Monetary Policy Report

For use at 11:00 a.m., EST February 23, 2018 M P r onetary olicy ePort February 23, 2018 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 23, 2018 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, Jerome H. Powell, Chairman s tatement on L onger -r un g oaLs and m onetary P oLicy s trategy Adopted effective January 24, 2012; as amended effective January 30, 2018 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 4.6 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 Economic and Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Special Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Part 1: Recent Economic and Financial Developments . . . . . . . . . . . . . . . . 5 Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . 39 The Outlook for Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 The Outlook for Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Appropriate Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Uncertainty and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 List of Boxes How Tight Is the Labor Market? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Low Inflation in the Advanced Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Monetary Policy Rules and Their Role in the Federal Reserve’s Policy Process . . . . . . . . . . . . 35 Forecast Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Note: This report reflects information that was publicly available as of noon EST on February 22, 2018. Unless otherwise stated, the time series in the figures extend through, for daily data, February 21, 2018; for monthly data, January 2018; and, for quarterly data, 2017: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 15 and 33, 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 © 2018 S&P Dow Jones Indices LLC, a division of S&P Global, 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 Economic activity increased at a solid pace objective of 2 percent. The price index for over the second half of 2017, and the labor personal consumption expenditures increased market continued to strengthen. Measured 1.7 percent over the 12 months ending in on a 12-month basis, inflation has remained December 2017, about the same as in 2016. below the Federal Open Market Committee’s The 12-month measure of inflation that (FOMC) longer-run objective of 2 percent. excludes food and energy items (so-called The FOMC raised the target range for the core inflation), which historically has been federal funds rate twice in the first half of a better indicator of where overall inflation 2017, resulting in a range of 1 to 1¼ percent will be in the future than the headline figure, by the end of its June meeting. With the was 1.5 percent in December—0.4 percentage federal funds rate rising toward more normal point lower than it had been one year earlier. levels, at its September meeting, the FOMC However, monthly readings on core inflation decided to initiate a program of gradually were somewhat higher during the last few and predictably reducing the size of its months of 2017 than earlier in the year. balance sheet. At its meeting in December, Measures of longer-run inflation expectations the Committee judged that current and have, on balance, been generally stable, prospective economic conditions called for although some measures remain low by a further increase in the target range for the historical standards. federal funds rate, to 1¼ to 1½ percent. Economic growth. Real gross domestic product Economic and Financial (GDP) is reported to have increased at an Developments annual rate of nearly 3 percent in the second half of 2017 after rising slightly more than The labor market. The labor market has 2 percent in the first half. Consumer spending continued to strengthen since the middle of expanded at a solid rate in the second half, last year. Payroll employment has posted solid supported by job gains, rising household gains, averaging 182,000 per month in the wealth, and favorable consumer sentiment. seven months starting in July 2017, about the Business investment growth was robust, and same as the average pace in the first half of indicators of business sentiment have been 2017. Although net job creation last year was strong. The housing market has continued slightly slower than in 2016, it has remained to improve slowly. Foreign activity remained considerably faster than what is needed, solid and the dollar depreciated further in the on average, to absorb new entrants into the second half, but net exports subtracted from labor force. The unemployment rate declined real U.S. GDP growth as imports of consumer from 4.3 percent in June to 4.1 percent in and capital goods surged late in the year. January—somewhat below the median of FOMC participants’ estimates of its longer- Financial conditions. Financial conditions run normal level. Other measures of labor for businesses and households have utilization also suggest that the labor market eased on balance since the middle of has tightened since last summer. Nonetheless, 2017 amid an improving global growth wage growth has been moderate, likely held outlook. Notwithstanding financial market down in part by the weak pace of productivity developments in recent weeks, broad measures growth in recent years. of equity prices are higher, and spreads of yields on corporate bonds over those of Inflation. Consumer price inflation has comparable-maturity Treasury securities have remained below the FOMC’s longer-run narrowed. Most types of consumer loans 2 SUMMARy remained widely available, though credit The FOMC expects that, with further gradual was still difficult to access in credit card and adjustments in the stance of monetary policy, mortgage markets for borrowers with low economic activity will expand at a moderate credit scores or harder-to-document incomes. pace and labor market conditions will remain Longer-term nominal Treasury yields and strong. Inflation on a 12-month basis is mortgage rates have moved up on net. The expected to move up this year and to stabilize dollar depreciated, on average, against the around the Committee’s 2 percent objective currencies of our trading partners. In foreign over the next few years. The federal funds financial markets, equity prices generally rate is likely to remain, for some time, below increased in the second half of 2017, and most levels that are expected to prevail in the longer of those indexes remain higher, on net, despite run. Consistent with this outlook, in the most recent declines. Most longer-term yields rose recent Summary of Economic Projections noticeably. (SEP), which was compiled at the time of the December FOMC meeting, the median of Financial stability. Vulnerabilities in the U.S. participants’ assessments for the appropriate financial system are judged to be moderate on level of the federal funds rate through the end balance. Valuation pressures continue to be of 2019 remains below the median projection elevated across a range of asset classes even for its longer-run level. (The December SEP is after taking into account the current level presented in Part 3 of this report.) However, of Treasury yields and the expectation that as the Committee has continued to emphasize, the reduction in corporate tax rates should the actual path of the federal funds rate will generate an increase in after-tax earnings. depend on the economic outlook as informed Leverage in the nonfinancial business sector by incoming data. In particular, with inflation has remained high, and net issuance of risky having persistently run below the 2 percent debt has climbed in recent months. In contrast, longer-run objective, the Committee will leverage in the household sector has remained carefully monitor actual and expected inflation at a relatively low level, and household debt developments relative to its symmetric in recent years has expanded only about in inflation goal. line with nominal income. Moreover, U.S. banks are well capitalized and have significant Balance sheet policy. In the second half of liquidity buffers. 2017, the Committee initiated the balance sheet normalization program that is described Monetary Policy in the Addendum to the Policy Normalization Principles and Plans the Committee issued in Interest rate policy. The FOMC continued June.1 Specifically, since October, the Federal to gradually increase the target range for the Reserve has been gradually reducing its federal funds rate. After having raised it twice holdings of Treasury and agency securities in the first half of 2017, the Committee raised by decreasing the reinvestment of principal the target range for the federal funds rate payments it receives from these securities. again in December, bringing it to the current range of 1¼ to 1½ percent. The decision Special Topics to increase the target range for the federal funds rate reflected the solid performance of How tight is the labor market? Although the economy. Even with this rate increase, there is no way to know with precision, the the stance of monetary policy remains accommodative, thereby supporting strong 1. The June addendum is available on the Board’s labor market conditions and a sustained return website at https://www.federalreserve.gov/monetarypolicy/ to 2 percent inflation. files/FOMC_PolicyNormalization.20170613.pdf. MONETARy POLICy REPORT: FEBRUARy 2018 3 labor market appears to be near or a little such as global economic slack or the beyond full employment at present. The integration of emerging economies into the unemployment rate is somewhat below most world economy—as contributing to lower estimates of its longer-run normal rate, and inflation. Policymakers remain attentive the labor force participation rate is relatively to the possibility of such forces leading to close to many estimates of its trend. Although continued low inflation; they also are watchful employers report having more difficulties regarding the opposite risk of inflation moving finding qualified workers, hiring continues undesirably high. (See the box “Low Inflation apace, and serious labor shortages would likely in the Advanced Economies” in Part 1.) have brought about larger wage increases than have been evident to date. (See the box “How Monetary policy rules. Monetary policymakers Tight Is the Labor Market?” in Part 1.) consider a wide range of information on current economic conditions and the outlook Low global inflation. Inflation has generally before deciding on a policy stance they deem come in below central banks’ targets in the most likely to foster the FOMC’s statutory advanced economies for several years now. mandate of maximum employment and stable Resource slack and commodity prices—as prices. They also routinely consult monetary well as, for the United States, movements in policy rules that connect prescriptions for the the U.S. dollar—appear to explain inflation’s policy interest rate with variables associated behavior fairly well. But our understanding is with the dual mandate. The use of such rules imperfect, and other, possibly more persistent, requires careful judgments about the choice factors may be at work. Resource slack at and measurement of the inputs into these home and abroad might be greater than it rules as well as the implications of the many appears to be, or inflation expectations could considerations these rules do not take into be lower than suggested by the available account. (See the box “Monetary Policy Rules indicators. Moreover, some observers have and Their Role in the Federal Reserve’s Policy pointed to increased competition from online Process” in Part 2.) retailers or international developments— 5 P 1 art r e f d ecent conomic and inanciaL eveLoPments Domestic Developments during the past few years is consistent with an overall picture of improving labor market The labor market strengthened further conditions. In line with this perspective, the during the second half of 2017 and early LFPR for individuals aged 25 to 54—which is this year much less sensitive to population aging—has Payroll employment has continued to post been rising since 2015. The employment- solid gains, averaging 182,000 per month to-population ratio for individuals 16 and in the seven months starting in July 2017, older—that is, the share of people who are about the same pace as in the first half of working—was 60.1 percent in January and has 2017.2 Although net job creation last year was been increasing since 2011; this gain primarily slightly slower than in 2016, it has remained reflects the decline in the unemployment rate. considerably faster than what is needed, on (The box “How Tight Is the Labor Market?” average, to absorb new entrants to the labor describes the available measures of labor force and is therefore consistent with the market slack in more detail.) view that the labor market has strengthened further (figure 1). The strength of the labor Other indicators are also consistent with market is also evident in the decline in the continuing strong labor demand. The unemployment rate to 4.1 percent in January, number of people filing initial claims for ¼ percentage point below its level in June 2017 unemployment insurance has remained near and about ½ percentage point below the its lowest level in decades.3 As reported in the median of Federal Open Market Committee Job Openings and Labor Turnover Survey, the (FOMC) participants’ estimates of its longer- rate of job openings remained elevated in the run normal level (figure 2). second half of 2017, while the rate of layoffs remained low. In addition, the rate of quits Other indicators also suggest that labor stayed high, an indication that workers are able market conditions have continued to tighten. to obtain a new job when they seek one. The labor force participation rate (LFPR)— that is, the share of adults either working or actively looking for work—was 62.7 percent 3. Initial claims jumped in the fall of 2017 as a in January. The LFPR is little changed, on consequence of disruptions from the hurricanes and then net, since early 2014 (figure 3). However, the returned to a low level. average age of the population is continuing to increase. In particular, the members of the 1. Net change in payroll employment baby-boom cohort increasingly are moving 3-month moving averages Thousands of jobs into their retirement years, a time when labor force participation typically is low. That 400 Private development implies that a sustained period 200 in which the demand for and supply of labor + were in balance would be associated with a _0 downward trend in the overall participation Total nonfarm 200 rate. Accordingly, the flat profile of the LFPR 400 600 2. The hurricanes that struck the United States during 800 the second half of last year caused substantial variation in the month-to-month pattern of job gains, but the average performance over the period as a whole was 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 probably substantially unaffected. SOURCE: Bureau of Labor Statistics via Haver Analytics. 6 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 2. Measures of labor underutilization Monthly Percent 18 U-6 16 U-4 14 U-5 12 10 8 Unemployment rate 6 4 2006 2008 2010 2012 2014 2016 2018 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: Bureau of Labor Statistics via Haver Analytics. Unemployment rates have declined across demographic groups, but unemployment remains high for some groups Unemployment rates have trended downward 3. Labor force participation rates and employment-to-population ratio across racial and ethnic groups (figure 4). The decline in the unemployment rate for blacks or Percent Percent African Americans over the past few years has been particularly notable. This broad pattern 85 Labor force participation rate 68 is typical: The unemployment rates for blacks 66 84 and Hispanics tend to rise considerably more 64 than the rates for whites and Asians during 83 62 recessions, and then they decline more rapidly 82 during expansions. Yet even with the recent Employment-to-population ratio 60 narrowing, the disparities in unemployment 81 58 rates across demographic groups remain Prime-age labor force participation rate 80 56 substantial and largely the same as before the recession. The unemployment rate for whites 2002 2006 2010 2014 2018 has averaged 3.7 percent since the middle of NOTE: The data are monthly. The prime-age labor force participation rate 2017 and the rate for Asians has been about is a percentage of the population aged 25 to 54. The labor force participation rate and the employment-to-population ratio are percentages of the population 3.3 percent, while the unemployment rates for aged 16 and over. SOURCE: Bureau of Labor Statistics via Haver Analytics. Hispanics or Latinos (5.0 percent) and blacks (7.3 percent) have been substantially higher. In addition, the labor force participation rates for blacks, Hispanics, and Asians have generally been lower than those for whites of the same age group. As the labor market MONETARy POLICy REPORT: FEBRUARy 2018 7 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 2006 2008 2010 2012 2014 2016 2018 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: Bureau of Labor Statistics via Haver Analytics. has strengthened over the past few years, the participation rates for prime-age individuals in each of these groups have risen. Growth of labor compensation has been 5. Measures of change in hourly compensation moderate . . . Percent change from year earlier Despite the strong labor market, the available 6 indicators generally suggest that the growth Compensation per hour, business sector of hourly compensation has been moderate. 5 Atlanta Fed's Wage Growth Tracker Growth of compensation per hour in the 4 business sector—a broad-based measure 3 of wages, salaries, and benefits that is quite 2 volatile—was 2¼ percent over the four 1 quarters ending in 2017:Q4 (figure 5), well + _0 above the low reading in 2016 but about in Average hourly earnings Employment cost index 1 line with the average annual increase from 2010 to 2015.4 The employment cost index— 2010 2012 2014 2016 2018 which also measures both wages and the cost NOTE: Business-sector compensation is on a four-quarter percentage to employers of providing benefits—was up change basis. For the employment cost index, change is over the 12 months ending in the last month of each quarter; for average hourly earnings, change about 2½ percent in the fourth quarter of is from 12 months earlier; for the Atlanta Fed's Wage Growth Tracker, the data are shown as a 3-month moving average of the 12-month percent 2017 relative to its year-ago level, roughly change. SOURCE: Bureau of Labor Statistics via Haver Analytics; Federal Reserve Bank of Atlanta, Wage Growth Tracker. 4. The compensation per hour measure of wages and salaries declined at the end of 2016, possibly reflecting the shifting of bonuses or other types of income into 2017 in anticipation of a possible cut in personal income tax rates. 