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 1/12/2024. Authorized for Public Release Class I FOMC – Restricted Controlled (FR) Report to the FOMC on Economic Conditions and Monetary Policy Book B Monetary Policy Alternatives March 15, 2018 Prepared for the Federal Open Market Committee by the staff of the Board of Governors of the Federal Reserve System Authorized for Public Release (This page is intentionally blank.) Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Monetary Policy Alternatives continued to expand at a faster-than-potential pace and that the labor market has continued to strengthen. The average pace of job gains in recent months has been stronger than earlier last year and the unemployment rate has remained quite low. A number of other measures of labor market conditions also point to high and rising levels of labor utilization. Recent spending indicators, on balance, point to a moderation in real GDP growth in the current quarter. This moderation appears likely to be temporary, for two reasons. First, ongoing strengthening in the labor market, which is continuing to bolster income and confidence, as well as stronger expansions abroad and accommodative financial conditions, continue to support growth in consumer spending, business investment, and exports. Second, the increased federal government spending that will result from last month’s passage of the Bipartisan Budget Act of 2018 is expected to provide an additional boost to aggregate demand going forward. Inflation has continued to run below the Committee’s 2 percent objective, but recent monthly readings are consistent with the staff’s expectation that inflation will step up in coming months and run close to 2 percent this year. There are two key questions for the Committee at this meeting: first, whether the available information warrants raising the federal funds rate; and second, whether the economic outlook and associated risks indicate that the federal funds rate path suggested by recent FOMC statements remains appropriate. Against this background, three alternative draft statements are given below for the Committee’s consideration. The alternative policy statements differ in the views expressed about tightening resource utilization and its implication for the inflation outlook and, hence, for the appropriate message to convey about the federal funds rate path expected to be necessary to achieve the Committee’s objectives. Alternative B notes a stronger economic outlook but signals that this upgrade has not substantially changed the Committee’s judgement about the pace of rate hikes that will most likely prove appropriate. Alternative B includes a 25-basis-point increase in the target range for the federal funds rate in March but leaves the guidance about the future course of policy unchanged from the January statement. Page 1 of 36 Alternatives Data received over the intermeeting period indicate that the economy has Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Alternative C also acknowledges a stronger economic outlook but, unlike Alternative B, is predicated on the view that allowing resource utilization to tighten much further would create too large a risk that monetary policy will eventually need to tighten Alternatives abruptly. Consequently, Alternative C conveys the Committee’s intention to continue gradually increasing the federal funds rate until it is high enough to slow growth in employment and economic activity to sustainable rates. In contrast, Alternative A is motivated by the view that longer-run inflation expectations may be too low. It thus indicates that “A temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and may be needed to ensure that longer-run inflation expectations are consistent with that objective.” With regard to the specifics of the draft statement language:  The three Alternatives agree in their assessment of the state of the labor market but differ slightly in the assessment of the strength of incoming spending data. o Each of the Alternatives recognizes that the labor market has continued to strengthen and characterizes job gains as being “strong in recent months.” o The Alternatives differ in their characterization of consumer spending and business investment. Alternative A simply states that “Household spending and business fixed investment appear to be expanding at a moderate pace.” Alternative B notes that the moderation follows strong growth in the fourth quarter. Alternative C states that “Household spending and business fixed investment have been growing at solid rates, on average, in recent quarters.” o Consistent with the recent spending indicators, Alternative B notes that growth in economic activity has been “moderate” while Alternative A states that it has “moderated.” Alternative C retains the language from January and characterizes economic activity as “rising at a solid rate.”  Regarding recent inflation developments, all three Alternatives note that inflation continued to run below 2 percent, with Alternative C adding that both overall inflation and inflation for items other than food and energy have “increased from their lows last summer.”  The three Alternatives indicate that survey-based measures of longer-term inflation expectations “are little changed, on balance,” as in the January statement, but differ Page 2 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 slightly in the language concerning market-based measures of inflation compensation. Alternative B retains the language from January, Alternative C strikes the words “but remain low,” and Alternative A instead deletes the language indicating that these  The outlook for economic activity and the labor market is somewhat different across the three alternatives, as is the inflation outlook. In addition, the outlook associated with each alternative is conditioned on a different expectation for monetary policy, reflecting different views about the risks associated with reducing policy accommodation at the pace currently anticipated by market participants. o Alternatives B and C include a new sentence, “The economic outlook has strengthened in recent months.” This sentence is meant to capture the various factors that have contributed to a stronger outlook, including changes in fiscal policy, stronger and more synchronous growth abroad, and financial conditions that remain highly supportive of growth despite recent market volatility. Moreover, the outlook paragraph in Alternative C signals more strongly that the Committee sees further increases in the federal funds rate as necessary to achieve sustainable growth rates of economic activity and employment. o Regarding the outlook for inflation, Alternative B now states that inflation is expected to move up “in coming months” rather than “this year.” (The latter words were used in the January statement.) This modification is not meant to signal a change in the inflation outlook but rather to acknowledge that the time when inflation is expected to step up closer to 2 percent is drawing near. Alternative C also notes that inflation is expected to move up “in coming months” but then conveys that, once the increase occurs, the Committee will essentially have achieved its inflation objective. In contrast, Alternative A signals a greater intention to achieve higher inflation by conditioning the outlook on “appropriate monetary policy accommodation” and noting that “A temporary period of inflation modestly above 2 percent … may be needed to ensure that longer-run inflation expectations are consistent with” the Committee’s objective. o The three Alternatives retain the view that “Near-term risks to the economic outlook appear roughly balanced.” Alternatives A and B, but not C, keep the statement that “the Committee is monitoring inflation developments closely.” Page 3 of 36 Alternatives measures “have increased in recent months.” Authorized for Public Release Class I FOMC - Restricted Controlled (FR)  March 15, 2018 With respect to the current policy decision: o Alternatives B and C raise the target range to 1½ to 1¾ percent and continue Alternatives to note that the stance of monetary policy remains accommodative. o Alternative A leaves the target range at 1¼ to 1½ percent.  