Monetary Policy Report

For use at 11:00 a.m. EST February 7, 2020 M P r onetary olicy ePort February 7, 2020 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 7, 2020 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 L -r g m P S tatement on onger un oaLS and onetary oLicy trategy Adopted effective January 24, 2012; as amended effective January 29, 2019 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 4.4 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. Note: The Committee did not reaffirm this statement in January 2020 in light of its ongoing review of its monetary policy strategy, tools, and communications practices. This statement is a reprint of the statement affirmed in January 2019. C ontents Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Economic and Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Special Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Part 1: Recent Economic and Financial Developments . . . . . . . . . . . . . . . . . . . . . 5 Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 The Outlook for Real GDP Growth and Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 The Outlook for Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Appropriate Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Uncertainty and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 List of Boxes Manufacturing and U.S. Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Monetary Policy Rules and Uncertainty in Monetary Policy Settings . . . . . . . . . . . . . . . . . . . 33 Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Money Market Developments and Monetary Policy Implementation . . . . . . . . . . . . . . . . . . 42 Forecast Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 note: This report reflects information that was publicly available as of noon EST on February 5, 2020. Unless otherwise stated, the time series in the figures extend through, for daily data, February 4, 2020; for monthly data, December 2019; and, for quarterly data, 2019: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 16 and 34, 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 © 2020 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 The U.S. economy continued to grow was 1.6 percent in December 2019, as was the moderately last year and the labor market 12-month measure that excludes consumer strengthened further. With these gains, the food and energy prices (so-called core current expansion entered its 11th year, inflation), which historically has been a better becoming the longest on record. However, indicator of where inflation will be in the inflation was below the Federal Open Market future than the overall figure. The downshift Committee’s (FOMC) longer-run objective relative to 2018 partly results from particularly of 2 percent. In light of the implications low readings in the monthly price data in the of global developments for the economic early part of last year that appear to reflect outlook as well as muted inflation pressures, transitory influences. Survey-based measures the FOMC lowered the target range for the of longer-run inflation expectations have federal funds rate at its July, September, and been broadly stable since the middle of last October meetings, bringing it to the current year, and market-based measures of inflation range of 1½ to 1¾ percent. In the Committee’s compensation are little changed on net. subsequent meetings, it judged that the prevailing stance of monetary policy was Economic growth. Real gross domestic product appropriate to support sustained expansion (GDP) is reported to have increased at a of economic activity, strong labor market moderate rate in the second half of 2019, conditions, and inflation returning to the although growth was somewhat slower than Committee’s symmetric 2 percent objective. in the first half of the year and in 2018. Consumer spending rose at a moderate pace, on average, and residential investment Economic and Financial turned up after having declined in 2018 and Developments the first half of 2019. In contrast, business fixed investment declined in the second half The labor market. The labor market continued of last year, reflecting a number of factors to strengthen last year. Payroll employment that likely include trade policy uncertainty growth remained solid in the second half and weak global growth. Downside risks to of 2019, and while the pace of job gains the U.S. outlook seem to have receded in the during the year as a whole was somewhat latter part of the year, as the conflicts over slower than in 2018, it was faster than what is trade policy diminished somewhat, economic needed to provide jobs for new entrants to the growth abroad showed signs of stabilizing, labor force. The unemployment rate moved and financial conditions eased. More recently, down from 3.9 percent at the end of 2018 to possible spillovers from the effects of the 3.5 percent in December, and the labor force coronavirus in China have presented a new risk participation rate increased. Meanwhile, wage to the outlook. gains remained moderate although above the pace of gains seen earlier in the expansion. Financial conditions. Domestic financial conditions for businesses and households Inflation. After having been close to the remained supportive of spending and FOMC’s objective of 2 percent in 2018, economic activity. After showing some consumer price inflation, as measured by volatility over the summer, nominal the price index for personal consumption Treasury yields declined and equity prices expenditures, moved back below 2 percent increased notably, on balance, supported by last year, where it has been during most of accommodative monetary policy actions and the current expansion. The 12-month change easing of investors’ concerns regarding trade 2 SUMMARy policy prospects and the global economic appears to be nearing an end, and consumer outlook. Spreads of yields on corporate bonds spending and services activity around the over those on comparable-maturity Treasury world continue to hold up. Moreover, in some securities continued to narrow, and mortgage economically important regions, such as China rates remained low. Moreover, loans remained and the euro area, data through early this year widely available for most businesses and suggested that growth was steadying. The households, and credit provided by commercial recent emergence of the coronavirus, however, banks continued to expand at a moderate pace. could lead to disruptions in China that spill over to the rest of the global economy. Amid Financial stability. The U.S. financial system is weak economic activity and dormant inflation substantially more resilient than it was before pressures, foreign central banks generally the financial crisis. Leverage in the financial adopted a more accommodative policy stance. sector appears low relative to historical norms. Total household debt has grown at a Financial conditions abroad eased in slower pace than economic activity over the the second half of last year, supported past decade, in part reflecting that mortgage by accommodative actions by central credit has remained tight for borrowers with banks and, later in the period, positive low credit scores, undocumented income, political developments, including progress or high debt-to-income ratios. In contrast, on the U.S.–China trade negotiations and the levels of business debt continue to be diminished risks of a disorderly Brexit. elevated compared with the levels of either On balance, since July global equity prices business assets or GDP, with the riskiest firms moved higher, sovereign bond spreads in accounting for most of the increase in debt the European periphery narrowed, and in recent years. While overall liquidity and measures of sovereign spreads in emerging maturity mismatches and funding risks in the market economies decreased somewhat. In financial system remain low, the volatility in many advanced foreign economies, long-term repurchase agreement (repo) markets in mid- interest rates remained well below the levels September 2019 highlighted the possibility for seen at the end of 2018. frictions in repo markets to spill over to other markets. Finally, asset valuations are elevated Monetary Policy and have risen since July 2019, as investor risk appetite appears to have increased. (See Interest rate policy. In light of the implications the box “Developments Related to Financial of global developments for the economic Stability” in Part 1.) outlook as well as muted inflation pressures, the FOMC lowered the target range for the International developments. After weakening in federal funds rate over the second half of 2019. 2018, foreign economic growth slowed further Specifically, at its July, September, and October in 2019, held down by a slump in global meetings, the FOMC lowered the target manufacturing, elevated trade tensions, and range a cumulative 75 basis points, bringing political and social unrest in several countries. it to the current range of 1½ to 1¾ percent. Growth in Asian economies slowed markedly, In its subsequent meetings, the Committee especially in Hong Kong and India, and judged that the prevailing stance of monetary many Latin American economies continued policy was appropriate to support sustained to underperform. The pace of economic expansion of economic activity, strong labor activity weakened in several advanced foreign market conditions, and inflation returning to economies as well. However, recent indicators the Committee’s symmetric 2 percent objective. provide tentative signs of stabilization. The The Committee noted that it will continue global slowdown in manufacturing and trade to monitor the implications of incoming MONETARy POLICy REPORT: FEBRUARy 2020 3 information for the economic outlook as it to foster efficient and effective implementation assesses the appropriate path of the target of monetary policy. (See the box “Money range for the federal funds rate. Market Developments and Monetary Policy Implementation” in Part 2.) Balance sheet policy. At its July meeting, the FOMC decided to conclude the reduction of Special Topics its aggregate securities holdings in the System Open Market Account, or SOMA, in August. Manufacturing and U.S. business cycles. Ending the runoff earlier than initially planned After increasing solidly in 2017 and 2018, was seen as having only very small effects on manufacturing output turned down last the balance sheet, with negligible implications year. This decline raised fears among some for the economic outlook; it was also seen observers that the weakness could spread and as helpful in simplifying communications potentially lead to an economy-wide recession. regarding the use of the Committee’s policy In general, a decline in manufacturing similar tools at a time when the Committee was to that in 2019 would not be large enough to lowering the target range for the federal initiate a major downturn for the economy. funds rate. As discussed further in the next Furthermore, after accounting for changing paragraph, since October 2019, the size of the trends in growth of manufacturing output, balance sheet has been expanding to provide mild slowdowns have often occurred during an ample level of reserves to ensure that the expansionary phases of business cycles. In federal funds rate trades within the FOMC’s contrast, a more pronounced contraction in target range. manufacturing has historically been associated with an economy-wide recession. (See the box Monetary policy implementation. Domestic “Manufacturing and U.S. Business Cycles” in short-term funding markets were volatile in Part 1.) mid-September—amid large flows related to corporate tax payments and settlement Monetary policy rules. Prescriptions for the of Treasury securities—and experienced a policy interest rate from monetary policy rules significant tightening of conditions. Since often depend on judgments and assumptions then, the Federal Reserve has been conducting about economic variables that are inherently open market operations—repo operations uncertain and may change over time. Notably, and Treasury bill purchases—in order to many policy rules depend on estimates of maintain ample reserve balances over time. resource slack and of the longer-run neutral While the balance sheet has expanded in light real interest rate, both of which are not of the open market operations to maintain directly observable and are estimated with a ample reserves, these operations are purely high degree of uncertainty. As a result, the technical measures to support the effective amount of policy accommodation that these implementation of the FOMC’s monetary rules prescribe—and whether that amount is policy, are not intended to change the appropriate in light of underlying economic stance of monetary policy, and reflect the conditions—is also uncertain. Such a situation Committee’s intention to implement monetary cautions against mechanically following the policy in a regime with an ample supply prescriptions of any specific rule. (See the box of reserves. The Committee will continue “Monetary Policy Rules and Uncertainty in to monitor money market developments Monetary Policy Settings” in Part 2.) as it assesses the level of reserves most consistent with efficient and effective policy Framework review and Fed Listens events. In implementation and stands ready to adjust the 2019, the Federal Reserve System began a details of its technical operations as necessary broad review of the monetary policy strategy, 4 SUMMARy tools, and communication practices it uses to achieve and maintain the dual mandate, and to pursue its statutory dual-mandate goals how communication about monetary policy of maximum employment and price stability. can be improved. The Federal Reserve sees this review as particularly important at this time because the A key component of the review has been a U.S. economy appears to have changed in ways series of public Fed Listens events engaging that matter for monetary policy. For example, with a broad range of stakeholders in the U.S. the neutral level of the policy interest rate economy about how the Federal Reserve can appears to have fallen in the United States and best meet its statutory goals. During 14 Fed abroad, increasing the risk that the effective Listens events in 2019, policymakers heard lower bound on interest rates will constrain from individuals and groups around the central banks from reducing their policy country on issues related to the labor market, interest rates enough to effectively support inflation, interest rates, and the transmission economic activity during downturns. The of monetary policy. (See the box “Federal review is considering what monetary policy Reserve Review of Monetary Policy Strategy, strategy will best enable the Federal Reserve to Tools, and Communication Practices” in meet its dual mandate in the future, whether Part 2.) the existing monetary policy tools are sufficient 5 P 1 art r e f d eCent ConomiC and inanCiaL eveLoPments Domestic Developments The labor market strengthened further last year but at a slower pace than in 2018 . . . Payroll employment gains were solid in the second half of 2019 and averaged 176,000 1. Net change in payroll employment per month during the year as a whole. This Monthly Thousands of jobs pace is somewhat slower than the average monthly gains in 2018, even accounting for Total nonfarm (12-month) 300 the anticipated effects of the Bureau of Labor Statistics’ upcoming benchmark revision to 250 payroll employment (figure 1).1 However, the 200 pace of job gains appears to have remained faster than what is needed to provide jobs 150 for net new entrants to the labor force as the 100 population grows.2 Total nonfarm (3-month) 50 Reflecting the employment gains over this period, the unemployment rate declined 2013 2015 2017 2019 further in 2019 and stood at 3.5 percent in NOTE: The data are 3-month and 12-month moving averages. SOURCE: Bureau of Labor Statistics via Haver Analytics. December, 0.4 percentage point below its year- earlier level and at its lowest level since 1969 (figure 2). In addition, the unemployment rate is 0.6 percentage point below the median of Federal Open Market Committee (FOMC) participants’ estimates of its longer-run normal level.3 1. The annual benchmark revision to payroll employment will be published on February 7, after this report has gone to print. According to the Bureau of Labor Statistics’ preliminary estimates, increases in payrolls will be revised downward roughly 40,000 per month from April 2018 through March 2019. Payroll figures after March 2019 are subject to revision as well. 2. To keep up with population growth, roughly 115,000 to 145,000 payroll jobs per month need to be created, on average, to maintain a constant unemployment rate with an unchanged labor force participation rate. There is considerable uncertainty around these estimates, as the difference between monthly payroll gains and employment changes from the Current Population Survey (the source of the unemployment and participation rates) can be quite volatile over short periods. 3. See the most recent economic projections that were released after the December FOMC meeting in Part 3 of this report. 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 2 2009 2011 2013 2015 2017 2019 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. Strengthening labor market conditions are also evident in rising labor force participation rates 3. Labor force participation rates and employment-to-population ratio (LFPRs)—that is, the shares of the population either working or actively seeking work. The Percent Percent LFPR for individuals aged 16 and over was 63.2 percent in December, above its level a 86 Labor force participation rate 68 year ago despite the downward pressure of 85 66 about ¼ percentage point per year associated 84 64 with the aging of the population. The LFPR 83 62 for prime-age individuals (between 25 and 54 years old), which is much less sensitive 82 60 to the effects of population aging, has been 81 58 rising over the past few years and continued to Employment-to-population ratio Prime-age labor force 80 participation rate 56 increase in 2019 (figure 3). The employment- to-population ratio for individuals aged 16 2001 2004 2007 2010 2013 2016 2019 and over—that is, the share of people who are NOTE: The data are monthly. The prime-age labor force participation working—was 61.0 percent in December and rate is a percentage of the population aged 25 to 54. The labor force participation rate and the employment-to-population ratio are has been increasing since 2011. percentages of the population aged 16 and over. SOURCE: Bureau of Labor Statistics via Haver Analytics. Other indicators are also consistent with strong labor market conditions, albeit with some slowing in the pace of improvement since 2018. As reported in the Job Openings and Labor Turnover Survey (JOLTS), job openings have remained plentiful, although the private-sector MONETARy POLICy REPORT: FEBRUARy 2020 7 job openings rate has come down over the past year. Similarly, the quits rate in the JOLTS has remained near the top of its historical range, an indication that workers are being bid away from their current jobs or have become more confident that they can successfully switch jobs if they so wish. These data accord well with surveys of consumers that indicate households perceive jobs as plentiful. The JOLTS layoff rate and the number of people filing initial claims for unemployment insurance benefits— historically, a good early indicator of economic downturns—have both remained quite low. . . . and unemployment rates have fallen, on net, for all major demographic groups over the past several years Differences in unemployment rates across ethnic and racial groups have narrowed in recent years, on net, as they typically do during economic expansions, after having widened during the 2007–09 recession (figure 4). The decline in the unemployment rate for African Americans has been particularly sizable, and its average rate in the second half of October 2019 was the lowest recorded since the data began in 1972. Although the unemployment rates for African Americans 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 2009 2011 2013 2015 2017 2019 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. 