8 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS How Tight Is the Labor Market? Any assessment of labor market tightness is The fact that the LFPR for prime-age men remains inherently uncertain, as it involves comparing current below its pre-recession levels might suggest that slack labor market conditions with an estimate of conditions remains along this dimension; however, the lower that would prevail under full employment, where the level of the LFPR for prime-age men primarily seems latter circumstance cannot be directly observed or to reflect the continuation of a decades-long secular measured and can change over time. Many economists decline rather than a cyclical shortfall in their LFPR. In would describe the labor market as being at full addition, the U-6 measure of labor utilization—which employment when the unemployment rate has reached includes the unemployed, those marginally attached an “equilibrium” level, sometimes called the natural to the labor force, and those employed part time who rate of unemployment or the longer-run normal rate of would like full-time work—rose even more steeply unemployment. In judging the level of full employment, than the unemployment rate during and immediately one may also consider additional margins of labor after the recession and has since recovered to near utilization—including the labor force participation rate its pre-recession level. Although there is substantial (LFPR), the share of workers employed part time who uncertainty about the trends in each of the components would like to be working full time, and individuals of U-6, its current level can be cautiously interpreted who are classified as marginally attached to the labor as consistent with a labor market close to full force—as compared with trends in these measures. employment. While the uncertainty around the “normal” trends in One can also look at less-direct indicators of labor all of these variables is substantial, the labor market market tightness. For example, the share of small in early 2018 appears to be near or a little beyond full businesses with at least one job opening that they view employment. as hard to fill is now close to its record levels in the late The unemployment rate is now somewhat below 1990s (as seen in the black line in figure B), consistent most estimates of its natural rate. Specifically, the with the notion that as the labor market tightens, unemployment rate in January, at 4.1 percent, is businesses find it increasingly difficult to hire additional ½ percentage point below the median of Federal Open workers. Similarly, survey measures of households’ Market Committee (FOMC) participants’ estimates of the longer-run normal rate of unemployment, which Galbis-Reig,Christopher Smith, and William Wascher (2014), was reported to have been 4.6 percent as of the “Labor Force Participation: Recent Developments and December 2017 FOMC meeting. The unemployment Future Prospects,” Brookings Papers on Economic Activity, Fall, pp. 197–275, https://www.brookings.edu/wp-content/ rate is also about ½ percentage point below the uploads/2016/07/Fall2014BPEA_Aaronson_et_al.pdf. Congressional Budget Office’s (CBO) current estimate Estimates of trend LFPR are also provided by the CBO in their of the natural rate; by this measure, the labor market is recurring publication The Budget and Economic Outlook and about as tight as it was in the late 1980s but less tight its updates. than in the late 1990s (figure A). That said, the median A. Unemployment rate gap of FOMC participants’ estimates of the longer-run normal rate of unemployment and the CBO’s estimate Quarterly Percent of labor force of the natural rate of unemployment have both been revised down by about 1 percentage point over the past 5 few years, one indication of the substantial uncertainty surrounding estimates of the “full employment” rate of 4 unemployment.1 3 As discussed in the main text, the LFPR has been roughly unchanged, on net, over the past four years, 2 representing an important cyclical improvement 1 relative to its declining trend. While estimates of the + trend LFPR are subject to substantial uncertainty and _0 differ among analysts, the current level of the LFPR 1 is relatively close to many estimates of its trend.2 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 1. As another indication of this uncertainty, the range of FOMC participants’ estimates of the longer-run normal rate of NOTE: The unemployment rate gap is the unemployment rate minus the Congressional Budget Office's estimate of the natural rate of unemployment. unemployment was 4.3 to 5.0 percent in December 2017. The shaded bars indicate periods of business recession as defined by the 2. For a variety of approaches to assessing the level National Bureau of Economic Research. of trend LFPR and the associated range of estimates, see SOURCE: For unemployment rate, Bureau of Labor Statistics; for natural Stephanie Aaronson, Tomaz Cajner, Bruce Fallick, Felix rate of unemployment, Congressional Budget Office; all via Haver Analytics. MONETARy POLICy REPORT: FEBRUARy 2018 9 perceptions about job availability are currently at high taken longer for businesses to find workers in recent levels, as shown by the blue line in figure B. years, yet wage growth has remained steady or slowed. However, despite reports that employers are now Finally, while the aggregate labor market appears having more difficulties finding qualified workers, to be modestly tight at the moment, not all individuals hiring has continued apace. Although payroll have benefited equally from these developments. As employment gains have gradually slowed over time discussed in the main text, noticeable differences from about 250,000 per month, on average, in 2014 in labor market outcomes remain present across to about 180,000 per month, on average, in 2017, job racial and ethnic groups. Moreover, the labor market growth remains consistent with further strengthening improvement in recent years has not been sufficient in the labor market.3 Finally, the pace of wage gains to make important progress in narrowing income has been moderate; while wage gains have likely been inequality. Finally, regional disparities are also striking, held down by the sluggish pace of productivity growth and in certain aspects these disparities have widened in recent years, serious labor shortages would probably in recent years; for example, the employment- bring about larger increases than have been observed to-population ratio for prime-age individuals has thus far. recovered less for those outside of metro areas than for It is possible that labor shortages have arisen in those in metro areas (figure C).5 certain pockets of the economy, which could be an early indication of bottlenecks that are not yet readily transportation, health and education, leisure and hospitality, apparent in the aggregate labor market. However, even and professional and business services. at the industry level it is difficult to see much evidence of 5. See Alison Weingarden (2017), “Labor Market Outcomes emerging supply constraints.4 In some industries, such as in Metropolitan and Non-metropolitan Areas: Signs of trade and transportation as well as leisure and hospitality, Growing Disparities,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, September 25), employment growth has slowed markedly and it has https://www.federalreserve.gov/econres/notes/feds-notes/labor- market-outcomes-in-metropolitan-and-non-metropolitan- 3. Payroll gains in the range of about 90,000 to 120,000 areas-signs-of-growing-disparities-20170925.htm. per month are estimated to be consistent with a constant unemployment rate and a decline in the labor force participation rate in line with its demographically driven trend. 4. The analysis behind this statement considered six C. Prime-age employment-to-population ratio by broad industries—construction, manufacturing, trade and metropolitan status B. Job availability and hard-to-fill positions Monthly Percent Larger MSAs Percent Index 82 Smaller MSAs 35 160 80 140 30 78 Job availability 120 25 76 100 20 80 74 15 60 Non-metro 72 10 40 5 Hard-to-fill 20 199619982000200220042006200820102012201420162018 NOTE: The data are 12-month centered moving averages. Larger 1982198619901994199820022006201020142018 metropolitan statistical areas (MSAs) consist of 500,000 people or more, and smaller MSAs consist of 100,000 to 500,000 people. The shaded bars indicate NOTE: Job availability is the proportion of households believing jobs are periods of business recession as defined by the National Bureau of Economic plentiful minus the proportion believing jobs are hard to get, plus 100. Research. Hard-to-fill is the three-month moving average of the percent of small SOURCE: Alison Weingarden (2017), “Labor Market Outcomes in businesses surveyed with at least one hard-to-fill job opening, and it is Metropolitan and Non-metropolitan Areas: Signs of Growing Disparities,” seasonally adjusted by Federal Reserve Board staff. Monthly hard-to-fill data FEDS Notes (Washington: Board of Governors of the Federal Reserve from the National Federation of Independent Business start in January 1986. System, September 25), www.federalreserve.gov/econres/notes/feds-notes/ The shaded bars indicate periods of business recession as defined by the labor-market-outcomes-in-metropolitan-and-non-metropolitan-areas-signs-of National Bureau of Economic Research. Data are monthly. -growing-disparities-20170925.htm. Calculations use data from the U.S. SOURCE: For job availability, Conference Board; for hard-to-fill, National Census Bureau, Current Population Survey; note that the Bureau of Labor Federation of Independent Business. Statistics is involved in the survey process for the Current Population Survey. 10 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS ½ percentage point faster than its gain a year earlier. Among measures that do not take account of benefits, average hourly earnings rose slightly less than 3 percent through January of this year, a gain that was somewhat faster than the average increase in the preceding few years. Similarly, the measure of wage growth computed by the Federal Reserve Bank of Atlanta that tracks median 12-month wage growth of individuals reporting to the Current Population Survey showed an increase of about 3 percent in January, similar to its readings from the past three years and above the average increase in the preceding few years.5 . . . and likely was restrained by slow growth of labor productivity 6. Change in business-sector output per hour These moderate rates of compensation gain likely reflect the offsetting influences of a Percent, annual rate tightening labor market and persistently weak productivity growth. Since 2008, labor 4 productivity has increased only a little more than 1 percent per year, on average, well below the average pace from 1996 through 3 2007 and also below the gains in the 1974–95 period (figure 6). Considerable debate remains 2 about the reasons for the general slowdown in productivity growth and whether it will persist. 1 The slowdown may be partly attributable to the sharp pullback in capital investment 1948– 1974– 1996– 2001– 2008– during the most recent recession and the 73 95 2000 07 present relatively long period of modest growth NOTE: Changes are measured from Q4 of the year immediately preceding the period through Q4 of the final year of the period. The final period is in investment that followed, but a reduced measured from 2007:Q4 through 2017:Q4. SOURCE: Bureau of Labor Statistics via Haver Analytics. pace of capital deepening can explain only a portion of the step-down. Beyond that, some economists think that more recent technological advances, such as information technology, have been less revolutionary than earlier general-purpose technologies, such as electricity and internal combustion. Others have pointed to a slowdown in the speed at which capital and labor are reallocated toward their most productive uses, which is reflected in fewer business start-ups and a reduced 5. The Atlanta Fed’s measure differs from others in that it measures the wage growth only of workers who were employed both in the current survey month and 12 months earlier. MONETARy POLICy REPORT: FEBRUARy 2018 11 pace of hiring and investment by the most innovative firms. Still others argue that there have been important innovations in many fields in recent years, from energy to medicine, often underpinned by ongoing advances in information technology, which augurs well for productivity growth going forward. However, those economists note that such productivity gains may appear only slowly as new firms emerge to exploit the new technologies and as incumbent firms invest in new vintages of capital and restructure their businesses. Price inflation remains below 2 percent, but the monthly readings picked up toward the end of 2017 7. Change in the price index for personal consumption Consumer price inflation, as measured by expenditures the 12-month change in the price index for Monthly 12-month percent change personal consumption expenditures (PCE), remained below the FOMC’s longer-run Total 3.0 objective of 2 percent during most of 2017. Trimmed mean 2.5 Excluding food The PCE price index increased 1.7 percent and energy 2.0 over the 12 months ending in December 2017, about the same as in 2016 (figure 7). Core 1.5 inflation, which typically provides a better 1.0 indication than the headline measure of .5 where overall inflation will be in the future, + was 1.5 percent over the 12 months ending in _0 December 2017—0.4 percentage point lower 2011 2012 2013 2014 2015 2016 2017 than it had been one year earlier. NOTE: The data extend through December 2017; changes are from one year earlier. Both measures of inflation reflected some SOURCE: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Bureau of Economic Analysis; all via Haver Analytics. weak readings in the spring and summer of 2017. A portion of those weak readings seemed attributable to idiosyncratic events, such as a steep 1-month decline in the price index for wireless telephone services. However, the monthly readings on core inflation were somewhat higher during the last few months of 2017, in contrast to the more typical pattern that has prevailed in recent years in which readings around the end of the year have tended to be slightly below average. Moreover, the 12-month change in the trimmed mean PCE price index—an alternative indicator of underlying inflation produced by the Federal Reserve Bank of Dallas that may be less sensitive to idiosyncratic price movements— was 1.7 percent in December 2017 and has slowed by less than core PCE price inflation 12 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS over the past 12 months.6 (For more discussion of inflation both in the United States and abroad, see the box “Low Inflation in the Advanced Economies.”) Oil and metals prices increased notably 8. Brent spot and futures prices Headline inflation was a little higher than Weekly Dollars per barrel core inflation last year, which reflected a rise in consumer energy prices. The price of crude 130 Spot price 120 oil rose from $48 per barrel at the end of June 110 to a peak of about $70 per barrel early in the 100 year and, even after recent declines, remains 90 24-month-ahead more than 30 percent above its mid-2017 level futures contracts 80 70 (figure 8). The upswing in oil prices appears to 60 have been driven primarily by strengthening 50 global demand as well as OPEC’s decision to 40 further extend its November 2016 production 30 20 cuts through the end of 2018. The higher oil 2014 2015 2016 2017 2018 prices fed through to moderate increases in the cost of gasoline and heating oil. NOTE: The data are weekly averages of daily data and extend through February 21, 2018. SOURCE: ICE Brent Futures via Bloomberg. Inflation momentum was also supported by nonfuel import prices, which rose throughout 9. Nonfuel import prices and industrial metals indexes 2017 in part because of dollar depreciation (figure 9). That development marked a turn January 2014 = 100 January 2014 = 100 from the past several years, during which nonfuel import prices declined or held flat. 120 104 In addition to the decline in the dollar, 110 102 nonfuel import prices were driven higher by a substantial increase in the price of industrial 100 100 metals. Despite recent volatility, metals prices 90 98 remain higher, on net, boosted primarily by improved prospects for global demand and 80 Nonfuel import prices 96 Industrial metals also by government policies that restrained 70 94 production in China. 2014 2015 2016 2017 2018 In contrast, headline inflation has been NOTE: The data for nonfuel import prices are monthly. The data for held down by consumer food prices, which industrial metals are a monthly average of daily data and extend through February 21, 2018. increased only about ½ percent in 2017 after SOURCE: For nonfuel import prices, Bureau of Labor Statistics; for industrial metals, S&P GSCI Industrial Metals Spot Index via Haver having declined in 2016. Food prices have Analytics. 6. The trimmed mean index excludes whatever prices showed the largest increases or decreases in a given month; for example, the sharp decline in prices for wireless telephone services in March 2017 was excluded from this index. MONETARy POLICy REPORT: FEBRUARy 2018 13 been restrained by softness in the prices of farm commodities, which in turn has reflected robust supply in the United States and abroad. Although the harvests for many crops in the United States declined in 2017, they were larger than had been expected earlier in the year. Survey-based measures of inflation expectations have been generally stable. . . Expectations of inflation likely influence actual inflation by affecting wage- and price-setting decisions. Survey-based measures of inflation 10. Median inflation expectations expectations at medium- and longer-term horizons have remained generally stable. In the Percent Survey of Professional Forecasters conducted by the Federal Reserve Bank of Philadelphia, Michigan survey expectations 4 the median expectation for the annual rate of for next 5 to 10 years increase in the PCE price index over the next 3 10 years has been around 2 percent for the past several years (figure 10). In the University of 2 Michigan Surveys of Consumers, the median SPF expectations value for inflation expectations over the next for next 10 years 1 5 to 10 years—which had drifted downward starting in 2014—has held about flat since the end of 2016 at a level that is a few tenths lower 2006 2008 2010 2012 2014 2016 2018 than had prevailed through 2014. NOTE: The Michigan survey data are monthly and extend through February; the February data are preliminary. The SPF data for inflation expectations for personal consumption expenditures are quarterly and extend . . . and market-based measures of from 2007:Q1 through 2018:Q1. inflation compensation have increased in SOURCE: University of Michigan Surveys of Consumers; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters (SPF). recent months but remain relatively low Inflation expectations can also be gauged by market-based measures of inflation compensation, though the inference is not straightforward because market-based measures can be importantly affected by changes in premiums that provide compensation for bearing inflation and liquidity risks. Measures of longer-term inflation compensation—derived either from differences between yields on nominal Treasury securities and those on comparable Treasury Inflation-Protected Securities (TIPS) or from inflation swaps—have increased since June, returning to levels seen in early 2017, but 14 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Low Inflation in the Advanced Economies Inflation has been persistently low in recent years B. Inflation excluding food and energy in selected across many advanced economies. In the United States, advanced foreign economies both overall inflation and core (excluding food and energy prices) inflation, as measured by the price index Monthly 12-month percent change for personal consumption expenditures, have run below 2 percent for most of the period since 2008 (figure A). 4 In other advanced economies, measures of core United Kingdom 3 inflation have run even lower in some cases, with core Canada 2 inflation in the euro area currently at around 1 percent and in Japan at close to zero (figure B). 