With respect to the outlook for monetary policy: o Alternative B makes no changes from the January statement. o Alternative C drops the statement that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” thus suggesting that the federal funds rate may need to rise to its normal longer-run level faster than otherwise. o Alternative A drops all of the guidance about the path of the federal funds rate, thus conveying a more agnostic view of how policy will need to evolve in order to achieve the Committee’s objectives. Page 4 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 1. Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‐month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. 3. In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-1/4 to 1‐1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. Page 5 of 36 Alternatives JANUARY 2018 FOMC STATEMENT Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Alternatives ALTERNATIVE A FOR MARCH 2018 1. Information received since the Federal Open Market Committee met in December January indicates that the labor market has continued to strengthen remained strong and that while growth in economic activity has been rising at a solid rate moderated. Job gains in employment, household spending, and business fixed investment have been solid strong in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment appear to be expanding at a moderate pace. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of appropriate monetary policy accommodation, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‐month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. 3. In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-1/4 to 1‐1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation. A temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and may be needed to ensure that longer-run inflation expectations are consistent with that objective. 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. Page 6 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 1. Information received since the Federal Open Market Committee met in December January indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid moderate rate. Job gains in employment, household spending, and business fixed investment have been solid strong in recent months, and the unemployment rate has stayed low. Recent data suggest that growth of household spending and business fixed investment have moderated from their strong fourth-quarter rates. On a 12month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; surveybased measures of longer-term inflation expectations are little changed, on balance. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12‐month basis is expected to move up this year in coming months and to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. 3. 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 1-1/4 to 1‐1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. Page 7 of 36 Alternatives ALTERNATIVE B FOR MARCH 2018 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Alternatives ALTERNATIVE C FOR MARCH 2018 1. Information received since the Federal Open Market Committee met in December January indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains in employment, household spending, and business fixed investment have been solid strong in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have been growing at solid rates, on average, in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have increased from their lows last summer but have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity and employment will expand at a moderate pace and labor market conditions will remain strong sustainable rates in the medium term. Inflation on a 12‐month basis is expected to move up this year in coming months and then to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. 3. 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 1-1/4 to 1‐1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. Page 8 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 THE CASE FOR ALTERNATIVE B Economic Conditions and Outlook Available data indicate that the labor market has continued to strengthen but does not yet appear to be overheating. o Over the past three months, payrolls have increased by an average of 242,000 per month, well above the pace estimated to be consistent with an unchanged unemployment rate if the labor force participation rate declines in line with its estimated trend path. o The unemployment rate in February was 4.1 percent for the fifth consecutive month, below all FOMC participants’ estimates of the longer-run normal rate of unemployment in the December Summary of Economic Projections (SEP). o The labor force participation rate jumped 0.3 percentage point to 63.0 percent in February. While the staff projects this increase to be reversed by year end, the labor force participation rate is projected to continue to run above its estimated trend level. o Notwithstanding the strong pace of job gains, the low unemployment rate, and the increase in labor force participation, compensation data continued to point to moderate wage growth.  Although inflation on a 12-month basis remains below the Committee’s 2 percent objective, the past several monthly readings have corroborated the view that inflation is moving up gradually. o Over the 12 months ending in January, the core PCE inflation rate was 1.5 percent, up about ¼ percentage point from its low last summer. In coming months, when the extraordinarily low reading from last March drops out of the calculation of 12-month inflation, core PCE inflation is quite likely to move up closer to 2 percent. Thereafter, with resource utilization tightening substantially further in the staff’s projection, core inflation rises from 1.9 percent this year to 2.2 percent in 2020. o Over the 12 months ending in January, total PCE inflation was 1.7 percent. Total PCE inflation is projected to climb to 1.8 percent this year and to reach 2.1 percent in 2020. o On balance, longer-term survey-based measures of inflation expectations and market-based measures of inflation compensation have moved little since Page 9 of 36 Alternatives  Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 January. Median 10-year inflation expectations for PCE prices in the Survey of Professional Forecasters held steady at 2.0 percent in the first quarter, the median of expectations over the next 5 to 10 years from the Michigan survey Alternatives was stable at 2.5 percent in February, and the 3-year-ahead measure of median inflation expectations in the Federal Reserve Bank of New York’s Survey of Consumer Expectations edged up to 2.9 percent in February, reversing the previous month’s decline and remaining within the narrow range observed since last summer. The TIPS-based measure of 5-to-10-year-forward inflation compensation changed little over the latest intermeeting period but is up about 15 basis points since the December FOMC meeting and 25 basis points since the November FOMC meeting.  