greenbooks · December 13, 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.
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Report to the FOMC
on Economic Conditions
and Monetary Policy
Book B
Monetary Policy:
Strategies and Alternatives
December 8, 2016
Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System
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This section considers a selection of strategies for setting the federal funds rate
and compares the associated policy paths and macroeconomic outcomes with those in the
Tealbook baseline forecast. The simple rules and optimal control exercises considered
below prescribe a tighter stance of monetary policy in the medium term than they did in
the October Tealbook in response to more expansionary fiscal policy assumptions in the
staff projection. As was the case in the October Tealbook, most simple rules and optimal
control exercises prescribe a more rapid increase in the federal funds rate than assumed in
the staff forecast. A special exhibit examines the changes in optimal control paths
associated with the assumed shift to a more accommodative stance of fiscal policy.
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 assumption for the federal funds rate.
The near-term prescriptions of all of the Taylor-type rules are higher than in the
October Tealbook because incoming data over the intermeeting period led to a
modest upward revision to the staff’s estimate of the output gap in the near term and
because the real federal funds rate expected by the staff in the long run has been
revised up by ¼ percentage point. The Taylor (1993), Taylor (1999), and inertial
Taylor (1999) rules prescribe rates that are 34, 46, and 7 basis points higher in
2017:Q1 and are 28, 33, and 11 basis points higher in 2017:Q2.
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) rule, the first-difference rule, and the Tealbook baseline.
1
The appendix to this section provides details on each of these four simple rules.
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Monetary Policy Strategies
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Strategies
Policy Rules and the Staff Projection
Near−Term Prescriptions of Selected Simple Policy Rules1
(Percent)
2017:Q1
2017:Q2
2.76
2.42
2.77
2.49
3.01
2.55
3.04
2.71
Inertial Taylor (1999) rule
Previous Tealbook projection
0.86
0.79
1.19
1.08
First−difference rule
Previous Tealbook projection
0.65
0.65
0.79
0.83
Addendum:
Tealbook baseline
0.74
0.98
Taylor (1993) rule
Previous Tealbook
Taylor (1999) rule
Previous Tealbook
*
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 change
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
0.5
−2
2016 2017 2018 2019 2020 2021 2022
0.0
A Medium−Term Equilibrium Real Federal Funds Rate2
(Percent)
Tealbook−consistent FRB/US r*
Average projected real federal funds rate
Current
Tealbook
Previous
Tealbook
1.16
0.10
0.84
0.04
*
1. The intercepts of Taylor−type rules conditional on the current− and previous−Tealbook projections are 1 percent and
percent, respectively. For rules that have a lagged policy rate as a right−hand−side variable, the lines denoted "Previous
Tealbook projection" report prescriptions based on the previous Tealbook's staff outlook for inflation and the output gap, but
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
as the Tealbook−consistent FRB/US r*.
3/4
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The bottom panel of the exhibit reports the estimate of a medium-term notion of
the equilibrium real federal funds rate that is generated using the FRB/US model, given
the staff’s baseline projection. This Tealbook-consistent FRB/US r* corresponds to the
level of the real federal funds rate that, if maintained over a 12-quarter period, sets the
output gap to zero in the final quarter of that period.
The current estimate of FRB/US r* is 32 basis points higher than in the October
Tealbook, reflecting the revision to the forecast in the near term due to incoming data
as well as the new fiscal assumptions.
At 1.16 percent, FRB/US r* is well above the average level of the real federal funds
rate in the staff forecast for the same 12-quarter period, at 10 basis points, and above
the staff’s estimate of the real federal funds rate in the long run, at 1 percent.
The fact that the real federal funds rate in the baseline staff forecast is, on average,
below FRB/US r* 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 version of the Taylor (1999) rule,
and the first-difference rule.2 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
There has been a significant upward shift in the trajectory prescribed by each rule
relative to the October Tealbook. The magnitude of the shift ranges from 0.5 to
0.6 percentage point over the period from 2019 to 2022 during which the federal funds
rate reaches its peak under each policy rule. The shift in the Tealbook baseline policy
2
Unless otherwise noted, the policy rules and optimal control 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 of that policy strategy. Such policy strategies are
described as commitment strategies.
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.
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A MEDIUM-TERM EQUILIBRIUM REAL FEDERAL FUNDS RATE
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Strategies
Simple Policy Rule Simulations
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
5.0
4
3
2
4.5
1
2016
2017
2018
2019
2020
2021
2022
0
4.0
Real Federal Funds Rate
Percent
5
4
3
2016
2017
2018
2019
2020
2021
2022
3.5
2
1
PCE Inflation
Percent
Four−quarter average
2.5
0
−1
2016
2017
2018
2019
2020
2021
2022
−2
2.0
3
1.5
Real 10−year Treasury Yield
Percent
2
1.0
1
0.5
0
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.
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over the same period is of similar magnitude. These higher policy paths primarily reflect
demand for goods and services but have essentially no effect on potential GDP.
The relative position of the policy paths prescribed by the simple rules and
associated relative macroeconomic implications remain the same as in the October
Tealbook. These features are discussed in the bullets below.
The policy path in the staff forecast is constructed using 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, on average, about
80 basis points per year through the first quarter of 2020, when it reaches 3.5 percent.
The pace of tightening subsequently slows, and the federal funds rate peaks at
4 percent in 2021, before eventually returning to its long-run level of 3 percent. Over
the period from 2019 to 2022, the path of the federal funds rate runs, on average,
0.5 percentage point higher than in the October Tealbook projection.
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.
The difference in policy rates arising from this alternative intercept assumption is
small and dissipates too rapidly to have marked effects on the real longer-term
interest rates that influence economic activity in FRB/US. Thus, macroeconomic
outcomes under the inertial Taylor (1999) rule are similar to those in the Tealbook
baseline. Over the period from 2019 to 2022, the path of the federal funds rate runs
on average 0.5 percentage point above its counterpart in the October Tealbook.
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. Despite these initially higher policy
paths, the macroeconomic outcomes under these two rules are not far from those
4
In response to the new fiscal assumptions, the staff has increased its estimate of the real federal
funds rate in the long run from ¾ percent to 1 percent and raised the equilibrium spread between the 10year Treasury yield and the expected federal funds rate over the valuation window by 12.5 basis points.
The temporary adjustment to the intercept of the inertial Taylor (1999) rule used to construct the Tealbook
baseline projection is phased out by the end of 2019. See Tealbook A for details.
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the staff’s assumption that Congress will enact changes in fiscal policy that will boost
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under the Tealbook baseline because of the assumption that the public immediately
understands the macroeconomic effects of following the rules and believes the
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policymakers’ commitment to stabilize the economy in the future. 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 for the unemployment rate and a slightly lower trajectory
for inflation than does the Taylor (1993) rule. Over the period from 2019 to 2022, the
paths of the federal funds rate prescribed by the two rules are 0.6 and 0.5 percentage
point higher, respectively, than their counterparts in the October Tealbook.
The first-difference rule prescribes a slightly higher path for the federal funds rate
through the end of the decade than the Tealbook baseline. Thereafter, the federal
funds rate slowly drifts down to near its long-run level of 3 percent. In contrast, the
federal funds rate in the Tealbook baseline continues to rise for a while and reaches a
level of about 4 percent over much of this period. 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 2020, 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. Thus, 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 farther below the staff’s estimate of
the natural rate. As with the other simple rules, the path of the federal funds rate
under the first-difference rule runs on average 0.5 percentage point higher than its
counterpart in the October Tealbook over the period from 2019 to 2022.
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
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.
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which the plans that policymakers make today are assumed to constrain future policy
Since the October Tealbook, there has been an upward shift in the federal funds
rate paths prescribed by optimal control under each of the four loss functions, though
there is considerable dispersion in the size of these shifts across loss functions. For most
optimal control policy prescriptions, the magnitude of the revision in the path of the
federal funds rate since the October Tealbook ranges from 0.8 to 1 percentage point over
the period from 2019 to 2022 during which the federal funds rate reaches its peak under
each policy rule. The exception is the rule that places asymmetric weight on the
unemployment rate gap (ugap). This rule prescribes a trajectory of the federal funds rate
that is only 0.4 percentage point tighter than the October prescription over the period
from 2019 to 2020. We will consider this difference in more detail in the exhibit
“Optimal Control Response to Fiscal Stimulus.” As in the previous exhibit, these shifts
reflect the staff’s projection of greater resource utilization.
The relative position of the policy paths prescribed by optimal control under each
loss function remain the same as in the October Tealbook. The relative implications of
these paths also remain the same. These features are discussed in the bullets below.
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, the unemployment rate falls well below
the staff’s estimate of the natural rate over the next several years, an outcome that the
“equal weights” loss function judges to be costly. A 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 path of the federal funds rate runs on average
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.
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choices in a way that improves overall economic outcomes, given the baseline outlook.6
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Optimal Control Simulations under Commitment
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
5.0
4
3
2
4.5
1
2016
2017
2018
2019
2020
2021
2022
0
4.0
Real Federal Funds Rate
Percent
5
4
3
2016
2017
2018
2019
2020
2021
2022
3.5
2
1
PCE Inflation
Percent
Four−quarter average
2.5
0
−1
2016
2017
2018
2019
2020
2021
2022
−2
2.0
3
1.5
Real 10−year Treasury Yield
Percent
2
1.0
1
0.5
0
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.
