Monetary Policy Report

For use at 10:00 a.m., EST February 14, 2017 M P r onetary olicy ePort February 14, 2017 Board of Governors of the Federal Reserve System L t etter of ransmittaL Board of Governors of the Federal Reserve System Washington, D.C., February 14, 2017 The President of the Senate The Speaker of the House of Representatives The Board of Governors is pleased to submit its Monetary Policy Report pursuant to section 2B of the Federal Reserve Act. Sincerely, Janet L. Yellen, Chair S L -r g m P S tatement on onger un oaLS and onetary oLicy trategy Adopted effective January 24, 2012; as amended effective January 31, 2017 The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society. Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee’s policy decisions reflect its longer-run goals, its medium- term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee’s goals. The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances. The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee’s policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants’ estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC’s Summary of Economic Projections. For example, in the most recent projections, the median of FOMC participants’ estimates of the longer-run normal rate of unemployment was 4.8 percent. In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee’s assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January. C ontents Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Part 1: Recent Economic and Financial Developments . . . . . . . . . . . . . . . . 3 Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . 33 The Outlook for Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 The Outlook for Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Appropriate Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Uncertainty and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 List of Boxes The Recovery from the Great Recession and Remaining Challenges . . . . . . . . . . . . . . . . . . . . 6 Homeownership by Race and Ethnicity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Forecast Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Note: Unless stated otherwise, the time series in the figures extend through, for daily data, February 9, 2017; for monthly data, January 2017; and, for quarterly data, 2016:Q4. In bar charts, except as noted, the change for a given period is measured to its final quarter from the final quarter of the preceding period. For figures 14, 33, and 37, note that the S&P 500 Index and the Dow Jones Bank Index are products of S&P Dow Jones Indices LLC and/or its affiliates and have been licensed for use by the Board. Copyright © 20I7 S&P Dow Jones Indices LLC, a subsidiary of the McGraw Hill Financial Inc., and/or its affiliates. All rights reserved. Redistribution, reproduction, and/or photocopying in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent, and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. 1 s ummary Labor market conditions continued to spending has been expanding at a moderate strengthen over the second half of 2016. pace, supported by solid income gains and Payroll employment has continued to post the ongoing effects of increases in wealth. solid gains, averaging 200,000 per month since The housing market has continued its gradual last June, a touch higher than the pace in the recovery, and fiscal policy at all levels of first half of 2016, though down modestly government has provided a modest boost from its 225,000-per-month pace in 2015. The to economic activity. Business investment unemployment rate has declined slightly since had been weak for much of 2016 but posted mid-2016; the 4.8 percent reading in January larger gains toward the end of the year. of this year was in line with the median of Notwithstanding a transitory surge of exports Federal Open Market Committee (FOMC) in the third quarter, the underlying pace of participants’ estimates of its longer-run exports has remained weak, a reflection of the normal level. The labor force participation appreciation of the dollar in recent years and rate has edged higher, on net, since midyear the subdued pace of foreign economic growth. despite a structural trend that is moving down as a result of changing demographics of the Domestic financial conditions have generally population. In addition, wage growth seems to been supportive of economic growth since have picked up somewhat relative to its pace of mid-2016 and remain so despite increases in a few years ago. interest rates in recent months. Long-term Treasury yields and mortgage rates moved Consumer price inflation moved higher last up from their low levels earlier last year but year but remained below the FOMC’s longer- are still quite low by historical standards. run objective of 2 percent. The price index for Broad measures of stock prices rose, and the personal consumption expenditures (PCE) financial sector outperformed the broader increased 1.6 percent over the 12 months equity market. Spreads of yields of both ending in December, 1 percentage point more speculative- and investment-grade corporate than in 2015, importantly reflecting that bonds over yields of comparable-maturity energy prices have turned back up and declines Treasury securities declined from levels that in non-oil import prices have waned. The were somewhat elevated relative to the past PCE price index excluding food and energy several years. Even with an ongoing easing in items, which provides a better indication than mortgage credit standards, mortgage credit is the headline index of where overall inflation still relatively difficult to access for borrowers will be in the future, rose 1.7 percent over with low credit scores, undocumented income, the 12 months ending in December, about or high debt-to-income ratios. Student and ¼ percentage point more than its increase auto loans are broadly available, including in 2015. Meanwhile, survey-based measures to borrowers with nonprime credit scores, of longer-run inflation expectations have and the availability of credit card loans for remained generally stable, though some are at such borrowers appears to have expanded relatively low levels; market-based measures somewhat over the past several quarters. In of inflation compensation have moved up in foreign financial markets, meanwhile, equities, recent months but also are at low levels. bond yields, and the exchange value of the U.S. dollar have all risen, and risk spreads have Real gross domestic product is estimated to generally declined since June. have increased at an annual rate of 2¾ percent in the second half of the year after rising Financial vulnerabilities in the U.S. financial only 1 percent in the first half. Consumer system overall have continued to be moderate 2 SUMMARy since mid-2016. U.S. banks are well capitalized The Committee has continued to emphasize and have sizable liquidity buffers. Funding that, in determining the timing and size of markets functioned smoothly as money market future adjustments to the target range for mutual fund reforms took effect in October. the federal funds rate, it will assess realized The ratio of household debt to income has and expected economic conditions relative changed little in recent quarters and is still to its objectives of maximum employment far below the peak level it reached about a and 2 percent inflation. The Committee has decade ago. Nonfinancial corporate business expected that economic conditions will evolve leverage has remained elevated by historical in a manner that will warrant only gradual standards even though outstanding riskier increases in the federal funds rate, and that the corporate debt declined slightly last year. In federal funds rate will likely remain, for some addition, valuation pressures in some asset time, below levels that are expected to prevail classes increased, particularly late last year. in the longer run. Consistent with this outlook, The Federal Reserve has continued to take in the most recent Summary of Economic steps to strengthen the financial system, Projections (SEP), which was compiled at including finalizing a rule that imposes total the time of the December meeting of the loss-absorbing capacity and long-term debt FOMC, most participants projected that the requirements on the largest internationally appropriate level of the federal funds rate active bank holding companies as well as would be below its longer-run level through concluding an extensive review of its stress- 2018. (The December SEP is included as Part 3 testing and capital planning programs. of this report.) In December, the FOMC raised the target With respect to its securities holdings, the for the federal funds rate to a range of Committee has stated that it will continue to ½ to ¾ percent after maintaining it at ¼ to reinvest principal payments from its securities ½ percent for a year. The decision to increase portfolio, and that it expects to maintain this the federal funds rate reflected realized policy until normalization of the level of and expected labor market conditions and the federal funds rate is well under way. This inflation. With the stance of monetary policy policy of keeping the Committee’s holdings remaining accommodative, the Committee has of longer-term securities at sizable levels anticipated some further strengthening in labor should help sustain accommodative financial market conditions and a return of inflation to conditions. the Committee’s 2 percent objective. 3 P 1 art r e f d eCent ConomiC and inanCiaL eveLoPments Labor market conditions continued to improve during the second half of last year and early this year. Payroll employment has increased 200,000 per month, on average, since June, and the unemployment rate has declined slightly further, reaching 4.8 percent in January, in line with the median of Federal Open Market Committee (FOMC) participants’ estimates of its longer-run normal level. The labor force participation rate has edged higher, on net, which is all the more notable given a demographically induced downward trend. The 12-month change in the price index for overall personal consumption expenditures (PCE) was 1.6 percent in December—still below the Committee’s 2 percent objective but up noticeably from 2015, when the increase in top-line prices was held down by declines in energy prices. The 12-month change in the index excluding food and energy prices (the core PCE price index) was 1.7 percent last year. Measures of longer-term inflation expectations have been generally stable, though some survey-based measures remain lower than a few years ago; market-based measures of inflation compensation moved higher in recent months but also remain below their levels from a few years ago. Real gross domestic product (GDP) is estimated to have increased at an annual rate of 2¾ percent over the second half of 2016 after increasing just 1 percent in the first half. The economic expansion continues to be supported by accommodative financial conditions—including the still- low cost of borrowing for many households and businesses—and gains in household net wealth, which has been boosted further by a rise in the stock market in recent months and by increases in households’ real income spurred by continuing job gains. However, net exports were a moderate drag on GDP growth in the second half, as imports picked up and the rise in the exchange value of the dollar in recent years remained a drag on export demand. Domestic Developments The labor market has continued to 1. Net change in payroll employment tighten gradually . . . 3-month moving averages Thousands of jobs Labor market conditions strengthened over the second half of 2016 and early this year. Payroll 400 Private employment has continued to post solid gains, 200 averaging 200,000 per month since last June + (figure 1). This rate of job gains is a bit higher _0 than that seen during the first half of 2016, Total nonfarm 200 though it is a little slower than the 225,000 400 monthly pace in 2015. The unemployment rate 600 has declined slightly further, on net, since the middle of last year. After dipping as low as 800 4.6 percent in November, the unemployment 2009 2010 2011 2012 2013 2014 2015 2016 2017 rate stood at 4.8 percent in January, in line with the median of FOMC participants’ SOURCE: Department of Labor, Bureau of Labor Statistics. estimates of its longer-run normal level. The labor force participation rate, at 62.9 percent, is up slightly since June 2016. Changing demographics and other longer-run structural changes in the labor market likely 4 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS have continued to put downward pressure on the participation rate. A flat or increasing trajectory of the participation rate should therefore be viewed as a cyclical improvement 2. Labor force participation rate and relative to that downward trend. Reflecting employment-to-population ratio the slightly higher participation rate and the Monthly Percent small drop in the unemployment rate, the employment-to-population ratio has moved 68 up about ¼ percentage point since mid-2016 (figure 2). (For additional historical context 66 on the economic recovery, see the box “The 64 Recovery from the Great Recession and Labor force participation rate 62 Remaining Challenges.”) 60 . . . and is close to full employment 58 Employment-to-population ratio Other indicators are also consistent with a healthy labor market. Layoffs as a share 2001 2003 2005 2007 2009 2011 2013 2015 2017 of private employment, as measured in the NOTE: Both series are a percentage of the population aged 16 and over. Job Openings and Labor Turnover Survey SOURCE: Department of Labor, Bureau of Labor Statistics. (JOLTS), remained at a low level through December, and recent readings on initial claims for unemployment insurance, a more timely measure, point to a very low pace of involuntary separations. The JOLTS quits rate has generally continued to trend up and is now close to pre-crisis levels, indicating that workers feel increasingly confident about their employment opportunities. In addition, the rate of job openings as a share of private employment has remained near record-high levels. The share of workers who are employed part time but would like to work full time—which is part of the U-6 measure of underutilization from the Bureau of Labor Statistics (BLS)—is still somewhat elevated, however, even though it has declined further; as a result, the gap between U-6 and the headline unemployment rate is somewhat wider than it was in the years before the Great Recession (figure 3). The jobless rate for African Americans also continued to edge lower in the second half of 2016, while the rate for Hispanics remained flat; as with the overall unemployment rate, these rates are near levels seen leading into the recession. Despite these gains, the average unemployment rates for these groups of Americans have remained high relative to the aggregate, and those gaps have not narrowed over the past decade (figure 4). MONETARy POLICy REPORT: FEBRUARy 2017 5 3. Measures of labor underutilization Monthly Percent 18 U-6 16 U-4 14 U-5 12 10 8 Unemployment rate 6 4 2005 2007 2009 2011 2013 2015 2017 NOTE: Unemployment rate measures total unemployed as a percentage of the labor force. U-4 measures total unemployed plus discouraged workers, as a percentage of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work because they believe no jobs are available for them. U-5 measures total unemployed plus all marginally attached to the labor force, as a percentage of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not in the labor force, want and are available for work, and have looked for a job in the past 12 months. U-6 measures total unemployed plus all marginally attached workers plus total employed part time for economic reasons, as a percentage of the labor force plus all marginally attached workers. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research. SOURCE: Department of Labor, Bureau of Labor Statistics. 