Real GDP is now estimated to have increased at an annual rate of 2.9 percent in the fourth quarter of last year and is projected to increase 2.1 percent in the first quarter of this year but then to pick up, bringing about a further widening of the gap between actual and potential output. Despite somewhat softer readings on consumer spending, fundamentals underpinning consumer demand remain sound; most importantly, the ongoing strengthening in the labor market is continuing to bolster income and confidence. Moreover, the recently enacted tax bill should boost spending. The staff projects that the overall effect of the tax cuts enacted in December and the spending increases authorized in February will be to raise the growth rate of real GDP by ½ percentage point in 2018, ¾ percentage point in 2019, and ½ percentage point in 2020.  Real GDP in the foreign economies averaged a solid 2.7 percent in the fourth quarter. More recent foreign economic data point to an upbeat start to this year, and the staff sees foreign growth picking up to 3 percent this quarter. Policy Strategy  The rates of output growth in the current quarter and the fourth quarter of last year— while lower than expected in the January Tealbook—nonetheless imply a further widening of the gap between actual and potential output. This development, together with the projected pick-up in the pace of growth in real activity after the current quarter, may have bolstered policymakers’ confidence that inflation will reach 2 percent this year. That being so, they may see it as appropriate to continue the gradual removal of policy accommodation by raising the target range for the federal funds rate to 1½ to 1¾ percent at this meeting and to continue to signal that further Page 10 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 gradual rate hikes are likely appropriate to achieve maximum employment and a sustained return to 2 percent inflation. With the recent fiscal policy actions expected to provide significant stimulus to growth, financial conditions still supportive of growth (notwithstanding recent volatility in financial markets), and solid growth abroad, policymakers may wish to upgrade their assessment of the economic outlook by adding a sentence indicating that “The economic outlook has strengthened in recent months.”  Nonetheless, with an increase in the target range at this meeting and further gradual increases in the federal funds rate projected, policymakers may continue to perceive the near-term risks to the economic outlook as roughly balanced.  As shown in the “Monetary Policy Expectations and Uncertainty” box, financial market quotes indicate that market participants are nearly certain that the Committee will raise the target range by 25 basis points at this meeting, an assessment shared by respondents to the Desk’s latest surveys of primary dealers and market participants. Looking ahead, federal funds futures quotes imply that the modal outlook of market participants envisions a total increase of about 75 basis points by the end of this year. The median of the modal responses to the Desk’s surveys points to four 25-basispoints rate hikes this year, but respondents see the likelihood of four hikes as only slightly higher than the probability of three. In light of current market expectations, a statement along the lines of Alternative B seems unlikely, by itself, to generate an appreciable change in asset prices, though the indication that the outlook has strengthened could lead to some steepening of the expected path for the federal funds rate. THE CASE FOR ALTERNATIVE C Economic Conditions and Outlook  Policymakers may judge that the labor market is already appreciably beyond full employment and that economic activity—which was already growing at a faster-thansustainable rate—will be further spurred by the recently enacted tax cuts and spending legislation. o The unemployment rate was 4.1 percent in February, well below each FOMC participant’s estimate of its longer-run normal level in the December SEP. o Despite four increases in the target range for the federal funds rate from December 2016 to January 2018, the average pace of payroll gains in 2017 Page 11 of 36 Alternatives  Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Alternatives Monetary Policy Expectations and Uncertainty Futures markets have almost fully priced in a 25‐basis‐point increase in the target range for the federal funds rate at the FOMC’s upcoming March meeting, and the average odds assigned to this outcome by respondents to the Desk’s surveys of primary dealers and market participants are comparably high. Expectations for the path of the federal funds rate based on market and survey measures have also ticked up, on balance. Figure 1 shows the probability distribution, derived from quotes on federal funds futures contracts, of the total number of 25‐basis‐point rate increases over the next three FOMC meetings (March, May, and June). The probability that there will be two rate hikes has increased by about 10 percentage points over the intermeeting period, to around 70 percent. The probability of only one rate hike over these three meetings has come down by a similar amount. Looking ahead to the end of 2018, the probability distribution for the level of the federal funds rate, based on options quotes and assuming zero term premiums, has shifted only marginally to the right (figure 2). It continues to suggest that investors place the greatest odds on the federal funds rate falling into the 2 to 2¼ percent range—consistent with three 25‐basis‐point increases in the target range in 2018. Figure 3 shows the corresponding average probability distribution from the Desk’s surveys; respondents to those surveys see increased odds of higher rate outcomes relative to the January survey. Survey respondents now place almost the same probability on four 25‐basis‐point rate increases this year as on three such rate hikes. In addition, the survey‐based distribution now assigns roughly the same likelihood as the probability distribution from market quotes to end‐of‐year federal funds rate levels suggestive of four or more rate hikes this year—about 35 percent. Figure 4 shows how different measures of federal funds rate expectations for the end of 2018 have evolved since June 