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0.9 percentage point higher than its counterpart in the October Tealbook projection
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 path for the case of equal weights and the Tealbook baseline path. With the
asymmetric loss function, 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 The path of the federal funds
rate runs on average 0.4 percentage point higher than its counterpart in the October
Tealbook projection over the period from 2019 to 2022.
The third simulation, labeled “large weight on inflation gap,” posits a loss function
that assigns a cost to deviations of inflation from 2 percent that is five times larger
than the “equal weights” specification, but is otherwise identical. The resulting
optimal strategy is only slightly more accommodative than in the “equal weights”
case, 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 this specification of the loss function sees as
costly, in order to raise inflation in the near term by a modest amount. The path of
7
The simultaneous overshooting of the longer-run inflation objective and undershooting of the
natural rate of unemployment over the medium term is time inconsistent, in the sense that, given the
opportunity to reoptimize the path of the federal funds rate without regard to past policy commitments,
policymakers in the future would choose to pursue a tighter monetary policy. Under the assumption of
optimal control under discretion with “asymmetric weight on ugap” preferences, policy rates and
macroeconomic outcomes are between those under the Tealbook baseline and optimal control under
commitment. For the other three specifications of the loss function, the simulation results under
commitment and discretion are not much different from each other.
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over the period from 2019 to 2022.
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the federal funds rate runs on average 1 percentage point higher than its counterpart in
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the October Tealbook projection over the period from 2019 to 2022.
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 the unemployment rate close to the staff’s estimate of the natural rate. The
path of the federal funds rate runs on average 0.9 percentage point higher than its
counterpart in the October Tealbook projection over the period from 2019 to 2022.
OPTIMAL-CONTROL RESPONSE TO FISCAL STIMULUS
All simple rules and optimal control exercises presented above prescribe paths for
the federal funds rate that are higher than they were in the October Tealbook. These
higher paths reflect a different mix of accommodation from fiscal and monetary policies
in the projection; greater fiscal stimulus results in less monetary stimulus, with the size of
the adjustment in monetary policy reflecting the assumed strategy of the policymakers.
In this next exhibit, we explore how policy settings and associated macroeconomic
effects are sensitive to both the nature of the fiscal stimulus and the assumed monetary
policy strategy.
To this end, we consider optimal-control simulations for the “equal weights” (the
red lines) and “asymmetric weight on ugap” (the green lines) specifications of the loss
function under two alternative assumptions regarding fiscal stimulus:
In the “no stimulus” scenario, we drop the assumption of a personal income tax cut
equivalent to 1 percent of GDP introduced in the Tealbook baseline, leaving the fiscal
assumptions identical to those in the October Tealbook.
In the “larger stimulus” scenario, we include a 1 percentage point increase in
government purchases as a fraction of GDP, phased in over a four-year period starting
in 2017:Q3, in addition to the personal income tax cut considered in the Tealbook
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Unemployment Rate
Nominal Federal Funds Rate
Percent
Percent
12
Equal weights
Equal weights (no stimulus)
Equal weights (larger stimulus)
Asymmetric weight on ugap
Asymmetric weight on ugap (no stimulus)
Asymmetric weight on ugap (larger stimulus)
5.5
Staff's estimate of the natural rate
10
5.0
8
4.5
6
4
4.0
2
2016
2017
2018
2019
2020
2021
2022
0
2016
2017
2018
2019
2020
2021
2022
3.5
PCE Inflation
Real 10−year Treasury Yield
Percent
4
Percent
Four−quarter average
2.5
3
2.0
2
1.5
1
1.0
0
2016
2017
2018
2019
2020
2021
2022
−1
2016
2017
2018
2019
2020
2021
2022
0.5
Note: The simulations labeled "no stimulus" assume no cuts to personal income taxes, in contrast with the Tealbook
projection that includes personal income tax cuts equivalent to 1 percent of GDP in 2017:Q3. The simulations labeled "larger
stimulus" assume, in addition to personal income tax cuts, an equal−size increase in government spending phased in over
several years. See the similarly−named alternative scenarios in the Risks and Uncertainty section of Tealbook A for
descriptions.
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Optimal−Control Response to Fiscal Stimulus
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baseline. Half of the additional spending is assumed to be directed to public
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infrastructures; however, the staff’s estimates suggest that this has only small supplyside effects.
The consideration of a no-stimulus scenario provides a comparison point to assess
the economic response to fiscal stimulus shocks of the kind incorporated in the baseline
and larger-stimulus scenarios.8
In response to the fiscal stimulus, the policy paths are 1.1 percentage points and
0.8 percentage point higher in the equal-weights baseline (solid red line) and asymmetricweights baseline (solid green line) scenarios, respectively, than under their counterparts
in the no-stimulus scenario over the period 2019 to 2020.9 By comparison, in response to
the larger stimulus scenario, the policy paths are 3.2 percentage points and 2.8 percentage
points higher, respectively, than under their no-stimulus scenarios over the same period.
These optimal control simulations show substantially larger increases in the federal funds
rate than prescribed by the staff’s baseline policy rule, which implies 0.6 and
1.7 percentage points of tightening in response to the same fiscal policy shocks that are
illustrated in the Risk and Uncertainty section of Tealbook A. Under all policy strategies,
though, the introduction of fiscal stimulus helps policymakers raise the federal funds rate
to levels well above its effective lower bound more rapidly than otherwise.
The strong policy response prescribed by the equal-weight optimal control
simulation results in similar paths of the unemployment rate and inflation under all fiscal
8
The “no stimulus” scenario assumes that the real federal funds rate in the long run is ¾ percent
and that the equilibrium spread between the 10-year Treasury yield and the expected federal funds rate over
the valuation window is 12.5 basis points lower than in the December Tealbook. The “larger stimulus”
scenario assumes that the real federal funds rate in the long run is 1¼ percent and that the equilibrium
spread between the ten-year Treasury yield and the expected federal funds rate over the valuation window
is 12.5 basis points higher than in the December Tealbook. While these scenarios allow expansionary
fiscal policy to raise long-term interest rates in part by raising term premiums, the optimal control
simulations take the term premium paths in each scenario as exogenous. See the Risks and Uncertainty
section of Tealbook A for further description of the alternative scenarios and simulations under the
Tealbook baseline monetary policy assumptions.
9
As noted in the Risk and Uncertainty section of Tealbook A, in both alternative scenarios, the
responses of inflation to fiscal stimulus are likely larger than the revisions that the staff would implement
using its judgmental apparatus because inflation in FRB/US generally moves more with demand than it
does in the staff’s projection. Thus, the policy responses to fiscal stimulus in these scenarios are larger than
would be the case in the judgmental projection.
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stimulus packages.10 This result is consistent with the assumed ability of monetary policy
macroeconomic models.11 The asymmetric weight on ugap optimal control prescribes
somewhat less policy tightening, primarily because for much of the horizon
unemployment undershoots the natural rate and thus these policymakers focus on
harnessing the fiscal stimulus’ inflationary implications.
We have also run optimal control simulations under the other specifications of the
loss function described in the exhibit “Optimal Control Simulations under Commitment.”
Optimal monetary policy in response to fiscal stimulus results in little altered paths for
unemployment and inflation regardless of the loss function considered. Each
specification of the loss function results in a significantly less accommodative path of
monetary policy as fiscal stimulus increases such that nearly the entire impact of fiscal
stimulus is offset.
These simulations are subject to a number of caveats. One such caveat is that not
only are the size and nature of fiscal measures to come uncertain, but so are their
economic effects. As such, the appropriate speed at which to normalize monetary policy
is also uncertain. For instance, if the fiscal policy changes turn out to be ones that have a
larger positive effect on potential output than staff currently anticipates, then fiscal
stimulus would, all else equal, have smaller effects on the inflation and unemployment
gaps; as a consequence, policymakers in the simulations might prefer a slower
normalization than shown. Alternatively, if fiscal stimulus were to have larger effects on
10
The asymmetric loss function permits a limited increase in the undershooting of the
unemployment rate: the “no stimulus” and “large stimulus” average path of the unemployment rate are
within 13 basis points over the forecast horizon. The equal-weight loss function permits even less increase
in the undershooting of the unemployment rate: the “no stimulus” and “large stimulus” average path of the
unemployment rate are within 5 basis points over the forecast horizon. By comparison, the paths implied
by the staff’s baseline assumptions, illustrated in the Risk and Uncertainty section of Tealbook A, imply
that the unemployment gap significantly widens and the path of inflation becomes steeper as fiscal stimulus
increases under the policy paths prescribed: Compared with the “no stimulus” scenario, the unemployment
gap is nearly 25 basis points wider at its peak under the baseline scenario and just over 80 basis points
wider under the “larger stimulus” scenario. Inflation remains below 2 percent over the projection horizon
in the scenario with no fiscal stimulus, it overshoots 2 percent by 1 basis point in the baseline and by
5 basis points with larger fiscal stimulus.
11
With the federal funds rate in proximity of its effective lower bound, policymakers have more
limited ability to respond to a negative than a positive fiscal shock.