1 What explains this period of low inflation? Across Euro area + the advanced economies, the main factors holding _0 inflation down likely include the extended period of Japan 1 economic slack following the Great Recession and 2 the falling prices of oil and other commodities from around mid-2014 to early 2016. In the United States, 2008 2010 2012 2014 2016 2018 inflation also has been held down by the rise in the foreign exchange value of the dollar from mid-2014 NOTE: The data for the euro area incorporate the flash estimate for January 2018. The data for Canada and Japan extend through December 2017. through 2016. The low core U.S. inflation in 2017 has SOURCE: For the United Kingdom, Office for National Statistics; for Japan, been more of a puzzle (albeit modest in magnitude) Ministry of International Affairs and Communications; for the euro area, and harder to associate with an identifiable cause.1 Statistical Office of the European Communities; for Canada, Statistics Canada; all via Haver Analytics. As is discussed in the December 2017 Summary of Economic Projections (Part 3 of this report), most Federal Reserve policymakers view these recent low But our understanding of the forces that drive inflation readings as likely to prove transitory and inflation is imperfect, and the fact that many advanced project U.S. inflation this year to move closer to their economies are experiencing low inflation at the same 2 percent objective. Many private forecasters appear to time suggests that other, possibly more persistent, share this view. factors may be at work. As one possibility, the natural rate of unemployment—the rate at which labor markets 1. For additional discussion of the reasons for low inflation exert neither upward nor downward pressure on in the United States, see Janet yellen (2017), “Inflation, inflation—is highly uncertain, and it could be lower Uncertainty, and Monetary Policy,” speech delivered at “Prospects for Growth: Reassessing the Fundamentals,” 59th in many economies than most economists estimate. Annual Meeting of the National Association for Business Alternatively, inflation expectations could be lower Economics, Cleveland, Ohio, September 26, https://www. than suggested by the available indicators. federalreserve.gov/newsevents/speech/yellen20170926a.htm. More-fundamental changes in the global economy could also be contributing to the recent stretch of A. Change in the price index for personal consumption lower inflation. First, anecdotal reports suggest that expenditures technological changes could be reducing pricing power in many industries, holding down inflation as Monthly 12-month percent change that occurs.2 For example, the increased prevalence of 5 Internet shopping allows consumers to compare prices more easily across sellers, possibly implying greater 4 Total Excluding food competition that could be putting downward pressure and energy 3 on consumer prices (figure C). While this hypothesis is 2 certainly plausible, it does not easily square with the observation that, at least within the United States, profit 1 + margins have been high (figure D).3 _0 1 2. Goldman Sachs (2017), “The Amazon Effect in Perspective,” U.S. Economics Analyst (New york: Goldman 2 Sachs, September 30). 3. See Council of Economic Advisers (2016), “Benefits 2007 2009 2011 2013 2015 2017 of Competition and Indicators of Market Power,” Council of Economic Advisers Issue Brief (Washington: CEA, April), NOTE: The data extend through December 2017; changes are from one year earlier. https://obamawhitehouse.archives.gov/sites/default/files/page/ SOURCE: Bureau of Economic Analysis via Haver Analytics. files/20160414_cea_competition_issue_brief.pdf. MONETARy POLICy REPORT: FEBRUARy 2018 15 C. E-commerce sales as a share of retail sales D. Corporate profits as a share of gross national product Quarterly Percent Quarterly Percent 10 9 14 8 7 12 6 5 10 4 3 8 2 1 6 0 1999 2002 2005 2008 2011 2014 2017 1982 1987 1992 1997 2002 2007 2012 2017 NOTE: E-commerce sales are sales of goods and services where an order is NOTE: The data extend through 2017:Q3. Corporate profits include placed by the buyer or where the price and terms of sale are negotiated over inventory valuation and capital consumption adjustments. an online system. Payment may or may not be made online. SOURCE: Bureau of Economic Analysis via Haver Analytics. SOURCE: Retail Indicators Branch, U.S. Census Bureau. Second, some observers have pointed to global than other consumers.6 Others have pointed to a developments as helping to explain persistent low slowdown in medical services price increases across inflation across countries. These developments countries, possibly associated with either health-care include economic slack abroad or the integration of reform or fiscal austerity.7 This slowdown has had a emerging economies into the world economy, leading material effect on U.S. inflation, though the extent to to increased competition or downward pressures on which these declines will persist is uncertain. wages.4 But the evidence that global slack can help In summary, while standard economic models explain inflation in a given country, beyond its effect appear to explain much of the post–Great Recession on commodity and import prices, is mixed at best.5 period of low inflation, they do not preclude other Moreover, measures of integration, such as global explanations. Even as most policymakers expect trade as a fraction of gross domestic product or the inflation in their economies to move back to their participation in global value chains, appear to have targets over time, they remain attentive to the possibility leveled off in recent years. that factors not included in those models, such as those A number of other explanations for low global described here, may keep inflation low. At the same inflation have been advanced as well. These time, they are attentive to the opposite risk of inflation explanations include some tentative evidence moving undesirably high, should tightening demand suggesting that the aging of the population could be conditions lead to faster rises in wages and prices than exerting downward pressure on trend inflation, perhaps currently anticipated. because retirees may tend to be more price conscious 6. See Jong-Won yoon, Jinill Kim, and Jungjin Lee (2014), 4. See Claudio Borio and Andrew Filardo (2007), “Impact of Demographic Changes on Inflation and the “Globalisation and Inflation: New Cross-Country Evidence Macroeconomy,” IMF Working Paper WP/14/210 (Washington: on the Global Determinants of Domestic Inflation,” BIS International Monetary Fund, November), https://www.imf. Working Papers 227 (Basel, Switzerland: Bank for International org/external/pubs/ft/wp/2014/wp14210.pdf. However, other Settlements, May), www.bis.org/publ/work227.pdf; and evidence suggests increased inflationary pressure from an Raphael Auer, Claudio Borio, and Andrew Filardo (2017), “The aging population; see Mikael Juselius and Előd Takáts (2015), Globalisation of Inflation: The Growing Importance of Global “Can Demography Affect Inflation and Monetary Policy?” BIS value Chains,” BIS Working Papers 602 (Basel, Switzerland: Working Papers 485 (Basel, Switzerland: Bank for International Bank for International Settlements, January), www.bis.org/ Settlements, February), https://www.bis.org/publ/work485.pdf. publ/work602.pdf. 7. See Tim Mahedy and Adam Shapiro (2017), “What’s 5. See Jane Ihrig, Steven B. Kamin, Deborah Lindner, Down with Inflation?” FRBSF Economic Letter 2017-35 (San and Jaime Marquez (2010), “Some Simple Tests of the Francisco: Federal Reserve Bank of San Francisco, November), Globalization and Inflation Hypothesis,” International Finance, https://www.frbsf.org/economic-research/publications/ vol. 13 (Winter), pp. 343–75; and European Central Bank economic-letter/2017/november/contribution-to-low-pce- (2017), “Domestic and Global Drivers of Inflation in the Euro inflation-from-healthcare); and Goldman Sachs (2017), “What Area,” ECB Economic Bulletin, no. 4 (June), pp. 72–96, https:// Can We Learn from Lower Inflation Abroad?” U.S. Economics www.ecb.europa.eu/pub/pdf/other/ebart201704_01.en.pdf. Analyst (New york: Goldman Sachs, November 12) 16 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 11. 5-to-10-year-forward inflation compensation nevertheless remain relatively low (figure 11).7 The TIPS-based measure of 5-to-10-year- Weekly Percent forward inflation compensation and the analogous measure of inflation swaps are now 3.5 Inflation swaps slightly lower than 2¼ percent and 2½ percent, 3.0 respectively, with both measures below the ranges that persisted for most of the 10 years 2.5 before the start of the notable declines TIPS breakeven rates 2.0 in mid-2014. 1.5 Real gross domestic product growth 1.0 picked up in the second half of 2017 2010 2012 2014 2016 2018 Real gross domestic product (GDP) is NOTE: The data are weekly averages of daily data and extend through reported to have risen at an annual rate of February 16, 2018. TIPS is Treasury Inflation-Protected Securities. nearly 3 percent in the second half of 2017 SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve Board staff estimates. after increasing slightly more than 2 percent in the first half of 2017 (figure 12). Much of that faster growth reflects the stabilization of inventory investment, which had slowed 12. Change in real gross domestic product and gross considerably in the first half of last year. domestic income Private domestic final purchases—that is, Percent, annual rate final purchases by U.S. households and Gross domestic product businesses, which tend to provide a better Gross domestic income 5 indication of future GDP growth than most other components of overall spending—rose 4 at a solid annual rate of about 3½ percent in the second half of the year, similar to the first- H2* 3 H1 half pace. 2 The economic expansion continues to 1 be supported by steady job gains, rising household wealth, favorable consumer sentiment, strong economic growth abroad, 2011 2012 2013 2014 2015 2016 2017 and accommodative financial conditions, * Gross domestic income is not yet available for 2017:H2. SOURCE: Bureau of Economic Analysis via Haver Analytics. including the still low cost of borrowing and easy access to credit for many households and businesses. In addition to these factors, very 7. Inflation compensation implied by the TIPS breakeven inflation rate is based on the difference, at comparable maturities, between yields on nominal Treasury securities and yields on TIPS, which are indexed to the headline consumer price index (CPI). Inflation swaps are contracts in which one party makes payments of certain fixed nominal amounts in exchange for cash flows that are indexed to cumulative CPI inflation over some horizon. Focusing on inflation compensation 5 to 10 years ahead is useful, particularly for monetary policy, because such forward measures encompass market participants’ views about where inflation will settle in the long term after developments influencing inflation in the short term have run their course. MONETARy POLICy REPORT: FEBRUARy 2018 17 upbeat business sentiment appears to have 13. Change in real personal consumption expenditures and disposable personal income supported solid growth over the past year. Percent, annual rate Ongoing improvement in the labor Personal consumption expenditures 6 market and gains in wealth continue to Disposable personal income 5 support consumer spending . . . 4 H1 H2 3 Supported by ongoing improvement in the 2 labor market, real consumer spending rose at 1 a solid annual rate of 3 percent in the second + _0 half of 2017, a somewhat faster pace than 1 in the first half. Real disposable personal 2 income—that is, income after taxes and 3 adjusted for price changes—increased at a 2011 2012 2013 2014 2015 2016 2017 modest average rate of 1 percent in 2016 and 2017, as real wages changed little over this SOURCE: Bureau of Economic Analysis via Haver Analytics. period (figure 13). With spending growth 14. Personal saving rate estimated to have outpaced income growth, the personal saving rate has declined considerably Monthly Percent since the end of 2015 (figure 14). 12 Consumer spending has also been supported 10 by further increases in household net wealth. 8 Broad measures of U.S. equity prices rose robustly last year, though markets have been 6 volatile in recent weeks; house prices have also 4 continued to climb, strengthening the wealth of homeowners (figure 15). As a result of the 2 increases in home and equity prices, aggregate household net worth rose appreciably in 2017. 2007 2009 2011 2013 2015 2017 In fact, at the end of the third quarter of 2017, NOTE: Data are through December 2017. household net worth was 6.7 times the value of SOURCE: Bureau of Economic Analysis via Haver Analytics. disposable income, the highest-ever reading for 15. Prices of existing single-family houses that ratio, which dates back to 1947 (figure 16). Monthly Percent change from year earlier . . . borrowing conditions for consumers S&P/Case-Shiller CoreLogic 15 remain generally favorable . . . national index price index 10 Consumer credit expanded in 2017 at about 5 + the same pace as in 2016 (figure 17). Financing _0 conditions for most types of consumer loans 5 are generally favorable. However, banks have Zillow index 10 continued to tighten standards on credit card 15 and auto loans for borrowers with low credit scores, possibly in response to some upward 20 drift in delinquency rates for those borrowers. 2007 2009 2011 2013 2015 2017 Mortgage credit has remained readily available NOTE: The data for the S&P/Case-Shiller index extend through November for households with solid credit profiles, but 2017. The data for the Zillow index and the CoreLogic index extend through December 2017. it was still difficult to access for households SOURCE: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S. with low credit scores or harder-to-document 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 incomes. licensing information, see the note on the Contents page.) 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 16. Wealth-to-income ratio Although household borrowing continued to increase last year, the household debt service Quarterly Ratio burden—the ratio of required principal and interest payments on outstanding household 7.0 debt to disposable income, measured for the household sector as a whole—remained low by 6.5 historical standards. 6.0 . . . and consumer confidence is strong 5.5 Consumers have remained optimistic about 5.0 their economic situation. As measured by the Michigan survey, consumer sentiment was 1996 1999 2002 2005 2008 2011 2014 2017 solid throughout 2017, likely reflecting rising NOTE: The data extend through 2017:Q3. The series is the ratio of income, job gains, and low inflation (figure 18). household net worth to disposable personal income. Furthermore, the share of households SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; for income, Bureau of Economic expecting real income to rise over the next year Analysis via Haver Analytics. or two has continued to strengthen and now 17. Changes in household debt exceeds its pre-recession level. Billions of dollars, annual rate Activity in the housing sector has Mortgages Consumer credit 1,000 improved modestly Sum 800 Real residential investment spending increased 600 around 2 percent in 2017, about the same modest gain that was seen in 2016. Housing 400 activity was soft in the spring and summer, 200 possibly reflecting the rise in mortgage interest + _0 rates early in the year, and then picked up 200 toward the end of the year. For the year as a whole, sales of new and existing homes gained, 2007 2009 2011 2013 2015 2017 and single-family housing starts increased NOTE: The values for 2017 are the averages of the seasonally adjusted (figures 19 and 20). In contrast, multifamily annualized quarterly flows through 2017:Q3. SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial housing starts continued to edge down from Accounts of the United States.” the solid pace seen in 2016. Going forward, 18. Indexes of consumer sentiment and income expectations lean inventories are likely to support further gains in homebuilding activity, as the months’ Diffusion index Index supply of homes for sale has remained near 110 low levels. 90 Real income expectations 100 Business investment has continued to 80 90 rebound . . . 70 80 Real outlays for business investment—that 70 60 is, private nonresidential fixed investment— 60 rose at an annual rate of about 6 percent 50 Consumer sentiment 50 in the second half of 2017, a bit below the gain in the first half but still notably faster 2006 2008 2010 2012 2014 2016 2018 than the unusually weak pace recorded NOTE: The data extend through February 2018; the February data are in 2016 (figure 21). Business spending on preliminary. The consumer sentiment data are monthly and are indexed to 100 in 1966. The real income expectations data are calculated as the net equipment and intangibles (such as research 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. MONETARy POLICy REPORT: FEBRUARy 2018 19 and development) advanced at a solid pace 19. New and existing home sales in the second half of the year, and forward- Millions, annual rate Millions, annual rate looking indicators of business spending are generally favorable: Orders and shipments of 7.5 1.6 7.0 Existing home sales capital goods have posted net gains in recent 1.4 6.5 months, and indicators of business sentiment 1.2 6.0 and activity remain very upbeat. That said, 5.5 1.0 business outlays on structures turned down in 5.0 .8 the second half of 2017, as investment growth 4.5 .6 in drilling and mining structures retreated 4.0 from a very rapid pace in the first half and .4 3.5 investment in other nonresidential structures 3.0 New home sales .2 declined. 2006 2008 2010 2012 2014 2016 2018 . . . while corporate financing conditions NOTE: Data are monthly. New home sales extend through December 2017 and include only single-family sales. Existing home sales includes have remained accommodative single-family, condo, townhome, and co-op sales. SOURCE: For new home sales, U.S. Census Bureau; for existing home sales, National Association of Realtors; all via Haver Analytics. Aggregate flows of credit to large nonfinancial firms remained solid through the third quarter, supported in part by continued low 20. Private housing starts and permits interest rates (figure 22). The gross issuance of corporate bonds stayed robust during Monthly Millions of units, annual rate the second half of 2017, and yields on both investment-grade and high-yield corporate 2.0 Single-family starts bonds remained low by historical standards 1.6 (figure 23). 1.2 Despite solid growth in business investment, Single-family permits .8 outstanding commercial and industrial (C&I) loans on banks’ books continued to rise .4 only modestly in the third quarter of 2017. Multifamily starts 0 Respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices, 2006 2008 2010 2012 2014 2016 2018 or SLOOS, reported that demand for C&I SOURCE: U.S. Census Bureau via Haver Analytics. loans declined in the third quarter and was little changed in the fourth quarter even as lending standards and terms on such loans 21. Change in real private nonresidential fixed investment eased.8 Respondents attributed this decline in Percent, annual rate demand in part to firms drawing on internally Structures generated funds or using alternative sources Equipment and intangible capital 15 of financing. Financing conditions for small H1 businesses appear to have remained favorable, H2 10 and although credit growth has remained 5 sluggish, survey data suggest this sluggishness + is largely due to continued weak demand for _0 credit by small businesses. 5 10 8. The SLOOS is available on the Board’s website at https://www.federalreserve.gov/data/sloos/sloos.htm. 2010 2011 2012 2013 2014 2015 2016 2017 SOURCE: Bureau of Economic Analysis via Haver Analytics. 