2016. The figure displays market‐based metrics (with and without term premium adjustments) derived from quotes on overnight index swap contracts (OIS), the median projection from FOMC participants’ Summary of Economic Projections (SEP) through December 2017, and the median of respondents’ modal forecasts as well as the average of respondents’ implied mean forecasts from the Desk surveys. Of note, the latter two forecasts approximately correspond to the mode and mean, respectively, of the distribution shown in figure 3. All measures declined somewhat around the U.K.’s referendum on “Brexit” and subsequently rose notably in the wake of the U.S. presidential election. The SEP (the golden squares) and Desk survey modal forecasts (the black dots) remained stable at 2 to 2¼ percent from early 2017 to January 2018, whereas the market‐based measures (the red and blue lines) and the Desk survey implied mean forecasts (the grey dots) trended down from March to September 2017 and have inched up steadily since then. The narrowing Page 12 of 36 Authorized for Public Release March 15, 2018 of the gap between the forward rates implied by OIS quotes (the blue line) and the expected path of the federal funds rate with adjustments for term premiums as estimated by a staff term structure model (the red line) reflects, in part, the shrinkage of negative term premiums toward zero as the projection horizon nears, and possibly also the diminution of downside risks as interest rates move further away from the lower bound. Based on the most recent observations, the unadjusted market‐implied measure, the December SEP median, and the Desk survey’s implied mean forecast are consistent with three 25‐basis‐point rate increases in 2018, while the market measure that adjusts for term premiums and the Desk survey’s latest modal forecast both reflect an expectation of four hikes. Figure 5 shows market‐implied measures of the expected federal funds rate path beyond 2018. The path derived from quotes on OIS and not adjusted for term premiums (the blue line) has shifted up modestly over the intermeeting period, mostly in 2019 and 2020. The staff’s term structure model attributes much of this increase to higher (less negative) term premiums, leaving the term‐premium‐ adjusted path (the red line) only a touch higher. Expectations for the path of the federal funds rate have likely been buoyed, in part, by the prospective economic effects of additional government spending resulting from the passage of the Bipartisan Budget Act of 2018. In the March Desk surveys, participants further marked up their projections for the U.S. fiscal deficit in coming years. As shown by the two sets of bars to the left in figure 6, since the December survey, the median projection for the budget deficit in the Survey of Primary Dealers, as a percentage of GDP, has increased by roughly ½ percentage point for 2018 and 1¼ percentage points for 2019. The deficit for 2020 (not shown) is projected to remain at approximately its 2019 level. The bars to the right of the figure show that, over the same period, the median projection for real GDP growth has shifted up for 2018 and 2019 by 40 and 20 basis points, respectively. The median growth estimate for 2020 was little changed at 1.8 percent, in line with participants’ longer‐run estimate for GDP growth (not shown).1 1 Figure 6 is based on responses from primary dealers only as the Survey of Market Participants does not ask respondents for GDP growth forecasts. Page 13 of 36 Alternatives Class I FOMC - Restricted Controlled (FR) Authorized for Public Release March 15, 2018 Alternatives Class I FOMC - Restricted Controlled (FR) Page 14 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 and early 2018 significantly exceeded the pace necessary to absorb new entrants (and reentrants) into the labor force and to maintain a constant unemployment rate over the longer run. Moreover, the recent acceleration in conditions, monetary policy will need to tighten more than market participants currently anticipate if the Committee is to succeed in slowing economic growth to a sustainable pace. o The staff forecasts that, from 2018 through 2020, average payroll gains will continue to run above their longer-run sustainable pace. Accordingly, the unemployment rate is projected to continue to decline, reaching 3.1 percent at the end of 2019 and moving sideways throughout 2020. Such a low rate of unemployment has not been reached in the United States for more than half a century. o Other indicators pointing to an already tight labor market include an elevated rate of job openings, survey measures showing a high level of job availability, widespread reports of firms having difficulty hiring workers, and near-recordlow initial claims for unemployment insurance.  Policymakers may project that inflation will soon move above the Committee’s 2 percent objective. Twelve-month rates of total and core PCE inflation have been held down by an unusually large decline in the price of cell phone services in March 2017. As this reading drops out of the 12-month calculation, inflation should move closer to the target. Beyond the near term, the staff projects that core PCE price inflation will move up to 2.2 percent and total PCE price inflation to 2.1 percent, respectively, in 2020, conditional on a rising path for the federal funds rate. Policymakers may believe that more concerted upward pressures on both wages and prices are likely to emerge following a prolonged period of labor market tightness.  Despite the four increases in the target range for the federal funds rate implemented by the Committee between December 2016 and January 2018, financial conditions appear to remain highly supportive of growth. The stock market experienced considerable volatility and a decline in equity price indexes early in the intermeeting period, but those indexes have since mostly recovered their losses. Spreads on investment-grade and speculative-grade corporate bonds over comparable-maturity Treasury securities widened moderately but remained near the lower end of their historical ranges. Page 15 of 36 Alternatives payrolls may be seen as a signal that, given accommodative financial Authorized for Public Release Class I FOMC - Restricted Controlled (FR)  March 15, 2018 Policymakers may judge that the economic outlook has strengthened in recent months. o Indicators of consumer and business sentiment—including as measured by the Alternatives University of Michigan Surveys of Consumers, the ISM manufacturing index, and the Philadelphia Fed and Empire State future capital spending indexes— have been buoyant. o Foreign economic data released since the January FOMC meeting point to an upbeat start to this year, and the staff sees foreign growth picking up to 3 percent this quarter. Despite volatility in financial markets abroad, overall financial conditions continue to be supportive of foreign growth. o Recent tax cuts and spending legislation will provide significant stimulus to growth. The staff projects that the level of real GDP will be about 3½ percent above potential GDP by the end of 2020, about ¼ percentage point higher than in the January Tealbook. Policy Strategy  Despite past rate increases and a sequence of FOMC statements noting an expectation of further gradual hikes, employment and economic activity continue to expand more rapidly than is sustainable in the longer run. Consequently, policymakers may be concerned that market participants expect too small a cumulative increase in the federal funds rate, which would in turn risk significant overheating, inflation well above target, and eventually a need to tighten policy abruptly.  