4. Unemployment rate by race and ethnicity Monthly Percent 18 Black or African American 16 14 12 Hispanic or Latino 10 White 8 6 Asian 4 2 2005 2007 2009 2011 2013 2015 2017 NOTE: Unemployment rate measures total unemployed as a percentage of the labor force. Persons whose ethnicity is identified as Hispanic or Latino may be of any race. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research. SOURCE: Department of Labor, Bureau of Labor Statistics. 6 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS The Recovery from the Great Recession and Remaining Challenges The Great Recession severely affected the A. Median household income, by race and ethnicity U .S . economy . . . Annual Inflation-adjusted dollars The Great Recession of 2008 and 2009, and the financial crisis that precipitated it, resulted in 80,000 massive job losses and falling incomes for American Asian households. The Great Recession was, along many 70,000 dimensions, the most severe downturn since the Great Depression almost 80 years earlier. Economic output White 60,000 declined outright for 18 months, leaving real gross 50,000 domestic product (GDP) 4½ percent below its previous Hispanic or Latino peak. More than 8½ million jobs were lost, on net, 40,000 and the unemployment rate soared from 4½ percent in 2007 to a peak of 10 percent in late 2009 (text Black or African American 30,000 figure 3). The labor force participation rate (LFPR), the fraction of the population either employed or counted 2007 2009 2011 2013 2015 as unemployed, fell steeply, from 66 percent in 2007 to NOTE: Race refers to the race of the head of household. The Hispanic and 63 percent in 2014 (text figure 2). Household incomes Latino ethnicity and race categories are not mutually exclusive. Some individuals, for example, are both Hispanic and white, and they are tumbled, with real income for the median family represented in both lines. declining more than 8 percent from 2007 to 2012. SOURCE: Department of Commerce, Bureau of the Census (2016), Income The hardships were particularly acute for certain and Poverty in the United States: 2015, Table A-1: Households by Total Money Income, Race, and Hispanic Origin of Householder: 1967 to 2015 groups of Americans. As text figure 4 shows, (Washington: Census Bureau, September), www.census.gov/library/public- unemployment rates for blacks and Hispanics rose ations/2016/demo/p60-256.html. considerably more during the recession than did such rates for the nation as a whole. Of particular note, inflation-adjusted median household incomes for black expansion are all the more noteworthy given these households declined more than 12 percent from peak demographic pressures. to trough, substantially more in percentage terms than The labor market at present is likely close to being for white, Hispanic, or Asian households (figure A).1 at full employment. The unemployment rate is near the median of Federal Open Market Committee (FOMC) participants’ assessments of its longer-run normal value. . . . but considerable progress has been made In addition, real GDP now stands 11 percent above its In the eight years since the crisis, the U.S. economy pre-recession peak, and it is approaching, though still has made considerable progress across a broad range a bit below, the Congressional Budget Office’s estimate of measures; this progress has occurred while the of potential output—that is, the maximum sustainable resilience of the financial system has been shored level of economic output.2 up. More than 15 million jobs have been created, on Incomes for the median family have mostly net, since the fall of 2009, and the unemployment rate recovered from the Great Recession. Of note, real has fallen by half. In addition, the LFPR has moved median income is reported to have risen 5.2 percent roughly sideways since 2014, which should be viewed in 2015 (figure B). as a cyclical improvement given the demographic The recovery compares favorably with those of changes and other secular trends that have put other advanced economies. GDP has increased faster downward pressure on participation for the past and unemployment has declined more quickly in the 10 years. The robust job gains seen during the current United States than in other major advanced economies (figures C and D). And the Federal Reserve’s challenges in getting inflation back up to target are similar to, 1. Measures of household income derived from surveys— but not as severe as, those faced by some other major such as the Current Population Survey’s Annual Social and monetary authorities in the past few years. Although Economic Supplement, which informs the Census Bureau’s official statistics—may not fully capture earned income (such as from the self-employed) and unearned income (such as 2. Congressional Budget Office (2017), The Budget transfers and retirement income). These issues are likely to be and Economic Outlook: 2017 to 2027 (Washington: CBO, much more pronounced for the various subgroups than they January), p. 41, www.cbo.gov/sites/default/files/115th- are for the national median. congress-2017-2018/reports/52370-outlook.pdf. MONETARy POLICy REPORT: FEBRUARy 2017 7 has averaged only about 2 percent per year during this B. Indexed household income, by percentile expansion, the slowest pace of any postwar recovery (figure E). In part, that subdued pace is due to slower Annual Inflation-adjusted dollars, 2007 = 100 growth in the labor force in recent decades compared 106 with much of the postwar period.3 104 Another source of slow GDP growth has been lackluster labor productivity growth (text figure 6). 102 Since 2008, output per hour in the business sector 90th 100 has risen about 1 percent per year, far below the pace 98 that prevailed before the recession. Cyclical factors, 96 80th like weak business investment and firms rebuilding 50th (median) 94 workforces after cutting unusually deeply during 92 20th the crisis, likely explain some of the slow rise in 90 productivity during this expansion. But structural factors 10th 88 may also be at play, such as declines in innovation, reduced business dynamism, or decreased product 2007 2009 2011 2013 2015 market competition.4 The productivity slowdown has SOURCE: Department of Commerce, Bureau of the Census (2016), Income taken place in most advanced economies, which and Poverty in the United States: 2015, Table A-2: Selected Measures of Household Income Dispersion: 1967 to 2015 (Washington: Census Bureau, suggests a role for structural factors not specific to the September), www.census.gov/library/publications/2016/demo/p60-256.html. United States. (continued on next page) consumer price inflation, as measured by the price index for personal consumption expenditures, has run 3. In particular, the Congressional Budget Office estimates below the FOMC’s 2 percent objective through most of that the contribution to potential GDP growth from trend the expansion, in recent months inflation has moved labor force growth is 2 percentage points lower today than it was 40 years ago. This development reflects a slowing of closer to the Committee’s target (text figure 7). population growth and a switch from a rising LFPR to a falling one, among other factors. See Congressional Budget Office, Nonetheless, challenges remain Budget and Economic Outlook, table 2-3, p. 58, in note 2. 4. See Robert J. Gordon (2016), The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil While much progress has been made, important War (Princeton, N.J.: Princeton University Press); Steven J. challenges remain for the U.S. economy. GDP growth C. Real gross domestic product in international context D. Unemployment rate in international context Annual Percent change from 2009 Annual Percentage point change from 2009 Euro area 3 18 2 15 1 United Kingdom + 12 United States _0 9 Japan 1 2 Japan United Kingdom 6 United States 3 3 Euro area + 4 _0 5 2010 2012 2014 2016 2010 2012 2014 2016 SOURCE: Organisation for Economic Co-operation and Development SOURCE: Organisation for Economic Co-operation and Development (2017), “OECD Economic Outlook No. 100 (Edition 2016/2),” OECD (2017), “OECD Economic Outlook No. 100 (Edition 2016/2),” OECD Economic Outlook: Statistics and Projections (database), http://dx.doi. Economic Outlook: Statistics and Projections (database), http://dx.doi.org org/10.1787/7fa317bf-en (accessed January 2017). /10.1787/7fa317bf-en (accessed January 2017). 8 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS The Recovery from the Great Recession and Remaining Challenges (continued) Meanwhile, despite the notable pickup in 2015, real Similarly, the economic circumstances of blacks incomes for the median family are still a bit lower than and Hispanics have improved since the depths of the they were prior to the recession. Moreover, the gains recession, but they remain worse, on average, than have not been uniformly distributed; families at the those of whites or Asians. Unemployment rates for 10th percentile of the income distribution earned about blacks and Hispanics continue to be well above those 4 percent less in 2015 than they did in 2007, while for their white and Asian counterparts (text figure 4), families at the 90th percentile earned about 4 percent while incomes for these groups have stayed noticeably more than before the Great Recession (figure B). lower (figure A). These challenges lie substantially beyond the reach of monetary policy to address. Monetary policy cannot, Davis and John Haltiwanger (2014), “Labor Market Fluidity for instance, generate technological breakthroughs or and Economic Performance,” NBER Working Paper Series address the root causes of inequality. 20479 (Cambridge, Mass.: National Bureau of Economic Research, September); and Philippe Aghion, Nick Bloom, Richard Blundell, Rachel Griffith, and Peter Howitt (2005), E. Real gross domestic product in historical context “Competition and Innovation: An Inverted-U Relationship,” Quarterly Journal of Economics, vol. 120 (May), pp. 701–28. Quarterly Percent change from business cycle trough Economists are divided about the causes of the productivity slowdown and their consequences for the outlook. For an 45 optimistic view, see Erik Brynjolfsson and Andrew McAfee (2014), The Second Machine Age: Work, Progress, and 1982 1991 40 Prosperity in a Time of Brilliant Technologies (New york: W.W. 35 Norton & Company). For a less optimistic perspective, see Gordon, Rise and Fall of American Growth, earlier in this note. 30 Others have argued that difficulties associated with economic 1975 25 measurement may exaggerate the slowdown; see, for example, David M. Byrne, John G. Fernald, and Marshall B. 2002 20 Reinsdorf (2016), “Does the United States Have a Productivity 2009 15 Slowdown or a Measurement Problem?” Brookings Papers on Economic Activity, Spring, pp. 109–57, https://www.brookings. 10 edu/wp-content/uploads/2016/03/byrnetextspring16bpea.pdf. 5 Another, more optimistic explanation is that the slowdown in productivity reflects a “constructive pause” as firms adopt 0 4 8 12 16 20 24 28 32 36 40 new productivity-enhancing technology and organizational practices; see, for example, Paul A. David (1990), “The NOTE: Real gross domestic product indexed to business cycle trough as Dynamo and the Computer: An Historical Perspective on the dated by the National Bureau of Economic Research. The x-axis shows the Modern Productivity Paradox,” American Economic Review, number of quarters since the business cycle trough. vol. 80 (May), pp. 355–61. SOURCE: Department of Commerce, Bureau of Economic Analysis. MONETARy POLICy REPORT: FEBRUARy 2017 9 Labor compensation growth is picking up . . . The improving labor market appears to be 5. Measures of change in hourly compensation contributing to somewhat larger gains in labor compensation. Major BLS measures of hourly Percent change from year earlier compensation posted larger increases last year. Of these, the measures that include the costs of benefits have posted smaller gains than Atlanta Fed’s Wage Growth Tracker 4.0 wage-only measures because of a slowdown Compensation per hour, in the growth of employer health-care costs. business sector 3.0 A compensation measure computed by the Federal Reserve Bank of Atlanta, which tracks 2.0 only the wages of workers who were employed Employment cost index at two points in time spaced 12 months apart, 1.0 Average hourly earnings shows even more pickup than these BLS measures (figure 5). 2011 2013 2015 2017 NOTE: Business-sector compensation is the four-quarter percentage change . . . amid persistently slow productivity of the four-quarter moving average. For the employment cost index, change is growth over the 12 months ending in the last month of each quarter; for average hourly earnings, change is from 12 months earlier; for the Atlanta Fed’s Wage Growth Tracker, the data are shown as a three-month moving average and As in the previous several years, gains in labor extend through December 2016. SOURCE: Department of Labor, Bureau of Labor Statistics; Federal Reserve compensation last year occurred against a Bank of Atlanta, Wage Growth Tracker. backdrop of persistently slow productivity growth. Since 2008, labor productivity gains have averaged around 1 percent per year, 6. Change in business-sector output per hour well below the pace that prevailed from the mid-1990s to 2007 and somewhat below Percent, annual rate the 1974–95 average of 1½ percent per year (figure 6). Since 2011, output per hour has 4 averaged only a little more than ½ percent per year. The relatively slow pace of productivity 3 growth in recent years is in part a consequence of the slower pace of capital accumulation; 2 diminishing gains in technological innovations and downward trends in business formation 1 also may have played a role. Price inflation has picked up over the 1948– 1974– 1996– 2001– 2008– past year . . . 73 95 2000 07 present NOTE: Changes are measured from Q4 of the year immediately preceding In recent years inflation has been persistently the period through Q4 of the final year of the period. The final period is measured from 2007:Q4 through 2016:Q4. low, in part because the drop in oil prices and SOURCE: Department of Labor, Bureau of Labor Statistics. the rise in the exchange value of the dollar since mid-2014 have led to sharp declines in energy prices and relatively weak non-energy import prices. The effects of these earlier developments have been waning, however, and overall inflation has been moving up toward the FOMC’s 2 percent target; the 12-month 10 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 7. Change in the price index for personal consumption change in overall PCE prices reached expenditures 1.6 percent in December, compared with only 0.6 percent over 2015. The PCE price Monthly 12-month percent change index excluding food and energy items, which Total 3.0 provides a better indication than the headline 2.5 figure of where overall inflation will be in the Excluding food future, rose 1.7 percent over the 12 months 2.0 and energy ending in December, somewhat greater than 1.5 the 1.4 percent increase in the prior year, as 1.0 prices for a wide range of core goods and services accelerated. Nonetheless, the rate .5 + of inflation for both total and core PCE _0 prices remains below the Committee’s target (figure 7). 2010 2011 2012 2013 2014 2015 2016 NOTE: The data extend through December 2016; changes are from one year earlier. . . . as oil and other commodity prices SOURCE: Department of Commerce, Bureau of Economic Analysis. moved up moderately 8. Brent spot and futures prices The similar readings for headline and core PCE inflation last year partly reflect an upturn Weekly Dollars per barrel in crude oil in 2016 following the sharp decline 130 Spot price in the prior two years. Since July, oil prices 120 110 traded mostly in the $45 to $50 per barrel 100 range until the November OPEC agreement 90 regarding production cuts in 2017 (figure 8). Dec. 2018 futures contracts 80 In the wake of that agreement, prices moved 70 60 up to about $55, roughly $15 per barrel higher 50 since late 2015. Retail gasoline prices also rose 40 after the November OPEC agreement, but that 30 increase has partially reversed in recent weeks. 