20 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 22. Selected components of net debt financing for Net exports subtracted from GDP nonfinancial businesses growth in the fourth quarter after providing a modest addition during the Billions of dollars, monthly rate rest of the year Commercial paper Bonds 80 Bank loans U.S. real exports expanded at a moderate Sum 60 Q3 pace in the second half of last year after H1 40 having increased more rapidly in the first half, supported by solid foreign growth (figure 24). 20 + At the same time, real imports surged in the _0 fourth quarter following a slight contraction in 20 the third quarter. As a result, real net exports 40 moved from modestly lifting U.S. real GDP growth during the first three quarters of 2017 2007 2009 2011 2013 2015 2017 to subtracting more than 1 percentage point in SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial the fourth quarter. Although the nominal trade Accounts of the United States.” and current account deficits narrowed in the third quarter of 2017, the trade deficit widened 23. Corporate bond yields, by securities rating in the fourth quarter (figure 25). Daily Percentage points Federal fiscal policy actions had a 20 roughly neutral effect on economic 18 16 growth in 2017 . . . Triple-B 14 12 Federal government purchases rose 1 percent High-yield 10 in 2017, and policy actions had little effect on 8 federal taxes or transfers (figure 26). Under 6 currently enacted legislation, which includes 4 Double-A the Tax Cuts and Jobs Act (TCJA) and the 2 Bipartisan Budget Act, federal fiscal policy 0 will likely provide a moderate boost to GDP 2000 2003 2006 2009 2012 2015 2018 growth this year.9 NOTE: The yields shown are yields on 10-year bonds. SOURCE: ICE Bank of America Merrill Lynch Indices, used with permission. The federal unified deficit continued to widen in fiscal year 2017, reaching 3½ percent of 24. Change in real imports and exports of goods nominal GDP. Although expenditures as a and services share of GDP were relatively stable at a little under 21 percent, receipts moved lower in 2017 Percent, annual rate to roughly 17 percent of GDP (figure 27). Imports Exports Q4 15 The ratio of federal debt held by the public 12 to nominal GDP was 75¼ percent at the end of fiscal year 2017 and remains quite elevated 9 relative to historical norms (figure 28). H1 6 Q3 3 + _0 9. The Joint Committee on Taxation estimates that the 3 TCJA will reduce average annual tax revenue by a little more than 1 percent of GDP over the next few years. 2014 2015 2016 2017 This revenue estimate does not account for the potential SOURCE: Bureau of Economic Analysis via Haver Analytics. macroeconomic effects of the legislation. MONETARy POLICy REPORT: FEBRUARy 2018 21 . . . and the fiscal position of most state 25. U.S. trade and current account balances and local governments is stable Quarterly Percent of nominal GDP The fiscal position of most state and local + _0 governments is stable, although there is a 1 range of experiences across these governments. Many state governments are experiencing 2 lackluster revenue growth, as income tax 3 collections have only edged up, on average, 4 Trade in recent quarters. In contrast, house price 5 gains have continued to push up property tax 6 revenues at the local level. Employment in the Current account 7 state and local government sector only inched up in 2017, while outlays for construction by 2001 2003 2005 2007 2009 2011 2013 2015 2017 these governments continued to decline on net NOTE: GDP is gross domestic product. Current account data extend through 2017:Q3. (figure 29). SOURCE: Bureau of Economic Analysis via Haver Analytics. Financial Developments 26. Change in real government expenditures on consumption and investment The expected path of the federal funds Percent, annual rate rate has moved up Federal State and local 6 The path of the expected federal funds rate 4 implied by market quotes on interest rate H2 2 derivatives has moved up on net since the H1 + middle of last year amid an improving global _0 growth outlook (figure 30). Part of the upward 2 shift occurred around FOMC communications 4 in the fall that were interpreted as implying a 6 somewhat quicker pace of policy rate increases 8 than had been previously anticipated. The expected policy path also moved higher around 2009 2010 2011 2012 2013 2014 2015 2016 2017 the time when the U.S. tax legislation was SOURCE: Bureau of Economic Analysis via Haver Analytics. finalized. 27. Federal receipts and expenditures Survey-based measures of the expected path Annual PPeerrcceenntt ooff nnoommiinnaall GGDDPP of the policy rate have been generally little changed on net, suggesting that part of the 26 Expenditures rise in the market-implied path reflected higher 24 term premiums. In the Federal Reserve Bank 22 of New York’s Survey of Primary Dealers and Receipts Survey of Market Participants, which were 20 conducted just before the January 2018 FOMC 18 meeting, the median respondents expected 16 three 25 basis point increases in the FOMC’s 14 target range for the federal funds rate as the most likely outcome for this year, unchanged 1997 2001 2005 2009 2013 2017 from what they had expected in surveys NOTE: The receipts and expenditures data are on a unified-budget basis and conducted before the June FOMC meeting. are for fiscal years (October through September); gross domestic product (GDP) data are for the four quarters ending in Q4. Market-based measures of uncertainty about SOURCE: Office of Management and Budget via Haver Analytics. 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 28. Federal government debt held by the public the policy rate approximately one to two years ahead have, on balance, edged up from their Quarterly Percent of nominal GDP levels in the middle of 2017. 80 The nominal Treasury yield curve has 70 shifted up 60 The nominal Treasury yield curve has shifted 50 up on net since the middle of 2017, owing 40 to greater optimism about the global growth 30 outlook and investors’ perceptions of higher 20 odds for the removal of monetary policy accommodation (figure 31). Yields on shorter- 1967 1977 1987 1997 2007 2017 term nominal Treasury securities increased NOTE: The data extend through 2017:Q3. The data for gross domestic relatively more than those on longer-term 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 nominal Treasury securities, thus resulting in retirement accounts, evaluated at the end of the quarter. SOURCE: For GDP, Bureau of Economic Analysis via Haver Analytics; for some flattening of the yield curve. According federal debt, Federal Reserve Board, Statistical Release Z.1, “Financial to market participants, among the factors Accounts of the United States.” contributing to this outcome has been the 29. State and local employment and structures investment Treasury Department’s stated intention to Billions of chained (2009) dollars, annual rate Millions of employees increase its reliance on issuance of short-dated securities, as discussed in the two most recent 300 Real structures 19.8 releases of the Treasury’s quarterly financing statement. 280 19.6 260 Consistent with the changes in Treasury yields, 19.4 yields on 30-year agency mortgage-backed 240 securities (MBS)—an important determinant 19.2 220 of mortgage interest rates—increased but 200 Employment 19.0 remain quite low by historical standards (figure 32). 2010 2012 2014 2016 2018 Broad equity price indexes have NOTE: The employment data are monthly, and the structures data are quarterly. increased further . . . SOURCE: For employment data, Bureau of Labor Statistics; for structures data, Bureau of Economic Analysis; all via Haver Analytics. Broad U.S. equity indexes, despite some 30. Market-implied federal funds rate declines seen in recent weeks, have, on balance, Quarterly Percent increased further since June 2017, with most of the net gains occurring during the final Feb. 21, 2018 quarter of last year (figure 33). Equity prices 2.5 were reportedly supported in part by an increase in investors’ confidence that changes 2.0 to the federal tax law will boost corporate earnings. Stock prices generally increased June 30, 2017 1.5 across industries outside utilities and real estate, two sectors for which the increases in 1.0 interest rates described earlier are likely to have weighed more heavily on stock prices; stock 2017 2018 2019 2020 prices of banks rose more than the broader NOTE: The federal funds rate path is implied by quotes on overnight index market. Implied volatility for the S&P 500 swaps—a derivative contract tied to the effective federal funds rate. The implied path as of February 21, 2018, is compared with that as of June 30, index, as calculated from options prices, 2017. The path is estimated with a spline approach, assuming a term premium of 0 basis points. The paths extend through 2020:Q4. SOURCE: Bloomberg; Federal Reserve Board staff estimates. MONETARy POLICy REPORT: FEBRUARy 2018 23 increased notably in early February, ending 31. Yields on nominal Treasury securities the period close to the median of its historical Daily Percent distribution. 7 . . . while risk spreads on corporate bonds 6 have continued to decrease 10-year 30-year 5 Spreads on both high-yield and investment- 4 grade corporate bond yields over comparable- 3 maturity Treasury yields have decreased 2 further since the middle of last year, with 5-year 1 spreads for high-yield bonds moving closer 0 to the bottom of their historical ranges. The narrowing of the spreads since the middle of 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2017 appears to reflect both an anticipation NOTE: The Treasury ceased publication of the 30-year constant maturity that the losses from defaults on these bonds series on February 18, 2002, and resumed that series on February 9, 2006. SOURCE: Department of the Treasury. will be smaller and a lower compensation being charged for bearing the risk of such 32. Yield and spread on agency mortgage-backed securities losses. (For a discussion of financial stability issues, see the box “Developments Related to Percent Basis points Financial Stability.”) 9 300 Yield Markets for Treasury securities, mortgage- 8 250 backed securities, municipal bonds, and 7 200 short-term funding have functioned well 6 Spread 150 5 Available indicators of Treasury market 100 functioning have generally remained stable 4 50 over the second half of 2017 and early 2018, 3 with a variety of liquidity metrics—including 2 0 bid-ask spreads, bid sizes, and estimates of 2000200220042006200820102012201420162018 transaction costs—mostly unchanged over the period. Liquidity conditions in the agency 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 MBS market have also been generally stable. would be priced at par, or face, value. Spread shown is to the average of the 5- and 10-year nominal Treasury yields. The data extend through February In recent months, the functioning of Treasury 16, 2018. SOURCE: Department of the Treasury; Barclays. and agency MBS markets has not been notably affected by the implementation of the Federal 33. Equity prices Reserve’s balance sheet normalization program and the resulting reduction in reinvestment of Daily December 31, 1999 = 100 principal payments from the Federal Reserve’s securities holdings. In early February, amid 200 Dow Jones bank index financial market volatility, liquidity conditions 175 in the Treasury market deteriorated but have S&P 500 index 150 recovered somewhat since. Credit conditions 125 in municipal bond markets have also remained 100 generally stable since June 2017. Over that 75 period, yield spreads on 20-year general 50 obligation municipal bonds over comparable- maturity Treasury securities have narrowed 25 on balance. Nevertheless, significant financial 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 strains were still evident for some issuers. SOURCE: Standard & Poor's Dow Jones Indices via Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.) 24 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability Overall vulnerabilities in the U.S. financial system funding source for the corporate sector—stayed remain moderate on balance.1 valuation pressures compressed. In addition, nonprice terms eased on these continue to be elevated across a range of asset types of loans, indicating weaker investor protection classes, including equities and commercial real estate. than at the peak of the previous credit cycle in 2007. vulnerabilities from leverage in the financial sector Consistent with elevated risk appetite, virtual currencies appear low, reflecting in part capital and liquidity experienced sharp price increases in 2017. ratios of banks that have continued to improve from vulnerabilities related to financial-sector leverage already strong positions. However, there are signs appear low. Leverage at insurance companies and at that nonbank financial leverage has been increasing broker-dealers is on the low end of its historical range, in some areas—for example, in the provision of and most indicators of leverage at other nonbank margin credit to equity investors such as hedge funds. financial firms are stable. However, there is some vulnerabilities from nonfinancial leverage are judged evidence that dealers have eased price terms to hedge to be moderate. While household debt balances have funds and real estate investment trusts, and that hedge been increasing modestly, the leverage of the business funds have gradually increased their use of leverage, sector is elevated, particularly among speculative-grade in particular margin credit for equity trades. Although firms. vulnerabilities related to maturity and liquidity such easing of price terms has taken place against the transformation remain low on net. backdrop of building valuation pressures, the strong Over the second half of 2017, valuation pressures capital position of bank holding companies reduces edged up from already elevated levels. In general, the risk that sudden drops in asset prices could valuations are higher than would be expected based significantly affect bank-affiliated dealers. Risk-based solely on the current level of longer-term Treasury regulatory capital ratios for most of the largest bank yields. In part reflecting growing anticipation of the holding companies continued to increase from already boost to future (after-tax) earnings from a corporate high levels. tax rate cut, price-to-earnings ratios for U.S. stocks If interest rates were to increase unexpectedly, rose through January and were close to their highest banks’ strong capital position should help absorb the levels outside of the late 1990s (figure A); ratios consequent losses on securities. About one-third of dropped back somewhat in early February. In a sign of the losses that could be experienced by banks would increasing valuation pressures in commercial real estate affect held-to-maturity securities. While these losses markets, net operating income relative to property values (referred to as capitalization rates) have been declining relative to Treasury yields of comparable A. Forward price-to-earnings ratio of S&P 500 firms maturity for multifamily and industrial properties. While these spreads narrowed further from already Monthly Ratio low levels, they are wider than in 2007. Even though the aggregate residential house price-to-rent ratio has 30 been increasing faster than its long-run trend, it is only slightly elevated at present. In corporate credit 25 markets, spreads of corporate bond yields over those 20 of Treasury securities with comparable maturities fell, and the high-yield spread is now near the bottom of its 15 historical distribution. Spreads on leveraged loans and Historical median collateralized loan obligations—which are a significant 10 5 1. An overview of the framework for assessing financial stability in the United States is provided in Stanley Fischer 1986 1990 1994 1998 2002 2006 2010 2014 2018 (2017), “An Assessment of Financial Stability in the United States,” speech delivered at the IMF Workshop on Financial NOTE: The February 2018 value is based on a mid-month estimate. The data depict the aggregate forward price-to-earnings ratio of S&P 500 firms. Surveillance and Communication: Best Practices from The historical median is based on data from 1985 to the present. Shaded bars Latin America, the Caribbean, and Advanced Economies, indicate periods of recession as defined by the National Bureau of Economic Washington, June 27, www.federalreserve.gov/newsevents/ Research. Data are based on 12-month-ahead expected earnings per share. speech/fischer20170627a.htm. SOURCE: Staff estimates based on Thomson Reuters, IBES. MONETARy POLICy REPORT: FEBRUARy 2018 25 would not reduce regulatory capital, they could still quality liquid assets stand at high levels and exceed have a variety of negative consequences—for example, those required by the Liquidity Coverage Ratio. The by worsening banks’ funding terms. The large share of share of core deposits in total liabilities at G-SIBs deposits in bank liabilities is also likely to soften the also remains at historically high levels. More than effect of an unexpected rise in interest rates on banks, one year after the money market fund reform, which because deposit rates tend to adjust with a delay and reduced run risk as investors shifted from prime to bank profitability would improve in the meantime. government funds, the growth in alternative short- Overall vulnerabilities arising from leverage in term investment vehicles has been limited. Regarding the nonfinancial sector continue to be moderate. securitized products, although the issuance of asset- Continuing its pattern in recent years, household debt backed securities (ABS) was strong, overall issuance has expanded about in line with nominal income, has remained well below pre-crisis levels for most asset and the household credit-to-GDP gap remains sizable classes, and securitizations appear to involve limited and negative (figure B). Leverage in the nonfinancial maturity or liquidity transformation. Nonetheless, ABS business sector remains high, with net issuance of risky issuance was boosted by the securitization of assets debt climbing in recent months. However, the share of that were rarely securitized in the past, such as aircraft the lowest-quality debt in total issuance declined, and leases and mobile phone contracts. In addition, certain relatively low interest expenses mitigated some of the nontraditional liabilities of life insurers, including vulnerabilities associated with elevated leverage. funding-agreement-backed securities, have grown In part attributable to regulations introduced notably recently, although levels remain low relative to since the financial crisis, vulnerabilities associated the broader market for securitizations. with liquidity and maturity transformation—that is, Financial vulnerabilities in foreign economies are the financing of illiquid or long-maturity assets with moderate overall. Advanced foreign economies, many short-maturity debt—continue to be low. The reliance of which have strong financial and real linkages to of global systemically important banks (G-SIBs) on the United States, continue to struggle with elevated short-term wholesale funding has risen only slightly valuations, the disposal of legacy assets, and, in some from post-crisis lows, while their holdings of high- cases, worrisome rises in mortgage debt. Some major emerging market economies harbor more pronounced vulnerabilities, reflecting one or more of the following: B. Private nonfinancial sector credit-to-GDP gap substantial corporate leverage, fiscal concerns, or excessive reliance on foreign funding. Quarterly Percentage point difference from trend The countercyclical capital buffer (CCyB) is a macroprudential tool the Federal Reserve Board can Household 15 use to increase the resilience of the financial system by raising capital requirements on internationally Noncorporate business 10 active banking organizations. The CCyB is activated when there is an elevated risk of above-normal future Corporate business 5 losses and when the banking organizations for which + capital requirements would be raised by the buffer _0 are exposed to or are contributing to this elevated 5 risk—either directly or indirectly. The financial stability developments, assessments, and framework described 10 and used here bear importantly on the Board’s setting of the CCyB.2 In December 2017, the Board voted to 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 affirm the CCyB at its level of 0 percent. NOTE: The data extend through 2017:Q3 and are smoothed using a (continued on next page) Hodrick-Prescott filter. The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research. Gaps have been weighted by their share of overall credit. GDP is gross domestic 2. See Board of Governors of the Federal Reserve System product. (2016), “Regulatory Capital Rules: The Federal Reserve Board’s SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; Bureau of Economic Analysis via Haver Framework for Implementing the U.S. Basel III Countercyclical Analytics, national income and product accounts, Table 1.1.5: Gross Capital Buffer,” final policy statement (Docket No. R-1529), Domestic Product; Board staff calculations. Federal Register, vol. 81 (September 16), pp. 63682–88. 