Policymakers might be concerned that significant undershooting of the longer-run normal rate of unemployment, alongside accommodative financial conditions, could lead to a buildup of financial vulnerabilities. For example, in addition to already elevated asset valuations rising further, policymakers may also see the historically high levels of leverage in the nonfinancial corporate sector, and the accompanying danger that interest-expense ratios could rise rapidly if monetary policy needed to be tightened quickly, as a vulnerability.  For all of the above reasons, policymakers may opt not only to raise the target range of the federal funds rate to 1½ to 1¾ percent but also to highlight that the Committee anticipates tightening policy enough to slow growth of output and employment to sustainable rates in coming years. Page 16 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR)  March 15, 2018 A statement like Alternative C could surprise market participants, particularly if read as indicating an intention to raise the federal funds rate enough to slow growth to a sustainable pace fairly soon. If the public were to infer that the current Committee medium- and longer-term real interest rates would likely rise, as would the exchange value of the dollar, and equity prices and inflation compensation would probably fall. THE CASE FOR ALTERNATIVE A Economic Conditions and Outlook  On a 12-month basis, core inflation has continued to run notably below 2 percent. Twelve-month core PCE inflation including only market-based prices was 1.1 percent in January. Policymakers may judge that inflation this year has been held down, at least in part, by persistent factors.  One factor holding down both core and all-items inflation may be low expected inflation. Readings on market-based measures of inflation compensation remain substantially below where they were before the middle of 2014, and survey-based measures of longer-term inflation expectations also remain low by historical standards.  Moreover, the labor market may not yet have reached maximum sustainable employment. The unemployment rate has declined about ¾ percentage point over the past year, and average job gains have been solid; nonetheless, wages have shown little sign of accelerating. The employment-to-population ratio for prime-age workers has been rising but still remains below its pre-recession level, suggesting scope for further labor market strengthening. In addition, the labor force participation rate jumped 0.3 percentage point to 63.0 percent in February. The behavior of labor force participation rate over the past four years suggests that its trend may well be higher than previously estimated. Policy Strategy  Policymakers may be concerned that longer-term inflation expectations have declined materially in recent years and could drift down further if inflation continues to run below 2 percent. Policymakers may further judge that raising the federal funds rate while inflation is below 2 percent runs the risk of creating the perception that the Committee sees its longer-run objective as a ceiling rather than as a symmetric objective. Page 17 of 36 Alternatives has a less accommodative “reaction function” than last year’s Committee, then Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 o In order to solidify the Committee’s commitment to its inflation objective and to prevent further erosion in inflation expectations, policymakers may favor a statement like Alternative A and the addition of the sentence “A temporary Alternatives period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and may be needed to ensure that longer-run inflation expectations are consistent with that objective.”  Policymakers may view the current state of the financial system as sound and see the potential for a buildup of risks to financial stability as limited, partly reflecting a judgment that the banking system is well capitalized and that broad measures of leverage and credit growth remain contained. In addition, policymakers may see scope to address any emerging financial stability concerns through macroprudential policies and supervisory actions that target specific risks.  Despite the likely stimulative effects of the recently enacted changes in federal taxes and spending, other policies could pose downside risk. Policymakers may judge that their ability to react to downside outcomes is limited by proximity to the effective lower bound.  On the basis of these arguments, policymakers may want to communicate that an increase in the target range for the federal funds rate is not warranted at this meeting and that future increases are unlikely until a sustained return to the 2 percent inflation objective has been achieved.  Financial market quotes and the Desk’s latest surveys indicate that market participants view an increase in the target range at the March meeting as a near certainty. Thus, a statement along the lines of Alternative A would likely be regarded as a significant change in the Committee’s policy outlook and bring down expectations of further rate hikes. If the public saw this statement as primarily reflecting policymakers’ resolve to push inflation up to or above 2 percent, then inflation compensation could rise, real longer-term interest rates would probably fall somewhat, and equity prices might rise. Lower real rates and the prospect of higher inflation likely would encourage depreciation of the dollar. Conversely, if investors read the statement as reflecting an unexpectedly downbeat assessment of the economic outlook, equity prices and inflation compensation could fall. Page 18 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 IMPLEMENTATION NOTE If the Committee decides to maintain the current target range for the federal funds interest rates on required and excess reserves, the offering rate on overnight reverse repurchase agreements, and the primary credit rate—would be issued. 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 in these three policy tools would be issued. Draft implementation notes that correspond to these two cases appear on the following pages; struck-out text indicates language deleted from the January directive and implementation note, bold red underlined text indicates added language, and blue underlined text indicates text that links to websites. Page 19 of 36 Alternatives rate, an implementation note that indicates no change to its administered rates—the Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Implementation Note for March 2018 Alternative A Release Date: March 21, 2018 Alternatives Decisions Regarding Monetary Policy Implementation The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on January 31 March 21, 2018:  The Board of Governors of the Federal Reserve System voted [ unanimously ] to maintain the interest rate paid on required and excess reserve balances at 1.50 percent, effective February 1 March 22, 2018.  