20 2012 2013 2014 2015 2016 2017 After falling during 2014 and 2015, non-oil NOTE: The data are weekly averages of daily data and extend through import prices stabilized in late 2016, supported February 9, 2017. SOURCE: NYMEX via Bloomberg. by the rise in nonfuel commodity prices as well as by an uptick in foreign inflation (figure 9). 9. Non-oil import prices and U.S. dollar exchange rate In particular, prices of metals have increased Monthly 12-month percent change in the past few months, boosted by production cuts combined with improved prospects for 20 demand both in the United States and abroad. 15 However, factors holding non-oil import prices down include dollar appreciation in the second Broad nominal dollar 10 half of 2016 and lower prices of agricultural 5 goods last fall, as U.S. harvests hit record-high + _0 levels for many crops. Non-oil import prices 5 10 2011 2012 2013 2014 2015 2016 2017 NOTE: The data for non-oil import prices extend through December 2016. SOURCE: Department of Labor, Bureau of Labor Statistics; Federal Reserve Board, Statistical Release H.10, “Foreign Exchange Rates.” MONETARy POLICy REPORT: FEBRUARy 2017 11 Survey measures of longer-term inflation 10. Median inflation expectations expectations have been Percent generally stable . . . Wage- and price-setting decisions are likely Michigan survey expectations 4 influenced by expectations for inflation. for next 5 to 10 years Surveys of professional forecasters outside 3 the Federal Reserve System indicate that their longer-term inflation expectations have 2 remained stable and consistent with the SPF expectations for next 10 years FOMC’s 2 percent objective for PCE inflation. 1 In contrast, the median inflation expectation over the next 5 to 10 years as reported by the University of Michigan Surveys of Consumers 2003 2005 2007 2009 2011 2013 2015 2017 has generally trended downward over the past NOTE: The Michigan survey data are monthly and extend through February; the February data are preliminary. The SPF data for inflation few years, though it is little changed from a expectations for personal consumption expenditures are quarterly and extend year ago; this measure was at 2.5 percent in from 2007:Q1 through 2017:Q1. SOURCE: University of Michigan Surveys of Consumers; Federal Reserve early February (figure 10). It is unclear how Bank of Philadelphia, Survey of Professional Forecasters (SPF). best to interpret that downtrend; this measure 11. 5-to-10-year-forward inflation compensation of inflation expectations has been above actual inflation for much of the past 20 years. Weekly Percent . . . and market-based measures of 3.5 inflation compensation have moved up Inflation swaps 3.0 notably in recent months but also remain relatively low 2.5 TIPS-based inflation compensation (5 to TIPS breakeven rates 2.0 10 years forward), after declining to very 1.5 low levels through the middle of 2016, has risen to nearly 2 percent and is about 20 basis 1.0 points higher than it was at the end of 2015. However, this level is still below the 2½ to 2009 2011 2013 2015 2017 3 percent range that persisted for most of the NOTE: The data are weekly averages of daily data and extend through February 10, 2017. TIPS is Treasury Inflation-Protected Securities. 10 years prior to 2014 (figure 11). SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve Board staff estimates. Real GDP growth picked up in the 12. Change in real gross domestic product and gross second half of 2016 domestic income Real GDP is reported to have increased at an Percent, annual rate annual rate of 2¾ percent in the second half of Gross domestic product 2016 after increasing just 1 percent in the first Gross domestic income 5 half (figure 12). Much of the step-up reflects the stabilization of inventory investment, 4 which held down GDP growth considerably in H2* 3 the first half of last year, as well as a pickup in government purchases of goods and 2 services. Private domestic final purchases— H1 that is, final purchases by U.S. households 1 2010 2011 2012 2013 2014 2015 2016 * Gross domestic income is not yet available for 2016:H2. SOURCE: Department of Commerce, Bureau of Economic Analysis. 12 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 13. Change in real personal consumption expenditures and businesses—grew more steadily than and disposable personal income GDP last year and posted a fairly solid gain in the second half. PCE growth was bolstered Percent, annual rate by rising incomes and wealth, while private Personal consumption expenditures 6 Disposable personal income fixed investment was weak despite the low 5 costs of borrowing for many households and 4 H1 H2 businesses. Although the FOMC has increased 3 the federal funds rate twice as this expansion 2 1 has progressed—once in December 2015 and + _0 again in December 2016—in ¼ percentage 1 point steps, overall financial conditions have 2 been sufficiently accommodative to support 3 somewhat-faster-than-trend growth in real activity. 2010 2011 2012 2013 2014 2015 2016 SOURCE: Department of Commerce, Bureau of Economic Analysis. Gains in income and wealth have 14. Prices of existing single-family houses continued to support consumer spending . . . Monthly Percent change from year earlier Real consumer spending rose at an annual rate CoreLogic 20 price index of 2¾ percent in the second half of 2016, a S&P/Case-Shiller 15 national index solid pace similar to the one seen in the first 10 half. Consumption has been supported by 5 + the ongoing improvement in the labor market _0 and the associated increases in real disposable 5 Zillow index 10 personal income (DPI)—that is, income after taxes and adjusted for price changes. Real 15 DPI increased 2¼ percent in 2016 following 20 a gain of 3 percent in 2015, when purchasing 2006 2008 2010 2012 2014 2016 power was boosted by falling energy prices NOTE: The data for the S&P/Case-Shiller index extend through November (figure 13). 2016. The data for the Zillow and CoreLogic indexes extend through December 2016. SOURCE: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S. Consumer spending has also been supported National Home Price Index. The S&P/Case-Shiller Index is a product of S&P Dow Jones Indices LLC and/or its affiliates. (For Dow Jones Indices by further increases in household net worth. licensing information, see the note on the Contents page.) Broad measures of U.S. equity prices rose 15. Nominal house prices and price–rent ratio solidly over the past year, and house prices continued to move up (figure 14). (In Monthly Index nominal terms, national house prices are 200 approaching their peaks of the mid-2000s, 190 180 though relative to rents or income, house CoreLogic 170 price valuations are much lower than a decade price index 160 150 ago (figure 15).) Buoyed by these cumulative 140 increases in home and equity prices, aggregate 130 120 household net worth has risen appreciably 110 from its level during the recession, and the 100 Price–rent ratio 90 ratio of household net worth to income 80 remains well above its historical average 70 (figure 16). The benefits of homeownership 1992 1995 1998 2001 2004 2007 2010 2013 2016 have not been distributed evenly; see the box NOTE: The data extend through December 2016. The CoreLogic price “Homeownership by Race and Ethnicity.” index is seasonally adjusted by Federal Reserve Board staff. The price–rent ratio is the ratio of nominal house prices to the consumer price index of rent of primary residence. The data are indexed to 100 in January 2000. SOURCE: For prices, CoreLogic; for rents, Department of Labor, Bureau of Labor Statistics. MONETARy POLICy REPORT: FEBRUARy 2017 13 . . . as does credit availability 16. Wealth-to-income ratio Consumer credit has continued to expand Quarterly Ratio somewhat faster than income amid stable delinquencies on consumer debt (figure 17). 6.5 Auto and student loans remain widely available even to borrowers with lower credit 6.0 scores, and outstanding balances on these types of loans continued to expand at a robust 5.5 pace. Credit card balances continued to grow and were 6 percent higher than one year earlier 5.0 in December. That said, credit card standards have remained tight for nonprime borrowers. As a result, delinquencies on credit cards are 1996 2000 2004 2008 2012 2016 still near low historical levels. NOTE: The data extend through 2016:Q3. The series is the ratio of household net worth to disposable personal income. SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1, Consumer confidence is strong “Financial Accounts of the United States”; for income, Department of Commerce, Bureau of Economic Analysis. Household spending has also been supported 17. Changes in household debt by favorable consumer sentiment. In 2015 and through most of 2016, readings from the Billions of dollars, annual rate overall index of consumer sentiment from the Mortgages 1,000 Consumer credit Michigan survey were solid, likely reflecting Sum 800 rising incomes and job gains. Sentiment has 600 improved further in the past couple of months 400 (figure 18). The share of households expecting 200 real income gains over the next year or two + _0 is now close to its pre-recession level despite 200 having lagged improvements in the headline 400 sentiment measure earlier in the recovery. 600 Housing construction has been sluggish 2007200820092010201120122013201420152016 despite rising home demand NOTE: Changes are calculated from year-end to year-end except 2016 changes, which are calculated from Q3 to Q3. Residential investment spending appears to SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.” have only edged higher in 2016 following a 18. Indexes of consumer sentiment and income expectations larger gain in the previous year. Single-family housing starts registered a moderate increase Diffusion index Index in 2016, while multifamily housing starts flattened out on balance (figure 19). The pace 100 Real income expectations 120 of construction activity in 2016 remained 110 90 sluggish despite solid gains in house prices and 100 ongoing improvements in demand for both 80 90 new and existing homes (figure 20). As a result, 70 80 the months’ supply of inventories of homes for 70 sale dropped to low levels, and the aggregate 60 60 vacancy rate moved to its lowest level since 50 Consumer sentiment 50 2005. Reportedly, tight supplies of skilled labor and developed lots have been restraining 2001 2005 2009 2013 2017 home construction. NOTE: The data extend through February 2017; the February data are preliminary. The consumer sentiment data are monthly and are indexed to 100 in 1966. The real income expectations data are calculated as the net percentage of survey respondents expecting family income to go up more than prices during the next year or two plus 100 and are shown as a three-month moving average. SOURCE: University of Michigan Surveys of Consumers. 14 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Homeownership by Race and Ethnicity Most households in the United States own their Nationally representative data from 1900 through homes, and among those who do not, many continue 2015 indicate that the overall homeownership rate to aspire to own their homes.1 The popularity of rose sharply from 1940 to 1960 (figure A).4 Research homeownership may stem from the amenities and suggests that this surge in homeownership reflected financial benefits that are associated with ownership. a combination of factors, including the postwar For example, on the financial side, owning a home economic boom and an easing of terms for mortgage protects households against volatility in rental prices credit (such as reduced down payment requirements and may help them build wealth as they repay their and longer terms to maturity) through government- mortgage.2 Historically, we have seen disparities in backed lending programs run by the Federal Housing homeownership across racial and ethnic groups, and Administration and the veterans Administration.5 The these disparities are an important dimension of racial homeownership rate then edged up slightly further, on inequality in the United States.3 net, between 1960 and 2006. However, since the onset of the housing crash and the financial crisis in 2007, 1. A 2014 survey indicated that over 90 percent of young the homeownership rate has declined as foreclosures renters reported that they intended to purchase a home in became elevated for several years and first-time the future. See Fannie Mae (2014), Fannie Mae National homebuying dropped and remained subdued.6 Housing Survey: What Younger Renters Want and the Financial Constraints They See (Washington: Fannie Mae, May), www. These post-crisis declines in homeownership have fanniemae.com/resources/file/research/housingsurvey/pdf/ been similar for white, black, and Hispanic households nhsmay2014presentation.pdf. and somewhat smaller for Asian households.7 Thus, 2. See Todd Sinai and Nicholas S. Souleles (2005), “Owner- the large gaps between the homeownership rates of Occupied Housing as a Hedge against Rent Risk,” The Quarterly Journal of Economics, vol. 120 (2), pp. 763–89; white households and those of black and Hispanic see also David Laibson (1997), “Golden Eggs and Hyperbolic households have held steady, while the smaller gap Discounting,” Quarterly Journal of Economics, vol. 112 (2), between white and Asian households has narrowed pp. 443–78. Of course, as the financial crisis made clear, slightly. Perhaps the most striking feature of the data is homeownership carries risks as well. For example, highly the persistence of the black–white homeownership gap, leveraged homeowners are at risk of negative equity if house prices decline, which tends to impede mobility; see Fernando which has measured about 25 to 30 percentage points Ferreira, Joseph Gyourko, and Joseph Tracy (2010), “Housing throughout the past 115 years. Potential reasons for this Busts and Household Mobility,” Journal of Urban Economics, persistence will be discussed shortly. vol. 68 (July), pp. 34–45. The likelihood of owning one’s home rises with age. 3. Following standard practice, the homeownership rate is calculated here as the fraction of households that own their Thus, the aging of the U.S. population contributed to home. Thus, trends in household formation influence trends in increasing homeownership before 2006 and would the homeownership rate, and declining household formation in recent years has helped support the homeownership 4. The data are decennial census data from 1900 through rate. See Andrew Paciorek (2016), “The Long and Short of 2000 as well as American Community Survey (ACS) data from Household Formation,” Real Estate Economics, vol. 44 (1), 2006, 2009, 2012, and 2015. For individual-level census pp. 7–40. and ACS data, see Steven Ruggles, Katie Genadek, Ronald Goeken, Josiah Grover, and Matthew Sobek (2015), Integrated A. Homeownership rates, by race and ethnicity Public Use Microdata Series: version 6.0 [machine-readable database] (Minneapolis: University of Minnesota). The ACS has been conducted annually by the U.S. Census Bureau since Percent 2000. Data on homeownership are not available in the 1950 census data. White 75 5. See Daniel K. Fetter (2014), “The Twentieth-Century Increase in U.S. Home Ownership: Facts and Hypotheses,” 65 in Eugene N. White, Kenneth Snowden, and Price Fishback, Asian 55 eds., Housing and Mortgage Markets in Historical Perspective All (Chicago: University of Chicago Press). 45 6. See Neil Bhutta (2015), “The Ins and Outs of Mortgage Debt during the Housing Boom and Bust,” Journal of Monetary Hispanic or Latino 35 Economics, vol. 76, pp. 284–98. 