting the projected gradual shrinking of the portfolio.
Under the conundrum scenario, the term premium effect is roughly 5 basis points less
negative than under the baseline scenario for the next couple of years, reflecting
marginally lower SOMA holdings of agency MBS.
9
The Federal Reserve reports the quarter-end net unrealized gain/loss position of the SOMA
portfolio to the public in the “Federal Reserve Banks Combined Quarterly Financial Reports,” available on
the Board’s website at http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm#quarterly.
Page 54 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Projections for the 10-Year Treasury Term Premium Effect
(Basis Points)
Date
September
Tealbook
baseline
July
Tealbook
Greenspan
Conundrum
Quarterly Averages
-91
-87
-94
-90
-86
-82
2017:Q4
2018:Q4
2019:Q4
2020:Q4
2021:Q4
2022:Q4
2023:Q4
2024:Q4
2025:Q4
-71
-57
-46
-37
-31
-26
-21
-16
-12
-73
-59
-47
-39
-32
-26
-21
-16
-12
-65
-52
-42
-34
-29
-24
-20
-15
-11
Projections
2016:Q3
Q4
Page 55 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
SOMA characteristics. Regarding the size of the portfolio, under both the baseline
and the conundrum scenarios, approximately $216 billion in SOMA Treasury
holdings have already matured or will mature this year, and a total of $1.5 trillion will
mature between 2016 and 2020 (for the baseline scenario, see the top panel of the
exhibit “Projections for the Characteristics of SOMA Holdings”).10 The amounts of
Treasury securities maturing each month will vary considerably over time, while
projected MBS paydowns are much less variable. However, realized MBS paydowns
will reflect the evolution of interest rates and other factors and thus could be
significantly more volatile than projected.11
The weighted-average duration of the SOMA Treasury portfolio is currently about 6½
years (see the bottom panel of the exhibit). Under the two scenarios, the weightedaverage duration is projected to decline through 2017, reflecting the aging of the
portfolio, and subsequently to rise until mid- to late 2021, when the size of the
balance sheet is normalized.12 After reaching its peak, duration is projected to resume
its decline as the Desk conducts open market purchases of Treasury securities to keep
pace with the increase in currency. The duration contour in this latter portion of the
projection is based on the key assumption that the Federal Reserve will buy only
Treasury bills until those holdings are equal to approximately 30 percent of the
Treasury portfolio, similar to the pre-crisis composition of the portfolio (currently
SOMA holds no Treasury bills). Thereafter, purchases of Treasury securities are
Projections
assumed to be spread across the maturity spectrum.13
10
While following its current reinvestment policy, the Desk replaces maturing Treasury security
holdings with newly issued debt at Treasury auctions. Consistent with longstanding practice, these
rollovers are carried out at Treasury auctions by placing bids for the SOMA in a par amount equal to the
face value of holdings maturing on the issue date of newly issued securities. Moreover, across the various
maturities, these bids are placed proportionately to the issue amounts of the new securities. The Desk’s
bids at Treasury auctions are placed as noncompetitive tenders and are treated by Treasury as add-ons to
announced auction sizes.
11
Over the intermeeting period, the Desk reinvested $21 billion of maturing Treasury securities
and is expected to purchase a total of $65 billion of 15- and 30-year agency MBS under the reinvestment
program. Additionally, on August 16, the Desk conducted a small-value buyback operation on behalf of
the U.S. Treasury to ensure operational readiness of its buyback infrastructure.
12
The duration of the SOMA Treasury portfolio initially declines as Treasury securities in the
portfolio approach maturity. Once the pace of roll-offs accelerates, starting in 2018, and longer-tenor
securities account for a larger share of the remaining portfolio, the duration increases until the size of the
balance sheet is normalized.
13
We assume zero purchases of agency MBS after reinvestments cease.
Page 56 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Projections for the Characteristics of SOMA Holdings
Projected Receipts of Principal on SOMA Securities
Billions of Dollars
September Tealbook baseline
100
Projected MBS Paydowns
Treasury Maturities
80
60
40
20
0
2017
2018
2019
2020
SOMA Weighted−Average Treasury Duration
Monthly
Years
10
9
8
7
6
5
4
3
2
2008
2010
2012
2014
2016
Page 57 of 60
2018
2020
2022
2024
Projections
September Tealbook baseline
Greenspan Conundrum
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
Projections
(This page is intentionally blank.)
Page 58 of 60
September 15, 2016
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
Abbreviations
ABS
asset-backed securities
BEA
Bureau of Economic Analysis, Department of Commerce
BHC
bank holding company
CDS
credit default swaps
CFTC
Commodity Futures Trading Commission
C&I
commercial and industrial
CLO
collateralized loan obligation
CMBS
commercial mortgage-backed securities
CPI
consumer price index
CRE
commercial real estate
DEDO
section in Tealbook A, “Domestic Economic Developments and Outlook”
Desk
Open Market Desk
DSGE
dynamic stochastic general equilibrium
ECB
European Central Bank
EDO
Estimated, dynamic, optimization-based model
ELB
effective lower bound
EME
emerging market economy
EU
European Union
FAST Act
Fixing America’s Surface Transportation Act
FDIC
Federal Deposit Insurance Corporation
FOMC
Federal Open Market Committee; also, the Committee
GCF
general collateral finance
GDI
gross domestic income
GDP
gross domestic product
GSIBs
globally systemically important banking organizations
HQLA
high-quality liquid assets
IOER
interest on excess reserves
Page 59 of 60
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
September 15, 2016
ISM
Institute for Supply Management
LIBOR
London interbank offered rate
MBS
mortgage-backed securities
MMFs
money market funds
NBER
National Bureau of Economic Research
NI
nominal income
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
SCOOS
Senior Credit Officer Opinion Survey on Dealer Financing Terms
SEP
Summary of Economic Projections
SFA
Supplemental Financing Account
SLOOS
Senior Loan Officer Opinion Survey on Bank Lending Practices
SOMA
System Open Market Account
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 60 of 60
Cite this document
APA
Federal Reserve (2016, September 20). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_20160921_part2
BibTeX
@misc{wtfs_greenbook_20160921_part2,
author = {Federal Reserve},
title = {Greenbook/Tealbook},
year = {2016},
month = {Sep},
howpublished = {Greenbooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/greenbook_20160921_part2},
note = {Retrieved via When the Fed Speaks corpus}
}