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to offset a (positive) aggregate demand shock in FRB/US and in a broad class of
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inflation than assumed in the simulations, then the federal funds rate would eventually
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need to increase faster than otherwise.12
Another caveat is that, because the simulations are conducted under the
assumption of perfect foresight, the optimal control policies abstract from risk
management considerations, and in particular the possibility that the monetary policy
response to shocks might be restrained by the effective lower bound (ELB) on the federal
funds rate. Such considerations could induce policymakers to normalize the stance of
policy more rapidly as the size of the fiscal stimulus package grows and the ELB-related
risk wanes.
The next four exhibits tabulate the simulation results for key variables under the
policy rule and optimal control simulations described above.
12
For a discussion of potential nonlinearities in the response of inflation to resource slack, see
Stephanie Aaronson, Andrea De Michelis, Cynthia Doniger, Charles Fleischman, Manuel GonzalezAstudillo, Stacey Tevlin, and Joyce Zickler (2016), “Ramifications of Allowing the Unemployment Rate to
Undershoot its Natural Rate,” memorandum to the Federal Open Market Committee, Board of Governors
of the Federal Reserve System, Division of Research and Statistics, Division of Monetary Affairs, and
Division of International Finance, December 1.
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December 8, 2016
Outcomes of Simple Policy Rule Simulations
Measure and policy
2016
2017
2018
2019
2020
Nominal federal funds rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
0.5
0.5
0.5
0.5
0.5
2.9
3.1
1.8
1.7
1.5
3.3
3.6
2.7
2.7
2.5
3.6
4.0
3.4
3.2
3.3
3.7
4.1
3.8
3.3
3.8
Real GDP
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.8
1.8
1.8
1.8
1.8
1.9
1.8
2.1
2.3
2.2
1.9
1.8
1.9
2.2
2.0
2.0
1.9
1.8
2.0
1.8
1.7
1.7
1.5
1.7
1.5
Unemployment rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
4.8
4.8
4.8
4.8
4.8
4.7
4.8
4.6
4.5
4.5
4.5
4.6
4.3
4.2
4.3
4.3
4.4
4.2
4.0
4.2
4.2
4.4
4.3
3.9
4.3
Total PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.5
1.5
1.5
1.5
1.5
1.7
1.7
1.7
1.8
1.7
1.8
1.8
1.8
2.0
1.8
2.0
1.9
1.9
2.1
1.9
2.1
2.1
2.0
2.2
2.1
Core PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.7
1.7
1.7
1.7
1.7
1.7
1.7
1.7
1.8
1.7
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
1. Percent, average for the final quarter of the period.
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(Percent change, annual rate, from end of preceding period except as noted)
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Outcomes of Simple Policy Rule Simulations, Quarterly
Strategies
(Four-quarter percent change, except as noted)
2017
2018
Measure and policy
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Nominal federal funds rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
2.7
3.0
0.9
0.8
0.7
2.7
2.9
1.2
1.0
1.0
2.8
3.0
1.5
1.4
1.2
2.9
3.1
1.8
1.7
1.5
3.0
3.2
2.0
1.9
1.7
3.1
3.3
2.3
2.2
2.0
3.2
3.4
2.5
2.4
2.2
3.3
3.6
2.7
2.7
2.5
Real GDP
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
2.2
2.2
2.2
2.2
2.2
2.1
2.1
2.2
2.3
2.2
1.9
1.8
2.0
2.1
2.1
1.9
1.8
2.1
2.3
2.2
1.8
1.6
2.0
2.2
2.1
1.9
1.8
2.1
2.3
2.2
1.9
1.7
1.9
2.2
2.0
1.9
1.8
1.9
2.2
2.0
Unemployment rate¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
4.7
4.7
4.7
4.7
4.7
4.7
4.8
4.7
4.6
4.7
4.7
4.8
4.6
4.6
4.6
4.7
4.8
4.6
4.5
4.5
4.7
4.7
4.5
4.4
4.5
4.6
4.7
4.5
4.3
4.4
4.5
4.6
4.4
4.3
4.4
4.5
4.6
4.3
4.2
4.3
Total PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.9
1.9
1.9
1.9
1.9
1.8
1.8
1.8
1.9
1.8
1.9
1.9
1.9
1.9
1.9
1.7
1.7
1.7
1.8
1.7
1.7
1.7
1.7
1.8
1.7
1.8
1.7
1.7
1.9
1.7
1.8
1.8
1.8
1.9
1.8
1.8
1.8
1.8
2.0
1.8
Core PCE prices
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Extended Tealbook baseline
1.7
1.7
1.7
1.7
1.7
1.7
1.6
1.6
1.7
1.6
1.6
1.6
1.6
1.7
1.6
1.7
1.7
1.7
1.8
1.7
1.8
1.7
1.7
1.8
1.7
1.8
1.7
1.7
1.9
1.8
1.8
1.8
1.8
1.9
1.8
1.9
1.8
1.8
2.0
1.8
1. Percent, average for the quarter.
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Outcomes of Optimal Control Simulations under Commitment
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
0.5
0.5
0.5
0.5
0.5
2.5
1.0
2.5
4.3
1.5
4.1
1.5
3.9
4.7
2.5
5.0
2.1
4.7
5.1
3.3
5.3
2.6
5.0
5.4
3.8
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
1.7
2.5
1.8
1.4
2.2
1.4
2.3
1.5
1.3
2.0
1.6
2.0
1.6
1.7
1.8
1.5
1.5
1.6
1.7
1.5
Unemployment rate¹
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
4.8
4.8
4.8
4.8
4.8
4.7
4.4
4.7
5.0
4.5
4.8
4.0
4.7
5.0
4.3
4.8
3.8
4.7
4.9
4.2
4.9
3.9
4.8
5.0
4.3
Total PCE prices
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.5
1.5
1.5
1.5
1.5
1.6
1.7
1.6
1.6
1.7
1.6
1.9
1.7
1.6
1.8
1.8
2.0
1.8
1.8
1.9
1.9
2.1
2.0
1.9
2.1
Core PCE prices
Equal weights
Aymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.7
1.7
1.7
1.7
1.7
1.6
1.7
1.6
1.6
1.7
1.7
1.9
1.7
1.7
1.8
1.8
2.0
1.8
1.8
1.9
1.9
2.0
1.9
1.9
2.0
1. Percent, average for the final quarter of the period.
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(Percent change, annual rate, from end of preceding period except as noted)
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Outcomes of Optimal Control Simulations under Commitment, Quarterly
Strategies
(Four-quarter percent change, except as noted)
2017
2018
Measure and policy
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Nominal federal funds rate¹
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.0
0.6
1.0
2.6
0.7
1.6
0.7
1.5
3.7
1.0
2.1
0.8
2.0
4.1
1.2
2.5
1.0
2.5
4.3
1.5
3.0
1.1
2.9
4.4
1.7
3.4
1.2
3.3
4.5
2.0
3.8
1.3
3.6
4.6
2.2
4.1
1.5
3.9
4.7
2.5
Real GDP
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
2.2
2.2
2.2
2.2
2.2
2.1
2.3
2.1
2.0
2.2
1.8
2.2
1.8
1.5
2.1
1.7
2.5
1.8
1.4
2.2
1.5
2.4
1.6
1.1
2.1
1.5
2.5
1.6
1.2
2.2
1.4
2.4
1.5
1.2
2.0
1.4
2.3
1.5
1.3
2.0
Unemployment rate¹
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
4.7
4.7
4.7
4.7
4.7
4.7
4.6
4.7
4.8
4.7
4.7
4.5
4.7
4.9
4.6
4.7
4.4
4.7
5.0
4.5
4.8
4.3
4.7
5.0
4.5
4.8
4.2
4.7
5.0
4.4
4.8
4.1
4.7
5.0
4.4
4.8
4.0
4.7
5.0
4.3
Total PCE prices
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.9
1.9
1.9
1.9
1.9
1.8
1.8
1.8
1.8
1.8
1.8
1.9
1.8
1.8
1.9
1.6
1.7
1.6
1.6
1.7
1.6
1.7
1.6
1.6
1.7
1.6
1.8
1.6
1.6
1.7
1.6
1.8
1.7
1.6
1.8
1.6
1.9
1.7
1.6
1.8
Core PCE prices
Equal weights
Asymmetric weight on ugap
Large weight on inflation gap
Minimal weight on rate adjustments
Extended Tealbook baseline
1.6
1.7
1.7
1.6
1.7
1.6
1.7
1.6
1.6
1.6
1.6
1.7
1.6
1.6
1.6
1.6
1.7
1.6
1.6
1.7
1.6
1.8
1.6
1.6
1.7
1.6
1.8
1.6
1.6
1.8
1.6
1.8
1.7
1.6
1.8
1.7
1.9
1.7
1.7
1.8
1. Percent, average for the quarter.
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The monetary policy strategies considered in this section of Tealbook B typically 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.
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.
Page 19 of 66
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Appendix
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Taylor (1993) rule
0.5
Taylor (1999) rule
0.5
Inertial Taylor (1999) rule
First-difference rule
0.85
December 8, 2016
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 0.9 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 quarter. 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 macroeconomic projections on the prescriptions of these inertial rules, the lines
labeled “Previous Tealbook projection” report prescriptions conditional on the previous Tealbook
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.
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.3 This
“Tealbook-consistent FRB/US r*” depends on a broad array of economic factors, some of which
1
See, for example, Erceg and others (2012).