26 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability (continued) Over the second half of 2017, the Federal Reserve also adopted a final rule to improve the resolvability Board has taken some key steps to reduce regulatory and resilience of G-SIBs and their subsidiaries to burden while promoting the financial stability of the restrictions regarding the terms of their noncleared United States. The Federal Reserve Board, Office of qualified financial contracts.6 In addition, the Board the Comptroller of the Currency, and Federal Deposit proposed changes to its supervisory rating system Insurance Corporation jointly proposed amendments for large financial institutions to better align with the to the banking agencies’ commercial real estate post-crisis supervisory program for these firms; smaller appraisal regulations that raised the threshold price institutions, including community banks, would for mandating appraisals from $250,000 to $400,000, continue to use the current rating system.7 Finally, the thereby reducing the number of required appraisals.3 Board requested comment on a package of proposals In addition, the federal banking agencies issued a that would increase the transparency of its stress-testing proposal to simplify aspects of community banking program. In particular, the proposals would provide organizations’ regulatory capital rules, with the goal more information about the models used to estimate of reducing regulatory burden on smaller institutions hypothetical losses in the stress tests while maintaining while maintaining the safety and soundness of the the Board’s ability to test the resilience of the nation’s banking system.4 largest and most complex banks.8 The Board requested comment on a corporate governance proposal to enhance the effectiveness of financial firms’ boards of directors. The proposal refocuses the Federal Reserve’s supervisory expectations for the largest firms’ boards of directors on their core Two Proposals; Corporate Governance and Rating System responsibilities and would also reduce unnecessary for Large Financial Institutions,” press release, August 3, burden for the boards of smaller institutions.5 The Board https://www.federalreserve.gov/newsevents/pressreleases/ bcreg20170803a.htm. 6. See Board of Governors of the Federal Reserve System 3. See Office of the Comptroller of the Currency, Board (2017), “Restrictions on Qualified Financial Contracts of of Governors of the Federal Reserve System, and the Systemically Important U.S. Banking Organizations and the Federal Deposit Insurance Corporation (2017), “Real Estate U.S. Operations of Systemically Important Foreign Banking Appraisals,” notice of proposed rulemaking and request for Organizations; Revisions to the Definition of Qualifying comment (Docket No. R-1568), Federal Register, vol. 82 Master Netting Agreement and Related Definitions,” final rule (July 31), pp. 35478–93. (Docket No. R-1538), Federal Register, vol. 82 (September 12), 4. See Office of the Comptroller of the Currency, Board pp. 42882–926. of Governors of the Federal Reserve System, and the Federal 7. See Board of Governors, “Federal Reserve Board Invites Deposit Insurance Corporation (2017), “Simplifications to the Public Comment on Two Proposals,” in note 5. Capital Rule Pursuant to the Economic Growth and Regulatory 8. See Board of Governors of the Federal Reserve System Paperwork Reduction Act of 1996,” notice of proposed (2017), “Federal Reserve Board Requests Comment on rulemaking (Docket No. R-1576), Federal Register, vol. 82 Package of Proposals That Would Increase the Transparency (October 27), pp. 49984–50044. of Its Stress Testing Program,” press release, December 7, 5. See Board of Governors of the Federal Reserve System www.federalreserve.gov/newsevents/pressreleases/ (2017), “Federal Reserve Board Invites Public Comment on bcreg20171207a.htm. MONETARy POLICy REPORT: FEBRUARy 2018 27 In particular, prices for Puerto Rico general 34. Ratio of total commercial bank credit to nominal gross domestic product obligation bonds fell notably after Hurricane Maria hit the island and its economic outlook Quarterly Percent deteriorated even further. However, these developments left little imprint in broader 75 municipal bond markets. Conditions in domestic short-term funding markets have 70 remained stable since the middle of last year. 65 Bank credit continued to expand and 60 bank profitability remained stable 55 Aggregate credit provided by commercial banks continued to expand in the second half of 2017 at a pace similar to the one seen 2001 2003 2005 2007 2009 2011 2013 2015 2017 earlier in the year but more slowly than in SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and Liabilities of Commercial Banks in the United States”; Bureau of Economic 2016. Its pace was also slower than that of Analysis via Haver Analytics. nominal GDP, thus leaving the ratio of total 35. Profitability of bank holding companies commercial bank credit to current-dollar GDP Percent, annual rate Percent, annual rate slightly lower than earlier in 2017 (figure 34). Measures of bank profitability were little 2.0 30 changed at levels below their historical 1.5 Return on assets 20 averages (figure 35). 1.0 10 .5 Return on equity + + International Developments _0 _0 .5 10 Economic activity in most foreign 1.0 economies continued at a healthy pace in 20 1.5 the second half of 2017 30 2.0 Foreign real GDP appears to have expanded 2001 2003 2005 2007 2009 2011 2013 2015 2017 notably in the second half of 2017, extending NOTE: The data are quarterly and are seasonally adjusted. The data extend the period since mid-2016 when the pace of through 2017:Q3. SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial economic growth picked up broadly around Statements for Bank Holding Companies. the world. 36. Real gross domestic product growth in selected advanced foreign economies Growth in advanced foreign economies was solid, and unemployment fell to Percent, annual rate multidecade lows . . . United Kingdom Japan 5 Euro area In the advanced foreign economies (AFEs), Canada H1 4 the economic recovery has continued to firm. Q3 3 Real GDP in the euro area and the United Q4 2 Kingdom expanded at a solid pace in the second half of the year (figure 36). Economic 1 + activity also continued to expand in Japan, _0 though real GDP growth slowed sharply in 1 the fourth quarter. In Canada, data through November indicate that economic growth 2014 2015 2016 2017 moderated somewhat in the second half NOTE: The data for the United Kingdom and the euro area incorporate following a very rapid expansion earlier in flash estimates for 2017:Q4. The data for Japan incorporate the preliminary estimate for 2017:Q4. The data for Canada extend through 2017:Q3. the year. Unemployment declined further as SOURCE: For the United Kingdom, Office for National Statistics; for Japan, Cabinet Office, Government of Japan; for the euro area, Eurostat; for Canada, Statistics Canada; all via Haver Analytics. 28 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS well, reaching 40-year lows in Canada and the United Kingdom, while growth in labor compensation ticked up only modestly. 37. Consumer price inflation in selected advanced foreign economies . . . but inflation remained subdued . . . Monthly 12-month percent change Consumer price inflation rose somewhat in most AFEs, boosted by the rise in commodity 4 Japan prices (figure 37). However, headline and United Kingdom 3 especially core inflation remained below the Canada central banks’ targets in the euro area and 2 Japan. In contrast, U.K. inflation rose further 1 above the Bank of England’s (BOE) 2 percent + target as the substantial sterling depreciation _0 Euro area observed since the June 2016 Brexit 1 referendum continued to provide some uplift to import prices. (For more discussion 2014 2015 2016 2017 2018 of inflation both in the United States and NOTE: The data for the euro area incorporate the flash estimate for January abroad, see the box “Low Inflation in the 2018. The data for Canada and Japan extend through December 2017. SOURCE: For the United Kingdom, Office for National Statistics; for Japan, Advanced Economies” in the Domestic Ministry of International Affairs and Communications; for the euro area, Developments section.) Statistical Office of the European Communities; for Canada, Statistics Canada; all via Haver Analytics. . . . leading AFE central banks to maintain accommodative monetary policies The Bank of Japan kept its policy rates at historically low levels, with the target for 10-year government bond yields around zero. In October, the European Central Bank extended its asset purchase program until September 2018, albeit at a reduced pace. The 38. Real gross domestic product growth in selected Bank of Canada and the BOE both raised emerging market economies their policy rates but also indicated that they intend to proceed gradually with further Percent, annual rate removal of policy accommodation. China Korea 12 Mexico In emerging Asia, growth remained solid. . . Brazil 9 H1 Q3Q4 Economic growth in China remained relatively 6 strong in the second half of 2017 even as the 3 authorities enacted policies to limit production + _0 in heavily polluting industries, tighten financial 3 regulations, and curb house price growth (figure 38). Most other emerging Asian 6 economies registered very strong growth in the 2014 2015 2016 2017 third quarter of 2017, fueled by solid external NOTE: The data for China are seasonally adjusted by Board staff. The data demand, but slowed in the fourth quarter. for Korea, Mexico, and Brazil are seasonally adjusted by their respective government agencies. The data for Mexico incorporate the flash estimate for 2017:Q4. The data for Brazil extend through 2017:Q3. SOURCE: For China, China National Bureau of Statistics; for Korea, Bank of Korea; for Mexico, Instituto Nacional de Estadistica y Geografia; for Brazil, Instituto Brasileiro de Geografia e Estatistica; all via Haver Analytics. MONETARy POLICy REPORT: FEBRUARy 2018 29 . . . while the largest Latin American 39. Equity indexes for selected foreign economies economies continued to struggle Weekly Week ending January 8, 2014 = 100 In Mexico, real GDP declined in the third 150 145 quarter as two major earthquakes and a 140 hurricane significantly disrupted economic Emerging market economies Japan 135 130 activity, but rebounded in the fourth quarter. 125 Following a prolonged period of contraction, 120 115 the Brazilian economy continues to recover, 110 but only at a weak pace. Private investment has 105 Euro area 100 remained sluggish amid corporate deleveraging 95 and continued uncertainty about government 90 policies, although it turned positive in the third United Kingdom 85 quarter for the first time in nearly four years. 2014 2015 2016 2017 2018 NOTE: The data are weekly averages of daily data and extend through February 21, 2018. Foreign equity prices rose further on net. . . SOURCE: For euro area, DJ Euro Stoxx Index; for Japan, TOPIX Stock Index; for United Kingdom, FTSE 100 Stock Index; for emerging market Solid macroeconomic data and robust economies, MSCI Emerging Markets Local Currency Index; all via Bloomberg. corporate earnings helped broad AFE and emerging market economies (EMEs) equity indexes extend their 2016 gains through the start of this year (figure 39). Declines since the end of January have erased some of these gains, and volatility in foreign stock markets increased. On balance, most AFE stock 40. Emerging market mutual fund flows and spreads prices are higher, and EME equity markets Basis points Billions of dollars significantly outperformed those of AFEs. Bond fund flows (right axis) Capital flows into emerging market mutual 500 Equity fund flows (right axis) 60 funds generally remained robust as higher Jan. 40 450 commodity prices added to optimism about 20 the economic outlook (figure 40). 400 Feb. + _0 . . . and government bond yields 350 20 increased 300 40 Longer-term government bond yields in most 250 EMBI+ (left axis) 60 AFEs were noticeably higher than their mid- 2017 levels, reflecting strengthening growth 2014 2015 2016 2017 2018 and mounting prospects for the normalization NOTE: The bond and equity fund flow data are quarterly sums of weekly data from January 1, 2014, to December 31, 2017, and monthly sums of of monetary policies (figure 41). In Canada, weekly data from January 1, 2018, to February 14, 2018. The fund flows data where the central bank has raised its policy exclude funds located in China. The J.P. Morgan Emerging Markets Bond Index Plus (EMBI+) data are weekly averages of daily data and extend interest rate 75 basis points since June, the rise through February 20, 2018. in longer-term yields was particularly notable. SOURCE: For bond and equity fund flows, EPFR Global; for EMBI+, J.P. Morgan Emerging Markets Bond Index Plus via Bloomberg. On balance, spreads of dollar-denominated emerging market sovereign bonds over U.S. Treasury securities were stable around the levels observed in mid-2017 (as shown in figure 40). 30 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 41. Nominal 10-year government bond yields in The dollar depreciated on net selected advanced economies The broad dollar index––a measure of the Weekly Percent trade-weighted value of the dollar against foreign currencies––fell roughly 5 percent in 3.0 United States the first half of 2017. Notwithstanding some 2.5 appreciation in early February, the currency 2.0 Canada has depreciated further since the end of June, 1.5 partially reversing substantial appreciation 1.0 realized over the period from 2014 to 2016 Germany United Kingdom .5 (figure 42). The weakness in the dollar mostly + _0 reflects a broad-based improvement in the .5 outlook for foreign economic growth. Brexit- related headlines weighed on the British pound 2014 2015 2016 2017 2018 at times during the second half of 2017, but NOTE: The data are weekly averages of daily benchmark yields and extend progress regarding the terms of the U.K. through February 21, 2018. SOURCE: Bloomberg. separation from the European Union boosted the currency later in the year. In contrast, the dollar appreciated against the Mexican 42. U.S. dollar exchange rate indexes peso, on net, amid uncertainty around North Weekly Week ending January 8, 2014 = 100 American Free Trade Agreement negotiations. Dollar appreciation 170 Mexican peso 160 150 140 130 Euro 120 Broad dollar 110 British pound 100 90 2014 2015 2016 2017 2018 NOTE: The data, which are in foreign currency units per dollar, are weekly averages of daily data and extend through February 21, 2018. As indicated by the arrow, increases in the data represent U.S. dollar appreciation, and decreases represent U.S. dollar depreciation. SOURCE: Federal Reserve Board, Statistical Release H.10, “Foreign Exchange Rates.” 31 P 2 art m P onetary oLicy The Federal Open Market Committee the Committee expected that it would stabilize raised the federal funds rate target range around that target over the medium term. At in December its most recent meeting, which concluded on January 31, the Committee kept the target For more than two years, the Federal Open range for the federal funds rate unchanged.11 Market Committee (FOMC) has been gradually increasing its target range for Monetary policy continues to support the federal funds rate as the labor market economic growth strengthened and headwinds in the aftermath of the recession continued to abate. After Even with the gradual increases in the federal having raised the target range for the federal funds rate to date, the Committee judges funds rate twice in the first half of 2017, that the stance of monetary policy remains the Committee raised it again in December, accommodative, thereby supporting strong bringing the target range to 1¼ to 1½ percent labor market conditions and a sustained return (figure 43).10 As on previous occasions, the to 2 percent inflation. The federal funds rate decision to increase the federal funds rate in remains somewhat below most estimates of its December reflected realized and expected labor neutral rate—that is, the level of the federal market conditions and inflation relative to the funds rate that is neither expansionary nor FOMC’s objectives. Information available at contractionary. that time indicated that economic activity had been rising at a solid rate and the labor market In evaluating the stance of monetary policy, had continued to strengthen. In addition, policymakers routinely consult prescriptions although inflation had continued to run below from a variety of policy rules, which can the FOMC’s 2 percent longer-run objective, serve as useful benchmarks. However, the 10. See Board of Governors of the Federal Reserve 11. See Board of Governors of the Federal System (2017), “Federal Reserve Issues FOMC Reserve System (2018), “Federal Reserve Issues Statement,” press release, December 13, https:// FOMC Statement,” press release, January 31, https:// www.federalreserve.gov/newsevents/pressreleases/ www.federalreserve.gov/newsevents/pressreleases/ monetary20171213a.htm. monetary20180131a.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 2018 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. 