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 February 1 March 22, 2018, 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 1-1/4 to 1-1/2 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 1.25 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 percounterparty limit of $30 billion per day. The Committee directs the Desk to continue rolling over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month March that exceeds $12 billion, and to continue reinvesting in agency mortgagebacked securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month March that exceeds $8 billion. Effective in April, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $18 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $12 billion. Small deviations from these amounts for operational reasons are acceptable. Page 20 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018  In a related action, the Board of Governors of the Federal Reserve System voted [ unanimously ] to approve the establishment of the primary credit rate at the existing level of 2.00 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. More information regarding open market operations and reinvestments may be found on the Federal Reserve Bank of New York’s website. Page 21 of 36 Alternatives 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.” Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Implementation Note for March 2018 Alternatives B and C Release Date: March 21, 2018 Alternatives Decisions Regarding Monetary Policy Implementation The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on January 31 March 21, 2018:  The Board of Governors of the Federal Reserve System voted [ unanimously ] to maintain raise the interest rate paid on required and excess reserve balances at to 1.50 1.75 percent, effective February 1 March 22, 2018.  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 February 1 March 22, 2018, 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 1-1/4 to 1-1/2 to 1-3/4 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 1.25 1.50 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 percounterparty limit of $30 billion per day. The Committee directs the Desk to continue rolling over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month March that exceeds $12 billion, and to continue reinvesting in agency mortgagebacked securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month March that exceeds $8 billion. Effective in April, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $18 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $12 billion. Small deviations from these amounts for operational reasons are acceptable. Page 22 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018  In a related action, the Board of Governors of the Federal Reserve System voted [ unanimously ] to approve the establishment of a 1/4 percentage point increase in the primary credit rate at the existing level of 2.00 to 2.25 percent, effective March 22, 2018. In taking this action, the Board approved requests to establish that rate submitted by the Boards of Directors of the Federal Reserve Banks of . . . 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. More information regarding open market operations and reinvestments may be found on the Federal Reserve Bank of New York’s website. Page 23 of 36 Alternatives 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.” Authorized for Public Release Alternatives Class I FOMC - Restricted Controlled (FR) March 15, 2018 (This page is intentionally blank.) Page 24 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Balance Sheet and Income Projections The staff has prepared projections of the Federal Reserve’s balance sheet and elements of the associated income statement that are consistent with the baseline economic outlook presented in Tealbook A. Relative to the January Tealbook, the normalization of the size of the balance sheet occurs one quarter later, and the higher interest rate paths in the latest staff economic forecast lead to a larger unrealized loss position of the SOMA portfolio. Key features of these projections are described below. SOMA redemptions and reinvestments. As reported in the exhibit titled “Redemptions and Reinvestments of SOMA Principal Payments,” the staff projects that the balance sheet normalization program initiated in October 2017 will lead to the during the current quarter. Over 2018 as a whole, holdings of Treasury and agency securities are projected to decline by about $230 billion and $140 billion, respectively. During this same period, about $200 billion of Treasury securities and about $60 billion of agency securities will be reinvested.1 The projections for agency securities are particularly uncertain because unscheduled prepayments depend on a number of factors that are difficult to predict, including the realized path of mortgage rates. Evolution of the size of the balance sheet. The size of the balance sheet is projected to normalize in the third quarter of 2021, about one month later than in the January Tealbook (see the exhibit titled “Total Assets and Selected Balance Sheet Items” and the table that follows the exhibit).2 The revision in the timing of normalization reflects higher MBS holdings due to lower prepayments, as well as a slower pace of 1 Once the cap on monthly reductions in SOMA holdings of Treasury securities has been fully phased in, reinvestments of principal from maturing Treasury securities will primarily take place in the middle month of each quarter. In contrast, under the staff’s current baseline forecast of rising longer-term interest rates, the maximum $20 billion cap on monthly redemptions of agency securities is not projected to bind. 2 Many factors will influence the size at which the balance sheet will be normalized, including banks’ post-crisis underlying demand for reserves. Generally speaking, the size of the balance sheet is considered to be normalized when the resumption of purchases of Treasury securities is required in order to maintain the desired longer-run level of reserve balances and accommodate the expansion of other key non-reserve liability items. Page 25 of 36 Balance Sheet & Income redemption of $36 billion of Treasury securities and $24 billion of agency securities Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Redemptions and Reinvestments of SOMA Principal Payments Projections for Treasury Securities Projections for Agency Securities (Billions of dollars) (Billions of dollars) Redemptions Period Reinvestments Period Redemptions Cumulative Period Reinvestments Cumulative Period Cumulative 2018: Q1 36.0 54.0 74.8 102.5 2018: Q1 24.0 36.0 40.7 101.8 2018: Q2 54.0 108.0 65.7 168.2 2018: Q2 36.0 72.0 17.7 119.5 115.8 0.6 120.1 2018: Q3 67.0 175.0 27.4 195.6 2018: Q3 43.8 2018: Q4 72.0 247.1 29.2 224.9 2018: Q4 38.2 154.1 0.0 120.1 2019 270.8 517.8 114.2 339.1 2019 143 297.0 0.0 120.1 2020 209.1 726.9 85.4 424.5 2020 128.1 425.1 0.0 120.1 2021 271.1 998.1 69.8 494.3 2021 118.4 543.5 0.0 120.1  Balance Sheet & Income Cumulative  Since October 2017. Since October 2017. SOMA Treasury Securities Principal Payments Monthly SOMA Agency Debt and MBS Principal Payments Billions of dollars 80 Monthly Billions of dollars 80 Redemptions Reinvestments Monthly Cap Redemptions Reinvestments Monthly Cap Projections Projections 60 60 40 40 20 20 0 0 2017 2018 2019 2020 Note: Projection dependent on assumed distribution of future Treasury issuance. 