In the October Tealbook, Taylor-type rules used a value of
equal to 0.75 percent,
corresponding to the staff’s estimate the real federal funds rate in the long run at that time. All nominal and
real federal funds rates reported in the Monetary Policy Strategies section are expressed on the same 360day 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.
3
For a discussion of this and other concepts of equilibrium interest rates, see Gust and others
(2016).
2
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December 8, 2016
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. A model simulation then determines 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 results presented in the exhibits “Simple Policy Rule Simulations” and “Optimal
Control Simulations under Commitment” are derived from dynamic simulations of the FRB/US
model. Each simulated policy strategy 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 OPTIMAL CONTROL POLICIES 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
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
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Strategies
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.4 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
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.
REFERENCES
Erceg, Christopher, Jon Faust, Michael Kiley, Jean-Philippe Laforte, David López-Salido,
Stephen Meyer, Edward Nelson, David Reifschneider, and Robert Tetlow (2012). “An
4
The inclusion of a minimal but strictly positive weight on changes in the federal funds rate helps
ensure a well-behaved numerical solution.
Page 22 of 66
December 8, 2016
Overview of Simple Policy Rules and Their Use in Policymaking in Normal Times and
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.
Gust, Christopher, Benjamin K. Johannsen, David López-Salido, and Robert Tetlow (2016). “r*:
Concepts, Measures, and Uses,” memorandum to the Federal Open Market Committee,
Board of Governors of the Federal Reserve System, Division of Monetary Affairs,
October 13.
Orphanides, Athanasios (2003). “Historical Monetary Policy Analysis and the Taylor Rule,”
Journal of Monetary Economics, Vol. 50 (July), pp. 9831022.
Taylor, John B. (1993). “Discretion versus Policy Rules in Practice,” Carnegie-Rochester
Conference Series on Public Policy, Vol. 39 (December), pp. 195214.
Taylor, John B. (1999). “A Historical Analysis of Monetary Policy Rules,” in John B. Taylor,
ed., Monetary Policy Rules. University of Chicago Press, pp. 319341.
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Monetary Policy Alternatives
At its November meeting, the Committee judged that the case for an increase in
the federal funds rate had continued to strengthen, but elected, “for the time being,” to
wait for “some” further evidence of continued progress toward its objectives. Incoming
data have supported the view that inflation will rise to 2 percent over the medium term,
and the two job market reports received in the interim indicated that labor market
conditions continued to improve: Payroll gains remained solid, and the unemployment
rate declined.
decision is whether the evidence accumulated since the end of summer is sufficient to
merit an immediate increase in the target range for the federal funds rate. The second is
what signal, if any, to provide regarding the prospects for future rate increases.
With regard to the first decision, Alternative B and Alternative C both raise the target
range to ½ to ¾ percent. In contrast, Alternative A maintains the current target range.
o Alternatives B and C point to “realized and expected labor market conditions
and inflation” as the rationale for raising rates, thereby implying that the
“progress” previous statements had indicated was needed has been achieved.
Alternative A cites “subdued labor market pressures and below-target
inflation” as sufficient reason to maintain the current stance of policy, thus
hinting that the Committee might not raise rates until inflation climbs to 2
percent or until greater wage pressures provide evidence of tight labor
markets.
o Alternatives B and C both emphasize that the stance of monetary policy, after
the increase in the federal funds rate, remains sufficiently accommodative to
support “some” further strengthening in labor market conditions and a return
to 2 percent inflation. The addition of the word “some” could be taken as a
signal that the Committee now sees less need than before for further
strengthening in the labor market. The insertion of “some” might also be read
as suggesting that the gap between the midpoint of the new target range and
the current level of the neutral federal funds rate—the level consistent with the
economy growing at its potential rate—might not be all that large.
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Alternatives
This month’s meeting presents the Committee with two key decisions. The first
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As for the second decision, the three alternatives’ summaries of the economic outlook
and future monetary policy, contained in paragraphs 2 and 4, differ only modestly
from one another and from the November statement.
o All three alternatives maintain the outlook from the November statement that
economic activity will expand at a moderate pace, labor market conditions
will strengthen somewhat further, and inflation is expected to rise to 2 percent
over the medium term.
o Alternatives A and B continue to state that “gradual adjustments” in the
federal funds rate are anticipated in order to achieve the Committee’s
objectives and that the expected rise in inflation will reflect the fading
influence of past declines in energy and import prices along with
Alternatives
strengthening in labor markets; Alternative C drops the reference to past
declines in energy and import prices. In so doing, Alternative C might be
taken as suggesting greater confidence that these temporary factors are
playing less of a role than before.
o Alternative C notes that “additional” gradual adjustments in the stance of
monetary policy will be needed for the Committee to achieve its objectives,
which suggests a faster, albeit still gradual, pace of rate increases than do
Alternatives A and B.
o All three alternatives retain the November statement’s characterizations of
risks to the economic outlook as being “roughly balanced.” However,
Alternative C omits the sentence indicating that the Committee “continues to
closely monitor” inflation indicators and global economic and financial
developments; this would likely be taken as a signal that the Committee is
currently less concerned about downside risks to the economic outlook than
before.
Turning to developments in inflation, described in paragraph 1, the alternatives differ
in a few respects.
o Alternative B says that “inflation has increased since earlier this year,”
differing from the November statement by omitting the “somewhat” qualifier
that had tempered the “inflation has increased” phrase. As in November,
Alternative B acknowledges that inflation “is still below the Committee’s
2 percent longer-run objective, partly reflecting earlier declines in energy
prices and in prices of non-energy imports.”
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o Alternative C also omits “somewhat” but emphasizes that, with the recent
increase, inflation is “moving closer” to the Committee’s objective. With this
addition, Alternative C suggests greater confidence that inflation is evolving
as expected, and so alludes to the possibility that increases in the federal funds
rate might come earlier than market participants currently appear to expect.
o The summary of inflation developments in Alternative A differs from the
November statement in two ways: First, it characterizes the shortfall of
inflation from 2 percent as “only partly” the result of earlier energy and
import price declines, hinting that inflation is being held back by other factors
that have more persistent effects; and second, it retains from the November
increases in inflation than do Alternatives B and C.
o Alternatives B and C upgrade the November statement’s description of
market-based measures of inflation compensation, stating that they have not
just “moved up,” but have “moved up considerably.” Alternative C reinforces
this message by no longer characterizing their levels as “low.” Alternative A
retains the language of the November statement.
On the labor market, all three alternatives state that it has “continued to strengthen.”
In this regard, they all speak to the condition the Committee set out in November that
it needed to see “some further evidence of continued progress” toward its objectives
in order to tighten the stance of policy.
o Alternatives B and C are succinct in how they characterize developments in
labor markets. Both state that job gains have been “solid” and add the
observation that the unemployment rate has declined.
o Alternative A tempers the assessment by noting the “subdued pace” of wage
growth in recent months.
All three alternatives characterize economic activity as having “been expanding at a
moderate pace since mid-year.”
The three alternatives are largely the same in describing how the Committee’s
outlook is likely to affect its decisions.
o In paragraph 4, Alternatives A and B continue to call out “the current shortfall
of inflation from 2 percent” as a factor that warrants special attention, while
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Alternatives
statement the modifier “somewhat,” thereby putting less emphasis on recent
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Alternative C deletes this reference. Alternative A notes, in addition, that the
Committee’s inflation goal is “symmetric.”
o Alternatives A and B state, as did the November statement, that economic
conditions are likely to “warrant only gradual increases” in the target range;
by contrast, Alternative C replaces “only” with “additional,” thereby
suggesting more increases, and perhaps earlier increases, may be forthcoming
than previously thought.
Two of the three alternatives differ from the November statement in their
characterization of the role that the Committee’s assessment of risks plays in its
policy decisions.
Alternatives
o Alternatives A and C add to paragraph 4 a phrase that states that the
Committee will assess not only the economic outlook but also “risks to the
economic outlook” as it determines the timing and size of future adjustments
to the target range for the federal funds rate. Alternative C tempers that
message—and differs from the other alternatives—in removing the final
sentence of paragraph 2 which states that the Committee is “closely
monitoring” certain developments.
Finally, the three Alternatives are unchanged from November in how they describe
the Committee’s policy concerning reinvestment of maturing securities from the
System Open Market Account.
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NOVEMBER 2016 FOMC STATEMENT
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market conditions will strengthen somewhat further.
Inflation is expected 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 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 continued to strengthen but decided, for the time
being, to wait for some 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.
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
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Alternatives
1. Information received since the Federal Open Market Committee met in September
indicates that the labor market has continued to strengthen and growth of economic
activity 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 have
been solid. Household spending has been rising moderately but business fixed
investment has remained soft. Inflation has increased somewhat since earlier this
year but is still 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 have moved up but remain low;
most survey-based measures of longer-term inflation expectations are little changed,
on balance, in recent months.
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Alternatives
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.
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DECEMBER 2016 ALTERNATIVE A
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market conditions will strengthen somewhat further.
Inflation is expected 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 appear roughly
balanced. The Committee continues to closely monitor inflation indicators and global
economic and financial developments.
3. Against this backdrop of subdued labor market pressures and below-target
inflation, 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 continued to strengthen but decided, for the time being, to
while waiting for some 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,
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
symmetric 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.