8 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 5. Prime-age labor force participation rate by race and and for Hispanics remain substantially ethnicity above those for whites and for Asians, those differentials in the second half of 2019 were Monthly Percent at their narrowest levels on record. The rise in 84 LFPRs for prime-age individuals over the past White 83 few years has also been apparent in each of Asian 82 these racial and ethnic groups (figure 5). Hispanic or Latino 81 80 Increases in labor compensation have 79 remained moderate by historical 78 standards . . . Black or African American 77 Despite strong labor market conditions, the 76 available indicators generally suggest that 2009 2011 2013 2015 2017 2019 increases in hourly labor compensation have NOTE: The prime-age labor force participation rate is a percentage of remained moderate, averaging about 3 percent the population aged 25 to 54. Persons whose ethnicity is identified as over the past two years. These indicators Hispanic or Latino may be of any race. The data are 12-month moving averages. The shaded bar indicates a period of business recession as include the employment cost index, a measure defined by the National Bureau of Economic Research. SOURCE: Bureau of Labor Statistics via Haver Analytics. of both wages and the cost to employers of providing benefits; compensation per hour in the business sector, a broad-based but volatile 6. Measures of change in hourly compensation measure of wages, salaries, and benefits; and Percent change from year earlier average hourly earnings from the payroll survey, a monthly index that is timely but Compensation per hour, Atlanta Fed’s 6 business sector Wage Growth Tracker does not account for benefits (figure 6). The 5 median 12-month wage growth of individuals 4 reporting to the Current Population Survey 3 calculated by the Federal Reserve Bank 2 of Atlanta, which tends to be higher than Employment cost index, 1 broader-based measures of wage growth, private sector + remains near the upper portion of its range _0 Average hourly earnings, over the past couple of years.4 Interestingly, private sector 1 wage growth over the past few years has been 2003 2005 2007 2009 2011 2013 2015 2017 2019 strongest for workers in relatively low-paying NOTE: Business-sector compensation is on a 4-quarter percent change jobs, suggesting that the strong labor market basis and extends through 2019:Q3. For the private-sector employment is having a more pronounced benefit for cost index, change is over the 12 months ending in the last month of each quarter; for private-sector average hourly earnings, the data are these workers. 12-month percent changes and begin in March 2007; for the Atlanta Fed’s Wage Growth Tracker, the data are shown as a 3-month moving average of the 12-month percent change. . . . and likely have been restrained by SOURCE: Bureau of Labor Statistics; Federal Reserve Bank of Atlanta, Wage Growth Tracker; all via Haver Analytics. slow growth in labor productivity over much of the expansion These moderate rates of hourly compensation gains likely reflect the offsetting influences of a strengthening labor market and productivity growth that has been weak through much of the expansion. From 2008 to 2018, labor 4. 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 2020 9 productivity increased a little more than 7. Change in business-sector output per hour 1 percent per year, on average, well below the average pace from 1996 to 2007 of nearly Percent, annual rate 3 percent and also below the average gain in the 1974–95 period (figure 7). Although 4 considerable debate remains about the reasons for the slowdown in productivity 3 growth over this period, the weakness may be partly attributable to the sharp pullback in 2 capital investment, including on research and development, during the most recent recession 1 and the relatively slow recovery that followed. More recently, labor productivity is estimated to have increased 1.5 percent over the four 1948– 1974– 1996– 2008– 2018 2019 73 95 2007 17 quarters ending in 2019:Q3—a small NOTE: Changes are measured from Q4 of the year immediately improvement from the preceding year, preceding the period through Q4 of the final year of the period except 2019 changes, which are calculated from 2018:Q3 to 2019:Q3. especially given the volatility of the SOURCE: Bureau of Labor Statistics via Haver Analytics. productivity data, but still moderate relative to earlier periods. While it is uncertain whether productivity growth will continue to improve, a sustained pickup in productivity growth, as well as additional labor market strengthening, would support stronger gains in labor compensation. Inflation was below 2 percent last year After having been close to the FOMC’s objective of 2 percent in 2018, inflation moved back below 2 percent last year, where it has been for most of the time since the end of the most recent recession. The 12-month change in the price index for personal consumption expenditures (PCE) was 1.6 percent in December 2019, as was the 12-month measure of inflation that excludes food and 8. Change in the price index for personal consumption energy items (so-called core inflation), which expenditures historically has been a better indicator of Monthly 12-month percent change where inflation will be in the future than the overall index (figure 8). Both measures are 3.0 down from the rates recorded a year ago; Trimmed mean 2.5 Excluding food the slowing partly results from particularly and energy low readings in the monthly price data in the 2.0 first quarter of 2019, which appear to reflect 1.5 idiosyncratic price declines in a number of 1.0 Total specific categories such as apparel, used cars, .5 banking services, and portfolio management services. Indeed, core inflation picked up after 0 the first quarter and was at an average annual 2013 2014 2015 2016 2017 2018 2019 rate of 1.9 percent over the remainder of SOURCE: For trimmed mean, Federal Reserve Bank of Dallas; for all the year. else, Bureau of Economic Analysis; all via Haver Analytics. 10 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS The trimmed mean PCE price index, calculated by the Federal Reserve Bank of Dallas, also suggests a transitory element to inflation readings early last year. The trimmed mean provides an alternative way to purge inflation of transitory influences, and it is less sensitive than the core index to idiosyncratic price movements such as those noted earlier.5 The 12-month change in this measure was about the same in December 2019 as it was in 2018. Oil prices fluctuated in 2019 9. Spot and futures prices for crude oil After falling from more than $80 per barrel to Weekly Dollars per barrel less than $60 per barrel in late 2018, the Brent 130 spot price of crude oil fluctuated between $60 Brent spot price 120 and $70 for most of 2019. Prices generally 110 moved up in the second half of last year, 100 supported by expectations of supply cuts 90 24-month-ahead futures contracts 80 in OPEC member countries and, later on, 70 diminished concerns about the global outlook 60 (figure 9). Prices also spiked briefly in early 50 January over tensions with Iran. In recent 40 30 weeks, however, oil prices moved lower amid 20 heightened fears that the coronavirus outbreak 2014 2015 2016 2017 2018 2019 2020 that started in China might weigh on economic NOTE: The data are weekly averages of daily data. The weekly data growth and the demand for oil. Despite begin on Thursdays and extend through January 29, 2020. these fluctuations in oil prices, retail gasoline SOURCE: ICE Brent Futures via Bloomberg. prices generally edged lower since mid-2019. For 2019 as a whole, consumer energy prices rose modestly more than the core index. Meanwhile, food prices posted only a small increase in 2019, held down by soft prices for farm commodities, and contributed very little to overall consumer price inflation. Reported prices of imports other than energy fell Nonfuel import prices, before accounting for the effects of tariffs on the price of imported goods, have continued to decline from their mid-2018 peak, responding to lower foreign inflation and declines in non-oil commodity 5. The trimmed mean index excludes prices that showed particularly large increases or decreases in a given month. Note that, since 1995, 12-month changes in the trimmed mean index have averaged about 0.3 percentage point above core PCE inflation and 0.2 percentage point above total PCE inflation. MONETARy POLICy REPORT: FEBRUARy 2020 11 prices (figure 10).6 After declining in the 10. Nonfuel import prices and industrial metals indexes first half of 2019, prices of industrial metals January 2014 = 100 January 2014 = 100 appear to have bottomed out in recent months, consistent with increased optimism 120 Industrial metals about global demand following positive trade 110 102 developments. 100 100 Survey-based measures of inflation 90 98 expectations have been broadly stable . . . 80 Nonfuel import prices 96 Expectations of inflation likely influence actual 70 inflation by affecting wage- and price-setting 94 60 decisions. Survey-based measures of inflation expectations at medium- and longer-term 2014 2015 2016 2017 2018 2019 2020 horizons have remained broadly stable over NOTE: The data for nonfuel import prices are monthly. The data for the past year. In the Survey of Professional industrial metals are a monthly average of daily data and extend through January 31, 2020. Forecasters, conducted by the Federal SOURCE: For nonfuel import prices, Bureau of Labor Statistics; for industrial metals, S&P GSCI Industrial Metals Spot Index via Haver Reserve Bank of Philadelphia, the median Analytics. expectation for the annual rate of increase in the PCE price index over the next 10 years 11. Surveys of inflation expectations has been very close to 2 percent for the past several years (figure 11). In the University of Percent Michigan Surveys of Consumers, the median value for inflation expectations over the next Michigan survey of consumers, NY Fed 4 5 to 10 years has fluctuated within a narrow next 5 to 10 years survey of consumers, range around 2½ percent since the end of 3 years ahead 3 2016, though this level is between ¼ and ½ percentage point lower than had prevailed 2 through 2014. In the Survey of Consumer Survey of Professional Expectations, conducted by the Federal Forecasters, next 10 years 1 Reserve Bank of New York, the median of respondents’ expected inflation rate three years hence moved lower, on net, in the second 2006 2008 2010 2012 2014 2016 2018 2020 half of last year and averaged 2.5 percent, NOTE: The series are medians of the survey responses. The Michigan ¼ percentage point below its average over the survey data are monthly and extend through January 2020. The Survey of Professional Forecasters data for inflation expectations for personal preceding three years. consumption expenditures are quarterly and begin in 2007:Q1. The NY Fed survey data are monthly and begin in June 2013. SOURCE: University of Michigan Surveys of Consumers; Federal . . . and market-based measures of Reserve Bank of New York, Survey of Consumer Expectations; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters. inflation compensation have also been little changed Inflation expectations can also be gauged by market-based measures of inflation compensation. However, the inference is not straightforward, because market- based measures can be importantly affected 6. Published import price indexes exclude tariffs. However, tariffs add to the prices that purchasers of imports actually pay, and tariff-inclusive import prices have likely increased, rather than declined, since mid-2018. 12 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 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 12. 5-to-10-year-forward inflation compensation securities and those on comparable-maturity Treasury Inflation-Protected Securities (TIPS) Weekly Percent or from inflation swaps—have been little changed, on net, since the middle of 2019, 3.5 Inflation swaps with both measures below their respective 3.0 ranges that persisted for most of the 10 years 2.5 before the start of notable declines in mid-2014 (figure 12).7 The TIPS-based measure of 5-to- 2.0 10-year-forward inflation compensation and TIPS breakeven rates 1.5 the analogous measure from inflation swaps 1.0 are now about 1¾ percent and 2 percent, respectively.8 2012 2014 2016 2018 2020 NOTE: The data are weekly averages of daily data and extend through Growth of gross domestic product was January 31, 2020. TIPS is Treasury Inflation-Protected Securities. SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve moderate in the second half of 2019 . . . Board staff estimates. Real gross domestic product (GDP) is reported 13. Change in real gross domestic product and gross to have increased at a moderate average domestic income annual rate of 2.1 percent in the second half Percent, annual rate of 2019, although growth was somewhat Gross domestic product slower than in the first half of the year and in Gross domestic income 5 2018 (figure 13). Consumer spending rose at a moderate pace, on average, and residential 4 investment turned up after having declined since the end of 2017. In contrast, business H1 3 fixed investment declined in the second half H2 2 of last year, reflecting a number of factors that likely include uncertainty regarding 1 trade tensions and the weak global growth outlook. Those factors also continued to weigh 2014 2015 2016 2017 2018 2019 on manufacturing output, which declined NOTE: Gross domestic income is not yet available for 2019:H2. SOURCE: Bureau of Economic Analysis via Haver Analytics. 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 total 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. Inflation compensation derived from inflation swaps typically exceeds TIPS-based compensation, but week-to-week movements in the two measures are highly correlated. 8. As these measures are based on CPI inflation, one should probably subtract about ¼ percentage point—the average differential with PCE inflation over the past two decades—to infer inflation compensation on a PCE basis. MONETARy POLICy REPORT: FEBRUARy 2020 13 over the first half of 2019 and has moved roughly sideways since then. (See the box “Manufacturing and U.S. Business Cycles.”) Despite those headwinds, the economic expansion continues to be supported by steady job gains, increases in household wealth, expansionary fiscal policy, and supportive domestic financial conditions that include moderate borrowing costs and easy access to credit for many households and businesses. . . . and downside risks to the outlook receded somewhat Downside risks to the economic outlook seem to have receded somewhat in the latter part of 2019. Labor market conditions and economic growth in the United States have been resilient to the global headwinds in 2019, and conflicts over trade policy diminished somewhat toward the end of the year. Economic growth abroad also shows signs of stabilizing, though the coronavirus outbreak presents a more recent risk. Reflecting these factors as well as more accommodative monetary policy stances in the United States and some foreign economies, financial conditions eased somewhat over the second half of the year. Statistical models designed to gauge the probability of recession using various indicators, including the Treasury yield curve, suggest that the likelihood of a recession occurring over the next year has fallen noticeably in recent months. Similarly, as shown in Part 3, when Federal Reserve policymakers most recently presented their 14. Change in real personal consumption expenditures and disposable personal income economic projections, in December, fewer participants judged the risks to the outlook to Percent, annual rate be tilted to the downside compared with their Personal consumption expenditures projections from last June. Disposable personal income 6 5 Ongoing improvements in the labor 4 market continue to support household H1 income and consumer spending 3 H2 Consumer spending rose at a moderate pace, 2 on average, in the third and fourth quarters 1 of 2019 and posted another solid gain for the year as a whole (figure 14). The growth in real 2014 2015 2016 2017 2018 2019 PCE in recent years reflects the continued SOURCE: Bureau of Economic Analysis via Haver Analytics. 14 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Manufacturing and U.S. Business Cycles Historically, the manufacturing sector in the United A. Industrial production index for manufacturing States has been a source of economic strength and of good jobs for workers at all levels of education. It is Quarterly 2012 = 100 also a highly cyclical sector that has tended to retrench dramatically during economy-wide contractions and to 106 rebound sharply during expansions. Concerns by some observers about a possible 105 economy-wide recession were prompted by declines 104 in the industrial production index for manufacturing (IP) in the first two quarters of 2019, particularly when 103 viewed in conjunction with the stagnant manufacturing growth that was occurring in many foreign economies. 