32 PART 2: MONETARy POLICy use and interpretation of such prescriptions The size of the Federal Reserve’s balance require careful judgments about the choice sheet has begun to decrease and measurement of the inputs to these The Committee had communicated for some rules as well as the implications of the many time that it intended to reduce the size of considerations these rules do not take into the Federal Reserve’s balance sheet once account (see the box “Monetary Policy Rules normalization of the level of the federal funds and Their Role in the Federal Reserve’s Policy rate was well under way. At its meeting in Process”). September, the FOMC decided to initiate the balance sheet normalization program described Future changes in the federal funds rate in the June 2017 Addendum to the Policy will depend on the economic outlook as Normalization Principles and Plans. This informed by incoming data program is gradually and predictably reducing The Committee has continued to emphasize the Federal Reserve’s securities holdings by that, in determining the timing and size of decreasing the reinvestment of the principal future adjustments to the target range for payments it receives from securities held in the the federal funds rate, it will assess realized System Open Market Account (SOMA). Since and expected economic conditions relative to October, such payments have been reinvested its objectives of maximum employment and only to the extent that they exceeded gradually 2 percent inflation. This assessment will take rising caps (figure 44). into account a wide range of information, including measures of labor market In the fourth quarter, the Open Market Desk conditions, indicators of inflation pressures at the Federal Reserve Bank of New York, as and inflation expectations, and readings on directed by the Committee, reinvested principal financial and international developments. payments from the Federal Reserve’s holdings The FOMC has emphasized that it will of Treasury securities maturing during each carefully monitor actual and expected inflation calendar month in excess of $6 billion. The developments relative to its symmetric inflation Desk also reinvested in agency mortgage- goal, as inflation has been running persistently backed securities (MBS) the amount of below the 2 percent longer-run objective. principal payments from the Federal Reserve’s holdings of agency debt and agency MBS The Committee expects that the ongoing received during each calendar month in excess strength in the economy will warrant further of $4 billion. Since January, payments of gradual increases in the federal funds rate, principal from maturing Treasury securities and that the federal funds rate will likely and from the Federal Reserve’s holdings remain, for some time, below the levels that of agency debt and agency MBS have been the Committee expects to prevail in the reinvested to the extent that they have exceeded longer run. Consistent with this outlook, $12 billion and $8 billion, respectively. The in the most recent Summary of Economic Committee has indicated that the cap for Projections, which was compiled at the time of Treasury securities will continue to increase the December FOMC meeting, the median of in steps of $6 billion at three-month intervals participants’ assessments for the appropriate until it reaches $30 billion per month, and level of the midpoint of the target range that the cap for agency debt and agency MBS for the federal funds rate at year-end rises will continue to increase in steps of $4 billion gradually over the period from 2018 to 2020, at three-month intervals until it reaches remaining below the median projection for its $20 billion per month. These caps will remain longer-run level through the end of 2019.12 in place until the Committee judges that the Federal Reserve is holding no more securities 12. See the December Summary of Economic minutes of the December 12–13, 2017, meeting of the Projections, which appeared as an addendum to the FOMC and is presented in Part 3 of this report. MONETARy POLICy REPORT: FEBRUARy 2018 33 44. Principal payments on SOMA securities Treasury securities Agency debt and mortgage-backed securities Monthly Billions of dollars Monthly Billions of dollars Redemptions Redemptions Reinvestments 80 Reinvestments 80 Monthly cap Monthly cap 70 70 60 60 50 50 40 40 30 30 20 20 10 10 2017 2018 2019 2017 2018 2019 Note: Reinvestment and redemption amounts of agency mortgage-backed securities are projections starting in January 2018. The data extend through December 2019. Source: Federal Reserve Bank of New York; Federal Reserve Board staff calculations. than necessary to implement monetary policy a small fraction of the SOMA securities efficiently and effectively. holdings. Consequently, the Federal Reserve’s total assets have declined somewhat to about The initiation of the balance sheet $4.4 trillion, with holdings of Treasury normalization program was widely anticipated securities at approximately $2.4 trillion and and therefore did not elicit a notable reaction holdings of agency debt and agency MBS at in financial markets. Subsequently, the approximately $1.8 trillion (figure 45). implementation of the program has proceeded smoothly without materially affecting Treasury Interest income on the SOMA portfolio has and MBS markets. With the caps having continued to support substantial remittances been set thus far at relatively low levels, the to the U.S. Treasury. Preliminary financial reduction in SOMA securities has represented statement results indicate that the Federal 45. Federal Reserve assets and liabilities Weekly Trillions of dollars 5.0 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 5.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 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 14, 2018. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” 34 PART 2: MONETARy POLICy Reserve remitted about $80.2 billion of its range and generally traded near the middle estimated 2017 net income to the Treasury. of the new target range amid orderly trading conditions in money markets. Usage of the The Federal Reserve’s implementation of ON RRP facility has declined on net since the monetary policy has continued smoothly middle of 2017, reflecting relatively attractive yields on alternative investments. In December 2017, the Federal Reserve raised the effective federal funds rate by increasing Although the normalization of the monetary the interest rate paid on reserve balances along policy stance has proceeded smoothly, the with the interest rate offered on overnight Federal Reserve has continued to test the reverse repurchase agreements (ON RRPs). operational readiness of other policy tools as Specifically, the Federal Reserve increased part of prudent planning. Two operations of the interest rate paid on required and excess the Term Deposit Facility were conducted in reserve balances to 1½ percent and the ON the second half of 2017; seven-day deposits RRP offering rate to 1¼ percent. In addition, were offered at both operations with a floating the Board of Governors approved an increase rate of 1 basis point over the interest rate in the discount rate (the so-called primary on excess reserves. In addition, the Desk credit rate) to 2 percent. Yields on a broad set conducted several small-value exercises solely of money market instruments moved higher for the purpose of maintaining operational in response to the FOMC’s policy action in readiness. December. The effective federal funds rate rose in line with the increase in the FOMC’s target MONETARy POLICy REPORT: FEBRUARy 2018 35 Monetary Policy Rules and Their Role in the Federal Reserve’s Policy Process What are monetary policy rules? the three key principles of good monetary policy noted earlier. Each rule takes into account estimates Monetary policy rules are formulas that prescribe of how far away the economy is from achieving the the setting of a policy rate, such as the federal funds Federal Reserve’s dual-mandate goals of maximum rate, that should prevail in relation to the values of a employment and price stability. Specifically, most of small number of other variables—typically including the rules include the difference between the rate of the gap between actual and target inflation along with unemployment that is sustainable in the longer run (uLR) an estimate of resource slack in the economy. Policy and the current unemployment rate (the unemployment rules can provide helpful guidance for policymakers. gap); the first-difference rule includes the change in the Indeed, since 2004, prescriptions from policy rules unemployment gap rather than its level.3 In addition, have been part of the information regularly reported most of the rules include the difference between to the Federal Open Market Committee (FOMC) inflation and its longer-run objective (2 percent as ahead of its meetings.1 However, interpretation of the measured by the annual change in the price index prescriptions of policy rules requires careful judgment for personal consumption expenditures (PCE), in the about the measurement of the inputs to the rules and case of the Federal Reserve), while the price-level rule the implications of the many considerations the rules includes the gap between the level of prices today do not take into account. and the level of prices that would be observed if Policy rules can incorporate key principles of good inflation had been constant at 2 percent from a monetary policy. One key principle is that monetary specified starting year. policy should respond in a predictable way to changes The Taylor (1993), balanced-approach, adjusted in economic conditions. A second key principle is Taylor (1993), and price-level rules provide that monetary policy should be accommodative when prescriptions for the level of the federal funds rate and inflation is below the desired level and employment require an estimate of the neutral real interest rate in is below its maximum sustainable level; conversely, the longer run (rLR)—that is, the level of the real federal monetary policy should be restrictive when the (continued on next page) opposite holds. A third key principle is that, to stabilize inflation, the policy rate should be adjusted by more than one-for-one in response to persistent increases or Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy Rules (Chicago: University of Chicago Press), pp. 319–41. The decreases in inflation. adjusted Taylor (1993) rule was studied in David Reifschneider Economists have analyzed many monetary policy and John C. Williams (2000), “Three Lessons for Monetary rules, including the well-known Taylor (1993) rule Policy in a Low-Inflation Era,” Journal of Money, Credit, and as well as other rules that will be discussed later: the Banking, vol. 32 (November), pp. 936–66. A price-level rule was discussed in Robert E. Hall (1984), “Monetary Strategy “balanced approach” rule, the “adjusted Taylor (1993)” with an Elastic Price Standard,” in Price Stability and Public rule, the “price level” rule, and the “first difference” Policy, proceedings of a symposium sponsored by the Federal rule (figure A).2 These policy rules generally embody Reserve Bank of Kansas City, held in Jackson Hole, Wyo., August 2–3 (Kansas City: Federal Reserve Bank of Kansas City), pp. 137–59, https://www.kansascityfed.org/publicat/ sympos/1984/s84.pdf. Finally, the first-difference rule was 1. Prescriptions from monetary policy rules are included introduced by Athanasios Orphanides (2003), “Historical in the Board staff’s Tealbook (previously the Bluebook); the Monetary Policy Analysis and the Taylor Rule,” Journal precise set of rules presented has changed from time to time. of Monetary Economics, vol. 50 (July), pp. 983–1022. A The transcripts and briefing materials for FOMC meetings comprehensive review of policy rules is in John B. Taylor through 2012 are available on the Board’s website at https:// and John C. Williams (2011), “Simple and Robust Rules for www.federalreserve.gov/monetarypolicy/fomc_historical. Monetary Policy,” in Benjamin M. Friedman and Michael htm. In the materials from 2012, the policy rule prescriptions Woodford, eds., Handbook of Monetary Economics, vol. 3B are contained in the Monetary Policy Strategies section of (Amsterdam: North-Holland), pp. 829–59. The same volume Tealbook B. The briefing materials that FOMC policymakers of the Handbook of Monetary Economics also discusses review regularly also include the Board staff’s baseline approaches other than policy rules for deriving policy rate forecast for the economy and model simulations of a variety of prescriptions. alternative scenarios intended to provide a sense of the effects 3. The Taylor (1993) rule represented slack in resource of other plausible developments that were not included in the utilization using an output gap (the difference between the staff’s baseline forecast. current level of real gross domestic product (GDP) and what 2. The Taylor (1993) rule was first suggested in John B. GDP would be if the economy was operating at maximum Taylor (1993), “Discretion versus Policy Rules in Practice,” employment). The rules in figure A represent slack in resource Carnegie-Rochester Conference Series on Public Policy, vol. 39 utilization using the unemployment gap instead, because that (December), pp. 195–214. The balanced-approach rule was gap better captures the FOMC’s statutory goal to promote analyzed in John B. Taylor (1999), “A Historical Analysis of maximum employment. Movements in these alternative 36 PART 2: MONETARy POLICy Monetary Policy Rules and Their Role (continued) A. Monetary policy rules Taylor (1993) rule 93= + +0.5( − )+( − ) Balanced-approach rule = + +0.5( − )+2( − ) Taylor (1993) rule, adjusted 93 = { 93− ,0} Price-level rule = { + +( − )+0.5( ),0} First-difference rule = +0.5( − )+( − )−( − ) −1 −4 −4 NOTE: 93, , 93 , , and represent the values of the nominal federal funds rate prescribed by the Taylor (1993), balanced-approach, adjusted Taylor (1993), price-level, and first-difference rules, respectively. denotes the actual nominal federal funds rate for quartert, is four-quarter price inflation for quarter t, is the unemployment rate in quarter t,and is the level of the neutral real federal funds rate in the longer run that, on average, is expected to be consistent with sustaining maximum employment and inflation at its 2percent longer-run objective, . In addition, is the rate of unemployment in the longer run. is the cumulative sum of past deviations of the federal funds rate from the prescriptions of the Taylor (1993) rule when that rule prescribes setting the federal funds rate below zero. is the percent deviation of the actual level of prices from a price level that rises 2 percent per year from its level in a specified starting period. The Taylor (1993) rule and other policy rules are generally written in terms of the deviation of real output from its full capacity level. In these equations, the output gap has been replaced with the gap between the rate of unemployment in the longer run and its actual level (using a relationship known as Okun’s law) in order to represent the rules in terms of the FOMC’s statutory goals. Historically, movements in the output and unemployment gaps have been highly correlated. Footnote 2 provides references for the policy rules. funds rate that is expected to be consistent in the longer In four of the rules, the interest rate responds to run with sustained maximum employment and stable deviations of inflation from its longer-run value of inflation.4 In contrast, the first-difference rule prescribes 2 percent; in the price-level rule, however, the interest how the level of the federal funds rate at a given time rate responds to the price-level gap (PLgap). This t should be altered from its previous level—that is, it gap measures how far the price level is from where it indicates how the existing rate should be increased or would have been had it been increasing at 2 percent decreased in a particular period. each year.5 The price-level rule thereby takes account The adjusted Taylor (1993) rule recognizes that of deviations of inflation from the longer-run objective the federal funds rate cannot be reduced materially in earlier periods as well in the current period. Thus, below zero, and that following the prescriptions of if inflation has been running persistently above the the Taylor (1993) rule after a period when interest central bank’s objective, the price-level rule would rates have been constrained may not provide enough prescribe a higher policy interest rate than rules that use policy accommodation. To make up for the cumulative the current inflation gap. Likewise, if inflation has been shortfall in accommodation (Z), the adjusted rule running persistently below the central bank’s objective, t prescribes only a gradual return of the policy rate to a price-level rule would prescribe setting the policy the (positive) levels prescribed by the unadjusted Taylor rate lower than rules that use the current inflation gap. (1993) rule as the economy recovers. The purpose of this dependence on previous inflation measures of resource utilization are highly correlated. For 5. Estimation of the price-level rule requires selecting a more information, see the note below figure A. starting year for the price level from which to cumulate the 4. Taylor-type rules—including John Taylor’s original 2 percent annual inflation. For the U.S. economy, 1998 is used rule—have often been estimated assuming that the value of as the starting year; around that time, the underlying trend the neutral real interest rate in the longer run, rLR, is equal to of inflation and longer-term inflation expectations stabilized 2 percent, which roughly corresponds to the average historical at a level consistent with PCE price inflation being close to value of the real federal funds rate before the financial crisis. 2 percent. MONETARy POLICy REPORT: FEBRUARy 2018 37 behavior is to bring the price level back into line with B. Real-time estimates of the neutral real interest where it would be if it had been running at a constant rate and the unemployment rate in the longer run 2 percent per year. Like the adjusted Taylor (1993) Percent Percent rule, the price-level rule recognizes that the federal funds rate cannot be reduced materially below zero. 3.2 Estimated neutral real interest 6.0 If inflation runs below the 2 percent objective during 3.0 rate in the longer run 2.8 periods when the rule prescribes setting the federal 5.8 2.6 funds rate well below zero, the price-level rule will 2.4 5.6 make up for past inflation shortfalls as the economy 2.2 5.4 recovers. 2.0 1.8 The adjusted Taylor (1993) and price-level rules 5.2 1.6 may prescribe more appropriate policy settings than 1.4 5.0 the other rules following a period when the policy rate 1.2 4.8 1.0 falls below zero. However, all of the rules shown are Estimated unemployment highly simplified and do not capture the substantial .8 rate in the longer run 4.6 .6 complexity of the U.S. economy. Furthermore, both 2001 2003 2005 2007 2009 2011 2013 2015 2017 the level of the neutral real interest rate in the longer run and the level of the unemployment rate that is NOTE: The data are biannual and have been interpolated to yield quarterly values. The estimated neutral real interest rate in the longer run equals the sustainable in the longer run are difficult to estimate three-month Treasury bill rate projected in the long run deflated by the precisely, and estimates made in real time may differ long-run projected annual change in the price index for gross domestic product. substantially from estimates made later on, after SOURCE: Wolters Kluwer, Blue Chip Economic Indicators. the relevant economic data have been revised and additional data have become available.6 For example, since 2000, respondents to the Blue Chip survey have in the economy by lowering short-term interest rates. markedly reduced their projections of the longer-run This asymmetric risk has, in recent years, provided a level of the real short-term interest rate (figure B). sound rationale for following a more gradual path of Survey respondents have also made considerable rate increases than that prescribed by policy rules.7 In changes over time to their estimates of the rate of these circumstances, increasing the policy rate quickly unemployment in the longer run, with consequences in order to have room to cut rates during an economic for the unemployment gap. Revisions of this magnitude downturn could be counterproductive because it would to the neutral real interest rate and the rate of make the downturn more likely to happen. unemployment in the longer run can have important Estimates of the neutral real interest rate in the implications for the federal funds rate prescribed by longer run (such as those in figure B), taken together monetary policy rules. Policy rules must be adjusted to with the FOMC’s inflation objective of 2 percent, take into account these changes in the projected values suggest that the neutral level of the federal funds rate of longer-run rates as they occur over time. that can be expected to prevail in the longer run is currently around 3 percent, well below the average federal funds rate of 6 percent from 1960 to 2007. Accounting for risks to the economic With the neutral federal funds rate so low, there is outlook a likelihood that the policy interest rate will hit its Monetary policy rules do not take account of lower limit of zero more frequently than in the past. broader risk considerations. In the years following the Historically, the FOMC has cut the federal funds rate financial crisis, with the federal funds rate still close by 5 percentage points, on average, during downturns to zero, the FOMC has recognized that it would have in the economy—cutting the policy rate by this much limited scope to respond to an unexpected weakening starting from a neutral level of 3 percent would not be feasible. Under these circumstances, the prescriptions from many policy rules would lead to poor economic 6. The first-difference rule shown in figure A reduces the performance, with inflation averaging below the need for good estimates of longer-run rates because it does (continued on next page) not require an estimate of the neutral real interest rate in the longer run. However, this rule has its own shortcomings. For example, research suggests that this sort of rule will result in greater volatility in employment and inflation relative to what 7. Asymmetric risk need not always provide a rationale would be obtained under the Taylor (1993) and balanced- for a more gradual path; if the risks were strongly tilted approach rules unless the estimates of the neutral real federal toward substantial and persistent overheating and too-high funds rate in the longer run and the rate of unemployment in inflation, the asymmetric risk could argue for higher rates than the longer run are sufficiently far from their true values. prescribed by simple rules. 