7. Households are classified by race and ethnicity 25 according to the race and ethnicity of the household head, Black or African American defined here as either the survey respondent or the spouse 15 of the respondent if older. The Hispanic ethnicity and race categories are not mutually exclusive. Some individuals are, 1900 1920 1940 1960 1980 2000 2020 for example, both Hispanic and white. The Asian category includes Pacific Islanders. Homeownership rates for Hispanic NOTE: The data are every 10 years through 2000, except 1950; after 2000, and Asian households are not shown before 1980 because, the data are for 2006, 2009, 2012, and 2015. Persons whose ethnicity is identified as Hispanic or Latino may be of any race. prior to 1980, Hispanic status was not asked about directly SOURCE: Department of Commerce, Bureau of the Census. and the Asian population was quite small. MONETARy POLICy REPORT: FEBRUARy 2017 15 have caused the homeownership rate to continue rising some of these may have had offsetting effects on the after 2006, all else being equal. Examining the data black–white gap. For example, from 1940 to 1960, separately by age group reveals homeownership trends the migration of many black families from the South to that differ from overall averages, with stronger declines northern central cities (where owning a home was less in homeownership observed for young and middle- likely regardless of race) tended to offset the positive aged households. For example, among households effects on the homeownership rate from gains in headed by a person 30 to 39 years old, homeownership income and education.10 rates fell more than 10 percentage points between 2006 In more recent decades, the relative rise in the and 2015 for all major races and ethnicities (figure B).8 fraction of black households headed by a single parent For both white and black households in this age range, may have offset factors that otherwise would have the homeownership rate peaked in 1980, much earlier generated increases in homeownership rates, including than the overall national average; by 2015, it stood the introduction and enforcement of anti-discrimination well below its level in 1960. Over the past century, the laws, such as the Equal Credit Opportunity Act and black–white homeownership gap has actually widened the Fair Housing Act. Research on the black–white for households in this age range. and Hispanic–white gaps indicates that a large portion In light of the gains in education, income, and of these gaps in recent years can be attributed to access to credit and housing over the long term for socioeconomic differences—such as age, income, minorities in the United States, the persistence of the and family structure—across groups.11 That said, some black–white gap is surprising. A considerable amount of the overall gap is not explainable on the basis of of academic research has sought to better understand those variables and could reflect other factors such differences in homeownership rates across racial as location and housing preferences; it also could and ethnic groups.9 Many factors have been found reflect continued discrimination in housing and credit to influence the likelihood of homeownership, and markets.12 Finally, recent research has also documented larger differences in credit scores between whites and minorities than can be explained by income disparities; 8. For more complete data on homeownership rates by age thus, the tighter mortgage credit environment that since 1900, see Laurie Goodman, Rolf Pendall, and Jun Zhu prevails today relative to a dozen or more years ago (2015), Headship and Homeownership: What Does the Future could cause the homeownership gap to widen in the Hold? (Washington: Urban Institute, June), www.urban.org/ near term.13 sites/default/files/2000257-headship-and-homeownership- what-does-the-future-hold.pdf. 9. For a review of the literature, see Donald R. Haurin, Christopher E. Herbert, and Stuart S. Rosenthal (2007), 10. See William J. Collins and Robert A. Margo (2001), “Homeownership Gaps among Low-Income and Minority “Race and Home Ownership: A Century-Long view,” Households,” Cityscape, vol. 9 (2), pp. 5–52. Explorations in Economic History, vol. 38 (January), pp. 68–92. 11. See Stuart A. Gabriel and Stuart S. Rosenthal (2005), “Homeownership in the 1980s and 1990s: Aggregate Trends B. Homeownership rates, by race and ethnicity, for and Racial Gaps,” Journal of Urban Economics, vol. 57 households headed by persons aged 30 to 39 (January), pp. 101–27; and Eric Fesselmeyer, Kien T. Le, and Kiat ying Seah (2012), “A Household-Level Decomposition of Percent the White–Black Homeownership Gap,” Regional Science and Urban Economics, vol. 42 (January), pp. 52–62. 12. See Kerwin Kofi Charles and Erik Hurst (2002), “The 70 White Transition to Home Ownership and the Black–White Wealth Gap,” Review of Economics and Statistics, vol. 84 (May), 60 pp. 281–97. Asian 50 13. See Neil Bhutta and Daniel Ringo (2016), “Credit Hispanic or Latino Availability and the Decline in Mortgage Lending to Minorities 40 after the Housing Boom,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, September 29), 30 https://www.federalreserve.gov/econresdata/notes/feds- notes/2016/credit-availability-and-the-decline-in-mortgage- Black or African American 20 lending-to-minorities-after-the-housing-boom-20160929.html. For additional research on heightened credit score thresholds 10 in recent years, see Steven Laufer and Andrew Paciorek (2016), “The Effects of Mortgage Credit Availability: Evidence 1900 1920 1940 1960 1980 2000 2020 from Minimum Credit Score Lending Rules,” Finance and Economics Discussion Series 2016-098 (Washington: Board NOTE: The data are every 10 years through 2000, except 1950; after 2000, the data are for 2006, 2009, 2012, and 2015. Persons whose ethnicity is of Governors of the Federal Reserve System, December), identified as Hispanic or Latino may be of any race. https://www.federalreserve.gov/econresdata/feds/2016/ SOURCE: Department of Commerce, Bureau of the Census. files/2016098pap.pdf. 16 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 19. Private housing starts and permits Homebuying and residential construction have been supported by low interest rates Monthly Millions of units, annual rate and ongoing easing of credit standards for mortgages. Banks indicated in the Single-family starts 1.8 October 2016 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) 1.4 that they eased standards on several categories 1.0 of residential home purchase loans.1 Even so, Single-family permits mortgage credit is still relatively difficult to .6 access for borrowers with low credit scores, harder-to-document income, or high debt- Multifamily starts .2 to-income ratios. Although mortgage rates moved up from their all-time low levels over 2004 2006 2008 2010 2012 2014 2016 the second half of last year, they remain quite NOTE: The data extend through December 2016. SOURCE: Department of Commerce, Bureau of the Census. low by historical standards, and, consequently, housing affordability remains favorable 20. New and existing home sales (figure 21). Millions, annual rate Millions, annual rate Business investment may be turning up 7.5 1.8 after a period of surprising weakness 7.0 Existing home sales 1.6 6.5 1.4 Real outlays for business investment—that is, 6.0 1.2 private nonresidential fixed investment—were generally weak in 2016 but posted larger gains 5.5 1.0 toward the end of the year (figure 22). Last 5.0 .8 year’s weakness occurred despite moderate 4.5 .6 increases in aggregate demand and generally 4.0 .4 3.5 New home sales .2 favorable financing conditions, and it was widespread across categories of equipment 2004 2006 2008 2010 2012 2014 2016 investment. Investment in equipment and NOTE: The data extend through December 2016. New home sales includes intangibles moved down over most of the year, only single-family sales. Existing home sales includes single-family, condo, townhome, and co-op sales. likely reflecting the effects of the combination SOURCE: For new home sales, Census Bureau; for existing home sales, of low oil prices, weak export demand, and National Association of Realtors. a muted longer-run demand outlook among 21. Mortgage rates and housing affordability businesses. Although such declines are unusual Percent Index outside of a recession, spending on these items did turn up in the fourth quarter. Investment Housing affordability index 205 7 in drilling and mining structures, which had 185 been falling sharply since the drop in oil prices 6 165 in 2014, fell further through most of 2016 but seems to be bottoming out. Outside of the 5 145 energy sector, investment in nonresidential 125 4 structures increased moderately in 2016. Mortgage rates 105 Finally, after having been subdued for much of 3 2016, a widespread set of business sentiment 85 indicators improved notably near the end of 2007 2009 2011 2013 2015 2017 last year. NOTE: The housing affordability index data are monthly through November, and the mortgage rate data are weekly through February 9, 2017. 1. The SLOOS is available on the Board’s website at At an index value of 100, a median-income family has exactly enough income to qualify for a median-priced home mortgage. Housing affordability https://www.federalreserve.gov/boarddocs/snloansurvey. is seasonally adjusted by Board staff. SOURCE: For housing affordability index, National Association of Realtors; for mortgage rates, Freddie Mac Primary Mortgage Market Survey. MONETARy POLICy REPORT: FEBRUARy 2017 17 Financing conditions for nonfinancial 22. Change in real private nonresidential fixed investment firms have generally remained favorable Percent, annual rate Nonfinancial businesses have continued to Structures raise funds through bond issuance and bank Equipment and intangible capital 15 loans, albeit at a somewhat slower pace than 10 in the first half of 2016 (figure 23). The pace H2 5 of such borrowing was supported in part H1 + by continued low interest rates: Corporate _0 bond yields for speculative-grade borrowers 5 have declined since last June, and those for investment-grade borrowers have increased 10 but a fair bit less than those on comparable- maturity Treasury securities (figure 24). 2010 2011 2012 2013 2014 2015 2016 Banks indicated in the October 2016 and SOURCE: Department of Commerce, Bureau of Economic Analysis. January 2017 SLOOS that they eased lending terms on commercial and industrial loans in 23. Selected components of net debt financing for the second half of the year, but that standards nonfinancial businesses on such loans remained unchanged relative to earlier in 2016; banks continued to tighten Billions of dollars, monthly rate standards on commercial real estate loans over Commercial paper Bonds 80 the second half of last year. Bank loans Q3 Sum H1 60 Net exports held down second-half real 40 GDP growth 20 + The rise in the dollar since mid-2014 and _0 subdued foreign economic growth have 20 continued to weigh on U.S. exports (figure 25). Nevertheless, exports increased at a moderate 40 pace in the second half of 2016, but with much 20062007200820092010201120122013201420152016 of the increase a result of rising agricultural SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial exports. In particular, soybean exports surged Accounts of the United States.” in the third quarter before falling back toward a more normal level in the fourth quarter. 24. Corporate bond yields, by securities rating Consistent with the stronger exchange value of the dollar, imports jumped in the second Daily Percentage points half of the year after having been about flat 20 in the first half, when investment demand for 18 imported equipment was very weak. Overall, 16 Triple-B real net exports were a moderate drag on 14 real GDP growth in the second half of 2016. 12 Although the trade balance and current High-yield 10 8 account deficit narrowed slightly in the second 6 and third quarters of 2016, the trade balance 4 Double-A widened in the fourth quarter, as imports 2 significantly outpaced exports (figure 26). 0 1999 2002 2005 2008 2011 2014 2017 NOTE: The yields shown are yields on 10-year bonds. SOURCE: BofA Merrill Lynch Global Research, used with permission. 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 25. Change in real imports and exports of goods Federal fiscal policy was a roughly neutral and services influence on GDP growth in 2016 . . . Percent, annual rate After being a drag on aggregate demand Imports during much of the expansion, discretionary Exports 12 Q3 changes in federal fiscal policy have had a Q4 9 more neutral influence over the past two 6 years. During 2016, policy actions had little effect on taxes and transfers, and federal 3 H1 + purchases of goods and services are little _0 changed over this period (figure 27). The 3 federal budget deficit increased in fiscal year 6 2016 to 3.2 percent of GDP from 2.4 percent in fiscal 2015. Revenues rose only 1 percent 2011 2012 2013 2014 2015 2016 last year in nominal terms and fell as a share SOURCE: Department of Commerce, Bureau of Economic Analysis. of GDP because of soft personal income tax revenues and a decline in corporate income 26. U.S. trade and current account balances tax collections. Outlays rose 5 percent, edging Quarterly Percent of nominal GDP up as a share of GDP, owing to increases in + mandatory spending and interest payments as _0 well as a shift in the timing of some payments 1 that ordinarily would have been made in fiscal 2 2017 (figure 28). The Congressional Budget 3 Office forecasts the deficit to be about the same size (as a share of GDP) in fiscal 2017 4 Trade and in the next couple of years before rising 5 thereafter. Consequently, the ratio of debt held 6 by the public to nominal GDP is projected to Current account 7 remain near its current level of 77 percent of GDP for the next couple of years and then 2000 2002 2004 2006 2008 2010 2012 2014 2016 begin to rise (figure 29). NOTE: The data for the current account extend through 2016:Q3. GDP is gross domestic product. SOURCE: Department of Commerce, Bureau of Economic Analysis. . . . and real purchases at the state and local level continue to increase, albeit at 27. Change in real government expenditures on a tepid pace consumption and investment The fiscal conditions of most state and local Percent, annual rate governments have continued to improve, Federal State and local 6 though the pace of improvement has been 4 slower in recent quarters than it had been H1 H2 2 previously. The ongoing improvement + _0 facilitated a step-up in the average pace of employment gain in the sector to the strongest 2 rate since 2008. At the same time, however, 4 real investment in structures by state and local 6 governments has declined, on net, since the 8 first quarter of 2016 after trending up during the prior two years (figure 30). All told, total 2009 2010 2011 2012 2013 2014 2015 2016 real state and local purchases rose anemically SOURCE: Department of Commerce, Bureau of Economic Analysis. in 2016. On the other side of the ledger, MONETARy POLICy REPORT: FEBRUARy 2017 19 revenue growth was subdued overall, with little 28. Federal receipts and expenditures growth in tax collections at the state level but Annual PPeerrcceenntt ooff nnoommiinnaall GGDDPP moderate gains at the local level. 26 Financial Developments Expenditures 24 The expected path for the federal funds 22 Receipts rate over the next several years steepened 20 18 Against the backdrop of continued strengthening in the labor market and an 16 increase in inflation over the course of 2016, 14 the path of the federal funds rate implied by market quotes on interest rate derivatives has 1996 2000 2004 2008 2012 2016 moved up, on net, since the middle of last year. NOTE: The receipts and expenditures data are on a unified-budget basis and Following the U.S. elections in November, are for fiscal years (October through September); gross domestic product (GDP) data are for the four quarters ending in Q3. the expected policy path in the United States SOURCE: Office of Management and Budget. steepened significantly, apparently reflecting investors’ expectations of a more expansionary 29. Federal government debt held by the public fiscal policy. Meanwhile, market-based measures of uncertainty about the policy rate Quarterly Percent of nominal GDP approximately one to two years ahead also 80 increased, on balance, suggesting that some of the firming in market rates may reflect a rise in 70 term premiums. 