102 Manufacturing output in the United States remained 101 weak through the end of the year (figure A). And, for 2019 as a whole, production decreased 1.3 percent, with fairly broad-based declines across both durable 2017 2018 2019 and nondurable goods industries. The slump in SOURCE: Federal Reserve Board, Statistical Release G.17, “Industrial manufacturing last year is attributable to several Production and Capacity Utilization.” factors, including trade developments, weak global growth, softer business investment, lower oil prices engendering a cutback in demand by drillers, and the U.S. economy imply that every dollar of factory output slower production of Boeing’s 737 Max aircraft due to requires 56 cents of input from other domestic sectors.2 safety issues.1 Manufacturing currently accounts for 12 percent of When considering the implications of these declines gross domestic product (GDP), so its 2019 decline in manufacturing production for the broader economy, of 1.3 percent would have directly subtracted about it is important to recognize that this weakness has likely 0.15 percent from GDP; including inputs purchased spilled over to other sectors. Manufacturing production from upstream sectors, the drag is a bit more requires inputs from other industries, and goods than 0.2 percent. After adding in the downstream that are produced need to be transported and sold. activities needed to bring products to market (such as For example, a reduction in auto assemblies affects transportation, wholesaling, and retailing), last year’s automakers’ demand both for intermediate inputs like decline in manufacturing likely reduced GDP by less steel and for business services like accounting. In turn, than 0.5 percent—not enough to tip an otherwise- the steelmakers need less iron ore, and the accountants expanding economy into recession. need less tech support. The input-output tables for the That modest effect partly reflects the decline in manufacturing’s share of the U.S. economy since the middle of the 20th century. Manufacturing employment 1. See, for example, Aaron Flaaen and Justin Pierce (2019), “Disentangling the Effects of the 2018–2019 Tariffs on a has dropped from about 30 percent of total employment Globally Connected U.S. Manufacturing Sector,” Finance and (continued) Economics Discussion Series 2019-086 (Washington: Board of Governors of the Federal Reserve System, December), https://dx.doi.org/10.17016/FEDS.2019.086. Also see 2. The input-output tables are published by the Bureau of Dario Caldara, Matteo Iacoviello, Patrick Molligo, Andrea Economic Analysis. Our estimates are from the 2018 sectoral Prestipino, and Andrea Raffo (2019), “The Economic Effects of “Domestic Requirements” table, which shows both the Trade Policy Uncertainty,” International Finance Discussion intermediate products used directly by manufacturers and the Papers 1256 (Washington: Board of Governors of the Federal intermediate products used further upstream by their suppliers. Reserve System, September), https://dx.doi.org/10.17016/ The tables do not, however, account for broader general IFDP.2019.1256. Boeing slowed production of the 737 Max in equilibrium effects such as, for example, the lower spending the spring of 2019 and subsequently announced a temporary by workers who may have been laid off when there were suspension of production beginning in early 2020. cutbacks in auto production. MONETARy POLICy REPORT: FEBRUARy 2020 15 B. Manufacturing share of GDP and employment C. Manufacturing IP and its trend Annual Percent Monthly Ratio scale, 2012 = 100 120 35 Share of employment 100 30 80 Trend 25 Manufacturing IP 60 Share of GDP 20 15 40 10 5 1959 1969 1979 1989 1999 2009 2019 1959 1969 1979 1989 1999 2009 2019 SOURCE: Staff estimates of data from the Bureau of Economic NOTE: The shaded bars indicate periods of business recession as Analysis (for gross domestic product) and from the Bureau of Labor defined by the National Bureau of Economic Research. Statistics (for employment). SOURCE: Federal Reserve Board, Statistical Release G.17, “Industrial Production and Capacity Utilization”; Federal Reserve Board staff estimates of the trend. to less than 9 percent today, and the value added from no expansion—includes at least some months when the manufacturing has fallen from more than 25 percent 12-month change in IP was at least 7 percentage points of GDP to a bit under 12 percent (figure B). However, below trend. The available data, however, suggest that although the manufacturing sector has shrunk, factory the recent experience in the United States falls well output may still be a good barometer of aggregate short of that threshold. demand and of the economy’s health. Growth in the U.S. manufacturing sector has slowed D. 12-month change in detrended manufacturing IP considerably over time. Measured from business cycle peak to business cycle peak, output grew about Monthly Percent 3.5 percent per year between 1920 and 1960, as well as from 1960 through 2001. As seen in figure C, factory 15 production has moved up only about 0.5 percent per 10 year since 2001, and only 2 of those 19 calendar years recorded gains of more than 3.5 percent. 5 + To interpret the recent weakness in manufacturing _0 in this light, figure D shows 12-month changes in 5 “detrended” IP, where values below zero indicate 10 year-over-year changes in IP that are slower than its trend at the time. Notably, most expansions include 15 periods of modest below-trend growth. In 2019, growth 20 averaged about 2 percentage points below trend, a slowdown fairly similar to that in the 2015–16 period. 1969 1979 1989 1999 2009 2019 Other episodes of modest below-trend growth appear NOTE: The red line is drawn at -7. The shaded bars indicate periods of in the expansions of the early 2000s, the 1990s, the business recession as defined by the National Bureau of Economic mid-1980s, and the 1960s. In contrast, as shown by the Research. SOURCE: Federal Reserve Board, Statistical Release G.17, “Industrial red line in figure D, every recession since 1960—but Production and Capacity Utilization.” 16 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 15. Personal saving rate improvements in the labor market, which have supported further increases in household Monthly Percent income. Real disposable personal income, a measure of households’ after-tax purchasing 12 power, increased 2.6 percent in 2019, a solid 10 gain albeit below the robust increase in 2018 that was bolstered by a reduction in personal 8 income taxes. The personal saving rate, at 6 7.7 percent in the fourth quarter, was little changed from the previous year (figure 15). 4 2 Spending was also supported by high household wealth . . . 2007 2009 2011 2013 2015 2017 2019 The relatively high level of aggregate SOURCE: Bureau of Economic Analysis via Haver Analytics. household net worth also supported consumer 16. Prices of existing single-family houses spending last year. House prices, which are of particular importance for the value of Monthly Percent change from year earlier assets held by a large portion of households, S&P/Case-Shiller 15 continued to increase in 2019, although at national index a more moderate pace than in recent years 10 CoreLogic (figure 16). In addition, U.S. equity prices, 5 price index + which fell sharply at the end of 2018, have _0 rebounded since then. Equity wealth is more 5 concentrated among high-wealth households Zillow index 10 with high propensities to save than is housing 15 wealth, however, and may therefore provide 20 less support for consumption. The ratio of aggregate household net worth to household 2009 2011 2013 2015 2017 2019 income held steady through the third quarter NOTE: The data for the S&P/Case-Shiller index extend through of last year at 6.9, near its all-time high November 2019. SOURCE: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S. (figure 17). 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 licensing information, see the note on the Contents page.) . . . and consumer sentiment remains strong 17. Wealth-to-income ratio Consumers have remained upbeat during the Quarterly Ratio past year. The Michigan index of consumer sentiment, which declined last summer as 7.0 trade tensions spiked, recovered in recent months and currently stands at a high level by 6.5 historical standards. The sentiment measure 6.0 from the Conference Board, which has been more stable, also suggests consumers are fairly 5.5 upbeat (figure 18). 5.0 1998 2001 2004 2007 2010 2013 2016 2019 NOTE: The data extend through 2019:Q3. The series is the ratio of household net worth to disposable personal income. SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; for income, Bureau of Economic Analysis via Haver Analytics. MONETARy POLICy REPORT: FEBRUARy 2020 17 Borrowing conditions for households 18. Indexes of consumer sentiment remain generally favorable, and borrowing costs have moved down since 1985 = 100 1966 = 100 the middle of 2019 . . . 170 120 Conference Board 150 Financing conditions for consumers remain 110 130 supportive of growth in household spending. 100 110 Interest rates on credit cards and auto loans 90 90 declined, on net, during the second half 80 70 of 2019, and consumer credit continued 70 to expand at a moderate pace (figure 19). 50 60 Standards and delinquency rates for these 30 Michigan survey loans have been generally stable. For student 10 50 loans, credit remains widely available, with 2002 2005 2008 2011 2014 2017 2020 over 90 percent of such credit being extended NOTE: The data are monthly and extend through January 2020. by the federal government. After peaking in SOURCE: University of Michigan Surveys of Consumers; Conference Board. 2013, delinquencies on such loans have been gradually declining, reflecting in part the continued improvements in the labor market. 19. Changes in household debt In the mortgage market, credit has continued Quarterly Percent change from year earlier to be readily available for households with solid credit profiles but remains noticeably 10 tighter than before the most recent recession Consumer credit 8 for borrowers with low credit scores. 6 4 . . . and activity in the housing sector 2 has picked up, likely reflecting lower + interest rates _0 Mortgages 2 Residential investment picked up in the second 4 half of 2019 after declining for six straight quarters. Housing starts for single-family and 2007 2009 2011 2013 2015 2017 2019 multifamily housing units increased sharply NOTE: The data extend through 2019:Q3. SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial in the second half of last year and posted Accounts of the United States.” appreciable gains for the year as a whole, with starts and permits for new construction rising 20. Private housing starts and permits to the highest levels in more than 10 years (figure 20). Sales of new and existing homes Monthly Millions of units, annual rate also increased during 2019 (figure 21). This improvement appears to have importantly 1.2 reflected the reduction in mortgage interest 1.0 rates; after increasing appreciably from mid- Single-family starts .8 2017 through 2018, rates declined markedly Single-family .6 last year, fully reversing those earlier increases permits (figure 22). Despite the lower mortgage rates, .4 households’ perceptions of homebuying .2 Multifamily starts conditions have remained low, likely reflecting 0 ongoing increases in housing prices. 2009 2011 2013 2015 2017 2019 SOURCE: U.S. Census Bureau via Haver Analytics. 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 21. New and existing home sales In contrast, business fixed investment weakened in the second half of 2019 . . . Millions, annual rate Millions, annual rate After increasing more than 5 percent per year 6.0 Existing home sales 1.0 in 2017 and 2018, business fixed investment— 5.5 spending by businesses on structures, .8 equipment, and intangibles such as research 5.0 and development—stalled in 2019, as a 4.5 .6 moderate gain in the first quarter was offset 4.0 by small declines over the rest of the year. The .4 3.5 softness in business investment last year was New home sales .2 evident in each of the three main components, 3.0 and a portion of the weakening appears to 2007 2009 2011 2013 2015 2017 2019 reflect concerns over trade policy and slower NOTE: Data are monthly. New home sales includes only single-family foreign growth; other factors included the sales. Existing home sales includes single-family, condo, townhome, and suspension of deliveries of the Boeing 737 co-op sales. SOURCE: For new home sales, U.S. Census Bureau; for existing home Max aircraft and the continued decline in sales, National Association of Realtors; all via Haver Analytics. drilling and mining structures investment amid oil prices that fell back from the levels 22. Mortgage rates reached in 2018. Forward-looking indicators Weekly Percent of business spending—such as orders of capital goods, surveys of business conditions and sentiment, and profit expectations from 6 industry analysts—all appear to have stabilized in recent months but suggest that investment is 5 likely to remain subdued (figure 23). 4 . . . despite corporate financing conditions that remained accommodative overall 3 Financing conditions for nonfinancial firms have remained accommodative amid 2010 2012 2014 2016 2018 2020 lower interest rates. Flows of credit to large NOTE: Data are weekly through January 30, 2020. nonfinancial firms remained solid overall in SOURCE: Freddie Mac Primary Mortgage Market Survey. the third quarter of 2019 (figure 24). The gross issuance of corporate bonds, although 23. Change in real business fixed investment lower than in the first half of last year, was Percent, annual rate robust across credit categories. Yields on both Structures investment- and speculative-grade corporate 12 Equipment and intangible capital bonds continued to decrease and are near 9 historical lows. Spreads on corporate bond 6 H1 yields over comparable-maturity Treasury 3 H2 + securities have continued to narrow, on net, _0 since the middle of last year and are at the 3 lower end of their historical distributions. 6 Respondents to the January Senior Loan 9 Officer Opinion Survey on Bank Lending 12 Practices, or SLOOS, reported that banks 2014 2015 2016 2017 2018 2019 eased several terms on commercial and NOTE: Business fixed investment is known as “private nonresidential industrial (C&I) loans but that demand for fixed investment” in the National Income and Product Accounts. SOURCE: Bureau of Economic Analysis via Haver Analytics. C&I loans has continued to weaken, consistent MONETARy POLICy REPORT: FEBRUARy 2020 19 with the slowdown in business investment. 24. Selected components of net debt financing for C&I loan growth at banks has slowed since nonfinancial businesses the first half of last year, while commercial Billions of dollars, monthly rate real estate loan growth has continued to be Commercial paper strong. Meanwhile, financing conditions for Bonds 60 small businesses have remained generally Bank loans Sum H1Q3 accommodative, but credit growth has been 40 subdued. 20 + Net exports added to GDP growth in _0 2019, as exports grew little but imports 20 declined 40 Real exports grew only a touch in 2019, as tariffs on U.S. exports increased and foreign 2007 2009 2011 2013 2015 2017 2019 growth weakened (figure 25). Real imports SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial declined last year, in part reflecting higher Accounts of the United States.” tariffs on imported goods and weakness in investment and manufacturing. As a result, 25. Change in real imports and exports of goods real net exports—after having subtracted from and services U.S. real GDP growth in 2018—provided a Percent, annual rate modest boost to GDP growth in 2019. Relative Imports to 2018, the nominal trade deficit is slightly Exports 6 less negative, and the current account deficit is little changed as a percent of GDP (figure 26). 4 2 Federal fiscal policy actions continued + to boost economic growth in 2019 _0 while raising the federal unified budget 2 deficit . . . 4 The effects of fiscal policy actions enacted at the federal level in earlier years continued 2015 2016 2017 2018 2019 to boost GDP growth in 2019; the Tax Cuts SOURCE: Bureau of Economic Analysis via Haver Analytics. and Jobs Act of 2017 lowered personal and business income taxes, and rising 26. U.S. trade and current account balances appropriations consistent with the Bipartisan Budget Act of 2018 boosted federal Annual Percent of nominal GDP purchases.9 In 2019, federal purchases rose + 4.3 percent, well above the 2.7 percent increase _0 of 2018 (figure 27). 1 2 The federal unified budget deficit widened 3 further in fiscal year 2019 to 4½ percent of 4 Trade 5 9. The Congressional Budget Office (CBO) estimated 6 that the Tax Cuts and Jobs Act would reduce annual tax Current account 7 revenue by around 1 percent of GDP, on average, from fiscal years 2018 through 2021. This revenue projection 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 includes the CBO’s estimated macroeconomic effects of the legislation, which add almost ¼ percentage point to NOTE: GDP is gross domestic product. Current account data for 2019 are the average of the first three quarters of the year. GDP growth, on average, over the same period. SOURCE: Bureau of Economic Analysis via Haver Analytics. 20 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 27. Change in real government expenditures on nominal GDP from 3¾ percent of GDP in consumption and investment 2018, as expenditures moved up as a share of the economy while receipts moved sideways Percent, annual rate (figure 28). Expenditures, at 21 percent of Federal State and local H1 6 GDP, are above the level that prevailed in the decade before the start of the 2007–09 H2 4 recession, while receipts have continued to run 2 below their average levels. The ratio of federal + _0 debt held by the public to nominal GDP rose 2 to 79 percent in fiscal 2019 and was quite elevated relative to historical norms (figure 29). 4 The Congressional Budget Office projects that 6 this ratio will rise further over the next several years, reflecting large and rising deficits under 2012 2013 2014 2015 2016 2017 2018 2019 current fiscal policy. SOURCE: Bureau of Economic Analysis via Haver Analytics. 28. Federal receipts and expenditures . . . and the fiscal position of most state and local governments is stable Annual Percent of nominal GDP The fiscal position of most state and local 26 governments remains stable, although Expenditures 24 there is a range of experiences across these 22 governments. Revenues for these governments Receipts have continued to grow in recent quarters, as 20 the economic expansion pushes up income 18 and sales tax collections for state governments, 16 and past house price gains continue to push up property tax collections for local 14 governments. Boosted by a rebound in 1998 2001 2004 2007 2010 2013 2016 2019 construction spending following two years of NOTE: The receipts and expenditures data are on a unified-budget weak growth, real purchases by state and local basis and are for fiscal years (October through September); gross domestic product (GDP) data are for the four quarters ending in Q3. governments rose moderately last year but still SOURCE: Office of Management and Budget via Haver Analytics. remained quite restrained, partly reflecting 29. Federal government debt held by the public budget pressures associated with pension and retiree health-care obligations. State and local Quarterly Percent of nominal GDP government payrolls increased moderately in 2019 but have only roughly regained the peak 80 observed before the current expansion, and 70 real outlays for construction are more than 60 10 percent below their pre-recession peak. 50 The debt of these governments as a share of the economy has continued to edge lower and 40 currently equals around 14 percent of GDP, 30 well below the previous peak of 21 percent 20 following the most recent recession. 1969 1979 1989 1999 2009 2019 NOTE: Federal debt extends through 2019:Q3. The data for gross domestic product (GDP) are at an annual rate. Federal debt held by the public equals federal debt less Treasury securities held in federal employee defined benefit retirement accounts, evaluated at the end of the quarter. SOURCE: For GDP, Bureau of Economic Analysis via Haver Analytics; for federal debt, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.” MONETARy POLICy REPORT: FEBRUARy 2020 21 Financial Developments 30. Market-implied federal funds rate path The expected path of the federal funds rate Quarterly Percent over the next several years shifted down July 1, 2019 2.50 Market-based measures of the expected 2.25 path of the federal funds rate over the next 2.00 several years have moved down, on net, since the middle of last year and show about a 1.75 30 basis point decrease in the federal funds 1.50 rate over 2020 and a relatively flat path February 4, 2020 1.25 thereafter (figure 30). Survey-based measures of the expected path of the policy rate also 1.00 shifted down from the levels observed in the 2019 2020 2021 2022 2023 middle of 2019 but indicate no change to Note: The federal funds rate path is implied by quotes on overnight the target range for the federal funds rate index swaps—a derivative contract tied to the effective federal funds rate. over 2020 from its level at the end of 2019. The implied path as of July 1, 2019, is compared with that as of February 4, 2020. The path is estimated with a spline approach, assuming According to the results of the most recent a term premium of 0 basis points. The July 1, 2019, path extends through Survey of Primary Dealers and Survey of July 2023 and the February 4, 2020, path through December 2023. Source: Bloomberg; Federal Reserve Board staff estimates. Market Participants, both conducted by the Federal Reserve Bank of New York in December, the median of respondents’ modal projections implies a flat trajectory for the target range of the federal funds rate for the next few years.10 Additionally, market-based measures of uncertainty about the policy rate approximately one to two years ahead declined, on balance, from their levels at the end of last June and are close to their average level in recent years. U.S. nominal Treasury yields decreased 31. Yields on nominal Treasury securities on net Daily Percent After moving significantly lower over the first half of 2019, nominal Treasury yields also 5 fell sharply in August, largely in response to 10-year 5-year 4 investors’ concerns regarding trade tensions between the United States and China and the 3 global economic outlook (figure 31). Later in 2 the year, as these concerns abated, Treasury yields rose, the yield curve steepened, and 2-year 1 uncertainty about near-term Treasury yields— 0 measured by option-implied volatility on short- and longer-dated swap rates—declined. 