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Alternatives
1. Information received since the Federal Open Market Committee met in September
November indicates that the labor market has continued to strengthen and growth of
that economic activity has picked up from the modest been expanding at a
moderate pace seen in the first half of this year since mid-year. Although The
unemployment rate is little changed in has declined over recent months, and job
gains have been solid; however, wages have continued to rise at a subdued pace,
on average. Household spending has been rising moderately but business fixed
investment has remained soft. Inflation has increased somewhat since earlier this
year but is still 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 have moved up but remain low;
most survey-based measures of longer-term inflation expectations are little changed,
on balance, in recent months.
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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.
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DECEMBER 2016 ALTERNATIVE B
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with gradual
adjustments in the stance of monetary policy, economic activity will expand at a
moderate pace and labor market conditions will strengthen somewhat further.
Inflation is expected 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 appear roughly
balanced. The Committee continues to closely monitor inflation indicators and global
economic and financial developments.
3. Against this backdrop In view of realized and expected labor market conditions
and inflation, the Committee decided to maintain raise the target range for the
federal funds rate at ¼ to ½ to ¾ percent. The Committee judges that the case for an
increase in the federal funds rate has continued to strengthen but decided, for the time
being, to wait for some further evidence of continued progress toward its objectives.
The stance of monetary policy remains accommodative, 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.
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.
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Alternatives
1. Information received since the Federal Open Market Committee met in September
November indicates that the labor market has continued to strengthen and growth of
that economic activity has picked up from the modest been expanding at a
moderate pace seen in the first half of this year since mid-year. Although the
unemployment rate is little changed in recent months, Job gains have been solid in
recent months and the unemployment rate has declined. Household spending has
been rising moderately but business fixed investment has remained soft. Inflation has
increased somewhat since earlier this year but is still 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 have
moved up but remain low considerably but still are low; most survey-based
measures of longer-term inflation expectations are little changed, on balance, in
recent months.
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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.
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DECEMBER 2016 ALTERNATIVE C
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with additional
gradual adjustments in the stance of monetary policy, economic activity will expand
at a moderate pace and labor market conditions will strengthen somewhat further.
Inflation is expected 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 appear roughly
balanced. The Committee continues to closely monitor inflation indicators and global
economic and financial developments.
3. Against this backdrop In view of realized and expected labor market conditions
and inflation, the Committee decided to maintain raise the target range for the
federal funds rate at ¼ to ½ to ¾ percent. The Committee judges that the case for an
increase in the federal funds rate has continued to strengthen but decided, for the time
being, to wait for some further evidence of continued progress toward its objectives.
The stance of monetary policy remains accommodative, 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 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 additional 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.
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Alternatives
1. Information received since the Federal Open Market Committee met in September
November indicates that the labor market has continued to strengthen and growth of
that economic activity has picked up from the modest been expanding at a
moderate pace seen in the first half of this year since mid-year. Although the
unemployment rate is little changed in recent months, Job gains have been solid in
recent months and the unemployment rate has declined. Household spending has
been rising moderately but business fixed investment has remained soft. Inflation has
increased somewhat since earlier this year, but is still below moving closer to 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 have moved up but remain low considerably; most surveybased measures of longer-term inflation expectations are little changed, on balance, in
recent months.
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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.
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THE CASE FOR ALTERNATIVE B
Policymakers may view the information received over the intermeeting period as
providing the evidence of continued progress toward the Committee’s objectives
necessary to warrant an increase in the federal funds rate at the December meeting. They
might also see the modal outlook as not greatly different from what they previously
thought. Or policymakers may decide that it is premature to reach or express a judgment
about the implications of future fiscal and trade policies for their forecasts until they have
more information about those policies. Accordingly, policymakers may choose for now
to say little that is new about the likely future path of the federal funds rate.
Data received over the intermeeting period indicate that inflation has increased
relative to its pace earlier this year.
o The 12-month change in overall PCE prices had been running at roughly
1 percent over the first eight months of this year but is now estimated to have
increased to 1.4 percent over the 12 months ending in October.
o Oil prices firmed over the past several months, and with earlier declines in
energy prices dropping out of the calculation, consumer energy prices are
likely to provide a boost to 12-month headline PCE inflation in the fourth
quarter.
o Twelve-month core PCE inflation in October was 1.7 percent, up about a tenth
from mid-year.
Market-based measures of inflation compensation continued to move up over the
intermeeting period. Over the same period, 5-year, 5-year ahead inflation
compensation rose 33 basis points, an unusually large increase, and is coming on the
heels of a 21 basis point increase over the previous intermeeting period. In addition,
the Michigan survey measure of longer-run inflation expectations in November
returned to the level seen earlier in the year.
The two employment reports received since the Committee met in November
provided evidence that labor market conditions continued to strengthen.
o Both reports showed further solid gains in payroll employment.
o The employment-to-population ratio and the labor force participation rate
have increased since a year ago—notwithstanding downward structural trends.
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Alternatives
Economic Conditions and Outlook
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o The unemployment rate declined to 4.6 percent in November, following a
lengthy period over which it had changed little. A broader measure of
unemployment that includes marginally attached workers and workers
employed part time for economic reasons (U-6) also declined in November,
albeit by less than did the official unemployment rate (U-3).
o New data for all three measures of labor compensation that the staff regularly
monitor—compensation per hour, the employment cost index, and average
hourly earnings—have been received since the November FOMC meeting.
Taken together, these series continue to show modest gains in compensation
over the past year. However, measures that focus narrowly on wages and
Alternatives
salaries, including average hourly earnings and the Atlanta Fed Wage Growth
Tracker, have shown some acceleration recently, albeit from low levels.1
Real GDP growth for the third quarter turned out to be markedly higher than was
expected when the October Tealbook was completed. However, most of the upward
surprise is attributable to a jump in net exports that staff expects to be largely
reversed in the fourth quarter. Growth in private domestic final purchases—normally
thought to be a more reliable gauge of the underlying state of aggregate demand—
was more moderate, in line with what staff wrote down in October.
o Looking ahead, staff expects continued moderate consumption growth during
the first half of next year in part because household income and employment
have continued to grow at solid rates, indicators of consumer sentiment
climbed further, and financial conditions have stayed broadly supportive. In
the second half of the year, real PCE is expected to accelerate in response to
the assumed fiscal stimulus.
o Business fixed investment, after declining notably in the first half of the year,
finally shows signs of picking up in the third quarter and appears to be on
track to make a small positive contribution to GDP growth in the fourth
quarter.
1
For more on the construction of alternative measures of labor compensation and the information
gleaned from those measures, see the box “Measures of Labor Compensation” in Tealbook A.
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Looking out to the medium term, the Congress seems likely to enact a package of tax
and government spending programs that will provide some fiscal stimulus, but no
specific aspects of such a package are known at this time.2
Policy Strategy
Policymakers might judge that they have accumulated sufficient further evidence of
continued progress toward maximum employment and 2 percent inflation, and that an
increase in the target range for the federal funds rate is therefore appropriate. They
might also continue to expect that the pace of further increases in the target range will
be gradual.
o Leading up to the November meeting, policymakers had little new hard
“continued progress” toward their goals. Only one new employment report
was available. For the December meeting, policymakers have two more solid
employment reports and tangible evidence of firming inflation.
o Given the uncertainty about the timing, size, and composition of prospective
changes in fiscal policy, policymakers may consider it premature to
communicate that they see an appreciable change in their modal economic
outlook, or in the associated path of the federal funds rate that would be
consistent with achieving their statutory goals. Or, even if they judge that the
appropriate path for the federal funds rate has steepened, participants may still
see the pace of likely rate increases as gradual by historical standards. To the
extent this is so, they may see paragraphs 2 and 4 of Alternative B, which are
unchanged from the November statement, as appropriately preserving the
Committee’s flexibility going forward.
Federal funds futures quotes imply that market participants regard a rate hike at this
meeting as highly likely, and responses to the Desk’s latest surveys suggest that
dealers concur in this assessment.3 Thus, the change in the stance of policy
2
As a placeholder for what will eventually occur, the staff included within the December
Tealbook forecast a cut in personal income taxes amounting to 1 percent of GDP, beginning in the third
quarter of 2017. A memo circulated recently to participants provides details. See, Byron Lutz and William
Peterman “Revisions to Fiscal Assumptions in the December 2016 Tealbook” (December 2). See the
“Risks and Uncertainties” section of Tealbook A for an analysis of the implications of a fiscal stimulus
program that is larger than the baseline assumption, as well as the implications of no program at all.
3
The box “Monetary Policy Expectations and Uncertainty,” in this section of Tealbook B details
how both market measures and surveys, over the intermeeting period, came to reflect an increasing
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Alternatives
information, relative to September, to chalk up as “further evidence” of
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Monetary Policy Expectations and Uncertainty
Alternatives
Over the intermeeting period, market participants became increasingly convinced
about a rate increase at the December FOMC meeting. The market‐implied probability
of a December rate hike now stands at 90 percent (figure 1). Results from the Desk’s
December Survey of Primary Dealers showed a similar conviction among survey
respondents (figure 2).