38 PART 2: MONETARy POLICy Monetary Policy Rules and Their Role (continued) Committee’s 2 percent objective.8 Rules that try to offset and the estimates of the neutral real interest rate in the cumulative shortfall of accommodation posed by the longer run and of the rate of unemployment in the the zero bound on interest rates, such as the adjusted longer run—data and estimates that were available to Taylor (1993) rule, or make up the cumulative shortfall FOMC policymakers at the time.) Moreover, the rules in the level of prices, such as the price-level rule, are sometimes prescribe setting short-term interest rates intended to help achieve average inflation at or near well below zero—a setting that is not feasible. With 2 percent over time.9 the exception of the adjusted Taylor (1993) and price- Different monetary policy rules often offer quite level rules, which impose a lower limit of zero, all of different prescriptions for the federal funds rate, and the rules shown in figure C called for the federal funds there is no unambiguous metric for favoring one rule rate to turn negative in 2009 and to stay below zero over another. While monetary policy rules often agree for several years thereafter. Thus, these rules indicated about the direction (up or down) in which policymakers that the Federal Reserve should provide more monetary should move the federal funds rate, they frequently stimulus than could be achieved by setting the federal disagree about the appropriate level of that rate. funds rate at zero. Almost all of the policy rules have Historical prescriptions from policy rules differ from called for rising values of the federal funds rate in one another and also differ from the Committee’s target recent years, but the pace of tightening that the rules for the federal funds rate, as shown in figure C. (These prescribe has varied widely. Prescriptions from these prescriptions are calculated using both the actual data rules for the level of the federal funds rate in the fourth quarter of 2017 ranged from 0 basis points (price-level 8. For further discussion of these issues, see Michael T. rule) to 3.0 percent (balanced-approach rule).10 Kiley and John M. Roberts (2017), “Monetary Policy in a Low Interest Rate World,” Brookings Papers on Economic Activity, Spring, pp. 317–72, https://www.brookings.edu/wp-content/ uploads/2017/08/kileytextsp17bpea.pdf. in New Challenges for Monetary Policy, proceedings of a 9. Economists have found that a “makeup” policy can symposium sponsored by the Federal Reserve Bank of Kansas be the best response in theory when the policy interest City, held in Jackson Hole, Wyo., August 26–28 (Kansas rate is constrained at zero. See Ben S. Bernanke (2017), City: Federal Reserve Bank of Kansas City), pp. 277–316, “Monetary Policy in a New Era,” paper presented at https://www.kansascityfed.org/publications/research/escp/ “Rethinking Macroeconomic Policy,” a conference held at the symposiums/escp-1999. Peterson Institute for International Economics, Washington, 10. As noted earlier, the price-level rule makes up for the October 12–13, https://www.brookings.edu/wp-content/ cumulative shortfall in the price level when inflation runs uploads/2017/10/bernanke_rethinking_macro_final.pdf; below 2 percent. Because inflation has been below 2 percent and Michael Woodford (1999), “Commentary: How Should in recent years, the price-level rule calls for the federal funds Monetary Policy Be Conducted in an Era of Price Stability?” rate to remain at zero. C. Historical federal funds rate prescriptions from simple policy rules Quarterly Percent 8 Taylor (1993) rule, adjusted 6 Taylor (1993) rule 4 2 + _0 Target federal funds rate Price-level rule 2 First-difference rule 4 Balanced-approach rule 6 8 2001 2003 2005 2007 2009 2011 2013 2015 2017 NOTE: The rules use real-time historical values of inflation, the federal funds rate, and the unemployment rate. Inflation is measured as the four-quarter percent change in the price index for personal consumption expenditures excluding food and energy. Quarterly projections of long-run values for the federal funds rate and the unemployment rate are derived through interpolations of biannual projections from Blue Chip Economic Indicators. The long-run value for inflation is taken as 2 percent. The target value of the price level is the average level of the price index for personal consumption expenditures excluding food and energy in 1998, extrapolated at 2 percent per year. SOURCE: Federal Reserve Bank of Philadelphia; Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff estimates. 39 P 3 art s e P ummary of conomic rojections The following material appeared as an addendum to the minutes of the December 12–13, 2017, meeting of the Federal Open Market Committee. In conjunction with the Federal Open monetary policy, growth in real GDP in Market Committee (FOMC) meeting held on 2018 would be somewhat stronger than their December 12–13, 2017, meeting participants individual estimates of its longer-run rate. submitted their projections of the most likely All participants projected that real GDP outcomes for real gross domestic product growth would moderate in 2019, and nearly (GDP) growth, the unemployment rate, and all predicted that it would ease further in inflation for each year from 2017 to 2020 2020; a solid majority of participants thought and over the longer run.13 Each participant’s that growth in real GDP would be at or projection was based on information available close to their individual estimates of the at the time of the meeting, together with his economy’s longer-run growth rate by 2020. or her assessment of appropriate monetary All participants who submitted longer-run policy—including a path for the federal projections expected that the unemployment funds rate and its longer-run value—and rate would run below their estimates of assumptions about other factors likely to its longer-run normal level through 2020. affect economic outcomes. The longer-run Participants generally projected that inflation, projections represent each participant’s as measured by the four-quarter percentage assessment of the value to which each variable change in the price index for personal would be expected to converge, over time, consumption expenditures (PCE), would under appropriate monetary policy and in the step up toward the Committee’s 2 percent absence of further shocks to the economy.14 objective in 2018 and be at or close to that “Appropriate monetary policy” is defined as objective by 2019. Most participants indicated the future path of policy that each participant that prospective changes in federal tax policy deems most likely to foster outcomes for were a factor that led them to boost their economic activity and inflation that best projections of real GDP growth over the next satisfy his or her individual interpretation of couple of years; some participants, however, the statutory mandate to promote maximum noted that they had already incorporated at employment and price stability. least some effects of future tax cuts in their September projections. Several also noted the All participants who submitted longer-run possibility that changes to tax policy could projections expected that, under appropriate raise the level of potential GDP in the longer run.15 Table 1 and figure 1 provide summary 13. Four members of the Board of Governors were statistics for the projections. in office at the time of the December 2017 meeting, the same number as in September 2017. However, since As shown in figure 2, participants generally the September meeting, one member, Stanley Fischer, expected that the evolution of the economy resigned from the Board and another, Randal K. Quarles, relative to their objectives of maximum joined. The incoming president of the Federal Reserve employment and 2 percent inflation would Bank of Richmond is scheduled to assume office on January 1, 2018; First Vice President Mark L. Mullinix submitted economic projections at this meeting as he did in September. 15. Participants completed their submissions for 14. One participant did not submit longer-run the Summary of Economic Projections before the projections for real output growth, the unemployment reconciliation of the House and Senate tax bills in the rate, or the federal funds rate. Congress. 40 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 2017 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2017 2018 2019 2020 2017 2018 2019 2020 2017 2018 2019 2020 run run run Change in real GDP ..... 2.5 2.5 2.1 2.0 1.8 2.4–2.5 2.2–2.6 1.9–2.3 1.7–2.0 1.8–1.9 2.4–2.6 2.2–2.8 1.7–2.4 1.1–2.2 1.7–2.2 September projection .. 2.4 2.1 2.0 1.8 1.8 2.2–2.5 2.0–2.3 1.7–2.1 1.6–2.0 1.8–2.0 2.2–2.7 1.7–2.6 1.4–2.3 1.4–2.0 1.5–2.2 Unemployment rate. . . . . . 4.1 3.9 3.9 4.0 4.6 4.1 3.7–4.0 3.6–4.0 3.6–4.2 4.4–4.7 4.1 3.6–4.0 3.5–4.2 3.5–4.5 4.3–5.0 September projection .. 4.3 4.1 4.1 4.2 4.6 4.2–4.3 4.0–4.2 3.9–4.4 4.0–4.5 4.5–4.8 4.2–4.5 3.9–4.5 3.8–4.5 3.8–4.8 4.4–5.0 PCE inflation ............ 1.7 1.9 2.0 2.0 2.0 1.6–1.7 1.7–1.9 2.0 2.0–2.1 2.0 1.5–1.7 1.7–2.1 1.8–2.3 1.9–2.2 2.0 September projection .. 1.6 1.9 2.0 2.0 2.0 1.5–1.6 1.8–2.0 2.0 2.0–2.1 2.0 1.5–1.7 1.7–2.0 1.8–2.2 1.9–2.2 2.0 Core PCE inflation4 ...... 1.5 1.9 2.0 2.0 1.5 1.7–1.9 2.0 2.0–2.1 1.4–1.5 1.7–2.0 1.8–2.3 1.9–2.3 September projection .. 1.5 1.9 2.0 2.0 1.5–1.6 1.8–2.0 2.0 2.0–2.1 1.4–1.7 1.7–2.0 1.8–2.2 1.9–2.2 Memo: Projected appropriate policy path Federal funds rate ....... 1.4 2.1 2.7 3.1 2.8 1.4 1.9–2.4 2.4–3.1 2.6–3.1 2.8–3.0 1.1–1.4 1.1–2.6 1.4–3.6 1.4–4.1 2.3–3.0 September projection .. 1.4 2.1 2.7 2.9 2.8 1.1–1.4 1.9–2.4 2.4–3.1 2.5–3.5 2.5–3.0 1.1–1.6 1.1–2.6 1.1–3.4 1.1–3.9 2.3–3.5 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 19–20, 2017. 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 19–20, 2017, meeting, and one participant did not submit such projections in conjunction with the December 12–13, 2017, 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. likely warrant further gradual increases in as broadly similar to the average of the the federal funds rate. Compared with the past 20 years, and all participants saw the projections they submitted in September, uncertainty associated with their projections some participants raised their federal funds for real GDP growth, the unemployment rate, rate projections for 2018 and 2019, while and inflation as essentially unchanged from several others lowered their projections, leaving September. As in September, most participants the median projection for the federal funds judged the risks around their projections for rate in those years unchanged; the median economic growth, the unemployment rate, and projection for 2020 was slightly higher, and the inflation as broadly balanced. median projection for the longer-run normal level of the federal funds rate was unchanged. The Outlook for Economic Activity Nearly all participants saw it as likely to be appropriate for the federal funds rate to rise The median of participants’ projections for the above their estimates of its longer-run normal growth rate of real GDP for 2018, conditional level at some point during the forecast period. on their individual assessments of appropriate Participants generally noted several sources monetary policy, was 2.5 percent, the same of uncertainty about the future course of as for 2017. The median projections for GDP the federal funds rate, including the details growth in 2019 and 2020 were slightly lower, of potential changes in tax policy, how those at 2.1 and 2.0 percent, respectively. Compared changes would affect the economy, and the with the Summary of Economic Projections range of factors influencing inflation over the (SEP) from September, the median of the medium term. projections for real GDP growth for 2018 was notably higher, while the medians for real In general, participants viewed the uncertainty GDP growth for 2019 and 2020 were modestly attached to their economic projections higher. The median of projections for the MONETARy POLICy REPORT: FEBRUARy 2018 41 Figure 1. Medians, central tendencies, and ranges of economic projections, 2017–20 and over the longer run Percent Change in real GDP Median of projections Central tendency of projections Range of projections 3 2 Actual 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 Longer run Percent Unemployment rate 8 7 6 5 4 2012 2013 2014 2015 2016 2017 2018 2019 2020 Longer run Percent PCE inflation 3 2 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 Longer run Percent Core PCE inflation 3 2 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 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. 42 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 2017 2018 2019 2020 Longer run Note: Each shaded circle indicates the value (rounded to the nearest 1/8 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. longer-run normal rate of real GDP growth the unemployment rate ticked up slightly to remained at 1.8 percent. Most participants 4.0 percent in 2020. pointed to changes in tax policy as likely to provide some boost to real GDP growth Figures 3.A and 3.B show the distributions of over the forecast period; in September, fewer participants’ projections for real GDP growth than half of the participants incorporated and the unemployment rate from 2017 to 2020 prospective tax policy changes in their and in the longer run. The distribution of projections. Several participants indicated individual projections for real GDP growth that they had marked up their estimates of for 2018 shifted up, with more than half of the magnitude of tax cuts, relative to their the participants now expecting real GDP assumptions in September. growth of 2.5 percent or more and none seeing it below 2.2 percent. The distribution The medians of projections for the of projected real GDP growth in 2019 and unemployment rate in the fourth quarter 2020 also shifted up, albeit only slightly. The of both 2018 and 2019 were 3.9 percent, distribution for the longer-run normal rate 0.2 percentage point below the medians from of GDP growth was little changed from September and about ¾ percentage point September. The distributions of individual below the median assessment of its longer- projections for the unemployment rate in run normal level. The median projection for 2018 and 2019 shifted down relative to those MONETARy POLICy REPORT: FEBRUARy 2018 43 Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2017–20 and over the longer run Number of participants 2017 December projections 18 September projections 16 14 12 10 8 6 4 2 1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 – 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 – 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 – 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 – 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 – 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 44 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2017–20 and over the longer run Number of participants 2017 December projections 18 September projections 16 14 12 10 8 6 4 2 3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 3.3 3.5 3.7 3.9 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 3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 3.3 3.5 3.7 3.9 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 3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 3.3 3.5 3.7 3.9 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 3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 – 3.3 3.5 3.7 3.9 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 2018 45 in September, broadly consistent with the the projections were 2.69 percent at the end changes in the distributions for real of 2019 and 3.07 percent at the end of 2020. GDP growth. Nearly all participants projected that it would likely be appropriate for the federal funds The Outlook for Inflation rate to rise above their individual estimates of the longer-run normal rate at some point The median of projections for headline over the forecast period. Compared with their PCE price inflation was 1.9 percent in 2018 projections prepared for the September SEP, and 2 percent in 2019 and 2020, the same a few participants raised their projections for as in the September SEP. Most participants the federal funds rate in the longer run and anticipated that inflation would continue to one lowered it; the median was unchanged at run a bit below 2 percent in 2018, and only 2.75 percent. one participant expected inflation above 2 percent that year. A majority of participants In discussing their projections, many projected that inflation would be equal to participants once again expressed the view the Committee’s objective in 2019 and 2020. that the appropriate trajectory of the federal Several participants projected that inflation funds rate over the next few years would would slightly exceed 2 percent in 2019 or likely involve gradual increases. This view 2020. The medians of projections for core PCE was predicated on several factors, including a price inflation over the 2018–20 period were judgment that the neutral real interest rate the same as those for headline inflation. was currently low and would move up only slowly, as well as the balancing of risks Figures 3.C and 3.D provide information on associated with, among other things, the the distributions of participants’ views about possibility that inflation pressures could build the outlook for inflation. On the whole, the if the economy expands well beyond its long- distributions of projections for headline run sustainable level, and the possibility that PCE price inflation and core PCE price the forces depressing inflation could prove to inflation beyond 2017 were little changed be more persistent than currently anticipated. from September. As always, the actual path of the federal funds rate will depend on evolving economic Appropriate Monetary Policy conditions and their implications for the economic outlook. Figure 3.E provides the distribution of participants’ judgments regarding the Uncertainty and Risks appropriate target—or midpoint of the target range—for the federal funds rate at the end In assessing the path for the federal funds rate of each year from 2017 to 2020 and in the that, in their view, is