2010 2012 2014 2016 2018 2020 SOURCE: Department of the Treasury via Haver Analytics. 10. The results of the Survey of Primary Dealers and the Survey of Market Participants are available on the Federal Reserve Bank of New York’s website at https://www.newyorkfed.org/markets/primarydealer_ survey_questions.html and https://www.newyorkfed.org/ markets/survey_market_participants, respectively. 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 32. Yield and spread on agency mortgage-backed However, in the second half of January, securities investors’ concerns about the implications of the coronavirus outbreak for the economic Percent Basis points outlook weighed on Treasury yields and led to a flattening of the yield curve as well as 7 200 some increase in uncertainty about near-term 6 Spread Treasury yields. Since the middle of last year, 150 5 Treasury yields ended lower on net. 100 4 Consistent with changes in the yields on 50 3 nominal Treasury securities, yields on 30-year Yield agency mortgage-backed securities (MBS)—an 0 2 important determinant of mortgage interest rates—decreased, on balance, since the middle 2010 2012 2014 2016 2018 2020 of last year and remained low by historical NOTE: The data are daily. Yield shown is for the Fannie Mae 30-year current coupon, the coupon rate at which new mortgage-backed standards (figure 32). Meanwhile, yields securities would be priced at par, or face, value. Spread shown is to the on both investment- and speculative-grade average of the 5- and 10-year nominal Treasury yields. SOURCE: Department of the Treasury; Barclays Live. corporate bonds continued to decline and also stayed low by historical standards (figure 33). 33. Corporate bond yields, by securities rating Spreads on corporate bond yields over Daily Percentage points comparable-maturity Treasury yields narrowed moderately, on net, over the second half of 12 2019 and remained in the lower end of their High-yield 10 historical distribution. 8 Broad equity price indexes increased notably 6 4 Equity prices fluctuated in August and Investment-grade September along with investors’ concerns 2 about trade developments and the economic 0 outlook. Later in 2019 and into 2020, as these concerns abated, equity prices rose 2010 2012 2014 2016 2018 2020 substantially and were reportedly boosted NOTE: Investment-grade is the 10-year triple-B, which reflects the effective yield of the ICE BofAML 7-to-10-year triple-B U.S. Corporate by greater certainty among investors that Index (C4A4). High-yield is the 10-year high-yield and reflects the effective yield of the ICE BofAML 7-to-10-year U.S. Cash Pay High monetary policy would remain accommodative Yield Index (J4A0). in the near term (figure 34). Gains were spread SOURCE: ICE Data Indices, LLC, used with permission. across most major economic sectors, with 34. Equity prices the exception of the energy sector, for which stock prices declined markedly. Measures of Daily December 31, 2009 = 100 implied and realized stock price volatility for 300 the S&P 500 index—the VIX and the 20-day realized volatility—increased in August to 250 fairly elevated levels but declined later in the S&P 500 index 200 year (figure 35). (For a discussion of financial stability issues, see the box “Developments 150 Related to Financial Stability.”) Dow Jones bank index 100 50 2010 2012 2014 2016 2018 2020 SOURCE: S&P’s Dow Jones Indices via Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.) MONETARy POLICy REPORT: FEBRUARy 2020 23 Markets for Treasury securities, mortgage- 35. S&P 500 volatility backed securities, and municipal bonds Daily Percent have functioned well VIX While available indicators of Treasury market 50 functioning have generally remained stable since 40 the first half of 2019—including bid-ask spreads, bid sizes, and estimates of transaction 30 costs—some, such as measures of market 20 depth, have decreased. However, the decline in 10 measures of market depth has reportedly not led Realized volatility to any concerns about Treasury market liquidity. 0 Liquidity conditions in the agency MBS market were also generally stable. Credit conditions in 2010 2012 2014 2016 2018 2020 municipal bond markets remained stable as well, NOTE: The VIX is a measure of implied volatility that represents the expected annualized change in the S&P 500 index over the following 30 with yield spreads on 20-year general obligation days. For realized volatility, five-minute S&P 500 returns are used in an municipal bonds over comparable-maturity exponentially weighted moving average with 75 percent of weight distributed over the past 20 days. Treasury securities declining notably and SOURCE: Cboe Volatility Index® (VIX®) accessed via Bloomberg; Federal Reserve Board staff estimates. standing near historically low levels. Money market rates moved down in line with decreases in the FOMC’s target range, except for some notable volatility in mid-September Decreases in the FOMC’s target range for the federal funds rate in July, September, and October transmitted effectively through money markets, with yields on a broad set of money market instruments moving lower in response to the FOMC’s policy actions. The effective federal funds rate moved nearly in parity with the interest rate paid on reserves and was closely tracked by the overnight Eurodollar rate. Other short-term interest rates, including those on commercial paper and negotiable certificates of deposit, also moved down in line with decreases in the policy rate. Domestic short-term funding markets were volatile in mid-September—amid large flows related to corporate tax payments and settlement of Treasury securities—and experienced significant tightening of conditions. The effective federal funds rate rose above the target range on September 17 but then moved back within the target range following the Federal Reserve’s open market operations, which eased pressures in money markets (see the box “Money Market Developments and Monetary Policy Implementation” in Part 2). 24 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability The framework used by the Federal Reserve Board A. Forward price-to-earnings ratio of S&P 500 firms for assessing the resilience of the U.S. financial system focuses on financial vulnerabilities in four broad areas: Monthly Ratio asset valuations, household and business debt, leverage in the financial sector, and funding risks.1 Asset prices have risen partly because of declines 25 in interest rates, but valuation pressures are elevated. Equity prices increased nearly 30 percent over 2019, 20 and the forward price-to-earnings ratio has reached the recent peak seen in 2018 (figure A). In corporate debt 15 markets, the spreads of interest rates on newly issued Median leveraged loans over LIBOR (London interbank offered rate) have decreased since July 2019 across the credit- 10 quality spectrum, with spreads for the relatively higher- rated issuers reaching their post-crisis lows. Spreads on investment- and speculative-grade bonds over 1990 1995 2000 2005 2010 2015 2020 comparable-maturity Treasury yields narrowed since NOTE: The data extend through January 2020. The series represents July 2019 and stand notably below their respective the aggregate forward price-to-earnings ratio of S&P 500 firms based on expected earnings for 12 months ahead. medians (figure B). In commercial real estate markets, SOURCE: Federal Reserve Board staff calculations using Refinitiv prices continued to grow at a robust pace in recent (formerly Thomson Reuters), IBES Estimates. quarters, with capitalization rates at historically low levels. Although house price growth slowed noticeably B. Corporate bond spreads to similar-maturity in 2019, house prices still appear to lie modestly above Treasury securities the level predicted by their historical relationship Percentage points Percentage points with rents. vulnerabilities associated with total private-sector 8 16 debt continue to be at a moderate level relative to their 7 14 historical norms. Total household debt has grown at 6 12 a slower pace than economic activity over the past decade, in part reflecting that mortgage credit has 5 10-year high-yield 10 remained tight for borrowers with low credit scores, 4 8 undocumented income, or high debt-to-income ratios. 3 6 In contrast, business debt levels continue to be elevated 2 4 compared with either business assets or gross domestic 1 2 product, with the riskiest firms accounting for most of 10-year triple-B the increase in debt in recent years (figure C). Although 0 0 the net issuance of riskier forms of business debt— 2000 2004 2008 2012 2016 2020 high-yield bonds and institutional leveraged loans— has slowed since July 2019, it is still solid by historical NOTE: The data are monthly and extend through January 2020. The 10-year triple-B reflects the effective yield of the ICE BofAML standards (figure D). 7-to-10-year triple-B U.S. Corporate Index (C4A4), and the 10-year In addition, about half of investment-grade debt high-yield reflects the effective yield of the ICE BofAML 7-to-10-year U.S. Cash Pay High Yield Index (J4A0). Treasury yields from smoothed outstanding is currently rated in the lowest category yield curve estimated from off-the-run securities. of the investment-grade range (triple-B), a share that is SOURCE: ICE Data Indices, LLC, used with permission; Department of the Treasury. near an all-time high. The concentration of investment- grade debt at the lower end of the investment-grade to a sizable volume of bond downgrades to speculative- spectrum creates the risk that adverse developments, grade ratings. Such conditions could trigger investors to such as a deterioration in economic activity, could lead sell the downgraded bonds rapidly, increasing market illiquidity and causing outsized downward price 1. The Financial Stability Report published on pressures. November 15, 2019, presents the most recent, detailed assessment of these vulnerabilities. (continued) MONETARy POLICy REPORT: FEBRUARy 2020 25 C. Nonfinancial business- and household-sector D. Net issuance of risky debt credit-to-GDP ratios Billions of dollars Quarterly Ratio Institutional leveraged loans 120 High-yield and unrated bonds 1.10 100 1.00 80 .90 60 Household 40 .80 20 .70 + _0 .60 20 Nonfinancial business .50 40 .40 2005 2007 2009 2011 2013 2015 2017 2019 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019 NOTE: Institutional leveraged loans generally exclude loan commitments held by banks. pe N rio O d T s E : o T f h b e u s d i a n t e a s s e x r t e e c n e d ss i t o h n r o a u s g h d e 2 fi 0 n 1 e 9 d :Q b 3. y T t h h e e s N ha a d ti e o d n a b l ar B s u i r n e d au ic a o te f SOURCE: Mergent, Fixed Investment Securities Database; S&P Global, Leveraged Commentary & Data. Economic Research. GDP is gross domestic product. SOURCE: Federal Reserve Board staff calculations based on Bureau of Economic Analysis, national income and product accounts, and Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the funding and maintain large amounts of high-quality United States.” liquid assets in compliance with liquidity regulations introduced after the financial crisis and the improved Leverage in the financial sector appears low relative understanding by banks of their liquidity risks. In to historical norms. The banking sector is much more addition, money market mutual funds remain less prone highly capitalized, in part due to the regulatory reforms to runs than they were before the implementation of enacted after the financial crisis. In addition, the results the money market reforms, as the composition of assets of the most recent stress test, released in June 2019, under management remains heavily tilted toward the indicated that these banks are well positioned to safer and more liquid government funds. Nonetheless, continue lending to households and businesses even the volatility in repurchase agreement (repo) markets in the event of a severe global recession.2 However, in mid-September 2019 highlighted the possibility for several large banks have announced plans to distribute frictions in repo markets to spill over to other markets.3 capital to their shareholders in excess of expected Foreign financial, economic, and political earnings, implying that capital at those banks will developments could pose a number of near-term risks decrease. Outside the banking sector, broker-dealers to the U.S. financial system. In China, fragilities in as well as property-and-casualty insurance companies the corporate and financial sector leave it vulnerable continue to operate with historically low levels of to adverse developments. Because of the size of leverage. Leverage at life insurance companies has risen the Chinese economy, significant distress in China but continues to be close to its average level over the could spill over to U.S. and global markets through a past two decades, and leverage at hedge funds remains retrenchment of risk appetite, U.S. dollar appreciation, near the top of its range since 2014. Furthermore, and declines in trade and commodity prices. the outlook for profitability of a range of financial In Europe, the risk of a “no-deal Brexit” passed institutions has weakened following declines in interest at the end of January, but the United Kingdom and rates. Weaker profitability could affect their ability to the European Union are still committed to conclude absorb losses or build capital through retained earnings. negotiations over their future relationship—including Funding risk in the banking sector remains low. new trade arrangements—by the end of 2020. Failure Banks rely only modestly on short-term wholesale to do so could trigger market and economic disruptions in Europe that may weaken systemically important 2. See Board of Governors of the Federal Reserve System financial institutions and spill over to global markets, (2019), Dodd-Frank Act Stress Test 2019: Supervisory Stress leading to a tightening of U.S. financial conditions. Test Results (Washington: Board of Governors, June), https:// www.federalreserve.gov/publications/files/2019-dfast- 3. See the box “Money Market Developments and results-20190621.pdf. Monetary Policy Implementation” in Part 2. 26 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 36. Ratio of total commercial bank credit to nominal Bank credit continued to expand, and gross domestic product bank profitability remained robust Quarterly Percent Aggregate credit provided by commercial banks continued to expand through the second 75 half of 2019, as the strength in commercial real estate and residential real estate loan growth, 70 helped by falling interest rates, more than offset the slowdown in C&I and consumer 65 loans. In the second half of last year, the pace 60 of bank credit expansion was about in line with that of nominal GDP, leaving the ratio 55 of total commercial bank credit to current- dollar GDP little changed from its value last 2005 2007 2009 2011 2013 2015 2017 2019 June (figure 36). Overall, measures of bank SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and profitability ticked down a bit in the third Liabilities of Commercial Banks in the United States”; Bureau of Economic Analysis via Haver Analytics. quarter because of narrower net interest margins but remain near their post-crisis highs 37. Profitability of bank holding companies (figure 37). Percent, annual rate Percent, annual rate International Developments 2.0 30 Return on assets 1.5 20 Growth in advanced foreign economies 1.0 weakened, but it appears to be stabilizing 10 .5 + + _0 _0 Real GDP growth in several advanced .5 Return on equity 10 foreign economies (AFEs) appears to have 1.0 stepped down in the second half of the year 20 1.5 (figure 38). However, incoming data suggest 30 2.0 that the slowdown in the AFEs may have bottomed out. Household spending has 2005 2007 2009 2011 2013 2015 2017 2019 generally remained resilient, sustained by NOTE: The data are quarterly and are seasonally adjusted. The data extend through 2019:Q3. low unemployment rates and rising wages. SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Bank Holding Companies. Financial conditions have improved further, supported in part by accommodative monetary 38. Real gross domestic product growth in selected policy actions. The protracted slump in global advanced foreign economies manufacturing, which weighed on external Percent, annual rate demand across the AFEs, is showing tentative United Kingdom signs of nearing an end. In the euro area, Japan 4 where manufacturing activity was particularly Euro area Canada 3 weak, recent indicators suggest that growth H1 may be steadying. In Japan, real GDP appears Q3 2 to have contracted sharply at the end of 2019, 1 following a consumption tax hike in October, Q4 + but its effects are likely to be transitory. _0 In the United Kingdom, Brexit-related 1 uncertainty weighed on economic activity throughout 2019; around the turn of the year, 2015 2016 2017 2018 2019 U.K. and European Union authorities took NOTE: The data for the euro area incorporate a preliminary release for the necessary steps to prevent a disorderly 2019:Q4. SOURCE: For the United Kingdom, Office for National Statistics; for Brexit from occurring on January 31, 2020, Japan, Cabinet Office, Government of Japan; for the euro area, Eurostat; for Canada, Statistics Canada; all via Haver Analytics. MONETARy POLICy REPORT: FEBRUARy 2020 27 but they still need to negotiate a new trade 39. Consumer price inflation in selected advanced foreign economies arrangement. Monthly 12-month percent change Inflationary pressures remained subdued in many advanced foreign economies 4 United Kingdom Against a backdrop of slower economic 3 Japan growth, consumer prices in many AFEs Canada 2 continued to rise at a subdued pace, especially in the euro area and Japan (figure 39). Canada 1 remains an exception, as inflation there + _0 hovered around 2 percent. Euro area 1 Central banks in several advanced foreign economies provided accommodation 2015 2016 2017 2018 2019 2020 NOTE: The data for the euro area incorporate the flash estimate for In response to subdued growth and below- January 2020. SOURCE: For the United Kingdom, Office for National Statistics; for target inflation, the European Central Japan, Ministry of Internal Affairs and Communications; for the euro area, Statistical Office of the European Communities; for Canada, Bank introduced a new stimulus package in Statistics Canada; all via Haver Analytics. September of last year, including a deposit rate cut of 10 basis points to negative 0.5 percent, a restart of its Asset Purchase Programme, and more favorable terms for its targeted longer-term refinancing operations. Similarly, the Reserve Bank of Australia and the Reserve Bank of New Zealand reduced their policy rates in the second half of last year, citing concerns about the global outlook. The Bank of Canada, the Bank of England, and the Bank of Japan kept their policy rates unchanged, although communications by their officials took a more dovish tone, emphasizing increased downside risks to the global economy. In contrast, Sweden’s Riksbank and Norway’s Norges Bank increased their policy rates, citing favorable macroeconomic 40. Nominal 10-year government bond yields in conditions and concerns about growing selected advanced foreign economies financial imbalances. Weekly Percent Financial conditions in advanced foreign 3.5 economies eased further 3.0 United States 2.5 Notwithstanding slowing global growth United Kingdom 2.0 and bouts of political tensions, financial 1.5 Germany conditions in the AFEs, on balance, eased 1.0 further in the second half of 2019, supported .5 + by accommodative central bank actions, 0 Japan – progress on trade negotiations between the .5 1.0 United States and China, and diminished fears of a hard Brexit. Long-term interest rates in 2015 2016 2017 2018 2019 2020 many AFEs remained well below the levels NOTE: The data are weekly averages of daily benchmark yields. The seen at the end of 2018 (figure 40). Equity weekly data begin on Thursdays and extend through January 29, 2020. SOURCE: Bloomberg. 