Looking ahead, investors seem to recognize that the economy and the federal funds
rate could evolve in a variety of ways over the coming year. For example, the
probability distribution of the federal funds rate at the end of 2017 implied by quotes
on Eurodollar futures options (figure 3) shifted to the right but still attaches
considerable odds to a wide range of outcomes. The distribution from the December
Desk survey (figure 4) is somewhat less dispersed.
The federal funds rate path implied by a straight read of OIS quotes (the black lines in
figure 5) steepened noticeably following the outcome of the U.S. elections. If term
premiums are zero, these market‐implied forward rates would imply fewer than 2
hikes (of 25 basis points each) in 2017 and 2 hikes in 2018 and with the target policy
rate not reaching 2 percent until the end of 2020. However, results from the staff’s
OIS‐based term structure model, which takes the effective lower bound into account,
suggest that OIS rates beyond six months likely contain negative term premiums. The
expected federal funds rate path adjusted for those term premiums (the light blue
line in figure 5) points to a somewhat faster expected pace of tightening of about 3
hikes in both 2017 and 2018, and reaches 3 percent by the end of 2020. As shown in
figure 6, the model‐based path (the light blue line) lies above the modal federal funds
rate path from the primary dealer survey (the brown line) but is roughly consistent
with the staff’s baseline path in the December Tealbook (the dark blue line).
Results from the model and the survey also shed light on market participants’
expectations of the longer‐run level of the federal funds rate (the dots in figure 6).
The staff’s term structure model estimates that the federal funds rate will reach about
3¾ percent in the longer run, in line with the longer‐term average of the target funds
rate in the staff’s December baseline projection but 1 percentage point higher than
the median estimate of the longer‐run federal funds rate from the primary dealer
survey.
The Desk’s December survey also asked primary dealers about their assessment of the
current level of the neutral real federal funds rate, as well as the levels at the end of
the next three years. Compared with the November survey, the median estimates of
the current level and the level at the end of 2019 were revised down by 25 basis points
each to 0 and 1 percent, respectively, while the levels for the end of 2017 and 2018
were little changed at ¾ and 1 percent, respectively (not shown).
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Alternatives
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announced in Alternative B would be completely in line with the expectations of
financial market participants.
o The market-implied path for the federal funds rate shifted up by 26 and 55
basis points at year-end 2017 and year-end 2018, respectively, and now points
to a level of the federal funds rate at the end of 2018 of about 1.4 percent. The
modal path for the funds rate of the median dealer also steepened: Dealers
now expect three 25-basis-point rate hikes in 2018 and two in 2019, one more
in each year than was the case in November; at two rate hikes, expectations
for 2017 are unchanged. Thus, the market expectation for the federal funds
rate has moved notably closer to the median of the dealers’ survey.
o Survey respondents were asked for estimates of the probability distribution of
Alternatives
10-year Treasury rates in the future. They expected the recent increase in
Treasury yields of about ½ percentage point to persist for some time. Dealers
cited expectations of a more accommodative fiscal policy stance as playing a
major role in the changes to their forecasts for the federal funds rate and yields
on Treasury securities.
o Nonetheless, the Survey of Primary Dealers reveals that dealers do not expect
significant changes to statement language regarding the future of monetary
policy. The near-absence of a change in language in the forward-looking
portions of Alternative B would likely be greeted placidly.
THE CASE FOR ALTERNATIVE C
Policymakers may judge not only that the evidence accumulated since the November
meeting is sufficient to warrant an immediate increase in the target range for the federal
funds rate, they might also regard it as prudent for the Committee’s statement to include
language signaling that the federal funds rate may rise somewhat more quickly than
previously expected, though still at a gradual pace.
Economic Conditions and Outlook
The staff expects that 12-month overall PCE inflation will be 1.7 percent in
December and will step up further in subsequent months, reaching 2 percent in March
2017. And while the staff expects PCE inflation to edge down after March, the U.S.
likelihood of a rate increase at the December FOMC meeting. The box also notes that the new modelimplied levels of expected future federal funds rates are higher than the more familiar market-implied
estimates.
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economy has not experienced a period of excess demand for some time; inflation
could well come in above 2 percent in the not-to-distant future.
o Oil prices increased significantly since mid-year, and the November 30
agreement between OPEC and non-OPEC oil producing countries to reduce
production suggests that at least some portion of the increase might be
sustained over time.
o With rising prices of energy and a lower unemployment rate, some
policymakers may anticipate that 12-month headline inflation will run above 2
percent relatively soon, and they may see the effects of earlier declines in
energy and import prices as having largely run their course.
from the Committee’s 2 percent objective, and staff projects that the 12-month
core PCE inflation rate will remain near the current rate through March,
before gradually moving higher.
Indicators of expected future inflation are on the rise.
o Estimates of 5-year, 5-year ahead expected inflation based on Board term
structure models increased around 10 basis points over the intermeeting
period; inflation compensation, measured on the same basis, increased
33 basis points, bringing the total increase since its low in June to 64 basis
points. The staff’s estimate of five-year inflation compensation also moved
up appreciably over the intermeeting period.
o A straight read of quotes for inflation caps suggests that, over the intermeeting
period, market participants marked up noticeably their assessment of the
probability that headline CPI inflation over the next five years will run
somewhat above 2 percent. Rising inflation compensation appears to be
driven in part by increased cost of protection against above-target inflation
outcomes.
The two employment reports released since the Committee last met in November
were notably uniform in the further progress they portrayed in labor markets, with
solid job gains and reductions in the U-3 unemployment rate as well as broader
measures of unemployment and underemployment.
Taking a somewhat longer-term perspective, job gains have been consistently solid
from June through November.
Page 43 of 66
Alternatives
o Twelve-month core PCE inflation in October was 1.7 percent, not very far
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o Policymakers may see the ¼ percentage point increases over the past year in
the employment-to-population ratio and labor force participation rate—despite
their downward structural trends—as supporting a view that labor utilization
has continued to increase.
o The U-3 measure of unemployment is now at its lowest level since the onset
of the Great Recession.
A variety of measures of labor market tightness have been running near or above precrisis levels; these include the job openings rate and the quits rate. And initial claims
for unemployment insurance have for some time been below levels seen around
recent business cycle peaks.
Alternatives
o While the three primary measures of labor compensation suggest only
moderate wage growth, the Wage Growth Tracker constructed by the Federal
Reserve Bank of Atlanta, has for some time shown a more marked
acceleration.4
Growth in real GDP in the third quarter was nearly a percentage point higher than
projected in October, and the underprediction in real gross domestic income was even
larger. And while the miss in GDP was largely a result of a transitory boom in net
exports, with the Michigan survey measure of consumer sentiment having climbed
markedly in November and the Confidence Board confidence index reaching its
highest level since the recession, participants may see some upside risk in the outlook
for real PCE and hence GDP.
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. They
may also judge, and wish to communicate, that additional gradual increases are likely
in the not-too-distant future.
o Some policymakers may favor reducing accommodation at this meeting and
may see a need for several additional gradual increases in the federal funds
rate over the coming year, in part to lower the risk that policy may need to be
tightened rapidly in the future, possibly cutting short the expansion.
4
The box “Measures of Labor Compensation,” which appears in the current Tealbook A,
discusses, among other things, the construction of the Federal Reserve Bank of Atlanta’s Wage Growth
Tracker and how it differs from the other measures that staff monitor.
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Policymakers may be concerned that reducing policy accommodation too
slowly could lead to substantial undershooting of the longer-run normal
unemployment rate, and they may be skeptical that such undershooting can be
unwound smoothly.
o These policymakers might emphasize that several measures of wage growth
have increased in recent years, even as productivity growth has remained low.
They might anticipate that, if labor market tightening leads to additional
acceleration of wages without a pickup in productivity growth, inflation
would rise, requiring a higher policy rate.
o Policymakers might also be worried that maintaining the federal funds rate at
in financial markets that could eventually endanger financial stability.
o Policymakers may judge that, even after a 25 basis point increase, the stance
of monetary policy would remain overly accommodative; they might note that
the real federal funds rate would still lie below the prescriptions from a wide
range of policy frameworks—including most simple policy rules and optimal
control exercises shown in the “Monetary Policy Strategies” section of
Tealbook B. Policymakers also might note that the simple rules reported in
Tealbook B call for an increase in the federal funds rate even when taking into
account a substantial decline (relative to the pre-crisis period) in the
longer-run equilibrium level of the federal funds rate.
The prospect of sizable fiscal policy stimulus presents another risk that is novel by
recent experience.
o Staff has included a moderate-sized tax cut within the Tealbook forecast, but
the actual fiscal package could turn out to be much larger. Accordingly, some
participants might worry about an outcome such as the “Larger Fiscal
Stimulus” alternative scenario in Tealbook A. Regardless of its size, some
additional fiscal stimulus appears likely, and its effects are likely to be felt at a
time of significant undershooting of the unemployment rate, which could
present higher-than-normal risks to inflation or financial stability.