60 50 Survey-based measures of the expected path of policy also moved up in recent months. 40 In the Survey of Primary Dealers that was 30 conducted by the Federal Reserve Bank of 20 New York just prior to the January 2017 FOMC meeting, the median dealer expected 1967 1977 1987 1997 2007 2017 two rate hikes in 2017 and three rate hikes in NOTE: The data extend through 2016:Q3. The data for gross domestic 2018 as the most likely outcome.2 product (GDP) are at an annual rate. Federal debt held by the public equals federal debt less Treasury securities held in federal employee defined benefit retirement accounts, evaluated at the end of the quarter. U .S . nominal Treasury yields increased SOURCE: For GDP, Department of Commerce, Bureau of Economic Analysis; for federal debt, Federal Reserve Board, Statistical Release Z.1, considerably “Financial Accounts of the United States.” After dropping significantly during the first half of 2016 and reaching near-historical lows in the aftermath of the U.K. referendum on exit from the European Union, or Brexit, in June, yields on medium- and longer-term nominal Treasury securities rebounded strongly in the second half of last year, with a substantial rise following the U.S. 2. The Federal Reserve Bank of New York’s Survey of Primary Dealers is available at https://www.newyorkfed. org/markets/primarydealer_survey_questions.html. 20 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS elections (figure 31). Market participants have attributed the increase in yields following the 30. State and local employment and structures investment elections primarily to expectations of a more expansionary fiscal policy. The boost in longer- Billions of chained (2009) dollars, annual rate Employees in millions term nominal yields in recent months reflects 320 roughly equal increases in real yields and Employment 19.8 inflation compensation. Consistent with the 300 19.6 changes in Treasury yields, yields on 30-year 280 agency mortgage-backed securities (MBS)––an 19.4 important determinant of mortgage interest 260 rates––increased significantly over the second 19.2 240 half of the year (figure 32). However, Treasury and MBS yields remain quite low by historical 19.0 220 Real structures standards. 2009 2011 2013 2015 2017 Broad equity price indexes increased NOTE: The employment data are monthly, and the structures data are notably . . . quarterly. SOURCE: For employment data, Department of Labor, Bureau of Labor Statistics; for structures data, Department of Commerce, Bureau of Economic U.S. equity markets were volatile around Analysis. the Brexit vote in the United Kingdom but operated without disruptions. Broad equity price indexes have increased notably 31. Yields on nominal Treasury securities since late June, with a sizable portion of the Daily Percent gain occurring after the U.S. elections in November (figure 33). Reportedly, equity 7 prices have been supported in part by the 6 10-year 30-year perception that corporate tax rates may be 5 reduced. Stock prices of banks, which tend to 4 benefit from a steepening in the yield curve, 3 outperformed the broader market. Moreover, market participants pointed to expectations 2 5-year of changes in the regulatory environment as 1 a factor contributing to the outperformance 0 of bank stocks. By contrast, stock prices of 2001 2003 2005 2007 2009 2011 2013 2015 2017 firms that tend to benefit from lower interest NOTE: The Treasury ceased publication of the 30-year constant maturity rates, such as utilities, declined moderately series on February 18, 2002, and resumed that series on February 9, 2006. on net. The implied volatility of the S&P 500 SOURCE: Department of the Treasury. index—the VIX— fell, ending the period close to the bottom of its historical range. (For a discussion of financial stability issues over this same period, see the box “Developments Related to Financial Stability.”) . . . while risk spreads on corporate bonds narrowed Bond spreads in the nonfinancial corporate sector declined significantly across the credit spectrum, suggesting increased investor confidence in the outlook for the corporate MONETARy POLICy REPORT: FEBRUARy 2017 21 sector since the middle of last year. Declines in spreads were particularly large for firms 32. Yield and spread on agency mortgage-backed in the energy sector, likely reflecting improved securities prospects for U.S. producers as they continue to increase efficiency and benefit from Percent Basis points higher prices. 9 400 350 Treasury market functioning and liquidity 8 Yield conditions in the mortgage-backed 7 300 securities market were generally stable 250 6 200 Indicators of Treasury market functioning 5 150 remained broadly stable over the second half 4 100 Spread of 2016 and early 2017. A variety of liquidity 3 50 metrics––including bid-asked spreads and 2 0 bid sizes––have displayed minimal signs of liquidity pressures overall, with a modest 1999200120032005200720092011201320152017 reduction in liquidity following the U.S. NOTE: The data are daily. Yield shown is for the Fannie Mae 30-year current coupon, the coupon rate at which new mortgage-backed securities elections. In addition, Treasury auctions would be priced at par, or face, value. Spread shown is to the average of the 5- and 10-year nominal Treasury yields. generally continued to be well received by SOURCE: Department of the Treasury; Barclays. investors. Liquidity conditions in the agency MBS market were also generally stable. 33. Equity prices The compliance deadline for money Daily December 31, 2007 = 100 market mutual fund reform passed in mid-October with no market disruption 160 140 In the weeks leading up to the Dow Jones bank index October 14, 2016, deadline for money 120 market mutual funds (also referred to as 100 money market funds, or MMFs) to comply 80 with a variety of regulatory reforms, shifts in 60 investments from prime to government MMFs S&P 500 index 40 were substantial. However, the transition was 20 smooth and without any market disruptions. Overnight Eurodollar deposit volumes 1996 1999 2002 2005 2008 2011 2014 2017 fell significantly and have remained low as SOURCE: Standard & Poor's Dow Jones Indices via Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.) prime funds pulled back from lending in this market. Meanwhile, the rise in total assets of government funds appeared to contribute to modestly higher levels of take-up at the overnight reverse repurchase agreement (ON RRP) facility through late 2016. Overnight money market rates were little affected, although the spread between the three-month LIBOR (London interbank offered rate) and the OIS (overnight index swap) rate has remained elevated, likely reflecting MMFs’ reduced appetite for term lending. 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability Financial vulnerabilities in the U.S. financial Asset valuation pressures have increased, on system overall have continued to be moderate since balance, since mid-2016, along with several indicators mid-2016. U.S. banks are well capitalized and have of investors’ risk appetite. Although yields on Treasury sizable liquidity buffers. Nonfinancial corporate securities and term premiums increased as market business leverage has remained elevated by historical expectations about future growth shifted higher in the standards, and household borrowing has increased fall, they both remain low. In addition, the spread of modestly, leaving the household debt-to-income ratio yields on corporate bonds over those on comparable- about unchanged. On balance, the ratio of aggregate maturity Treasury securities narrowed. Estimates nonfinancial credit to gross domestic product (GDP) of risk premiums in equity markets also declined. has moved up a little in recent years to about its level in Outstanding riskier corporate debt edged down over the mid-2000s but remains well below its recent peak. the past year, but gross issuance of leveraged loans valuation pressures in some asset classes have been was strong and the share of bond issuance rated B or rising, particularly late last year. below remained in the fourth quarter at the high end vulnerabilities stemming from leverage in the of its range over the past few years. Commercial real financial sector appear low. Regulatory capital has estate (CRE) valuations, which have been an area of remained at historically high levels for most large growing concern over the past year, rose further, with domestic banks, and all 33 firms participating in the property prices continuing to climb and capitalization Federal Reserve’s supervisory stress tests for 2016 rates decreasing to historically low levels. While CRE were able to maintain capital ratios above required debt remains modest relative to the overall size of the minimums through the severely adverse recession economy and the tightening in bank lending standards scenario.1 Moreover, market-based measures of for CRE loans in the second half of last year may reflect leverage for domestic banks have decreased somewhat some reduction in the appetite for CRE lending, the since November. However, valuations of many of the heightening of valuation pressures may leave some largest foreign banks remain depressed. Despite the smaller banks vulnerable to a sizable CRE price settlement on December 23 between Deutsche Bank decline. Also, residential home prices continued to rise and the U.S. Department of Justice and some progress briskly through November. Although most measures of toward addressing problems in the Italian banking residential valuation have moved up somewhat, they sector, several large European financial institutions are still only modestly above the levels that would be have continued to be vulnerable to unexpected predicted, given rents and investment costs. The results developments. Available data suggest that the leverage of the Federal Reserve’s 2017 stress tests, for which the of nonbank financial institutions was relatively stable in scenarios were released on February 3, will help gauge the second half of 2016. the vulnerability of large U.S. banks to all of these asset On balance, vulnerabilities associated with liquidity valuation pressures. and maturity transformation are also somewhat below vulnerabilities stemming from private nonfinancial- their longer-run average. The reliance of large bank sector borrowing remain moderate. The credit-to-GDP holding companies on short-term funding remains ratio for the corporate sector is elevated after several subdued, and their holdings of high-quality liquid years of rapid growth. Despite this high leverage, assets are robust, owing in part to the implementation interest-expense ratios are low by historical standards of the Liquidity Coverage Ratio. Money market mutual even among higher-risk firms, as are measures of fund (also referred to as money market fund, or MMF) expected default based on accounting and stock return reforms designed to reduce the advantages associated data, especially outside of the oil sector. Turning to with being the first to exit a fund in times of financial households, debt growth was modest through the stress led to large declines in prime MMF assets under third quarter of 2016, and the debt-to-income ratio management, with most of these funds migrating to has changed little over the past few years. Except for government MMFs. While the resulting smaller size of a recent increase in early-payment delinquencies prime funds and the new regulations should make the in subprime auto loans—a small segment of overall industry more stable, the longer-term effect will depend indebtedness—broad indicators of household solvency on the degree to which such activity migrates to other have remained within historical norms. On balance, types of short-term investment vehicles that may be the private nonfinancial-sector credit-to-GDP ratio is far subject to similar fragilities. below the levels seen late last decade and lies near its level in the mid-2000s (figure A). 1. The 2016 supervisory stress-test methodology and Last fall, the Federal Reserve Board finalized its results are available on the Board’s website at https://www. framework for setting the Countercyclical Capital Buffer federalreserve.gov/bankinforeg/stress-tests/2016-supervisory- stress-test-results.htm. MONETARy POLICy REPORT: FEBRUARy 2017 23 A. Private nonfinancial sector credit-to-GDP ratio minimum amount of unsecured long-term debt that could be converted into equity in a possible resolution Percent Ratio of that firm, thereby recapitalizing the firm without putting taxpayer funds at risk and diminishing the threat 8.0 Year-over-year growth Ratio 1.8 that its failure would pose to financial stability. In addition, the Board completed an extensive 1.6 review of its statutory stress-test and Comprehensive 4.0 Capital Analysis and Review (CCAR) programs + 1.4 and made some related modifications to the rules _0 1.2 associated with those programs for the 2017 cycle.4 Among other changes, the Board removed certain large, 4.0 1.0 noncomplex firms from the qualitative assessment of the CCAR.5 Moreover, the Board, together with the 8.0 .8 other federal banking agencies, issued an advance notice of proposed rulemaking, inviting public 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 comment on a set of potential enhanced cybersecurity NOTE: The data on the credit-to-GDP ratio and its year-over-year growth risk-management and resilience standards that would are quarterly and extend through 2016:Q3. The shaded bars indicate periods apply to depository institutions and regulated holding of business recession as defined by the National Bureau of Economic Research. companies with over $50 billion in assets and to SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial certain financial market infrastructure companies.6 Accounts of the United States”; Bureau of Economic Analysis, national income and product accounts (NIPA); Board staff calculations. The standards would be tiered, with an additional set of higher standards for systems that provide key (CCyB) and later voted to maintain the CCyB at zero.2 functionality to the financial sector. In forming its view about the appropriate size of the The Board and the Federal Deposit Insurance U.S. CCyB, the Board intends to monitor a wide range Corporation (FDIC) also have continued to actively of financial and economic indicators and consider engage in the resolution-planning process with the their implications for financial system vulnerabilities, largest banks. As part of that process, the Board and including but not limited to asset valuation pressures, the FDIC announced that Bank of America, BNy risk appetite, leverage in the financial and nonfinancial Mellon, JPMorgan Chase, and State Street adequately sectors, and maturity and liquidity transformation in the remediated deficiencies in their 2015 resolution plans. financial sector. The decision to maintain the CCyB at The two agencies also announced that Wells Fargo did zero in part reflected an assessment that vulnerabilities not adequately remedy all of its deficiencies and will associated with financial-sector leverage were at the be subject to restrictions on certain activities until the lower end of their historical ranges. deficiencies are remedied.7 As part of its effort to improve the resilience of 4. See Daniel K. Tarullo (2016), “Next Steps in the Evolution financial institutions and overall financial stability, the of Stress Testing,” speech delivered at the yale University Board has also taken several further regulatory steps. School of Management Leaders Forum, New Haven, Conn., Among those steps is that the Board finalized a rule that September 26, https://www.federalreserve.gov/newsevents/ would impose total loss-absorbing capacity and long- speech/tarullo20160926a.htm. 5. See Board of Governors of the Federal Reserve System term debt requirements on U.S. global systemically (2017), “Federal Reserve Board Announces Finalized important bank holding companies (G-SIBs) and on Stress Testing Rules Removing Noncomplex Firms from the U.S. operations of certain foreign G-SIBS.3 The final Qualitative Aspect of CCAR Effective for 2017,” press release, rule would require each covered firm to maintain a January 30, https://www.federalreserve.gov/newsevents/press/ bcreg/20170130a.htm. 6. See Board of Governors of the Federal Reserve System, 2. See Board of Governors of the Federal Reserve System Office of the Comptroller of the Currency, and Federal (2016), “Federal Reserve Board Announces It Has voted Deposit Insurance Corporation (2016), “Agencies Issue to Affirm Countercyclical Capital Buffer (CCyB) at Current Advanced Notice of Proposed Rulemaking on Enhanced Level of 0 Percent,” press release, October 24, https://www. Cyber Risk Management Standards,” joint press release, federalreserve.gov/newsevents/press/bcreg/20161024a.htm. October 19, https://www.federalreserve.gov/newsevents/press/ 3. See Board of Governors of the Federal Reserve System bcreg/20161019a.htm. (2016), “Federal Reserve Board Adopts Final Rule to 7. See Board of Governors of the Federal Reserve System Strengthen the Ability of Government Authorities to Resolve in and Federal Deposit Insurance Corporation (2016), “Agencies Orderly Way Largest Domestic and Foreign Banks Operating Announce Determinations on October Resolution Plan in the United States,” press release, December 15, https:// Submissions of Five Systemically Important Domestic Banking www.federalreserve.gov/newsevents/press/bcreg/ Institutions,” joint press release, December 13, https://www. 20161215a.htm. federalreserve.gov/newsevents/press/bcreg/20161213a.htm. 24 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 34. Ratio of total commercial bank credit to nominal gross Bank credit continued to expand, and domestic product bank profitability improved Quarterly Percent Aggregate credit provided by commercial banks continued to grow at a solid pace in the 75 second half of 2016 (figure 34). The expansion in bank credit was driven by strong growth in 70 core loans coupled with an increase in banks’ holdings of securities. Measures of bank 65 profitability improved since the middle of 60 last year but remained below their historical averages (figure 35). 