28 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 41. Equity indexes for selected advanced foreign prices, as well as prices of other risky assets, economies increased moderately (figure 41). Sovereign bond spreads over German bund yields for Weekly Week ending January 7, 2015 = 100 euro-area peripheral countries narrowed 140 slightly. In recent weeks, however, equity and Japan bond markets gave up some of their gains as 130 Euro area uncertainty about the economic effects of the 120 coronavirus weighed on investors’ sentiment. 110 100 Growth slowed markedly in many 90 emerging market economies, but there United Kingdom are tentative signs of stabilization 80 Chinese GDP growth slowed further in the 2015 2016 2017 2018 2019 2020 second half of 2019 against the backdrop of NOTE: The data are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020. increased tariffs on Chinese exports, global SOURCE: For euro area, DJ Euro Stoxx Index; for Japan, TOPIX Stock Index; for United Kingdom, FTSE 100 Stock Index; all via weakness in trade and manufacturing, and Bloomberg. authorities’ deleveraging campaign that continued to exert a drag on the economy (figure 42). However, recent data suggest that 42. Real gross domestic product growth in selected China’s economic activity picked up at the emerging market economies end of last year, in part supported by some Percent, annual rate fiscal and monetary policy stimulus and China 12 some easing of trade tensions. In emerging Korea Mexico 10 Asia excluding China, economic growth Brazil 8 was dragged down by a sharp contraction in H1 Q4 Q3 6 Hong Kong, where social and political unrest 4 resulted in severe economic disruptions, and 2 by weakness in India, where an ongoing credit + _0 crunch continues to weigh on activity. In 2 several other Asian economies, GDP growth 4 held steady but at a lackluster pace amid 6 headwinds from moderating global growth. 2015 2016 2017 2018 2019 GDP growth in Korea, Taiwan, and the NOTE: The data for China are seasonally adjusted by Board staff. The Philippines rebounded in the last quarter of data for Korea, Mexico, and Brazil are seasonally adjusted by their respective government agencies. The 2019:Q4 value for Mexico is 0 2019, consistent with signs of stabilization percent. in the global manufacturing cycle, especially SOURCE: For China, National Bureau of Statistics of China; for Korea, Bank of Korea; for Mexico, Instituto Nacional de Estadística y in the high-tech sector. However, the recent Geografía; for Brazil, Instituto Brasileiro de Geografia e Estatística; all via Haver Analytics. emergence of the coronavirus could lead to disruptions in China that spill over to other Asian countries and, more generally, to the rest of the global economy. MONETARy POLICy REPORT: FEBRUARy 2020 29 Many Latin American economies continued to 43. Equity indexes for selected emerging market underperform. Economic stagnation persisted economies in Mexico, reflecting both domestic factors— Weekly Week ending January 7, 2015 = 100 including market concerns about economic policies—and external factors, notably, 260 renewed weakness in U.S. manufacturing 240 220 production. Severe social unrest in several 200 countries—including Chile, Ecuador, and Brazil 180 Bolivia—disrupted economic activity. 160 Argentina’s financial crisis continued, while 140 South Korea Venezuela’s economy likely continued to 120 100 contract. Growth in Brazil, in contrast, edged China Mexico 80 up as aggregate demand continued to recover, 60 supported by further reductions in policy 2015 2016 2017 2018 2019 2020 interest rates. NOTE: The data are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020. SOURCE: For China, Shanghai Composite Index; for Brazil, Bovespa Financial conditions in emerging market Index; for South Korea, Korean Composite Index; for Mexico, IPC economies fluctuated but, on net, eased Index; all via Bloomberg. somewhat Notwithstanding social and political tensions 44. Sovereign spreads in selected emerging market economies as well as concerns about the global outlook, financial conditions in the emerging market Weekly Basis points economies (EMEs) eased somewhat in 600 the second half of 2019. Conditions were 550 supported by the accommodative actions Brazil 500 of the FOMC and several foreign central 450 banks and, later in the year, by progress in Mexico 400 350 the negotiations between the United States 300 and its major trading partners as well as 250 improved prospects about global growth. EME 200 EME Asia equity prices generally increased, especially 150 for Brazil (figure 43). And measures of EME 100 sovereign bond spreads over U.S. Treasury 2015 2016 2017 2018 2019 2020 yields generally decreased (figure 44). Political NOTE: The data are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020. tensions in Hong Kong contributed to an SOURCE: J.P. Morgan Emerging Markets Bond Index Global via underperformance of Chinese risky assets. Bloomberg. After several months of withdrawals, flows to dedicated EME mutual funds resumed in the fourth quarter of 2019, consistent with the improved sentiment toward global prospects 30 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 45. Emerging market mutual fund flows (figure 45). However, in reaction to the emergence of the coronavirus, in late January Billions of dollars equity and bond markets gave up some of Equity fund flows their gains. Bond fund flows 60 Jan. 40 The dollar fluctuated but is, on balance, 20 little changed + _0 The foreign exchange value of the U.S. dollar 20 fluctuated but is, on balance, little changed 40 compared with last July (figure 46). While concerns about global growth and trade 60 tensions contributed to the appreciation of 2015 2016 2017 2018 2019 2020 the dollar over the summer, monetary policy easing by the Federal Reserve and progress NOTE: The bond and equity fund flows data are quarterly sums of weekly data from January 1, 2015, to December 25, 2019. Weekly data on U.S.–China trade negotiations led to a span Thursday through Wednesday, and the quarterly and January 2020 values are sums over weekly data for weeks ending in that quarter or depreciation of the dollar, especially with month. The data exclude funds located in China. SOURCE: EPFR Global. respect to the Chinese renminbi. The British pound appreciated notably against the dollar as fears of a disorderly Brexit diminished. 46. U.S. dollar exchange rate indexes Weekly Week ending January 7, 2015 = 100 Dollar appreciation 130 British pound Broad dollar 120 110 Euro 100 Chinese renminbi 90 2015 2016 2017 2018 2019 2020 NOTE: The data, which are in foreign currency units per dollar, are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020. As indicated by the leftmost 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 Committee judged that the prevailing stance reduced the federal funds rate to support of monetary policy was appropriate to support sustained economic expansion and foster sustained expansion of economic activity, a return of inflation to the Committee’s strong labor market conditions, and inflation 2 percent objective returning to its symmetric 2 percent objective. After having gradually increased its target Future changes in the federal funds rate range for the federal funds rate from late will depend on the economic outlook 2015 through the end of 2018, the Committee and risks to the outlook as informed by maintained its target range for the federal incoming data funds rate at 2¼ to 2½ percent during the first half of 2019. In light of the implications The FOMC has continued to emphasize of global developments for the economic that the actual path of monetary policy will outlook as well as muted inflation pressures, depend on the evolution of the economic the Federal Open Market Committee outlook and risks to the outlook as informed (FOMC) lowered the target range for the by incoming data. Specifically, in deciding on federal funds rate at its July, September, and the timing and size of future adjustments to October meetings by 25 basis points each, the target range for the federal funds rate, the bringing it to 1½ to 1¾ percent (figure 47).11 Committee will assess realized and expected At its December and January meetings, the economic conditions relative to its objectives of maximum employment and symmetric 11. See the FOMC statements issued after the July, 2 percent inflation. This assessment will take September, and October meetings, which are available into account a wide range of information, (along with other postmeeting statements) on the including measures of labor market conditions, Monetary Policy portion of the Board’s website at https://www.federalreserve.gov/monetarypolicy.htm. indicators of inflation pressures and inflation 47. Selected interest rates Daily Percent 5 10-year Treasury rate 4 3 2 2-year Treasury rate 1 0 Target federal funds rate 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 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 expectations, and readings on financial and Since then, the Federal Reserve has rolled international developments. over at auction all principal payments from its holdings of Treasury securities and has In addition to evaluating a wide range of reinvested all principal payments from its economic and financial data and information holdings of agency debt and agency mortgage- gathered from business contacts and other backed securities (MBS) received during each informed parties around the country, calendar month. The Committee intends to policymakers routinely consult prescriptions continue to reduce its holdings of agency for the policy interest rate from various debt and agency MBS, consistent with the monetary policy rules, which can provide aim of holding primarily Treasury securities useful guidance to the FOMC. Although many in the long run. To allow for a gradual runoff practical considerations make it undesirable of the MBS portfolio, principal payments for the FOMC to mechanically follow the from agency debt and agency MBS of up to prescriptions of any specific rule, the FOMC’s $20 billion per month have been reinvested framework for conducting systematic in Treasury securities; agency MBS principal monetary policy respects key principles of payments in excess of $20 billion each month good monetary policy embodied by these rules, have been reinvested in agency MBS.13 while at the same time, providing flexibility to address many of the limitations of these policy . . . and reaffirmed its intention to rules (see the box “Monetary Policy Rules and implement monetary policy in a regime Uncertainty in Monetary Policy Settings”). with an ample supply of reserves In a monetary policy regime with an ample The FOMC concluded the reduction of supply of reserves, control over the level of its aggregate securities holdings in the the federal funds rate and other short-term System Open Market Account . . . interest rates is exercised primarily through the At its July meeting, along with its decision to setting of the Federal Reserve’s administered lower the target range for the federal funds rates, and active management of the supply rate, the FOMC also announced that it was of reserves is not required. The Federal ending the runoff of securities holdings two Reserve will still conduct periodic open market months earlier than the initially planned operations as necessary to accommodate the termination at the end of September.12 Ending trend growth in the demand for its nonreserve the runoff earlier than initially planned was liabilities, such as currency in circulation, and seen as having only very small effects on the maintain an ample supply of reserves over balance sheet, with negligible implications for time. Separate from such periodic open market the economic outlook. Moreover, doing so operations, beginning in October 2019, the avoided the appearance of inconsistency in Federal Reserve has implemented a temporary continuing to allow the balance sheet to run program of open market operations, off while simultaneously lowering the target specifically Treasury bill purchases, aimed range for the federal funds rate. at durably raising reserves to levels at or above those prevailing in early September (see the box “Money Market Developments and Monetary Policy Implementation” at the end of Part 2). These actions are purely 12. The Committee had initially indicated in its Balance Sheet Normalization Principles and Plans, issued technical measures to support the effective in March 2019, that it intended to conclude the reduction of its aggregate securities holdings in the System Open Market Account at the end of September 2019. The 13. See the Balance Sheet Normalization Principles document is available on the Board’s website at https:// and Plans in note 12. Since August, the Federal Reserve www.federalreserve.gov/newsevents/pressreleases/ has reinvested, on average, about $7 billion per month in monetary20190320c.htm. agency MBS. MONETARy POLICy REPORT: FEBRUARy 2020 33 Monetary Policy Rules and Uncertainty in Monetary Policy Settings Monetary policy rules are mathematical formulas policymakers’ longer-run inflation objective and that relate a policy interest rate, such as the federal employment is below its maximum sustainable level; funds rate, to a small number of other economic conversely, monetary policy should be restrictive when variables—typically including the deviation of inflation the opposite holds. A third principle is that, to stabilize from its target value and a measure of resource slack in inflation, the policy rate should be adjusted over time the economy. The prescriptions for the policy interest by more than one-for-one in response to persistent rate from these rules can provide helpful guidance for increases or decreases in inflation. the Federal Open Market Committee (FOMC).1 Economists have analyzed many monetary policy This discussion examines prescriptions from selected rules, including the well-known Taylor (1993) rule, the policy rules and considers how these prescriptions “balanced approach” rule, the “adjusted Taylor (1993)” often depend on judgments and assumptions about rule, the “price level” rule, and the “first difference” economic variables that are inherently uncertain and rule (figure A).3 These policy rules embody the three may change over time. Notably, many policy rules key principles of good monetary policy and take into depend on estimates of resource slack and of the account estimates of how far the economy is from the longer-run neutral real interest rate, both of which Federal Reserve’s dual-mandate goals of maximum are not directly observable and are estimated with employment and price stability. The Taylor (1993), a high degree of uncertainty. As a result, the policy balanced-approach, adjusted Taylor (1993), and stance that these rules prescribe—and whether that price-level rules provide prescriptions for the level of stance is appropriate in light of underlying economic the federal funds rate; all require an estimate of the conditions—is also uncertain. Such a situation cautions neutral real interest rate in the longer run (rLR)—that is, t against mechanically following the prescriptions of any the level of the real federal funds rate that is expected specific rule. to be consistent, in the longer run, with maximum (continued on next page) Policy Rules: Some Key Design Principles and Historical Prescriptions 3. The Taylor (1993) rule was suggested in John B. Taylor (1993), “Discretion versus Policy Rules in Practice,” Carnegie- In many models of the economy, good economic Rochester Conference Series on Public Policy, vol. 39 performance can be achieved by following a monetary (December), pp. 195–214. The balanced-approach rule was policy rule that fosters public understanding and that analyzed in John B. Taylor (1999), “A Historical Analysis of Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy incorporates key principles of good monetary policy.2 Rules (Chicago: University of Chicago Press), pp. 319–41. The One such principle is that monetary policy should adjusted Taylor (1993) rule was studied in David Reifschneider respond in a predictable way to changes in economic and John C. Williams (2000), “Three Lessons for Monetary conditions. A second principle is that monetary policy Policy in a Low-Inflation Era,” Journal of Money, Credit and should be accommodative when inflation is below Banking, vol. 32 (November), pp. 936–66. A price-level rule was discussed in Robert E. Hall (1984), “Monetary Strategy with an Elastic Price Standard,” in Price Stability 1. FOMC policymakers first discussed prescriptions from and Public Policy, proceedings of a symposium sponsored monetary policy rules in 1995 and have consulted them by the Federal Reserve Bank of Kansas City, held in Jackson routinely since 2004. Hole, Wyo., August 2–3 (Kansas City: Federal Reserve Bank 2. The effectiveness of monetary policy is enhanced when of Kansas City), pp. 137–59, https://www.kansascityfed.org/ it is well understood by the public. For a discussion of how publicat/sympos/1984/s84.pdf. The first-difference rule is the public’s understanding of monetary policy matters for the based on a rule suggested by Athanasios Orphanides (2003), effectiveness of monetary policy, see Janet L. yellen (2012), “Historical Monetary Policy Analysis and the Taylor Rule,” “Revolution and Evolution in Central Bank Communications,” Journal of Monetary Economics, vol. 50 (July), pp. 983–1022. speech delivered at the Haas School of Business, University A comprehensive review of policy rules is in John B. Taylor of California, Berkeley, November 13, https://www. and John C. Williams (2011), “Simple and Robust Rules for federalreserve.gov/newsevents/speech/yellen20121113a. Monetary Policy,” in Benjamin M. Friedman and Michael htm. For a discussion regarding principles for the conduct Woodford, eds., Handbook of Monetary Economics, vol. 3B of monetary policy, see Board of Governors of the Federal (Amsterdam: North-Holland), pp. 829–59. The same volume Reserve System (2018), “Monetary Policy Principles and of the Handbook of Monetary Economics also discusses Practice,” webpage, https://www.federalreserve.gov/ approaches other than policy rules for deriving policy rate monetarypolicy/monetary-policy-principles-and-practice.htm. prescriptions. 