On average, respondents to the Desk’s latest surveys put the probability that the
Committee will increase the target range at this meeting at about 90 percent. Federal
funds futures also imply that the perceived likelihood of a rate hike at this meeting is
very high. It follows that the portion of a statement like Alternative C that raises the
Page 45 of 66
Alternatives
its current low level, or raising it too slowly, will lead to excessive risk-taking
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December 8, 2016
target range for the federal funds rate by 25 basis points would not surprise the
market. The question is how changes in the statement that speak to future changes in
the stance of policy would be interpreted.
o The inclusion of the word “additional” before “gradual increases in the federal
funds rate” might be taken as suggesting that further increases in the target
range will come sooner than market participants would have otherwise
expected—indeed, that is the intent. To the extent this is so, medium- and
longer-term real interest rates would likely rise, equity prices and inflation
compensation would decline, and the dollar would appreciate. However, if
Alternative C were taken as an expression of optimism about the underlying
forces driving the economy, the market responses could be different.
Alternatives
o As noted in the accompanying box, “Monetary Policy Expectations and
Uncertainty,” investors seem to recognize that the economy and the funds rate
could evolve in a variety of ways over the coming year.
THE CASE FOR ALTERNATIVE A
Policymakers might view information received since the November FOMC as indicating
not only that further progress is being made in labor markets but also that there remain
opportunities for further improvement in labor market outcomes. In light of how long
inflation has been running below 2 percent, they might elect to defer an increase in the
federal funds rate. Rather, they may emphasize the importance of having inflation be
close to 2 percent in order to confirm that 2 percent is not a ceiling for inflation in the
minds of Committee members. These policymakers might see risk management
considerations as reinforcing the case against reducing accommodation immediately.
Economic Conditions and Outlook
GDP growth in the third quarter came in unexpectedly strong, but growth in private
domestic final purchases—a measure commonly considered to be more representative
of underlying demand conditions than is GDP—slowed and was only moderate.
o Recent readings on consumer spending suggest that output may grow more
slowly in the near term than policymakers may have been expecting.
o Residential investment in the third quarter continued to shrink, and business
investment is increasing only modestly after notable declines earlier this year.
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The November employment situation report showed solid job gains and a surprisingly
large drop in the unemployment rate, but also a disappointing decline in average
hourly earnings that could be taken as indicating that labor market pressures are
subdued. In addition, the labor force participation rate slipped and the average work
week was flat.
Core inflation rates are higher now than they were earlier in the year, but no higher
than had been expected.
o Survey measures of longer-run inflation expectations and readings on longerterm inflation compensation, while higher than they once were, are still low
by historical standards. Policymakers may be concerned that if forecasts of a
could decrease. If this were to occur now, after a lengthy period of
underperformance on inflation, the Committee’s reputation could suffer.
o While 5-year, 5-year ahead inflation compensation rose 33 basis points over
the intermeeting period, at 2.0 percent, it remains at a low level by historical
standards, and is lower still when recast in terms of PCE inflation.
Policymakers may still assess the risks to the economic outlook as tilted to the
downside—especially over the medium term—in part because adverse developments
abroad could lead to tightening global financial conditions and decreased demand for
U.S. exports.
o The Brexit process could lead to financial stress in Europe and beyond if
negotiations are especially contentious.
o The growing populist movement in Europe, coming as it does during a period
where several key elections are looming, presents a risk. The outcome of the
constitutional referendum in Italy and the ensuing resignation of President
Renzi also represents a source of downside risk.
o The divergence between the monetary policy outlook in the United States and
many major economies suggests the possibility of additional upward pressure
on the exchange value of the U.S. dollar, as well as financial stresses in
emerging market economies.
Policy Strategy
Policymakers might judge that labor market conditions are strengthening only slowly
and that significant room remains for labor market improvement. They might take
Page 47 of 66
Alternatives
pickup in inflation prove too optimistic, longer-run inflation expectations
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December 8, 2016
comfort from the fact that recent increases in inflation were close to expectations and
therefore regard labor market pressures as subdued. If so, policymakers might want
to communicate that an increase in the federal funds rate is not yet warranted, and that
it would be appropriate to wait for further progress toward maximum employment
and 2 percent inflation.
o Policymakers might also judge that inflation dynamics in recent decades
demonstrate that the Phillips curve is fairly flat, implying that greater resource
utilization will have only a muted effect on inflation.
o With inflation remaining below the Committee’s 2 percent objective and the
Phillips curve as flat as it appears to be, policymakers might conclude that
further strengthening in the labor market is appropriate in order to assure that
Alternatives
inflation returns to 2 percent in a timely fashion.
o In addition, 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, meager productivity growth, or
borrowing conditions that remain tight for some households. They may see
such headwinds as unlikely to subside in the near term.
o Some policymakers may see benefits—not just risks—associated with some
undershooting of unemployment. For example, policymakers might judge
that a tight labor market could have persistent positive effects on the
productive capacity of the economy.
Additionally, noting that longer-term interest rates, the exchange value of the dollar,
and equity prices, have all risen appreciably since the Committee last met,
policymakers might conclude that, on balance, financial conditions have tightened
and that no further actions or statements that might tighten those condition further are
necessary.
o These policymakers might argue that there may be some merit to waiting to
see how financial markets and the real economy respond to the extant
tightening in conditions before considering further policy actions.
In recognition of the asymmetric risks noted above, policymakers might regard it as
prudent risk management to maintain the current target range for the federal funds
rate for the time being.
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Some policymakers might regard the prospects for fiscal stimulus as still highly
uncertain, and might therefore think that the optimism that has been built into asset
prices over the last few weeks is overdone.
o Any fiscal package could turn out to be smaller, perhaps because of concerns
about budget deficits, and therefore disappoint market expectations. Or the
fiscal package could turn out to be dominated by corporate tax cuts which
have much smaller fiscal multipliers than do personal income tax cuts. It is
also possible that the Congress will be unable to come to any agreement.
Thus, some participants might regard as likely an outcome such as “No Fiscal
Stimulus” alternative scenario in Tealbook A.
Federal funds futures quotes suggest that market participants see a very high
probability of a rate hike at this meeting. A postmeeting statement like Alternative A,
which suggests that a near-term increase is unlikely, would therefore be very
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, putting downward pressure on longer-term yields.
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 economic conditions and greater-than-anticipated
concerns about the downside risks to the outlook, equity prices and inflation
compensation could fall.
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Alternatives
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IMPLEMENTATION NOTE
If the Committee 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 its 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 maintain the current target range for the federal funds
rate, an implementation note that indicates no change in these three policy tools would be
issued.
On the following pages, struck-out text indicates language deleted from the
Alternatives
November directive and implementation note, bold red underlined text indicates added
language, and blue underlined text indicates text that links to websites.
Page 50 of 66
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December 8, 2016
Implementation Note for December 2016 Alternatives B and C
Release Date: November 2 December 14, 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 December 15, 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 November 3 December 15, 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 mortgagebacked 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 December 15, 2016. In taking this action, the Board
approved requests submitted by the Boards of Directors of the Federal
Reserve Banks of . . .
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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 November
2, 2016 December 14, 2016:
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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 52 of 66
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December 8, 2016
Implementation Note for December 2016 Alternative A
Release Date: November 2 December 14, 2016
Decisions Regarding Monetary Policy Implementation
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:
“Effective November 3 December 15, 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 mortgagebacked 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 53 of 66
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 November
2, 2016 December 14, 2016:
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December 8, 2016
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December 8, 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 a baseline scenario for the paths
of monetary policy and longer-term interest rates.1 In the analysis below, we have
extended the projection period through 2030 from the 2025 projection period reported in
previous Tealbooks.
The “December Tealbook baseline” scenario is consistent with the monetary policy
assumptions incorporated in the staff’s baseline forecast presented in Tealbook A. In
this scenario, interest rates are higher than those in the October Tealbook, with the
federal funds rate projected to rise to nearly 4 percent at the end of 2021, before
moving down to about 3 percent by the end of the projection period. Longer-term
interest rates follow a similar pattern, reaching peak levels by 2022 before declining
somewhat through the remainder of the projection period.
Compared with the baseline projection in October, higher interest rate paths result in a
slightly slower pace of MBS prepayments and therefore higher MBS holdings throughout
in smaller unrealized gains on the SOMA portfolio early in the projection period, and
larger unrealized losses in later years.
The key policy assumptions associated with the projections 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 to 1½ percent. As in the previous Tealbook, reinvestments are expected to cease
during the third quarter of 2017 based on this criterion. Once reinvestments cease,
the SOMA portfolio shrinks through redemptions of maturing Treasury and agency
1
In this scenario, the response of the federal funds rate to deviations of the endogenous variables
from their baseline values is determined by the inertial Taylor (1999) policy rule.
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Projections
the projection period. Together, the higher rate paths and the larger MBS holdings result
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December 8, 2016
debt securities as well as paydowns of principal on agency MBS until reserve
balances reach their assumed longer-run level of $100 billion.
Use of policy normalization tools: We continue to assume that take-up of overnight
reverse repurchase agreements (ON RRPs) runs at $100 billion through the end of
2018, before declining to zero by the end of 2019, and that term deposits (the TDF)
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 first quarter of 2022, one quarter later than projected in the October Tealbook (see
the solid black lines in the exhibit titled “Total Assets and Selected Balance Sheet
Items” and the table that follows).3 The projected timing of the normalization of the
size of the balance sheet occurs later in this Tealbook because of the slower winddown of MBS holdings that results from the higher path of mortgage rates. At the
time of normalization, 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 Federal Reserve
notes in circulation and Federal Reserve Bank capital.