2017 2018 2019 2020 Note: Projection dependent on future interest rates and housing market developments. Page 26 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Total Assets and Selected Balance Sheet Items March Tealbook baseline Reserve Balances Billions of dollars 5500 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 Monthly 2500 2000 1500 1000 500 Billions of dollars Monthly Billions of dollars 4500 Monthly 4000 3500 3000 2500 2000 1500 1000 500 Assets as a Share of GDP 2030 2028 2026 2024 2022 2020 2018 2016 2014 2012 2010 2030 2028 2026 2024 2022 2020 2018 2016 2014 2012 2010 0 Liabilities as a Share of GDP Percent Treasury Securities Agency Securities Other Assets Loans Percent Federal Reserve notes in circulation Treasury General Account Other Liabilities Total Reserves 30 25 Projections 30 25 Projections 20 Page 27 of 36 2030 2028 2026 2024 2022 0 2020 0 2018 5 2016 5 2014 10 2012 10 2010 15 2008 15 2006 2030 2028 2026 2024 2022 2020 2018 2016 2014 2012 2010 20 2008 2400 2200 2000 1800 1600 1400 1200 1000 800 600 400 200 0 Balance Sheet & Income 2030 2028 2026 2024 2022 2020 2018 2016 2014 0 SOMA Agency MBS Holdings SOMA Treasury Holdings 2006 3500 3000 2030 2028 2026 2024 2022 2020 2018 2016 2014 2012 2010 Monthly 2010 Billions of dollars 2012 Total Assets January Tealbook baseline Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Federal Reserve Balance Sheet End-of-Year Projections -- March Tealbook (Billions of dollars) Feb 28, 2018 Total assets 4,393 2018 2020 2022 2024 2026 2030 4,045 3,273 3,181 3,335 3,518 3,954 Selected assets Loans and other credit extensions* Securities held outright U.S. Treasury securities 2 Balance Sheet & Income 0 0 0 0 0 4,189 3,869 3,124 3,050 3,218 3,413 3,867 2,424 2,220 1,747 1,895 2,224 2,553 3,237 Agency debt securities Agency mortgage-backed securities 0 4 1,760 2 2 2 2 2 2 1,646 1,375 1,152 991 857 627 Unamortized premiums 156 141 111 91 76 63 43 Unamortized discounts -14 -13 -10 -8 -7 -6 -4 61 48 48 48 48 48 48 Total other assets Total liabilities 4,354 4,006 3,233 3,137 3,287 3,465 3,890 1,580 1,663 1,874 2,003 2,132 2,286 2,652 Selected liabilities Federal Reserve notes in circulation Reverse repurchase agreements Deposits with Federal Reserve Banks Reserve balances held by depository institutions U.S. Treasury, General Account Other deposits 277 255 230 230 230 230 2,484 2,008 1,099 898 919 944 1,003 2,208 1,656 721 500 500 500 500 199 277 302 323 344 369 428 77 75 75 75 75 75 75 1 0 0 0 0 0 0 39 39 40 44 48 53 63 Earnings remittances due to the U.S. Treasury Total Federal Reserve Bank capital** 330 Source: Federal Reserve H.4.1 statistical releases and staff calculations. Note: Components may not sum to totals due to rounding. *Loans and other credit extensions includes primary, secondary, and seasonal credit; central bank liquidity swaps; and net portfolio holdings of Maiden Lane LLC. **Total capital includes capital paid-in and capital surplus accounts. Page 28 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 growth in Federal Reserve notes in the near term, two factors which imply higher reserve balances of depository institutions throughout the projection period.3 From the start of the balance sheet normalization program in October 2017 to its conclusion in 2021, the Federal Reserve’s securities holdings are projected to decline by about $1.3 trillion, with holdings of Treasury and agency securities shrinking by about $800 billion and $475 billion, respectively. At the time of normalization:  Reserve balances reach the assumed longer-run level of $500 billion;4  Total assets are projected to stand at roughly $3 trillion, with the SOMA portfolio consisting of about $1.6 trillion in Treasury securities and $1.3 trillion in MBS. Once these declines in asset holdings have taken place, the size of the balance of about 25 percent in late 2014 and a pre-crisis average of about 6 percent. After the size of the balance sheet is normalized, SOMA holdings will rise, keeping pace with the projected increases in Federal Reserve liabilities including Federal Reserve notes in circulation, the Treasury General Account (TGA), and Federal Reserve Bank capital. However, when expressed as a share of nominal GDP, Federal Reserve assets and liabilities are projected to edge down, as their pace of expansion is projected to be slightly slower than that of current-dollar GDP. Federal Reserve remittances. Remittances to the Treasury are projected to decline to about $55 billion this year from $80 billion in 2017.5 This decline reflects both the projected increases in the interest rate paid on reserve balances associated with future increases in the target range for the federal funds rate (see the “Income Projections” 3 Other factors contributing to this outcome are a slight decrease in capital as a result of the Bipartisan Budget Act of 2018, as well as a slight decrease in projected foreign repo pool balances. 4 Other noteworthy assumptions about liability items underlying the projections are as follows: The Treasury General Account is assumed to increase in line with nominal GDP; Federal Reserve notes in circulation are assumed to increase at an average annual pace of about 6 percent through 2020 and at the same pace as nominal GDP thereafter; the foreign repo pool and balances in the accounts of designated financial market utilities remain at their February 2018 levels of about $232 billion and $70 billion, respectively; and take-up at the overnight RRP facility is assumed to maintain a value of $100 billion until the level of reserve balances reaches $1 trillion, at which point take-up declines to zero over the course of one year. 5 The Federal Reserve Board’s public announcement of remittances to the Treasury for 2017 is available at https://www.federalreserve.gov/newsevents/pressreleases/other20180110a.htm. Page 29 of 36 Balance Sheet & Income sheet is projected to stand at roughly 13 percent of nominal GDP, compared with a peak Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Income Projections March Tealbook baseline Interest Income Interest Expense 0 Billions of dollars 140 Annual −20 −20 Billions of dollars End of year Page 30 of 36 400 300 200 100 0 −100 −200 −300 2030 2028 2026 2024 2022 2020 2018 2016 −400 2014 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 2030 2028 2026 2024 2000−2007 2022 2030 0 2028 0 2026 20 2024 40 20 2022 40 2020 60 2018 60 2016 80 2014 80 2012 100 2012 Annual 2020 120 100 2030 2028 2026 2024 2022 2020 2018 140 Memo: Unrealized Gains/Losses Percent 2018 2030 0 2028 20 2026 20 2024 40 2022 60 40 2020 60 2018 80 2016 80 2012 100 2030 2028 2026 2024 2022 2020 2018 100 Remittances as a Percent of GDP 2016 140 120 120 2016 2014 