55 Municipal bond markets continued to 2006 2008 2010 2012 2014 2016 function smoothly SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and Liabilities of Commercial Banks in the United States”; Department of Credit conditions in municipal bond markets Commerce, Bureau of Economic Analysis. have generally remained stable since late June. Over that period, the MCDX—an index of credit default swap spreads for a broad 35. Profitability of bank holding companies portfolio of municipal bonds—decreased Percent, annual rate Percent, annual rate moderately, while yield spreads on 20-year general obligation municipal bonds over 2.0 30 Return on assets comparable-maturity Treasury securities 1.5 20 were little changed on balance. The Puerto 1.0 10 Rico Oversight, Management, and Economic .5 Return on equity + + Stability Act was passed into law in late June, _0 _0 providing the commonwealth with a clearer .5 10 path toward debt restructuring. Although 1.0 20 Puerto Rico missed a small amount of debt 1.5 30 payments on general obligation bonds in 2.0 August, this default appeared to have had no 1998 2001 2004 2007 2010 2013 2016 significant effect on the broader municipal NOTE: The data, which are seasonally adjusted, are quarterly and extend bond market. through 2016:Q3. SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Bank Holding Companies. International Developments Foreign financial market conditions improved despite global political uncertainties Financial market conditions in both the advanced foreign economies (AFEs) and the emerging market economies (EMEs) have generally improved since June. In the AFEs, increasing distance from the Brexit vote, better-than-expected economic data for Europe, and the continuation of accommodative monetary policies by advanced-economy central banks have MONETARy POLICy REPORT: FEBRUARy 2017 25 contributed to improved risk sentiment. 36. 10-year nominal benchmark yields in selected advanced economies Advanced-economy bond yields reversed their downward trend seen in the first half of the Weekly Percent year and increased notably following the U.S. elections, in part on expectations of a more 3.0 United States expansionary U.S. fiscal policy (figure 36). 2.5 2.0 Equity prices in the AFEs have generally risen Germany 1.5 since June, with financial stocks outperforming United Kingdom 1.0 broader stock indexes as third-quarter Japan .5 earnings largely beat expectations, several + major risk events passed, and the steepening _0 of yield curves was expected to boost profits .5 going forward (figure 37). Despite some 2014 2015 2016 2017 widening of euro-area corporate spreads in NOTE: The data are weekly averages of daily data and extend through the last months of 2016, corporate credit February 9, 2017. SOURCE: Bloomberg. conditions in the advanced foreign economies 37. Equity indexes for selected foreign economies have remained accommodative, with the continuation of corporate asset purchase Weekly Week ending January 9, 2014 = 100 programs by several AFE central banks and Advanced foreign economies with low corporate spreads. 125 Emerging market economies 115 In EMEs, equities have risen significantly and 105 sovereign yield spreads have narrowed since 95 June, supported in part by higher commodity 85 prices. Financial conditions did tighten briefly 75 following the U.S. elections, with increased 65 capital outflows and wider sovereign spreads, Euro-area banks on concerns that higher global interest rates, 55 as well as the possibility of more protectionist 2014 2015 2016 2017 trade policies, would weigh on EME growth NOTE: The data are weekly averages of daily data and extend through (figure 38). However, the favorable risk February 9, 2017. sentiment seen in the summer and early fall SOURCE: For advanced foreign economies, MSCI EAFE Index via Thomson Reuters Datastream; for emerging market economies, MSCI of 2016 resumed by the end of the year for Emerging Markets Index via Thomson Reuters Datastream; for euro-area banks, Dow Jones Euro STOXX Bank Index via Bloomberg. (For Dow Jones most EMEs. Indices licensing information, see the note on the Contents page.) 38. Emerging market mutual fund flows and spreads After depreciating slightly in the first half of last year, the dollar strengthened in Basis points Billions of dollars the second half Bond fund flows (right axis) 500 Equity fund flows (right axis) 30 The dollar has strengthened since June, with 450 the broad dollar index—a measure of the 15 trade-weighted value of the dollar against 400 + foreign currencies—rising about 4 percent on _0 350 balance (figure 39). Much of this strengthening 15 of the U.S. dollar reflects the combined 300 influences of the large depreciation of the 30 250 EMBI+ (left axis) Mexican peso, expectations of fiscal and trade policy changes after the U.S. elections, and 2014 2015 2016 2017 NOTE: The EMBI+ data are weekly averages of daily data and extend through February 9, 2017. The EPFR data are monthly sums of weekly data. The fund flows data exclude funds located in China. SOURCE: For bond and equity fund flows, EPFR Global; for EMBI+, J.P. Morgan Emerging Markets Bond Index Plus via Bloomberg. 26 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 39. U.S. dollar exchange rate indexes market expectations of tighter Federal Reserve monetary policy. The Chinese renminbi also Weekly Week ending January 9, 2014 = 100 weakened notably against the dollar, on net, as capital outflows from China picked up; 170 Chinese authorities tightened capital controls British pound 160 in response. 150 Mexican peso 140 In general, AFE economic growth 130 was moderate and inflation remained 120 subdued 110 Chinese renminbi In Canada, economic growth picked up Broad dollar 100 sharply in the third quarter, following a 2014 2015 2016 2017 contraction in the previous quarter, as oil NOTE: The data, which are in foreign currency units per dollar, are weekly extraction recovered from the disruptions averages of daily data and extend through February 9, 2017. SOURCE: Federal Reserve Board, Statistical Release H.10, “Foreign caused by wildfires in May (figure 40). In Exchange Rates.” contrast, economic growth in Japan in the second and third quarters slowed after a 40. Real gross domestic product growth in selected strong first quarter, returning to a more typical advanced foreign economies moderate pace. Euro-area growth firmed in the second half, and, in the United Kingdom, Percent, annual rate economic activity was resilient in the aftermath United Kingdom of the Brexit referendum in June. Available Japan 5 Euro area indicators suggest that growth in most AFEs Canada Q3 4 was moderate near the end of 2016 and early H1 Q4 3 this year. 2 Headline inflation in most AFEs increased 1 + over the second half of 2016, in part driven _0 by higher oil prices. In the United Kingdom, 1 the substantial sterling depreciation after the Brexit referendum also exerted upward 2013 2014 2015 2016 pressure on consumer prices. Even so, core NOTE: The data for the United Kingdom incorporate the flash estimate for inflation readings in AFEs remained generally 2016:Q4. The data for the euro area incorporate the preliminary flash estimate for 2016:Q4. The data for Japan and Canada extend through subdued, and headline inflation stayed below 2016:Q3. SOURCE: For the United Kingdom, Office for National Statistics; for Japan, central bank targets in Canada, the euro area, Cabinet Office, Government of Japan; for the euro area, Eurostat; for Canada, Japan, and the United Kingdom (figure 41). Statistics Canada; all via Haver Analytics. AFE central banks maintained highly accommodative monetary policies In August, the Bank of England cut its policy rate 25 basis points, announced additional purchases of government and corporate bonds, and introduced a term funding scheme. In September, the Bank of Japan committed to expanding the monetary base until inflation exceeds 2 percent in a stable manner and adopted a new policy framework aimed at controlling the yield curve by targeting short- MONETARy POLICy REPORT: FEBRUARy 2017 27 and long-term interest rates. In December, 41. Inflation in selected advanced foreign economies the European Central Bank announced an Monthly 12-month percent change extension of the intended duration of its asset purchases through at least December 2017, 4 albeit with a slight reduction in those Japan purchases beginning in April 2017. 3 Canada 2 In EMEs, Asian growth was solid . . . 1 Chinese economic activity remained robust + in the second half of 2016, as earlier policy _0 United Kingdom easing supported stable manufacturing growth Euro area 1 and a strong property market (figure 42). However, the property market cooled 2014 2015 2016 2017 somewhat toward the end of the year following NOTE: The data for the euro area incorporate the flash estimate for January the introduction of new macroprudential 2017. The data for Canada, Japan, and the United Kingdom extend through December 2016. measures aimed at curbing rapidly rising house SOURCE: For the United Kingdom, Office for National Statistics; for Japan, Ministry of International Affairs and Communications; for the euro area, prices. Elsewhere in emerging Asia, growth Statistical Office of the European Communities; for Canada, Statistics held steady in the third quarter but stepped Canada; all via Haver Analytics. down in some countries in the fourth, even though exports and manufacturing improved. 42. Real gross domestic product growth in selected And in India, a surprise mandatory exchange emerging market economies of large-denomination bank notes—a move Percent, annual rate aimed at battling tax evasion and corruption— China has disrupted activity. Korea 12 Q4 Mexico . . . but many Latin American economies Brazil 9 H1 Q3 continued to struggle 6 3 In Mexico, after considerable weakness in the + first half of 2016, growth surged in the third _0 quarter, supported in part by a recovery in 3 exports to the United States. However, activity 6 weakened again in the fourth quarter, as consumer and business confidence dropped. 2013 2014 2015 2016 Furthermore, inflation in Mexico jumped over NOTE: The data for Mexico incorporate the flash estimate for 2016:Q4. the second half of the year, pressured in part The data for China are seasonally adjusted by Board staff. The data for Mexico, Brazil, and Korea are seasonally adjusted by their respective by the peso’s sizable depreciation, prompting government agencies. The data for Brazil extend through 2016:Q3. the Bank of Mexico to hike its policy rate SOURCE: For China, China National Bureau of Statistics; for Korea, Bank of Korea; for Mexico, Instituto Nacional de Estadistica y Geografia; for sharply. Brazil’s recession deepened in the third Brazil, Instituto Brasileiro de Geografia e Estatistica; all via Haver Analytics. quarter, reflecting in part tight macroeconomic policies, although the central bank began to ease monetary policy as inflation dropped in response to the weak economy. Elsewhere in the region, activity in the third quarter was mixed; Chile’s economy rebounded, but Argentina’s GDP contracted and the crisis in Venezuela deepened. 29 P 2 art m P onetary oLiCy In December, the Federal Open Market Committee (FOMC) raised the target for the federal funds rate by ¼ percentage point to a range of ½ to ¾ percent. The FOMC’s decision reflected realized and expected labor market conditions and inflation. Moreover, the decision to raise the target range was consistent with the Committee’s expectation that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace, labor market conditions would strengthen somewhat further, and inflation would rise to the FOMC’s 2 percent objective over the medium term. 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. In addition, the Committee anticipates reinvesting principal payments of its securities holdings until normalization of the level of the federal funds rate is well under way. The FOMC raised the federal funds rate pending further evidence of continued target range in December progress toward its objectives. In December, in view of realized and expected labor market About a year ago, in December 2015, the conditions and inflation, the FOMC raised FOMC raised the target range for the federal the target range for the federal funds rate funds rate after holding the range at near zero another ¼ percentage point, to a range of since late 2008 to support economic activity ½ to ¾ percent (figure 43).3 The Committee and stem disinflationary pressures in the wake kept that same target range at its most recent of the Great Recession. At that time, the meeting, which concluded on February 1. Committee judged that it had seen sufficient improvement in the labor market and was reasonably confident that inflation would move 3. See Board of Governors of the Federal back to its 2 percent objective, which would Reserve System (2016), “Federal Reserve Issues warrant an initial increase in the federal funds FOMC Statement,” press release, December 14, rate. Through most of 2016, the Committee https://www.federalreserve.gov/newsevents/press/ maintained the target range of ¼ to ½ percent, monetary/20161214a.htm. 43. Selected interest rates Daily Percent 5 10-year Treasury rate 4 3 2 2-year Treasury rate 1 0 Target range for the federal funds rate 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 NOTE: The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities. SOURCE: Department of the Treasury; Federal Reserve Board. 