likely to be appropriate, longer run. Overall, the distributions differed FOMC participants take account of the in only small ways from those reported in range of possible economic outcomes, the September SEP. There was a moderate the likelihood of those outcomes, and the reduction in the dispersion of the distribution potential benefits and costs should they for 2020 and for the longer run; some of the occur. As a reference, table 2 provides a lower-end projections for those horizons from measure of forecast uncertainty, based on the September SEP were revised up in the the forecast errors of various private and current projections. government forecasts over the past 20 years, for real GDP growth, the unemployment The median projection of the year-end federal rate, and total consumer price inflation. That funds rate continued to rise gradually over the measure is incorporated graphically in the 2018–20 period. The median projection for the top panels of figures 4.A, 4.B, and 4.C, which end of 2018 was 2.13 percent; the medians of display “fan charts” plotting the median SEP 46 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants’ projections for PCE inflation, 2017–20 and over the longer run Number of participants 2017 December projections 18 September projections 16 14 12 10 8 6 4 2 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.6 1.8 2.0 2.2 2.4 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2018 47 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2017–20 Number of participants 2017 December projections 18 September projections 16 14 12 10 8 6 4 2 1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.4 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.4 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.4 1.6 1.8 2.0 2.2 2.4 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 – 1.4 1.6 1.8 2.0 2.2 2.4 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 48 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, 2017–20 and over the longer run Number of participants 2017 December projections 18 September projections 16 14 12 10 8 6 4 2 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 – 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 Percent range Number of participants 2018 18 16 14 12 10 8 6 4 2 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 – 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 Percent range Number of participants 2019 18 16 14 12 10 8 6 4 2 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 – 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 – 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 – 1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2018 49 projections for the three variables surrounded Table 2. Average historical projection error ranges by symmetric confidence intervals derived Percentage points from the forecast errors presented in table 2. Variable 2017 2018 2019 2020 If the degree of uncertainty attending these Change in real GDP1 ...... ±0.8 ±1.7 ±2.1 ±2.2 projections is similar to the typical magnitude Unemployment rate1 ...... ±0.1 ±0.8 ±1.5 ±1.9 of past forecast errors and the risks around Total consumer prices2 .... ±0.2 ±1.0 ±1.1 ±1.0 the projections are broadly balanced, future Short-term interest rates3 . ±0.1 ±1.4 ±1.9 ±2.4 outcomes of these variables would have Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 1997 through 2016 that were released in the winter by various about a 70 percent probability of occurring private and government forecasters. As described in the box “Forecast Uncertain- ty,” under certain assumptions, there is about a 70 percent probability that actual within these confidence intervals. For all outcomes for real GDP, unemployment, consumer prices, and the federal funds rate will be in ranges implied by the average size of projection errors made in the past. three variables, this measure of projection For more information, see David Reifschneider and Peter Tulip (2017), “Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The uncertainty is substantial and generally Federal Reserve’s Approach,” Finance and Economics Discussion Series 2017-020 (Washington: Board of Governors of the Federal Reserve System, February), www. increases as the forecast horizon lengthens. federalreserve.gov/econresdata/feds/2017/files/2017020pap.pdf. 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 Participants’ assessments of the level of most widely used in government and private economic forecasts. Projections are percent changes on a fourth quarter to fourth quarter basis. uncertainty surrounding their economic 3. For Federal Reserve staff forecasts, measure is the federal funds rate. For other forecasts, measure is the rate on 3-month Treasury bills. Projection errors are calculat- projections are shown in the bottom-left ed using average levels, in percent, in the fourth quarter. panels of figures 4.A, 4.B, and 4.C. Nearly all participants viewed the degree of uncertainty consistent with a symmetric fan chart. The attached to their economic projections about balance of risks to the economic outlook GDP growth, the unemployment rate, and shifted slightly in the direction of strength, inflation as broadly similar to the average of with two more participants seeing upside risks the past 20 years, a view that was essentially to growth in real GDP than in September and unchanged from September.16 About half of one more seeing risks to the unemployment the participants who commented on this topic rate as weighted to the downside. In addition, suggested that uncertainties about the details one more participant than before saw risks to of the pending tax legislation had raised their inflation as weighted to the upside. assessment of uncertainty for GDP growth, albeit not by enough to tip their assessments Participants’ assessments of the future into the higher-than-average category. path of the federal funds rate consistent with appropriate policy are also subject Because the fan charts are constructed to be to considerable uncertainty. Because the symmetric around the median projection, Committee adjusts the federal funds rate they do not reflect any asymmetries in the in response to actual and prospective balance of risks that participants may see developments over time in real GDP growth, in their economic projections. Accordingly, unemployment, and inflation, uncertainty participants’ assessments of the balance of surrounding the projected path for the funds risks to their economic projections are shown rate importantly reflects the uncertainties in the bottom-right panels of figures 4.A, 4.B, about the path for those key economic and 4.C. As in September, most participants variables. Figure 5 provides a graphical judged the risks to their projections of representation of this uncertainty, plotting real GDP growth, the unemployment rate, the median SEP projection for the federal headline inflation and core inflation as funds rate surrounded by confidence intervals broadly balanced—in other words, as broadly derived from the results presented in table 2. As with the macroeconomic variables, forecast 16. At the end of this summary, the box “Forecast uncertainty is substantial and increases for Uncertainty” discusses the sources and interpretation longer horizons. of uncertainty in the economic forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections. 50 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 4.A. Uncertainty and risks in projections of GDP growth Median projection and confidence interval based on historical forecast errors Percent Change in real GDP Median of projections 70% confidence interval 4 3 2 Actual 1 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 FOMC participants’ assessments of uncertainty and risks around their economic projections Number of participants Number of participants Uncertainty about GDP growth Risks to GDP growth December projections December projections September projections 18 September projections 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: The blue and red lines in the top panel show actual values and median projected values, respectively, of the percent change in real gross domestic product (GDP) from the fourth quarter of the previous year to the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” MONETARy POLICy REPORT: FEBRUARy 2018 51 Figure 4.B. Uncertainty and risks in projections of the unemployment rate Median projection and confidence interval based on historical forecast errors Percent Unemployment rate Median of projections 10 70% confidence interval 9 8 7 6 Actual 5 4 3 2 1 2012 2013 2014 2015 2016 2017 2018 2019 2020 FOMC participants’ assessments of uncertainty and risks around their economic projections Number of participants Number of participants Uncertainty about the unemployment rate Risks to the unemployment rate December projections December projections September projections 18 September projections 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: The blue and red lines in the top panel show actual values and median projected values, respectively, of the average civilian unemployment rate in the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” 52 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 4.C. Uncertainty and risks in projections of PCE inflation Median projection and confidence interval based on historical forecast errors Percent PCE inflation Median of projections 70% confidence interval 3 2 1 Actual 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 FOMC participants’ assessments of uncertainty and risks around their economic projections Number of participants Number of participants Uncertainty about PCE inflation Risks to PCE inflation December projections December projections September projections 18 September projections 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 December projections December projections September projections 18 September projections 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: The blue and red lines in the top panel show actual values and median projected values, respectively, of the percent change in the price index for personal consumption expenditures (PCE) from the fourth quarter of the previous year to the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” MONETARy POLICy REPORT: FEBRUARy 2018 53 Figure 5. Uncertainty in projections of the federal funds rate Median projection and confidence interval based on historical forecast errors Percent Federal funds rate Midpoint of target range 6 Median of projections 70% confidence interval* 5 4 3 2 Actual 1 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Note: The blue and red lines are based on actual values and median projected values, respectively, of the Committee’s target for the federal funds rate at the end of the year indicated. The actual values are the midpoint of the target range; the median projected values are based on either the midpoint of the target range or the target level. The confidence interval around the median projected values is based on root mean squared errors of various private and government forecasts made over the previous 20 years. The confidence interval is not strictly consistent with the projections for the federal funds rate, primarily because these projections are not forecasts of the likeliest outcomes for the federal funds rate, but rather projections of participants’ individual assessments of appropriate monetary policy. Still, historical forecast errors provide a broad sense of the uncertainty around the future path of the federal funds rate generated by the uncertainty about the macroeconomic variables as well as additional adjustments to monetary policy that may be appropriate to offset the effects of shocks to the economy. The confidence interval is assumed to be symmetric except when it is truncated at zero—the bottom of the lowest target range for the federal funds rate that has been adopted in the past by the Committee. This truncation would not be intended to indicate the likelihood of the use of negative interest rates to provide additional monetary policy accommodation if doing so was judged appropriate. In such situations, the Committee could also employ other tools, including forward guidance and large-scale asset purchases, to provide additional accommodation. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections. * The confidence interval is derived from forecasts of the average level of short-term interest rates in the fourth quarter of the year indicated; more information about these data is available in table 2. The shaded area encompasses less than a 70 percent confidence interval if the confidence interval has been truncated at zero. 54 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Forecast Uncertainty The economic projections provided by the members of uncertainty surrounding their projections are summarized the Board of Governors and the presidents of the Federal in the bottom-left panels of those figures. Participants Reserve Banks inform discussions of monetary policy also provide judgments as to whether the risks to their among policymakers and can aid public understanding projections are weighted to the upside, are weighted to of the basis for policy actions. Considerable uncertainty the downside, or are broadly balanced. That is, while the attends these projections, however. The economic and symmetric historical fan charts shown in the top panels of statistical models and relationships used to help produce figures 4.A through 4.C imply that the risks to participants’ economic forecasts are necessarily imperfect descriptions projections are balanced, participants may judge that of the real world, and the future path of the economy there is a greater risk that a given variable will be above can be affected by myriad unforeseen developments and rather than below their projections. These judgments events. Thus, in setting the stance of monetary policy, are summarized in the lower-right panels of figures 4.A participants consider not only what appears to be the through 4.C. most likely economic outcome as embodied in their As with real activity and inflation, the outlook for projections, but also the range of alternative possibilities, the future path of the federal funds rate is subject to the likelihood of their occurring, and the potential costs to considerable uncertainty. This uncertainty arises primarily the economy should they occur. because each participant’s assessment of the appropriate Table 2 summarizes the average historical accuracy stance of monetary policy depends importantly on of a range of forecasts, including those reported in past the evolution of real activity and inflation over time. If Monetary Policy Reports and those prepared by the economic conditions evolve in an unexpected manner, Federal Reserve Board’s staff in advance of meetings then assessments of the appropriate setting of the federal of the Federal Open Market Committee (FOMC). The funds rate would change from that point forward. The projection error ranges shown in the table illustrate the final line in table 2 shows the error ranges for forecasts of considerable uncertainty associated with economic short-term interest rates. They suggest that the historical forecasts. For example, suppose a participant projects that confidence intervals associated with projections of the real gross domestic product (GDP) and total consumer federal funds rate are quite wide. It should be noted, prices will rise steadily at annual rates of, respectively, however, that these confidence intervals are not strictly 3 percent and 2 percent. If the uncertainty attending those consistent with the projections for the federal funds projections is similar to that experienced in the past and rate, as these projections are not forecasts of the most the risks around the projections are broadly balanced, the likely quarterly outcomes but rather are projections numbers reported in table 2 would imply a probability of of participants’ individual assessments of appropriate about 70 percent that actual GDP would expand within monetary policy and are on an end-of-year basis. a range of 2.2 to 3.8 percent in the current year, 1.3 to However, the forecast errors should provide a sense of the 4.7 percent in the second year, 0.9 to 5.1 percent in the uncertainty around the future path of the federal funds rate third year, and 0.8 to 5.2 percent in the fourth year. The generated by the uncertainty about the macroeconomic corresponding 70 percent confidence intervals for overall variables as well as additional adjustments to monetary inflation would be 1.8 to 2.2 percent in the current year, policy that would be appropriate to offset the effects of 1.0 to 3.0 percent in the second year, 0.9 to 3.1 percent shocks to the economy. in the third year, and 1.0 to 3.0 percent in the fourth If at some point in the future the confidence interval year. Figures 4.A through 4.C illustrate these confidence around the federal funds rate were to extend below zero, bounds in “fan charts” that are symmetric and centered on it would be truncated at zero for purposes of the fan chart the medians of FOMC participants’ projections for GDP shown in figure 5; zero is the bottom of the lowest target growth, the unemployment rate, and inflation. However, range for the federal funds rate that has been adopted in some instances, the risks around the projections may by the Committee in the past. This approach to the not be symmetric. In particular, the unemployment rate construction of the federal funds rate fan chart would be cannot be negative; furthermore, the risks around a merely a convention; it would not have any implications particular projection might be tilted to either the upside or for possible future policy decisions regarding the use of the downside, in which case the corresponding fan chart negative interest rates to provide additional monetary would be asymmetrically positioned around the median policy accommodation if doing so were appropriate. In projection. such situations, the Committee could also employ other Because current conditions may differ from those that tools, including forward guidance and asset purchases, to prevailed, on average, over history, participants provide provide additional accommodation. judgments as to whether the uncertainty attached to While figures 4.A through 4.C provide information on their projections of each economic variable is greater the uncertainty around the economic projections, figure 1 than, smaller than, or broadly similar to typical levels provides information on the range of views across FOMC of forecast uncertainty seen in the past 20 years, as participants. A comparison of figure 1 with figures 4.A presented in table 2 and reflected in the widths of the through 4.C shows that the dispersion of the projections confidence intervals shown in the top panels of figures 4.A across participants is much smaller than the average through 4.C. Participants’ current assessments of the forecast errors over the past 20 years. 55 a bbreviations AFE advanced foreign economy BOE Bank of England C&I commercial and industrial EME emerging market economy FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product LFPR labor force participation rate MBS mortgage-backed securities Michigan survey University of Michigan Surveys of Consumers 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 TCJA Tax Cuts and Jobs Act TIPS Treasury Inflation-Protected Securities For use at 11:00 a.m., EST February 23, 2018 M P r onetary olicy ePort February 23, 2018 Board of Governors of the Federal Reserve System

Federal Reserve (2018, February 22). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20180223

@misc{wtfs_monetary_policy_report_20180223,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2018},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20180223},
  note = {Retrieved via When the Fed Speaks corpus}
}