Annual 2014 160 Earnings Remittances to Treasury Billions of dollars 2012 Annual 120 Realized Capital Gains 2012 Billions of dollars 160 140 2016 2014 2012 Annual 2014 Billions of dollars Balance Sheet & Income January Tealbook baseline −500 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 exhibit), and the $2.5 billion reduction in surplus.6 Total interest expense is projected to rise to about $51 billion this year, while interest income from SOMA holdings is expected to decline slightly to $110 billion. As the target range for the federal funds rate moves up and the size of the SOMA portfolio decreases, remittances are expected to bottom out at about $31 billion in 2020. Thereafter, remittances begin to increase, particularly once the size of the balance sheet is normalized and higher-yielding Treasury securities are being added to the SOMA portfolio. Projected remittances over the next few years are similar to the January Tealbook baseline. Subsequently, projected remittances are higher, largely due to the upward revision to the projection of the interest rates the SOMA will receive on Treasury securities purchased after normalization. As shown in the bottom left panel of the “Income Projections” exhibit, annual remittances average about 0.25 percent of nominal Unrealized gains or losses. The staff estimates that the SOMA portfolio was in a net unrealized loss position of about $40 billion at the end of February. With longer-term rates expected to continue to rise over the next several years, the unrealized loss position is expected to reach nearly $300 billion in 2020:Q1. Of this amount, $120 billion is attributable to Treasury securities and $180 billion to agency MBS. The unrealized loss position subsequently narrows, in part because the value of securities acquired under the Federal Reserve’s large-scale asset purchase programs returns to par as those securities approach maturity. Relative to the January Tealbook baseline, the net unrealized position is projected to be, on average, about $40 billion more negative along the entire projection horizon, with this revision due to higher trajectories of medium- and longer-term interest rates. 6 We continue to assume that the FOMC will set a 25 basis-point-wide target range for the federal funds rate for the duration of the projection, and that the interest rate paid on excess reserve balances and the offering rate on overnight RRPs will be set at the top and bottom of the range, respectively. Page 31 of 36 Balance Sheet & Income GDP over the projection period, slightly higher than the pre-crisis average. Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Projections for the 10-Year Treasury Term Premium Effect (Basis Points) Date March Tealbook January Tealbook Balance Sheet & Income Quarterly Averages 2018:Q1 Q2 Q3 Q4 -86 -83 -80 -77 -84 -81 -79 -76 2019:Q4 2020:Q4 2021:Q4 2022:Q4 2023:Q4 2024:Q4 2025:Q4 2026:Q4 2027:Q4 2028:Q4 2029:Q4 2030:Q4 -66 -58 -53 -49 -46 -43 -40 -37 -35 -33 -31 -29 -66 -58 -52 -49 -46 -43 -40 -37 -35 -33 -31 -30 Page 32 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Term premium effect. As shown in the table “Projections for the 10-Year Treasury Term Premium Effect,” SOMA securities held as a result of the Federal Reserve’s asset purchase programs are currently estimated to be reducing the term premium in the 10-year Treasury yield by 86 basis points; this effect is projected to fade gradually over time.7 This projection is little changed from the previous Tealbook. SOMA characteristics. As shown in the top panel of the “Projections for the Characteristics of SOMA Treasury Securities Holdings” exhibit, the weighted-average duration of the SOMA Treasury portfolio is currently about six years. The weightedaverage duration of that portfolio is projected to increase throughout the process of balance sheet normalization, as the pace of redemptions picks up and longer-duration securities become a larger share of the portfolio. SOMA Treasury portfolio is projected to decline as the Federal Reserve resumes purchases of Treasury securities. The initial sharp decline in duration results from the staff’s assumption that these purchases will be limited to Treasury bills until they account for one-third of the Federal Reserve’s Treasury securities portfolio, close to the pre-crisis composition (currently the SOMA portfolio contains no Treasury bills). Thereafter, purchases of Treasury securities are assumed to be spread across the maturity spectrum (see the bottom panel of the exhibit). 7 The estimated path of the term premium effect depends on the difference between the expected path of the Federal Reserve’s balance sheet over coming years and a benchmark counterfactual projection based on the configuration of the balance sheet that prevailed before the financial crisis of 2007-2008. In particular, in the benchmark counterfactual balance sheet projection, the staff assumes a longer-run level of reserves of $100 billion and a constant, minimal TGA level, consistent with the pre-crisis minimum level of excess reserve balances and the Treasury’s pre-crisis cash management policy. Page 33 of 36 Balance Sheet & Income After normalization of the size of the balance sheet in 2021, the duration of the Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Projections for the Characteristics of SOMA Treasury Securities Holdings SOMA Weighted−Average Treasury Duration Monthly Years March Tealbook baseline January Tealbook baseline 10 9 8 7 6 5 Balance Sheet & Income 4 3 2 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 Maturity Composition of SOMA Treasury Portfolio March Tealbook baseline Billions of Dollars Maturing in less than 1 year Maturing between 1 year and 5 years Maturing between 5 years and 10 years Maturing in greater than 10 years 3500 3000 2500 2000 Normalization 1500 1000 500 0 2018 2020 2022 2024 Page 34 of 36 2026 2028 2030 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 Abbreviations ABS asset-backed securities AFE advanced foreign economy BEA Bureau of Economic Analysis, Department of Commerce BHC bank holding company CDS credit default swaps 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 DFMU Designated Financial Market Utilities ECB European Central Bank 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 ISM Institute for Supply Management Page 35 of 36 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 15, 2018 LIBOR London interbank offered rate LSAPs large-scale asset purchases 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 QS Quantitative Surveillance 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) TCJA Tax Cuts and Jobs Act of 2017 TGA U.S. Treasury’s General Account TIPS Treasury inflation-protected securities TPE Term premium effects ZLB zero lower bound Page 36 of 36 

Federal Reserve (2018, March 20). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_20180321_part2

@misc{wtfs_greenbook_20180321_part2,
  author = {Federal Reserve},
  title = {Greenbook/Tealbook},
  year = {2018},
  month = {Mar},
  howpublished = {Greenbooks, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/greenbook_20180321_part2},
  note = {Retrieved via When the Fed Speaks corpus}
}