34 PART 2: MONETARy POLICy Monetary Policy Rules (continued) A. Monetary policy rules Taylor (1993) rule 93 = + +0.5( − )+( − ) Balanced-approach rule = + +0.5( − )+2( − ) Adjusted Taylor (1993) rule 93 = { 93− , 0} Price-level rule = { + +( − )+ 0.5( ), 0} First-difference rule = −1 +0.5( − )+ ( − )−( −4 − −4 ) Note: Rt T93, Rt BA, Rt T93adj, Rt PL, and Rt FD 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. Rt denotes the realized nominal federal funds rate for quarter t, πt is the four-quarter price inflation for quarter t, ut is the unemployment rate in quarter t, and rt LR is the level of the neutral real federal funds rate in the longer run that is expected to be consistent with sustaining maximum employment and inflation at the FOMC’s 2 percent longer-run objective, πLR. In addition, ut LR is the rate of unemployment expected in the longer run. Zt 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. PLgapt is the percent deviation of the realized 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) to represent the rules in terms of the FOMC’s statutory goals. The rules are implemented as responding to core PCE inflation rather than to headline PCE inflation because current and near-term core inflation rates tend to outperform headline inflation rates as predictors of the medium-term behavior of headline inflation. Box note 3 provides references for the policy rules. employment and stable inflation.4 The rules feature the longer-run objective of 2 percent, whereas the price- unemployment rate gap, measured as the difference level rule includes the gap between the level of prices between an estimate of the rate of unemployment that today and the level of prices that would have been is sustainable in the longer run (uLR) and the current realized if inflation had been constant at 2 percent from t unemployment rate; the first-difference rule includes a specified starting year.6 The price-level rule thereby the change in the unemployment gap rather than its takes account of the deviation of inflation from the level.5 In addition, four of the five rules include the longer-run objective in earlier periods as well as in the difference between recent inflation and the FOMC’s current period, in contrast with the other rules that do not make up past misses of the inflation objective. The adjusted Taylor (1993) rule recognizes that 4. The expression of the first-difference rule shown in the federal funds rate cannot be reduced materially figure A does not involve an estimate of the neutral real below zero and that following the prescriptions interest rate in the longer run. However, this rule has its own shortcomings. For example, research suggests that this of the standard Taylor (1993) rule after a recession sort of rule often results in greater volatility in employment during which the federal funds rate has fallen to its and inflation relative to what would be obtained under the effective lower bound may therefore not provide Taylor (1993) and balanced-approach rules. enough policy accommodation. To make up for the 5. The original Taylor (1993) rule represented slack in resource utilization using an output gap (the difference (continued) between the current level of real gross domestic product (GDP) and the level that GDP would be if the economy 6. Calculating the prescriptions of the price-level rule were operating at maximum employment, measured in requires selecting a starting year for the price level from percent of the latter). The rules in figure A represent slack in which to cumulate the 2 percent annual rate of inflation. resource utilization using the unemployment gap instead, Figure B uses 1998 as the starting year. Around that time, because that gap better captures the FOMC’s statutory goal the underlying trend of inflation and longer-term inflation to promote maximum employment. However, movements in expectations stabilized at levels consistent with PCE (personal these alternative measures of resource utilization are highly consumption expenditures) price inflation being close to correlated. For more information, see the note below figure A. 2 percent. MONETARy POLICy REPORT: FEBRUARy 2020 35 cumulative shortfall in accommodation, the adjusted may not be directly measurable, hence leading to time- Taylor (1993) rule prescribes only a gradual return of varying and uncertain estimates of uLR and rLR. t t the policy rate to the (positive) levels prescribed by the Since 2000, forecasters in the Blue Chip survey standard Taylor (1993) rule after the economy begins have markedly reduced their estimates of the longer- to recover. Similarly, the price-level rule specified in run level of the real short-term interest rate (figure C). figure A recognizes that the federal funds rate cannot be FOMC participants have also lowered their estimates reduced materially below zero. If inflation runs below of the real federal funds rate in the longer run since the 2 percent objective during periods when the policy the Summary of Economic Projections, or SEP, began rate is constrained by the effective lower bound, this reporting this information in 2012. Similarly, in recent rule will, over time, call for more accommodation to years, FOMC participants as well as outside forecasters make up for the past inflation shortfall. and analysts generally have lowered their estimates of Figure B shows historical prescriptions for the the longer-run unemployment rate considerably.7 federal funds rate from the five rules described earlier. Figure D illustrates the imprecision with which For each period, the figure reports the policy rates the longer-run neutral real interest rate is estimated prescribed by the rules given prevailing economic by reporting values from several time-series models, conditions and estimates of uLR and rLR at the time. along with measures of the uncertainty surrounding t t The prescribed values often vary widely across rules. these values.8 The models use statistical techniques to Because there is no definitive standard for favoring capture the variations among inflation, interest rates, one rule over another, consulting a range of rules is real gross domestic product, unemployment, and other generally preferable to relying on any particular rule. data series. The point estimates are dispersed across models, ranging from 0.3 to 2.1 percent. Moreover, Estimates of rLR and uLR: Uncertainty and the 95 percent uncertainty bands around the estimates t t Revisions illustrate the substantial uncertainty inherent in such estimates.9 As already noted, the level of the neutral real interest (continued on next page) rate and the unemployment rate that is sustainable in the longer run is not directly observable and can be 7. The SEP median for the longer-run unemployment rate is estimated only imprecisely. The neutral real interest available since April 2009. 8. The estimates are based on data through 2019:Q3. rate in the longer run is determined by structural 9. The range of estimates is computed using published features of the economy, including trend productivity values or values computed using the methodology from growth, demographics, and risk-taking behavior. The the following studies: Jens H.E. Christensen and Glenn unemployment rate that can be sustained in the longer D. Rudebusch (2019), “A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt,” Review of Economics run is also determined largely by nonmonetary factors, and Statistics, vol. 101 (December), pp. 933–49; Marco such as demographics, educational attainment, and Del Negro, Domenico Giannone, Marc P. Giannoni, and the structure and dynamics of the labor market. These Andrea Tambalotti (2017), “Safety, Liquidity, and the Natural various determining factors may change over time and Rate of Interest,” Brookings Papers on Economic Activity, B. Historical federal funds rate prescriptions from policy rules Quarterly Percent 8 Taylor (1993) rule, adjusted Taylor (1993) rule 6 4 2 + _0 Price-level rule 2 First-difference rule 4 Target federal funds rate Balanced-approach rule 6 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 NOTE: The rules use historical values of the federal funds rate, core personal consumption expenditures (PCE) inflation, and the unemployment rate. Quarterly projections of longer-run values for the federal funds rate and the unemployment rate are derived through interpolations of biannual 6-to-10-year-ahead projections from Blue Chip Economic Indicators. The longer-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 PCE excluding food and energy in 1998 extrapolated at 2 percent growth per year. The data extend through 2019:Q3, with the exception of the midpoint of the target range for the federal funds rate data, which go through 2019:Q4. SOURCE: Federal Reserve Bank of Philadelphia; Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff estimates. 36 PART 2: MONETARy POLICy Monetary Policy Rules (continued) C. Real-time estimates of the neutral real interest rate and the unemployment rate in the longer run Estimates of rLR Estimates of uLR t t Quarterly Percent Quarterly Percent 3.5 6.0 3.0 2.5 5.5 Blue Chip median Blue Chip median SEP median 2.0 SEP median 5.0 1.5 1.0 4.5 .5 4.0 0 2001 2004 2007 2010 2013 2016 2019 2001 2004 2007 2010 2013 2016 2019 Note: The Blue Chip median for the longer-run neutral real interest rate, rLR, equals the 3-month Treasury bill rate projected 6 to 10 years ahead t deflated by the corresponding projected annual change in the price index for gross domestic product. The Summary of Economic Projections (SEP) median for the longer-run neutral real interest rate starts in January 2012 and equals the median of Federal Open Market Committee participants’ projections of the nominal federal funds rate in the longer run minus the corresponding median projection of personal consumption expenditures inflation. The SEP median for the longer-run unemployment rate, uLR, is available since April 2009. t Source: Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board. Some Implications for Monetary Policy about estimates of the longer-run neutral real interest rate leads to uncertainty about how far the current The longer-run neutral level of the federal funds federal funds rate is from its longer-run neutral level. rate—equal to the sum of the neutral real interest For the Taylor (1993), balanced-approach, adjusted rate in the longer run and the FOMC’s 2 percent Taylor (1993), and price-level rules, a decrease in the inflation objective—is one benchmark for evaluating assumed longer-run neutral real interest rate translates the current stance of monetary policy. Uncertainty (continued) Spring, pp. 235–94, https://www.brookings.edu/wp-content/ uploads/2017/08/delnegrotextsp17bpea.pdf; Kathryn Holston, (Washington: Board of Governors of the Federal Reserve Thomas Laubach, and John C. Williams (2017), “Measuring System, August), http://dx.doi.org/10.17016/FEDS.2015.077; the Natural Rate of Interest: International Trends and Thomas Laubach and John C. Williams (2003), “Measuring the Determinants,” Journal of International Economics, supp. 1, Natural Rate of Interest,” Review of Economics and Statistics, vol. 108 (May), pp. S59–75; Benjamin K. Johannsen and Elmar vol. 85 (November), pp. 1063–70; Kurt F. Lewis and Francisco Mertens (2016), “The Expected Real Interest Rate in the Long vazquez-Grande (2019), “Measuring the Natural Rate of Run: Time Series Evidence with the Effective Lower Bound,” Interest: A Note on Transitory Shocks,” Journal of Applied FEDS Notes (Washington: Board of Governors of the Federal Econometrics, vol. 34 (April), pp. 425–36; Thomas A. Lubik Reserve System, February 9), https://www.federalreserve.gov/ and Christian Matthes (2015), “Calculating the Natural Rate econresdata/notes/feds-notes/2016/the-expected-real-interest- of Interest: A Comparison of Two Alternative Approaches,” rate-in-the-long-run-time-series-evidence-with-the-effective- Economic Brief 15-10 (Richmond: Federal Reserve Bank of lower-bound-20160209.html; Michael T. Kiley (2015), “What Richmond, October), https://www.richmondfed.org/-/media/ Can the Data Tell Us about the Equilibrium Real Interest Rate?” richmondfedorg/publications/research/economic_brief/2015/ Finance and Economics Discussion Series 2015-77 pdf/eb_15-10.pdf. MONETARy POLICy REPORT: FEBRUARy 2020 37 D. Point estimates and uncertainty bands for the neutral E. Historical federal funds rate prescriptions from real rate in the longer run Taylor (1993) rule conditional on historical and 95 percent latest estimates of rLR and uLR Point t t Study uncertainty estimate bands Quarterly Percent Christensen and Rudebusch (2019) .3 (−.7,1.3) Prescriptions based on historical estimates 4 Del Negro and others (2017) 1.3 (1, 1.6) 3 Holston and others (2017) .6 (−1.1,2.3) Johannsen and Mertens (2016) .4 (−.4,1.2) 2 Difference due Kiley (2015) .5 (.1,1) to u t L R revisions 1 + Laubach and Williams (2003) .9 (−1.7, 3.5) _0 Lewis and Vazquez-Grande (2019) 2.1 (1.4, 2.8) Difference due Prescriptions based on latest estimates 1 Lubik and Matthes (2015) .7 (−.5,1.7) to r t L R revisions 2 Note: The estimates use data through 2019:Q3. Source: Federal Reserve Board staff calculations, along with references listed in box note 9. 2013 2015 2017 2019 Note: The note in figure B provides references to the data and calcula- tions used to derive the historical federal funds rate prescriptions from the one-for-one into a decline in these rules’ prescribed Taylor (1993) rule. The data extend through 2019:Q3. For each period, settings for the federal funds rate. Therefore, to the the “prescriptions based on historical estimates” use the interpolated extent that the downward revisions to estimates median Blue Chip estimates 6 to 10 years ahead for the neutral real interest rate, rLR, and the unemployment rate, uLR, as of that period. of rLR reflect learning that the longer-run neutral t t t “Prescriptions based on latest estimates” use the corresponding estimates rate was lower than had been assessed previously, as of 2019:Q3 for all periods shown. the historical prescriptions of these rules would Source: Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff calculations. be less accommodative than previously thought. Uncertainty about estimates of the longer-run normal unemployment rate also imparts uncertainty to these the difference in the policy rate prescriptions of the rules’ prescriptions. For example, given current Taylor (1993) rule based on the historical and the latest economic conditions, the assumption of a lower estimates of uLR and rLR.10 sustainable rate of unemployment in the longer run t t To conclude, this discussion illustrates that policy translates one-for-one into reduced unemployment rules crucially entail an important element of judgment. gaps in the rules and, in turn, leads to lower prescribed Moreover, the inherent uncertainty about some of the values of the policy rate. variables included in these rules leads to significant Figure E compares the prescriptions of the Taylor uncertainty regarding their policy settings, which (1993) rule based on the historical median estimates of uLR and rLR from the Blue Chip survey (shown in cautions against strict adherence to any particular rule. t t figure C) and the prescriptions generated based on the latest median estimates of these variables. The federal 10. The extent to which these downward revisions to funds rate prescriptions based on the latest estimates estimates of rLR and uLR lead to downward revisions in (black line) are lower than the prescriptions based on t t historical policy rate prescriptions varies across policy the historical estimates (red line). For example, using rules. For example, the historical prescriptions of the the latest median estimates, the rule’s prescribed federal balanced-approach rule, which responds more strongly to funds rates for 2012 are about 3 percentage points the unemployment gap than the Taylor (1993) rule, would decrease more than shown in figure E when conditioned on lower than the values prescribed based on the historical the latest estimates of rLR and uLR. By contrast, the historical estimates. Figure E also shows that revisions to the prescriptions of the first t -differen t ce rule are essentially estimates of uLR and rLR contribute roughly equally to unaffected by the downward revisions to rLR and uLR. t t t t 38 PART 2: MONETARy POLICy implementation of the FOMC’s monetary the Federal Reserve remitted about $55 billion policy and are not intended to change the in 2019. stance of monetary policy. These Treasury bill purchases are distinct from the large-scale The effective federal funds rate moved asset purchase programs that the Federal down in line with the FOMC’s target Reserve deployed after the financial crisis. In range for the federal funds rate those programs, the Federal Reserve purchased The Federal Reserve reduced the effective longer-term securities to put downward federal funds rate following the FOMC’s pressure on longer-term interest rates and ease decisions in July, September, and October to broader financial conditions. lower the target range for the federal funds rate by reducing the interest rate paid on required The Federal Reserve’s total assets have and excess reserve balances and the interest increased from about $3.8 trillion last July to rate offered on overnight reverse repurchase about $4.1 trillion at present, with holdings agreements (ON RRPs). Specifically, the of Treasury securities at approximately Federal Reserve lowered the interest rate paid $2.4 trillion and holdings of agency debt and on required and excess reserve balances to agency MBS at approximately $1.4 trillion 2.10 percent in July, 1.80 percent in September, (figure 48). The increase in the size of the and 1.55 percent in October. In addition, balance sheet partly reflects an increase in the Federal Reserve lowered the ON RRP the level of nonreserve liabilities—such as offering rate to 2 percent in July, 1.70 percent currency in circulation and the TGA—and a in September, and 1.45 percent in October. The rise in the level of reserve balances, which have Federal Reserve also approved a ¼ percentage increased from approximately $1.5 trillion last point decrease in the discount rate (the July to approximately $1.6 trillion at present. primary credit rate) in July, September, and October. Yields on a broad set of money Meanwhile, interest income on the Federal market instruments also moved lower, roughly Reserve’s securities holdings has continued in line with the effective federal funds rate, in to result in substantial remittances to the response to the FOMC’s policy decisions in U.S. Treasury. Preliminary data indicate that July, September, and October. 48. 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 Treasury securities held outright 1 . . 0 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 2019 2020 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 repurchase agreements as well as 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 January 29, 2020. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” MONETARy POLICy REPORT: FEBRUARy 2020 39 The Federal Reserve continued the order to ensure that the Federal Reserve is review of its strategic framework for best positioned going forward to achieve its monetary policy statutory mandate of maximum employment and price stability. (The box “Federal Reserve In the second half of 2019, the Federal Review of Monetary Policy Strategy, Tools, Reserve continued the review of its monetary and Communication Practices” discusses policy strategy, tools, and communication the review and the public outreach that has practices. The goal of this assessment is accompanied it.) to identify possible ways to improve the Committee’s current policy framework in 40 PART 2: MONETARy POLICy Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices Overview councils and community networks and from outreach conducted specifically for the Fed Listens initiative. The In 2019, the Federal Reserve began a broad participants represented small businesses, labor unions, review of the monetary policy strategy, tools, and state and local governments, schools and community communication practices it uses to pursue its statutory colleges, workforce development organizations, dual-mandate goals of maximum employment and housing groups, community development financial price stability. The Federal Reserve is undertaking the institutions (CDFIs), retirees, and academia. review because the U.S. economy appears to have Most of the events were conducted in a town changed in ways that matter for monetary policy. For hall format with one or more panel sessions. A few example, the neutral level of the policy interest rate incorporated site visits to schools and businesses appears to have fallen in the United States and abroad, to learn about local initiatives in underserved increasing the risk that the effective lower bound on communities to increase education, combine high interest rates will constrain central banks from reducing school completion with work experience, or offer their policy interest rates enough to effectively support after-hours vocational training to enhance skill levels. economic activity during downturns. The review is At the events, participants were asked how considering what monetary policy strategy will best they viewed the relative importance of maximum enable the Federal Reserve to meet its dual mandate employment and price stability and how monetary in the future, whether the existing monetary policy policy actions affected them and the people they tools are sufficient to achieve and maintain the dual represent. Participants commented on labor market mandate, and how its communication about monetary conditions and whether they saw those conditions policy can be improved. as consistent with the dual-mandate objective of maximum employment; they also offered perspectives Fed Listens Initiative on inflation, lending conditions, and how people in their organizations or communities responded to A key component of the review has been a series interest rate changes. In addition, participants often of public Fed Listens events aimed at consulting with compared economic conditions today with conditions a broad range of stakeholders in the U.S. economy. a few years or a decade ago and assessed the Federal The goal of Fed Listens was for policymakers to engage Reserve’s public communications. In keeping with directly with a range of individuals and groups on the transparency of the review, all of the events were issues pertaining to the dual-mandate objectives of livestreamed, with written summaries of the events maximum employment and stable prices. posted on System websites afterward.1 From February to October 2019, the Federal Reserve (continued) hosted 14 public Fed Listens events—one at the Board of Governors, one at each of the 12 Reserve Banks, and 1. Information on the Fed Listens events is available a System research conference at the Federal Reserve on the Board’s website at https://www.federalreserve.gov/ Bank of Chicago. The events featured a broad range of monetarypolicy/review-of-monetary-policy-strategy-tools-and- participants drawn from the System’s existing advisory communications-fed-listens-events.htm. MONETARy POLICy REPORT: FEBRUARy 2020 41 Takeaways from Fed Listens Participants acknowledged that inflation is low, and representatives of small businesses or business While the Fed Listens events covered a broad range associations emphasized the importance of stable and of topics, participants consistently highlighted a few predictable inflation for planning and decisionmaking. points. Representatives of disadvantaged communities Participants representing retirees said rising costs of generally saw the strong labor market as providing health care and prescription drugs pose challenges for significant benefits to their constituents—primarily by people on fixed incomes, while representatives of low- providing job opportunities for people who had had and middle-income communities said the people they difficulty finding jobs in the past. These representatives represent still struggle to afford basic necessities such also expressed concern about how newly hired workers as housing, utilities, and food. Participants generally would fare in the next downturn and whether the job did not regard the fact that aggregate inflation is experience they will have acquired by then would running modestly below the Federal Reserve’s 2 percent allow them to retain their jobs during the downturn or objective as a problem. That perception highlights obtain jobs easily after the economy recovers. a challenge for the Federal Reserve as it publicly Small business owners and representatives from communicates about the rationale for the review and business organizations said finding qualified workers the importance of anchoring inflation expectations at to fill available positions was a challenge in the current 2 percent for keeping policy interest rates sufficiently labor market conditions. As a result, businesses are above the effective lower bound. partnering with workforce development agencies or community colleges to devise training programs or specialized curriculums to prepare would-be workers. Policymaker Discussions In addition, firms have been more willing to hire people who would not have been considered in less favorable Since the summer of 2019, Federal Reserve labor market conditions. However, businesses generally policymakers have been discussing issues associated are not increasing wages to attract and retain workers. with the monetary policy strategy review at meetings Instead, they are offering new training or education of the Federal Open Market Committee (FOMC). At programs and adding or augmenting health-care and its July, September, and October meetings, the FOMC other benefits. reviewed the performance of its current approach to While businesses and CDFIs generally found monetary policy, discussed possible alternative policy low interest rates to be beneficial, representatives strategies, and reviewed policy tools. Key points of of underserved populations and retirees conveyed these discussions have been summarized in publicly different views. Many people in lower-income released meeting minutes. In December, the FOMC communities generally have little or no access to considered the views offered at the Fed Listens events conventional credit. Consequently, they often do not together with staff analysis on the distributional effects benefit when interest rates on conventional credit fall as of monetary policy. The FOMC’s discussions are a result of the Fed’s actions. In addition, we heard that continuing into 2020. Policymakers expect to complete retirees with savings have seen interest income on their the review around the middle of this year. At that time, savings decline. policymakers will report their findings to the public. 42 PART 2: MONETARy POLICy Money Market Developments and Monetary Policy Implementation Consistent with its decision at the January 2019 September 2019, imbalances in the supply of and meeting, the Federal Open Market Committee (FOMC) demand for short-term funding led to pressures in reaffirmed, in its Statement Regarding Monetary Policy the repurchase agreement (repo) market—a money Implementation on October 11, 2019, the intention market segment in which banks, securities dealers, to implement monetary policy in a regime with an money market funds (MMFs), and other financial ample supply of reserves.1 In such a system, active market participants lend to and borrow from each management of reserves through frequent open market other for short periods against high-quality collateral. operations is not required, and control over the level of On the demand side, dealers’ and other investors’ the federal funds rate and other short-term interest rates needs for financing securities had increased following is exercised primarily through the setting of the Federal the settlement of Treasury auctions at mid-month. On Reserve’s administered rates. the supply side, some institutional investors, such as In recent years, depository institutions’ reserve government-only MMFs and banks, may have been balances held at the Federal Reserve have declined as reluctant to increase lending because they faced a result of the normalization of the Federal Reserve’s uncertainty regarding cash outflows as their clients balance sheet as well as growth in nonreserve were making corporate tax payments due in mid- liabilities. Reserves dropped from a peak of about September. As a result, repo rates rose sharply in $2.8 trillion in 2014 to about $2.2 trillion in late mid-September (figure A). Pressures in the repo market September 2017, largely reflecting the expansion of spilled over to other short-term funding markets, nonreserve liabilities. Subsequently, reserves declined including the federal funds market. The federal funds further, reflecting the FOMC’s decision to allow a rate firmed, moving out of its target range for one day gradual runoff of maturing securities, and, by the (as shown in figure A). In response to elevated rates, time the FOMC decided to conclude the reduction the Federal Reserve began conducting repo operations of its aggregate securities holdings in August 2019, to help stabilize money markets and provide reserves reserves had fallen to about $1.5 trillion. Despite the to keep the federal funds rate within its target range cessation of balance sheet runoff in August 2019, (figure B). These operations have been effective in reserves subsequently continued to decline because of meeting these goals. increases in currency and other nonreserve liabilities Consistent with its decision to implement monetary and reached a multiyear low of about $1.4 trillion in policy in a regime with an ample supply of reserves, September 2019. on October 11, 2019, the Committee announced its Against a backdrop of declining reserves and high decision to purchase Treasury bills at least into the levels of Treasury securities outstanding, in mid- second quarter of 2020 in order to maintain reserves at or above the level that prevailed in early September (as shown in figure B).2 In addition, the FOMC announced 1. See the Statement Regarding Monetary Policy (continued) Implementation, which is available on the Board’s website at https://www.federalreserve.gov/newsevents/pressreleases/ 2. For additional information on the FOMC’s plans to monetary20191011a.htm. implement monetary policy over the longer run, see the MONETARy POLICy REPORT: FEBRUARy 2020 43 A. Selected money market rates B. Federal Reserve open market operations Daily Percent Daily Billions of dollars Cumulative bill purchases 6 Outstanding term repos 500 Overnight repos 5 400 4 SOFR 300 3 200 2 Target federal funds rate 1 100 Effective federal funds rate Mar. May July Sept. Nov. Jan. Sept. Oct. Nov. Dec. Jan. Feb. 2019 2020 2019 2020 NOTE: The Secured Overnight Financing Rate (SOFR) is a broad NOTE: Data are at a business-day frequency, excluding the holidays on measure of rates on overnight Treasury general collateral repurchase October 14, November 11, November 28, December 25, and January 1. agreement (repo) transactions and bilateral Treasury repo transactions. Data begin September 18, 2019. SOURCE: Federal Reserve Bank of New York; Federal Reserve Board. SOURCE: Federal Reserve Bank of New York; Federal Reserve Board staff calculations. term and overnight repo operations to ensure that on average, since the announcement on the supply of reserves remains ample even during October 11, 2019. These operations are expected to periods of sharp increases in nonreserve liabilities and decline over time as Treasury bill purchases supply a to mitigate the risk of money market pressures that larger base of reserves. could adversely affect policy implementation.3 Repos The Federal Reserve’s open market operations— outstanding, consisting of both overnight and term repo operations and bill purchases—lifted reserves operations, have been about $209 billion per day, to levels averaging about $1.6 trillion in early 2020. Besides adding reserves, the repo operations damped funding pressures in repo markets that may otherwise Statement Regarding Monetary Policy Implementation and have passed through to the federal funds market. As Balance Sheet Normalization, which can be found on the such, the combination of repo operations and bill Board’s website at https://www.federalreserve.gov/newsevents/ purchases fostered conditions that helped maintain pressreleases/monetary20190130c.htm. 3. The Statement Regarding Monetary Policy the federal funds rate within the target range. Notably, Implementation indicated that the Federal Reserve would with the provision of about $250 billion in liquidity via conduct term and overnight repo operations at least through the Federal Reserve’s repo operations, money market January 2020. Such operations will now be continued at conditions were quite calm on year-end. Both secured least through April 2020; see “Implementation Note Issued and unsecured overnight funding rates printed in line January 29, 2020,” which is available on the Board’s website at https://www.federalreserve.gov/newsevents/pressreleases/ with the interest rate on excess reserves (as indicated monetary20200129a1.htm. in figure A). 45 P 3 art s e P ummary of ConomiC rojeCtions The following material appeared as an addendum to the minutes of the December 10–11, 2019, meeting of the Federal Open Market Committee. In conjunction with the Federal Open longer-run rate. The median of the current Market Committee (FOMC) meeting held on projections for the unemployment rate was December 10–11, 2019, meeting participants lower than that in the September Summary of submitted their projections of the most likely Economic Projections (SEP) for each year of outcomes for real gross domestic product the projection period, and some participants (GDP) growth, the unemployment rate, and reduced their estimates of the longer-run inflation for each year from 2019 to 2022 normal rate of unemployment, resulting in and over the longer run. Each participant’s a slight decline in the median estimate. The projections were based on information medians of the projections for both total and available at the time of the meeting, together core inflation, as measured by the four-quarter with his or her assessment of appropriate percent change in the price index for personal monetary policy—including a path for the consumption expenditures (PCE), increase federal funds rate and its longer-run value— significantly from 2019 to 2020 and more and assumptions about other factors likely modestly in 2021 to reach 2 percent that year. to affect economic outcomes. The longer- Almost all participants expected that inflation run projections represent each participant’s would be at or slightly above the Committee’s assessment of the value to which each variable 2 percent objective in 2021 and 2022. A couple would be expected to converge, over time, more participants, relative to the September under appropriate monetary policy and in the SEP, projected inflation to exceed 2 percent absence of further shocks to the economy.14 at some point during the projection period. “Appropriate monetary policy” is defined as The medians of the projections for both total the future path of policy that each participant and core inflation were unchanged for 2020 deems most likely to foster outcomes for through 2022, compared with the September economic activity and inflation that best SEP. Table 1 and figure 1 provide summary satisfy his or her individual interpretation of statistics for the projections. the statutory mandate to promote maximum employment and price stability. As shown in figure 2, a substantial majority of participants indicated that their expectations Almost all participants expected that, under regarding the evolution of the economy, appropriate monetary policy, growth of real relative to the Committee’s objectives of GDP in 2020 would run at or slightly above maximum employment and 2 percent inflation, 1.9 percent, the median of current estimates would likely warrant keeping the federal of its longer-run rate. The median of the funds at its current level through the end of projections for the growth rate of real GDP 2020. Compared with the September SEP edges down each year over the projection submissions, the median projection for the horizon and, for 2022, is modestly below the federal funds rate was 25 basis points lower median of the current estimates of its in each year over the projection period and retained its modest upward tilt in 2021 and 2022. The median of participants’ assessments of the appropriate level for the federal funds 14. One participant did not submit longer-run rate in 2022 was slightly below the median of projections for real GDP growth, the unemployment rate, or the federal funds rate. estimates of its longer-run level; the median 46 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assumptions of projected appropriate monetary policy, December 2019 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2019 2020 2021 2022 2019 2020 2021 2022 2019 2020 2021 2022 run run run Change in real GDP ....... 2.2 2.0 1.9 1.8 1.9 2.1–2.2 2.0–2.2 1.8–2.0 1.8–2.0 1.8–2.0 2.1–2.3 1.8–2.3 1.7–2.2 1.5–2.2 1.7–2.2 September projection .... 2.2 2.0 1.9 1.8 1.9 2.1–2.3 1.8–2.1 1.8–2.0 1.7–2.0 1.8–2.0 2.1–2.4 1.7–2.3 1.7–2.1 1.6–2.1 1.7–2.1 Unemployment rate. . . . . . . . 3.6 3.5 3.6 3.7 4.1 3.5–3.6 3.5–3.7 3.5–3.9 3.5–4.0 3.9–4.3 3.5–3.6 3.3–3.8 3.3–4.0 3.3–4.1 3.5–4.5 September projection .... 3.7 3.7 3.8 3.9 4.2 3.6–3.7 3.6–3.8 3.6–3.9 3.7–4.0 4.0–4.3 3.5–3.8 3.3–4.0 3.3–4.1 3.3–4.2 3.6–4.5 PCE inflation .............. 1.5 1.9 2.0 2.0 2.0 1.4–1.5 1.8–1.9 2.0–2.1 2.0–2.2 2.0 1.4–1.7 1.7–2.1 1.8–2.3 1.8–2.2 2.0 September projection .... 1.5 1.9 2.0 2.0 2.0 1.5–1.6 1.8–2.0 2.0 2.0–2.2 2.0 1.4–1.7 1.7–2.1 1.8–2.3 1.8–2.2 2.0 Core PCE inflation4 ........ 1.6 1.9 2.0 2.0 1.6–1.7 1.9–2.0 2.0–2.1 2.0–2.2 1.6–1.8 1.7–2.1 1.8–2.3 1.8–2.2 September projection .... 1.8 1.9 2.0 2.0 1.7–1.8 1.9–2.0 2.0 2.0–2.2 1.6–1.8 1.7–2.1 1.8–2.3 1.8–2.2 Memo: Projected appropriate policy path Federal funds rate ......... 1.6 1.6 1.9 2.1 2.5 1.6 1.6–1.9 1.6–2.1 1.9–2.6 2.4–2.8 1.6 1.6–1.9 1.6–2.4 1.6–2.9 2.0–3.3 September projection .... 1.9 1.9 2.1 2.4 2.5 1.6–2.1 1.6–2.1 1.6–2.4 1.9–2.6 2.5–2.8 1.6–2.1 1.6–2.4 1.6–2.6 1.6–2.9 2.0–3.3 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 expen- ditures (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 17–18, 2019. 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 17–18, 2019, meeting, and one participant did not submit such projections in conjunction with the December 10–11, 2019, 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. estimate of the longer-run level was unchanged The Outlook for Real GDP Growth from its value in the September SEP. and Unemployment Most participants regarded the uncertainties As shown in table 1, the medians of around their projections as broadly similar participants’ projections for real GDP to the average over the past 20 years. The growth in 2019 and 2020, conditional on majority of participants continued to assess their individual assessments of appropriate the risks to their outlooks for real GDP growth monetary policy, were 2.2 percent and as weighted to the downside and for the 2.0 percent, respectively, a touch above the unemployment rate as weighted to the upside. median estimate of the longer-run growth rate However, compared with the September of 1.9 percent. The median of the projections submissions, several participants shifted their for the growth rate of real GDP declines slowly assessments of the balance of risks around over the projection horizon and, in 2022, is these projections to being broadly balanced. modestly below the median of the current Most participants judged the risks to their estimates of its longer-run rate. The medians inflation outlook as broadly balanced, though of the projections for real GDP growth in all one-third of participants viewed the risks to four years of the projection period, as well as their inflation projections as weighted to the in the longer run, were unchanged from the downside; no participant assessed the risks September SEP. to his or her inflation outlook as weighted to the upside. The uncertainties and risks A majority of participants marked down around participants’ projections for headline their projections of the unemployment rate in and core inflation were little changed from the each year of the projection period, and some September SEP. participants lowered their estimates of the MONETARy POLICy REPORT: FEBRUARy 2020 47 Figure 1. Medians, central tendencies, and ranges of economic projections, 2019–22 and over the longer run Percent Change in real GDP Median of projections Central tendency of projections Range of projections 3 Actual 2 1 2014 2015 2016 2017 2018 2019 2020 2021 2022 Longer run Percent Unemployment rate 7 6 5 4 3 2014 2015 2016 2017 2018 2019 2020 2021 2022 Longer run Percent PCE inflation 3 2 1 2014 2015 2016 2017 2018 2019 2020 2021 2022 Longer run Percent Core PCE inflation 3 2 1 2014 2015 2016 2017 2018 2019 2020 2021 2022 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. 