Federal Reserve remittances. Under the baseline scenario, annual remittances are
Projections
projected to decline from $98 billion in 2015 to about $93 billion this year (see the
solid black lines in the “Income Projections” exhibit).4 The step-down primarily
reflects increased interest expense on reserves resulting from the FOMC’s decision to
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. Separately, we assume that RRPs associated
with foreign official and international accounts remain near their October 31, 2016 level of $247 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
the assumed 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.
4
Earnings remittances for 2015 exclude a one-time transfer of $19 billion in Federal Reserve
surplus associated with the FAST Act.
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December 8, 2016
increase the target range for the federal funds rate, and thus the IOER rate, in
December 2015.5 Annual remittances are projected to continue to decline through
2020 as the size of the SOMA portfolio falls and the target range for the federal funds
rate increases, reaching a low of roughly $36 billion. Thereafter, remittances
gradually increase as higher-yielding Treasury securities are added to the SOMA
portfolio. No deferred asset is projected.6
Unrealized gains or losses. The staff estimates that the SOMA portfolio was in a net
unrealized gain position of about $260 billion at the end of September.7 Preliminary
staff estimates show that the net unrealized gain position fell to about $121 billion by
the end of November as a result of the rise in interest rates. Going forward, the net
unrealized gain or loss position of the portfolio will depend importantly on the path of
longer-term interest rates. Because of the rise in longer-term interest rates assumed
over the next several years in the baseline scenario, the portfolio is projected to shift
to an unrealized loss position in the third quarter of 2017, one year earlier than the
October Tealbook baseline. In particular, the portfolio is expected to record a peak
unrealized loss of approximately $212 billion in 2019, about $77 billion of which is
attributable to holdings of Treasury securities and $135 billion to holdings of agency
MBS. The unrealized loss position then narrows through 2030, as the value of
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
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 are estimated to be depressing the term premium embedded in the 10-year
nominal Treasury yield by 91 basis points in the current quarter. The estimated term
premium effect depends importantly on the expected path of the Federal Reserve’s
balance sheet over coming years relative to a benchmark counterfactual projection for
5
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 offering rate on ON RRPs will average 12.5 basis points
below the effective federal funds rate. The effective federal funds rate has averaged 41 basis points over
the intermeeting period.
6
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.
7
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 57 of 66
Projections
prevailing market yields.
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December 8, 2016
Total Assets and Selected Balance Sheet Items
December Tealbook baseline
Total Assets
October Tealbook baseline
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
SOMA Treasury Holdings
2030
2028
2026
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
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2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
0
2010
Projections
2012
2010
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
0
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December 8, 2016
Federal Reserve Balance Sheet
End-of-Year Projections -- December Tealbook baseline
(Billions of dollars)
Oct 31, 2016
Total assets
4,452
2017
2019
2021
2023
2025
2030
4,388 3,218 2,457 2,523 2,677 3,136
Selected assets
Loans and other credit extensions*
Securities held outright
U.S. Treasury securities
3
0
0
0
0
0
4,218
4,182 3,045 2,307 2,387 2,551 3,020
2,464
2,422 1,611
Agency debt securities
Agency mortgage-backed securities
0
18
1,736
4
2
1,133 1,417 1,727 2,480
2
2
2
2
1,756 1,432 1,172
968
821
538
Unamortized premiums
176
160
125
99
84
74
61
Unamortized discounts
-15
-14
-11
-8
-7
-6
-4
50
52
52
52
52
52
52
Total other assets
Total liabilities
4,412
4,346 3,173 2,408 2,470 2,619 3,063
1,434
1,547 1,706 1,831 1,962 2,111
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
U.S. Treasury, General Account
462
347
2,555
247
247
247
247
247
2,509
2,447 1,214
324
255
255
255
2,042
2,291 1,059
169
100
100
100
422
150
150
150
150
150
150
45
5
5
5
5
5
5
2
0
0
0
0
0
0
40
42
45
49
53
58
73
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.
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Projections
Selected liabilities
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 2016
Income Projections
December Tealbook baseline
Interest Income
October Tealbook baseline
Interest Expense
Billions of dollars
Annual
Billions of dollars
140
Annual
160
120
140
100
120
100
80
80
60
60
2028
2026
2024
2022
2030
140
20
0
0
2030
20
2028
40
2026
40
2024
60
2022
60
2020
80
2018
80
2016
100
2014
100
2012
120
Memo: Unrealized Gains/Losses
Billions of dollars
End of year
Page 60 of 66
400
300
200
100
0
−100
−200
2030
2028
2026
2024
2022
2020
2018
2016
−300
2014
120
110
100
90
80
70
60
50
40
30
20
10
0
2030
2028
2026
2024
2022
2020
2018
End of year
2012
Billions of dollars
2016
Annual
120
Deferred Asset
2014
Billions of dollars
140
2030
2028
2026
2024
2022
2020
2018
2016
2014
Annual
2012
2020
Earnings Remittances to Treasury
Billions of dollars
2012
2018
0
2016
0
2014
20
2012
20
Realized Capital Gains
Projections
40
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
40
−400
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 2016
Projections for the 10-Year Treasury Term Premium Effect
(Basis Points)
December
October
Tealbook
Date
Tealbook
baseline
baseline
Quarterly Averages
-91
-87
-82
-78
-74
-86
-82
-78
-74
-70
2018:Q4
2019:Q4
2020:Q4
2021:Q4
2022:Q4
2023:Q4
2024:Q4
2025:Q4
2026:Q4
2027:Q4
2028:Q4
2029:Q4
2030:Q4
-60
-49
-41
-35
-31
-28
-24
-22
-19
-17
-15
-13
-12
-56
-45
-36
-30
-25
-20
-16
-11
Projections
2016:Q4
2017:Q1
Q2
Q3
Q4
Page 61 of 66
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 2016
the balance sheet that excludes the effects of asset purchases. Over time, the term
premium effect gradually fades as the projected path of the balance sheet converges
to the benchmark path. Until 2022, the estimated TPE path in the current Tealbook is
more negative than in the October baseline scenario, primarily because of the larger
SOMA portfolio holdings as a result of larger MBS balances. Thereafter, the
December Tealbook baseline reports an even more negative term premium effect
relative to the October baseline. This additional widening is related to the extension
of the projection period in this Tealbook, and reflects the assumptions made in
modeling the SOMA portfolio in the years beyond the previous forecast period.
SOMA characteristics. Regarding the size of the portfolio, approximately
$216 billion in SOMA Treasury holdings have already matured or will mature this
year, and a total of nearly $1.5 trillion will mature between 2016 and 2020 (see the
top panel of the exhibit “Projections for the Characteristics of SOMA Holdings”).8
The amount of Treasury securities maturing each month will vary considerably over
time, while projected MBS paydowns vary less. Realized MBS paydowns will reflect
the evolution of interest rates and other factors and thus could be significantly more
volatile than projected.9
The weighted-average duration of the SOMA Treasury portfolio is currently about
6½ years (see the middle panel of the exhibit). The weighted-average duration is
Projections
projected to decline slightly next year, as the securities in the portfolio approach
maturity, and to subsequently rise until the size of the balance sheet is normalized in
early 2022.10 After reaching its peak, duration is projected to resume its decline as
the Desk resumes open market purchases of Treasury securities to keep pace with the
increase in currency and Federal Reserve Bank capital. The duration contour in this
8
Under the FOMC’s 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.
9
Over the intermeeting period, the Desk reinvested $24 billion of maturing Treasury securities
and is expected to purchase a total of $52 billion of 15- and 30-year agency MBS under the reinvestment
program.
10
The rise in portfolio duration starts in 2018 as the pace of roll-offs accelerates and longer-tenor
securities account for a larger share of the remaining portfolio, causing duration to increase until the size of
the balance sheet is normalized.
Page 62 of 66
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 2016
Projections for the Characteristics of SOMA Holdings
Projected Receipts of Principal on SOMA Securities
December Tealbook baseline
Billions of Dollars
100
Projected MBS Paydowns
Treasury Maturities
80
60
40
20
0
2017
2018
2019
2020
SOMA Weighted−Average Treasury Duration
Monthly
Years
December Tealbook baseline
October Tealbook baseline
10
9
8
7
6
5
3
2
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
Maturity Composition of SOMA Treasury Portfolio
December Tealbook baseline
Billions of Dollars
Maturing in less than 1 year
3000
Maturing between 1 year and 5 years
Maturing between 5 years and 10 years
Maturing in greater than 10 years
2500
2000
Normalization
1500
1000
500
0
2017
2018
2019
2020
2021
2022
2023
2024
Page 63 of 66
2025
2026
2027
2028
2029
2030
Projections
4
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 2016
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 assumed to be spread across the maturity spectrum (see the
Projections
bottom panel, “Maturity Composition of SOMA Treasury Portfolio”).11
11
We assume zero purchases of agency MBS after reinvestments cease.
Page 64 of 66
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 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 65 of 66
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
December 8, 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 66 of 66
Cite this document
APA
Federal Reserve (2016, December 13). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_20161214_part1
BibTeX
@misc{wtfs_greenbook_20161214_part1,
author = {Federal Reserve},
title = {Greenbook/Tealbook},
year = {2016},
month = {Dec},
howpublished = {Greenbooks, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/greenbook_20161214_part1},
note = {Retrieved via When the Fed Speaks corpus}
}