30 PART 2: MONETARy POLICy Monetary policy continues to support the The size of the Federal Reserve’s balance economic expansion sheet has remained stable The Committee has continued to see the To help maintain accommodative financial federal funds rate as likely to remain, for conditions, the Committee has continued some time, below the levels that are expected its existing policy of rolling over maturing to prevail in the longer run. With gradual Treasury securities at auction and reinvesting adjustments in the stance of monetary policy, principal payments on all agency debt and the FOMC expects that economic activity agency mortgage-backed securities in agency will expand at a moderate pace, labor market mortgage-backed securities. The Federal conditions will strengthen somewhat further, Reserve’s total assets have held steady at and inflation will rise to 2 percent over the around $4.5 trillion, with holdings of U.S. medium term. Treasury securities at $2.5 trillion and holdings of agency debt and agency mortgage-backed Consistent with this outlook, in the most securities at approximately $1.8 trillion recent Summary of Economic Projections (figure 44). The Committee has for some time (included as Part 3 of this report), which was stated that it anticipates maintaining this compiled at the time of the December 2016 policy until normalization of the level of the meeting, most participants projected that federal funds rate is well under way. the appropriate level of the federal funds rate would be below its longer-run level Interest income on the System Open Market through 2018. Account, or SOMA, portfolio has continued to support substantial remittances to the U.S. Future changes in the federal funds rate Treasury. Preliminary results indicate that will depend on the economic outlook as the Reserve Banks provided for payments informed by incoming data of $92 billion of their estimated 2016 net income to the Treasury. The Federal Reserve’s Although the Committee has expected that remittances to the Treasury have averaged economic conditions will evolve in a manner about $80 billion a year since 2008, compared that will warrant only gradual increases in with about $25 billion a year over the decade the federal funds rate, the Committee has prior to 2008.4 continued to emphasize that the actual path of monetary policy will depend on the evolution The Federal Reserve’s implementation of of the economic outlook. In determining monetary policy has continued smoothly the timing and size of future adjustments to the target range for the federal funds As in December 2015, the Federal Reserve rate, the Committee will assess realized and successfully raised the effective federal funds expected economic conditions relative to its rate in December 2016 using the interest objectives of maximum employment and rate paid on reserve balances, together with 2 percent inflation. This assessment will take an overnight reverse repurchase agreement into account a wide range of information, including measures of labor market 4. Total remittances include a one-time transfer of conditions, indicators of inflation pressures $19.3 billion in December 2015 to reduce the aggregate and inflation expectations, and readings on Reserve Bank capital surplus to $10 billion, as required financial and international developments. In by the Fixing America’s Surface Transportation Act. See Board of Governors of the Federal Reserve light of the current shortfall of inflation from System (2016), “Federal Reserve System Publishes 2 percent, the Committee has indicated that Annual Financial Statements,” press release, March 18, it will carefully monitor actual and expected https://www.federalreserve.gov/newsevents/press/ progress toward its inflation goal. other/20160317a.htm. MONETARy POLICy REPORT: FEBRUARy 2017 31 44. Federal Reserve assets and liabilities Weekly Trillions of dollars 4.5 Assets 4.0 Other assets 3.5 3.0 2.5 Agency debt and mortgage-backed securities holdings 2.0 Credit and liquidity 1.5 facilities 1.0 Treasury securities held outright .5 0 Federal Reserve notes in circulation .5 1.0 1.5 Deposits of depository institutions 2.0 2.5 3.0 Capital and other liabilities 3.5 Liabilities and capital 4.0 4.5 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 NOTE: “Credit and liquidity facilities” consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. “Other assets” includes unamortized premiums and discounts on securities held outright. “Capital and other liabilities” includes reverse repurchase agreements, the U.S. Treasury General Account, and the U.S. Treasury Supplementary Financing Account. The data extend through February 8, 2017. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” (ON RRP) facility.5 Specifically, the Federal The total take-up at the ON RRP facility Reserve raised the interest rate paid on increased modestly in the second half of 2016 required and excess reserve balances to as a result of higher demand by government ¾ percent and the ON RRP offering rate money market mutual funds in the wake to ½ percent. In addition, the Board of of money fund reform that took effect in Governors approved an increase in the mid-October. discount rate (the primary credit rate) to 1.25 percent. The effective federal funds rate Although the implementation of monetary rose into the new range amid orderly trading policy has been smooth, the Federal Reserve conditions in money markets. Increases in has continued to test the operational readiness interest rates in other money markets were of other policy tools as part of prudent similar to the rise in the federal funds rate planning. Two operations of the Term Deposit following the December meeting. Facility were conducted in the second half of 2016; seven-day deposits were offered at both operations with a floating rate of 1 basis point 5. See Board of Governors of the Federal Reserve over the interest rate on excess reserves. In System (2014), “Federal Reserve Issues FOMC Statement addition, the Open Market Desk conducted on Policy Normalization Principles and Plans,” press several small-value exercises solely for the release, September 17, https://www.federalreserve.gov/ newsevents/press/monetary/20140917c.htm. purpose of maintaining operational readiness. 33 P 3 art s e P ummary of ConomiC rojeCtions The following material appeared as an addendum to the minutes of the December 13–14, 2016, meeting of the Federal Open Market Committee. In conjunction with the Federal Open level through 2019. All participants projected Market Committee (FOMC) meeting held on that inflation, as measured by the four-quarter December 13–14, 2016, meeting participants percentage change in the price index for submitted their projections of the most personal consumption expenditures (PCE), likely outcomes for real output growth, the would increase over the next two years, and unemployment rate, and inflation for each several expected inflation to slightly exceed year from 2016 to 2019 and over the longer the Committee’s 2 percent objective in 2018 or run.6 Each participant’s projection was based 2019. Table 1 and figure 1 provide summary on information available at the time of the statistics for the projections. meeting, together with his or her assessment of appropriate monetary policy, including a path As shown in figure 2, almost all participants for the federal funds rate and its longer-run expected that the evolution of economic value, and assumptions about other factors conditions would warrant only gradual likely to affect economic outcomes. The longer- increases in the federal funds rate to achieve run projections represent each participant’s and sustain maximum employment and assessment of the value to which each variable 2 percent inflation. Many participants judged would be expected to converge, over time, that the appropriate level of the federal under appropriate monetary policy and in the funds rate in 2019 would be close to their absence of further shocks to the economy. estimates of its longer-run normal level. “Appropriate monetary policy” is defined as However, the economic outlook is uncertain, the future path of policy that each participant and participants noted that their economic deems most likely to foster outcomes for projections and assessments of appropriate economic activity and inflation that best monetary policy may change in response to satisfy his or her individual interpretation of incoming information. the Federal Reserve’s objectives of maximum employment and stable prices. A majority of participants viewed the level of uncertainty associated with their individual Most FOMC participants expected that, under forecasts for economic growth, unemployment, appropriate monetary policy, growth in real and inflation as broadly similar to the norms gross domestic product (GDP) would pick of the previous 20 years, though some up a bit next year and run at or slightly above participants saw uncertainty associated with their individual estimates of its longer-run their forecasts as higher than average. Most rate through 2019. Almost all participants participants also judged the risks around projected that the unemployment rate would their projections for economic activity, the run below their estimates of its longer-run unemployment rate, and inflation as broadly normal level in 2017 and remain below that balanced, while several participants saw the risks to their forecasts of real GDP growth as weighted to the upside and the risks to 6. One participant did not submit longer-run their unemployment rate forecasts as tilted to projections for real output growth, the unemployment rate, or the federal funds rate. the downside. 34 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assessments of projected appropriate monetary policy, December 2016 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 run run run Change in real GDP .... 1.9 2.1 2.0 1.9 1.8 1.8–1.9 1.9–2.3 1.8–2.2 1.8–2.0 1.8–2.0 1.8–2.0 1.7–2.4 1.7–2.3 1.5–2.2 1.6–2.2 September projection .. 1.8 2.0 2.0 1.8 1.8 1.7–1.9 1.9–2.2 1.8–2.1 1.7–2.0 1.7–2.0 1.7–2.0 1.6–2.5 1.5–2.3 1.6–2.2 1.6–2.2 Unemployment rate. . . . . 4.7 4.5 4.5 4.5 4.8 4.7–4.8 4.5–4.6 4.3–4.7 4.3–4.8 4.7–5.0 4.7–4.8 4.4–4.7 4.2–4.7 4.1–4.8 4.5–5.0 September projection .. 4.8 4.6 4.5 4.6 4.8 4.7–4.9 4.5–4.7 4.4–4.7 4.4–4.8 4.7–5.0 4.7–4.9 4.4–4.8 4.3–4.9 4.2–5.0 4.5–5.0 PCE inflation ........... 1.5 1.9 2.0 2.0 2.0 1.5 1.7–2.0 1.9–2.0 2.0–2.1 2.0 1.5–1.6 1.7–2.0 1.8–2.2 1.8–2.2 2.0 September projection .. 1.3 1.9 2.0 2.0 2.0 1.2–1.4 1.7–1.9 1.8–2.0 1.9–2.0 2.0 1.1–1.7 1.5–2.0 1.8–2.0 1.8–2.1 2.0 Core PCE inflation4 ..... 1.7 1.8 2.0 2.0 1.7–1.8 1.8–1.9 1.9–2.0 2.0 1.6–1.8 1.7–2.0 1.8–2.2 1.8–2.2 September projection .. 1.7 1.8 2.0 2.0 1.6–1.8 1.7–1.9 1.9–2.0 2.0 1.5–2.0 1.6–2.0 1.8–2.0 1.8–2.1 Memo: Projected appropriate policy path Federal funds rate ...... 0.6 1.4 2.1 2.9 3.0 0.6 1.1–1.6 1.9–2.6 2.4–3.3 2.8–3.0 0.6 0.9–2.1 0.9–3.4 0.9–3.9 2.5–3.8 September projection .. 0.6 1.1 1.9 2.6 2.9 0.6–0.9 1.1–1.8 1.9–2.8 2.4–3.0 2.8–3.0 0.4–1.1 0.6–2.1 0.6–3.1 0.6–3.8 2.5–3.8 Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. The September projections were made in conjunction with the meeting of the Federal Open Market Committee on September 20–21, 2016. One participant did not submit longer-run projections for the change in real GDP, the unemployment rate, or the federal funds rate in conjunction with the September 20–21, 2016, meeting, and one participant did not submit such projections in conjunction with the December 13–14, 2016, meeting. 1. For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. 2. The central tendency excludes the three highest and three lowest projections for each variable in each year. 3. The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year. 4. Longer-run projections for core PCE inflation are not collected. The Outlook for Economic Activity Those increasing their projections for output growth in those years cited expected changes The median of participants’ projections for in fiscal, regulatory, or other policies as factors the growth rate of real GDP, conditional on contributing to their revisions. However, their individual assumptions about appropriate many participants noted that the effects monetary policy, was 1.9 percent in 2016, on the economy of such policy changes, if 2.1 percent in 2017, 2.0 percent in 2018, and implemented, would likely be partially offset 1.9 percent in 2019; the median of projections by tighter financial conditions, including for the longer-run normal rate of real GDP higher longer-term interest rates and a growth was 1.8 percent. Most participants strengthening of the dollar. projected that economic growth would pick up a bit in 2017 from the current year’s pace The median of projections for the and run at or slightly above their individual unemployment rate in the fourth quarter of estimates of its longer-run rate through 2019. 2016 was 4.7 percent, slightly lower than in Compared with the September Summary of September. Based on the median projections, Economic Projections (SEP), the medians the anticipated path of the unemployment of the projections for real GDP growth were rate for coming years also shifted down a slightly higher over the period from 2017 to bit, with the median for the end of 2019 at 2019, while the median assessment of the 4.5 percent, 0.3 percentage point below the longer-run growth rate was unchanged. Since median assessment of the longer-run normal September, almost half of the participants rate of unemployment, which was unchanged revised up their projections for real GDP from September. growth in 2018 or 2019, generally only slightly. MONETARy POLICy REPORT: FEBRUARy 2017 35 Figure 1. Medians, central tendencies, and ranges of economic projections, 2016–19 and over the longer run Percent Change in real GDP Median of projections Central tendency of projections 3 Range of projections 2 Actual 1 2011 2012 2013 2014 2015 2016 2017 2018 2019 Longer run Percent Unemployment rate 9 8 7 6 5 4 2011 2012 2013 2014 2015 2016 2017 2018 2019 Longer run Percent PCE inflation 3 2 1 2011 2012 2013 2014 2015 2016 2017 2018 2019 Longer run Percent Core PCE inflation 3 2 1 2011 2012 2013 2014 2015 2016 2017 2018 2019 Longer run Note: Definitions of variables and other explanations are in the notes to table 1. The data for the actual values of the variables are annual. 36 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 2. FOMC participants’ assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate Percent 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2016 2017 2018 2019 Longer run Note: Each shaded circle indicates the value (rounded to the nearest ⅛ percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. One participant did not submit longer-run projections for the federal funds rate. Figures 3.A and 3.B show the distributions The Outlook for Inflation of participants’ projections for real GDP growth and the unemployment rate from In the December SEP, the median of 2016 to 2019 and in the longer run. The projections for headline PCE price inflation distributions of individual projections of real in 2016 was 1.5 percent, a bit higher than in GDP growth shifted slightly higher relative to September. The median of projections for the distribution of the September projections headline PCE price inflation was 1.9 percent for 2017 through 2019. The distributions in 2017 and 2.0 percent in 2018 and 2019, of projections for the unemployment rate unchanged from September. Several shifted modestly lower for 2016 through 2019, participants projected that inflation will while the distribution of projections for the slightly exceed the Committee’s objective in longer-run normal rate of unemployment 2018 or 2019. The medians of projections for was unchanged. core PCE price inflation were the same as in September, rising from 1.7 percent in 2016 to 1.8 percent in 2017 and 2.0 percent in 2018 and 2019. MONETARy POLICy REPORT: FEBRUARy 2017 37 Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2016 –19 and over the longer run Number of participants 2016 December projections 18 September projections 16 14 12 10 8 6 4 2 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4- 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4- 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4- 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4- 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 38 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2016 –19 and over the longer run Number of participants 2016 December projections 18 September projections 16 14 12 10 8 6 4 2 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2017 39 Figures 3.C and 3.D provide information on rate 25 basis points, resulting in an increase in the distribution of participants’ views about the median of 13 basis points. the outlook for inflation. The distributions of projections for headline and core PCE In discussing their December forecasts, many price inflation shifted up slightly relative to participants expressed a view that increases in projections for the September meeting. Some the federal funds rate over the next few years participants attributed the upward shift in would likely be gradual in light of a short- projected inflation this year and next to recent term neutral real interest rate that currently data that showed somewhat higher inflation was low—a phenomenon that a number of than they had expected. A few saw higher participants attributed to the persistence of inflation in 2019 in conjunction with somewhat low productivity growth, continued strength greater undershooting of the unemployment of the dollar, a weak outlook for economic rate below its longer-run normal level. growth abroad, strong demand for safe longer- term assets, or other factors—and that was Appropriate Monetary Policy likely to rise only slowly as the effects of these factors faded over time. Some participants Figure 3.E provides the distribution of noted the continued proximity of short- participants’ judgments regarding the term nominal interest rates to the effective appropriate target for the federal funds rate at lower bound, even with an increase at this the end of each year from 2016 to 2019 and meeting, as limiting the Committee’s ability to over the longer run.7 All participants saw an increase monetary accommodation to counter increase of 25 basis points in the federal funds possible adverse shocks to the economy. rate at the December meeting as appropriate. These participants judged that, as a result, the The distributions for 2017 through 2019 Committee should take a cautious approach shifted up modestly. The median projections to removing policy accommodation. Many of the federal funds rate continued to show participants noted that there was currently gradual increases, to 1.4 percent at the end substantial uncertainty about the size, of 2017, 2.1 percent at the end of 2018, and composition, and timing of prospective fiscal 2.9 percent at the end of 2019; the median policy changes, but they also commented that of the longer-run projections of the federal a more expansionary fiscal policy might raise funds rate was 3.0 percent. The medians of aggregate demand above sustainable levels, the projections for the level of the federal potentially necessitating somewhat tighter funds rate for 2017 through 2019 were all monetary policy than currently anticipated. 25 basis points higher than in the September Furthermore, several participants indicated projections. A few participants revised up their that recent inflation data and the continued assessments of the longer-run federal funds strengthening in labor market conditions increased their confidence that inflation would move toward the 2 percent objective, making a slightly firmer path of monetary 7. One participant’s projections for the federal policy appropriate. funds rate, real GDP growth, the unemployment rate, and inflation were informed by the view that there are multiple possible medium-term regimes for the U.S. Uncertainty and Risks economy, that these regimes are persistent, and that the economy shifts between regimes in a way that cannot be The left-hand column of figure 4 shows that, forecast. Under this view, the economy currently is in a for each variable, a majority of participants regime characterized by expansion of economic activity judged the levels of uncertainty associated with low productivity growth and a low short-term real with their December projections for real GDP interest rate, but longer-term outcomes for variables other than inflation cannot be usefully projected. growth, the unemployment rate, headline 40 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants’ projections for PCE inflation, 2016 –19 and over the longer run Number of participants 2016 December projections 18 September projections 16 14 12 10 8 6 4 2 1.1– 1.3 – 1.5 – 1.7– 1.9 – 2.1– 1.2 1.4 1.6 1.8 2.0 2.2 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 1.1– 1.3 – 1.5 – 1.7– 1.9 – 2.1– 1.2 1.4 1.6 1.8 2.0 2.2 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.1– 1.3 – 1.5 – 1.7– 1.9 – 2.1– 1.2 1.4 1.6 1.8 2.0 2.2 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.1– 1.3 – 1.5 – 1.7– 1.9 – 2.1– 1.2 1.4 1.6 1.8 2.0 2.2 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.1– 1.3 – 1.5 – 1.7– 1.9 – 2.1– 1.2 1.4 1.6 1.8 2.0 2.2 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2017 41 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2016 –19 Number of participants 2016 December projections 18 September projections 16 14 12 10 8 6 4 2 1.5 – 1.7– 1.9 – 2.1– 1.6 1.8 2.0 2.2 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 1.5 – 1.7– 1.9 – 2.1– 1.6 1.8 2.0 2.2 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.5 – 1.7– 1.9 – 2.1– 1.6 1.8 2.0 2.2 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.5 – 1.7– 1.9 – 2.1– 1.6 1.8 2.0 2.2 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 42 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.E. Distribution of participants’ judgments of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate, 2016 –19 and over the longer run Number of participants 2016 December projections 18 September projections 16 14 12 10 8 6 4 2 0.38 – 0.63 – 0.88 – 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 0.62 0.87 1.12 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 0.38 – 0.63 – 0.88 – 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 0.62 0.87 1.12 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 0.38 – 0.63 – 0.88 – 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 0.62 0.87 1.12 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 0.38 – 0.63 – 0.88 – 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 0.62 0.87 1.12 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 0.38 – 0.63 – 0.88 – 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 0.62 0.87 1.12 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2017 43 Figure 4. Uncertainty and risks in economic projections Number of participants Number of participants Uncertainty about GDP growth Risks to GDP growth December projections December projections 18 18 September projections September projections 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about the unemployment rate Risks to the unemployment rate 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about PCE inflation Risks to PCE inflation 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about core PCE inflation Risks to core PCE inflation 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Note: For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” Definitions of variables are in the notes to table 1. 44 PART 3: SUMMARy OF ECONOMIC PROJECTIONS inflation, and core inflation to be broadly Table 2. Average historical projection error ranges similar to the average of the past 20 years.8 Percentage points However, more participants than in September Variable 2016 2017 2018 2019 saw uncertainty surrounding real GDP growth, Change in real GDP1 ...... ±0.9 ±1.7 ±2.1 ±2.1 the unemployment rate, or inflation as higher Unemployment rate1 ...... ±0.1 ±0.8 ±1.4 ±1.9 Total consumer prices2 .... ±0.2 ±1.0 ±1.1 ±1.1 than average. Many participants mentioned an Note: Error ranges shown are measured as plus or minus the root mean squared increase in uncertainty associated with fiscal, error of projections for 1996 through 2015 that were released in the winter by various private and government forecasters. (The note to this table that was included trade, immigration, or regulatory policies as in the Summary of Economic Projections for the meeting of September 20–21, 2016, incorrectly stated that the error ranges were based on projections for 1995 through a factor influencing their judgments about 2015. The correct time period was 1996 through 2015.) As described in the box “Forecast Uncertainty,” under certain assumptions, there is about a 70 percent prob- the degree of uncertainty surrounding their ability that actual outcomes for real GDP, unemployment, and consumer prices will projections. Participants cited the difficulty of be in ranges implied by the average size of projection errors made in the past. For more information, see David Reifschneider and Peter Tulip (2007), “Gauging the predicting the size, composition, and timing of Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance and Economics Discussion Series 2007-60 (Washington: Board of Governors of the these policy changes as well as the magnitude Federal Reserve System, November), available at www.federalreserve.gov/pubs/ feds/2007/200760/0760abs.html; and Board of Governors of the Federal Reserve and timing of their effects on the economy. System, Division of Research and Statistics (2014), “Updated Historical Forecast Errors,” memorandum, April 9, www.federalreserve.gov/foia/files/20140409-histori- cal-forecast-errors.pdf. As can be seen in the right-hand column of 1. Definitions of variables are in the general note to table 1. 2. Measure is the overall consumer price index, the price measure that has been figure 4, a majority of participants continued most widely used in government and private economic forecasts. Projection is percent change, fourth quarter of the previous year to the fourth quarter of the year to see the risks to real GDP growth, the indicated. unemployment rate, headline inflation, and some participants judged that the recent core inflation as broadly balanced; however, rise in market-based measures of inflation fewer participants saw risks to economic compensation suggested that downside risks growth and inflation as weighted to the to inflation had declined. However, many downside or saw risks to the unemployment also pointed to various sources of downside rate as weighted to the upside than in risk to economic activity, such as the limited September. A number of participants noted potential for monetary policy to respond to that the prospect of expansionary fiscal adverse shocks when the federal funds rate is policy had increased the upside risks to near the effective lower bound, downside risks economic activity and inflation, and a few in Europe and China, a possible increase in assessed the possibility of a reduction in trade barriers, and the possibility of a sharp regulation as posing upside risks to their rise in financial market volatility in the event forecasts of economic activity. Moreover, that fiscal and other policy changes diverged from market expectations. In addition, some 8. Table 2 provides estimates of the forecast uncertainty for the change in real GDP, the participants pointed to factors such as global unemployment rate, and total consumer price inflation disinflationary trends and downward pressure over the period from 1996 through 2015. At the end on import prices from further strengthening of this summary, the box “Forecast Uncertainty” of the dollar as sources of downside risk discusses the sources and interpretation of uncertainty to inflation. in the economic forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections. MONETARy POLICy REPORT: FEBRUARy 2017 45 Forecast Uncertainty The economic projections provided by the members 4.7 percent in the second year, and 0.9 to 5.1 percent of the Board of Governors and the presidents of in the third and fourth years. The corresponding the Federal Reserve Banks inform discussions of 70 percent confidence intervals for overall inflation monetary policy among policymakers and can aid would be 1.8 to 2.2 percent in the current year, 1.0 to public understanding of the basis for policy actions. 3.0 in the second year, and 0.9 to 3.1 percent in the Considerable uncertainty attends these projections, third and fourth years. however. The economic and statistical models and Because current conditions may differ from those relationships used to help produce economic forecasts that prevailed, on average, over history, participants are necessarily imperfect descriptions of the real world, provide judgments as to whether the uncertainty and the future path of the economy can be affected by attached to their projections of each variable is greater myriad unforeseen developments and events. Thus, than, smaller than, or broadly similar to typical levels in setting the stance of monetary policy, participants of forecast uncertainty in the past, as shown in table 2. consider not only what appears to be the most likely Participants also provide judgments as to whether the economic outcome as embodied in their projections, risks to their projections are weighted to the upside, but also the range of alternative possibilities, the are weighted to the downside, or are broadly balanced. likelihood of their occurring, and the potential costs to That is, participants judge whether each variable is the economy should they occur. more likely to be above or below their projections Table 2 summarizes the average historical accuracy of the most likely outcome. These judgments of a range of forecasts, including those reported in about the uncertainty and the risks attending each past Monetary Policy Reports and those prepared participant’s projections are distinct from the diversity by the Federal Reserve Board’s staff in advance of of participants’ views about the most likely outcomes. meetings of the Federal Open Market Committee. Forecast uncertainty is concerned with the risks The projection error ranges shown in the table associated with a particular projection rather than with illustrate the considerable uncertainty associated divergences across a number of different projections. with economic forecasts. For example, suppose a As with real activity and inflation, the outlook participant projects that real gross domestic product for the future path of the federal funds rate is subject (GDP) and total consumer prices will rise steadily at to considerable uncertainty. This uncertainty arises annual rates of, respectively, 3 percent and 2 percent. primarily because each participant’s assessment of If the uncertainty attending those projections is similar the appropriate stance of monetary policy depends to that experienced in the past and the risks around importantly on the evolution of real activity and the projections are broadly balanced, the numbers inflation over time. If economic conditions evolve reported in table 2 would imply a probability of about in an unexpected manner, then assessments of the 70 percent that actual GDP would expand within a appropriate setting of the federal funds rate would range of 2.1 to 3.9 percent in the current year, 1.3 to change from that point forward. 47 a bbreviations AFE advanced foreign economy BLS Bureau of Labor Statistics DPI disposable personal income EME emerging market economy FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product JOLTS Job Openings and Labor Turnover Survey LIBOR London interbank offered rate MBS mortgage-backed securities Michigan survey University of Michigan Surveys of Consumers MMF money market mutual fund OIS overnight index swap ON RRP overnight reverse repurchase agreement OPEC Organization of the Petroleum Exporting Countries PCE personal consumption expenditures SEP Summary of Economic Projections SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices SOMA System Open Market Account S&P Standard & Poor’s TIPS Treasury Inflation-Protected Securities For use at 10:00 a.m., EST February 14, 2017 M P r onetary olicy ePort February 14, 2017 Board of Governors of the Federal Reserve System

Federal Reserve (2017, February 13). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20170214

@misc{wtfs_monetary_policy_report_20170214,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2017},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20170214},
  note = {Retrieved via When the Fed Speaks corpus}
}