48 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 2019 2020 2021 2022 Longer run Note: Each shaded circle indicates the value (rounded to the nearest ⅛ percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. One participant did not submit longer-run projections for the federal funds rate. longer-run normal rate of unemployment. respectively, from 2019 to 2022 and in the As a result, the medians of the projections longer run. The distribution of individual for the unemployment rate in the fourth projections for real GDP growth for 2020 quarter of 2020 through 2022 were tilted slightly higher, as many participants 3.5 percent, 3.6 percent, and 3.7 percent, upgraded their projections a bit relative to respectively, each 0.2 percentage point lower those in the September SEP, although the than in the September projections. The median projection was unchanged. The median estimate of the longer-run normal distributions of individual projections of real rate of unemployment was 4.1 percent, GDP growth in 2021 and 2022 and in the 0.1 percentage point lower than in September. longer run were little changed overall. The distributions of individual projections for the Figures 3.A and 3.B show the distributions unemployment rate from 2020 to 2022 and in of participants’ projections for real GDP the longer run shifted lower relative to those growth and the unemployment rate, in September. MONETARy POLICy REPORT: FEBRUARy 2020 49 The Outlook for Inflation lowered their projections for the appropriate level in 2021 and 2022. The median projection As shown in table 1, the median projection for for the federal funds rate was 25 basis points core PCE price inflation was 1.6 percent for lower in each year in the projection period. 2019, a modest decrease from the September Realized inflation running persistently below projections. The medians of the projections target and risks associated with trade policy for both total and core PCE price inflation and foreign economic growth were cited as were each 1.9 percent in 2020 and 2.0 percent key factors informing participants’ judgments in both 2021 and 2022—all unchanged from about the appropriate path for the federal September. Figures 3.C and 3.D show the funds rate. distributions of participants’ views about their outlooks for inflation. Although the Uncertainty and Risks medians of the projections for total and core PCE price inflation from 2020 through 2022 In assessing the appropriate path of the federal were unchanged from the September SEP, a funds rate, FOMC participants take account couple more participants projected inflation of the range of possible economic outcomes, to be slightly above the Committee’s 2 percent the likelihood of those outcomes, and the objective in 2022. potential benefits and costs should they occur. As a reference, table 2 provides measures of Appropriate Monetary Policy forecast uncertainty—based on the forecast errors of various private and government Figure 3.E shows the distributions of forecasts over the past 20 years—for real participants’ judgments regarding the GDP growth, the unemployment rate, and appropriate target—or midpoint of the target total PCE price inflation. Those measures are range—for the federal funds rate at the end represented graphically in the “fan charts” of each year from 2019 to 2022 and over shown in the top panels of figures 4.A, 4.B, the longer run. A substantial majority of and 4.C. The fan charts display the SEP participants projected a federal funds rate medians for the three variables surrounded of 1.63 percent for the end of 2020. Four by symmetric confidence intervals derived participants assessed that the most likely from the forecast errors reported in table 2. appropriate rate at year-end for 2020 would If the degree of uncertainty attending these be 1.88 percent. For subsequent years, the medians of the projections were 1.88 percent Table 2. Average historical projection error ranges at the end of 2021 and 2.13 percent at the Percentage points end of 2022. The distribution of participants’ Variable 2019 2020 2021 2022 estimates of the longer-run level of the federal Change in real GDP1 ....... ±0.8 ±1.6 ±2.0 ±2.0 funds rate was little changed, and the median Unemployment rate1 ....... ±0.1 ±0.8 ±1.5 ±1.9 estimate was unchanged from September at Total consumer prices2 ..... ±0.2 ±0.9 ±1.0 ±0.9 2.50 percent. Short-term interest rates3 ... ±0.1 ±1.4 ±2.0 ±2.4 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 1999 through 2018 that were released in the winter by various Compared with the projections prepared for private and government forecasters. As described in the box “Forecast Uncertain- ty,” under certain assumptions, there is about a 70 percent probability that actual the September SEP, a number of participants outcomes for real GDP, unemployment, consumer prices, and the federal funds rate marked down their assessments of the will be in ranges implied by the average size of projection errors made in the past. For more information, see David Reifschneider and Peter Tulip (2017), “Gauging appropriate level of the federal funds rate the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach,” Finance and Economics Discussion Series 2017-020 at the end of 2020, reflecting in part the (Washington: Board of Governors of the Federal Reserve System, February), https:// dx.doi.org/10.17016/FEDS.2017.020. reduction in the target range at the October 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 meeting and causing both the range and most widely used in government and private economic forecasts. Projections are percent changes on a fourth quarter to fourth quarter basis. central tendency of projections for 2020 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- to narrow considerably. Some participants ed using average levels, in percent, in the fourth quarter. 50 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2019–22 and over the longer run Number of participants 2019 December projections 18 September projections 16 14 12 10 8 6 4 2 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2021 18 16 14 12 10 8 6 4 2 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2022 18 16 14 12 10 8 6 4 2 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2020 51 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2019–22 and over the longer run Number of participants 2019 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− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 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− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 Percent range Number of participants 2021 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− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 Percent range Number of participants 2022 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− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 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− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 52 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants’ projections for PCE inflation, 2019–22 and over the longer run Number of participants 2019 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 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 Number of participants 2021 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 2022 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 Longer run 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. MONETARy POLICy REPORT: FEBRUARy 2020 53 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2019–22 Number of participants 2019 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 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 2021 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 2022 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. 54 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, 2019–22 and over the longer run Number of participants 2019 December projections 18 September projections 16 14 12 10 8 6 4 2 1.38− 1.63− 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 Percent range Number of participants 2020 18 16 14 12 10 8 6 4 2 1.38− 1.63− 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 Percent range Number of participants 2021 18 16 14 12 10 8 6 4 2 1.38− 1.63− 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 Percent range Number of participants 2022 18 16 14 12 10 8 6 4 2 1.38− 1.63− 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.38− 1.63− 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: FEBRUARy 2020 55 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 Actual 2 1 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 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 September projections 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Note: 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 difer 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 summa- rized 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 approximate- ly symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” 56 PART 3: SUMMARy OF ECONOMIC PROJECTIONS 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 10 Median of projections 70% confidence interval 9 8 7 Actual 6 5 4 3 2 1 2014 2015 2016 2017 2018 2019 2020 2021 2022 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 September projections 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Note: 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 difer 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 2020 57 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 3 70% confidence interval 2 1 Actual 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 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 September projections 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about core PCE inflation Risks to core PCE inflation December projections December projections September projections September projections 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Note: 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 difer 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.” 58 PART 3: SUMMARy OF ECONOMIC PROJECTIONS projections is similar to the typical magnitude In discussing the uncertainty and risks of past forecast errors and the risks around the surrounding their economic projections, some projections are broadly balanced, then future participants mentioned trade developments outcomes of these variables would have about and concerns about foreign economic growth a 70 percent probability of being within these as sources of uncertainty or downside risk confidence intervals. For all three variables, to the U.S. economic growth outlook. In this measure of uncertainty is substantial and contrast, the underlying strength of both generally increases as the forecast horizon consumer spending and the labor market lengthens. was cited as balancing the risks around the growth outlook. In addition, most of the participants who shifted their balance of risks Participants’ assessments of the level of for output growth to “broadly balanced” cited uncertainty surrounding their individual more accommodative monetary policy as a economic projections are shown in the bottom- contributing factor. For the inflation outlook, left panels of figures 4.A, 4.B, and 4.C. A the possibility that inflation expectations substantial majority of participants viewed could be drifting below levels consistent with the uncertainty surrounding each of the four the FOMC’s 2 percent inflation objective economic variables as being broadly similar to was viewed as a downside risk. A couple of the average over the past 20 years. participants mentioned higher tariffs as a source of upside risk to their inflation outlook. Because the fan charts are constructed to be symmetric around the median projections, Participants’ assessments of the appropriate they do not reflect any asymmetries in the future path of the federal funds rate are also balance of risks that participants may see subject to considerable uncertainty. Because in their economic projections. Participants’ the Committee adjusts the federal funds assessments of the balance of risks to their rate in response to actual and prospective current economic projections are shown in developments over time in key economic the bottom-right panels of figures 4.A, 4.B, variables—such as real GDP growth, and 4.C. Relative to the September SEP, more the unemployment rate, and inflation— participants saw the risks to the outlook for uncertainty surrounding the projected path real GDP growth and the unemployment for the federal funds rate importantly reflects rate as broadly balanced, although a small the uncertainties about the paths for these majority continued to view the risks to their economic variables, along with other factors. outlooks for real GDP growth as weighted to Figure 5 provides a graphic representation the downside and for the unemployment rate of this uncertainty, plotting the SEP median as weighted to the upside. Most participants for the federal funds rate surrounded by continued to judge the risks to their inflation symmetric confidence intervals derived from outlook as broadly balanced, while some the results presented in table 2. As with participants viewed the risks to their inflation the macroeconomic variables, the forecast outlook as weighted to the downside. No uncertainty surrounding the appropriate path participant assessed the risks to his or her of the federal funds rate is substantial and inflation outlook as weighted to the upside. increases for longer horizons. MONETARy POLICy REPORT: FEBRUARy 2020 59 Figure 5. Uncertainty and risks in projections of the federal funds rate Percent Federal funds rate Midpoint of target range 6 Median of projections 70% confidence interval* 5 4 3 2 1 Actual 0 2014 2015 2016 2017 2018 2019 2020 2021 2022 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 onset 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 difer 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. 60 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Forecast Uncertainty The economic projections provided by the reported in table 2 would imply a probability of about members of the Board of Governors and the presidents 70 percent that actual GDP would expand within a of the Federal Reserve Banks inform discussions of range of 2.2 to 3.8 percent in the current year, 1.4 to monetary policy among policymakers and can aid 4.6 percent in the second year, and 1.0 to 5.0 percent public understanding of the basis for policy actions. in the third and fourth years. The corresponding Considerable uncertainty attends these projections, 70 percent confidence intervals for overall inflation however. The economic and statistical models and would be 1.8 to 2.2 percent in the current year, 1.1 relationships used to help produce economic forecasts to 2.9 percent in the second year, 1.0 to 3.0 percent are necessarily imperfect descriptions of the real in the third year, and 1.1 to 2.9 percent in the world, and the future path of the economy can be fourth year. Figures 4.A through 4.C illustrate these affected by myriad unforeseen developments and confidence bounds in “fan charts” that are symmetric events. Thus, in setting the stance of monetary policy, and centered on the medians of FOMC participants’ participants consider not only what appears to be projections for GDP growth, the unemployment rate, the most likely economic outcome as embodied in and inflation. However, in some instances, the risks their projections, but also the range of alternative around the projections may not be symmetric. In possibilities, the likelihood of their occurring, and the particular, the unemployment rate cannot be negative; potential costs to the economy should they occur. furthermore, the risks around a particular projection Table 2 summarizes the average historical accuracy might be tilted to either the upside or the downside, of a range of forecasts, including those reported in in which case the corresponding fan chart would past Monetary Policy Reports and those prepared be asymmetrically positioned around the median by the Federal Reserve Board’s staff in advance of projection. meetings of the Federal Open Market Committee Because current conditions may differ from those (FOMC). The projection error ranges shown in the that prevailed, on average, over history, participants table illustrate the considerable uncertainty associated provide judgments as to whether the uncertainty with economic forecasts. For example, suppose a attached to their projections of each economic participant projects that real gross domestic product variable is greater than, smaller than, or broadly (GDP) and total consumer prices will rise steadily at similar to typical levels of forecast uncertainty seen annual rates of, respectively, 3 percent and 2 percent. in the past 20 years, as presented in table 2 and If the uncertainty attending those projections is similar reflected in the widths of the confidence intervals to that experienced in the past and the risks around shown in the top panels of figures 4.A through 4.C. the projections are broadly balanced, the numbers (continued) MONETARy POLICy REPORT: FEBRUARy 2020 61 Participants’ current assessments of the uncertainty rather are projections of participants’ individual surrounding their projections are summarized in the assessments of appropriate monetary policy and are bottom-left panels of those figures. Participants also on an end-of-year basis. However, the forecast errors provide judgments as to whether the risks to their should provide a sense of the uncertainty around the projections are weighted to the upside, are weighted future path of the federal funds rate generated by the to the downside, or are broadly balanced. That is, uncertainty about the macroeconomic variables as while the symmetric historical fan charts shown in well as additional adjustments to monetary policy that the top panels of figures 4.A through 4.C imply that would be appropriate to offset the effects of shocks to the risks to participants’ projections are balanced, the economy. participants may judge that there is a greater risk that If at some point in the future the confidence a given variable will be above rather than below their interval around the federal funds rate were to extend projections. These judgments are summarized in the below zero, it would be truncated at zero for purposes lower-right panels of figures 4.A through 4.C. of the fan chart shown in figure 5; zero is the bottom As with real activity and inflation, the outlook of the lowest target range for the federal funds rate for the future path of the federal funds rate is subject that has been adopted by the Committee in the past. to considerable uncertainty. This uncertainty arises This approach to the construction of the federal funds primarily because each participant’s assessment of rate fan chart would be merely a convention; it would the appropriate stance of monetary policy depends not have any implications for possible future policy importantly on the evolution of real activity and decisions regarding the use of negative interest rates to inflation over time. If economic conditions evolve provide additional monetary policy accommodation in an unexpected manner, then assessments of the if doing so were appropriate. In such situations, the appropriate setting of the federal funds rate would Committee could also employ other tools, including change from that point forward. The final line in forward guidance and asset purchases, to provide table 2 shows the error ranges for forecasts of short- additional accommodation. term interest rates. They suggest that the historical While figures 4.A through 4.C provide information confidence intervals associated with projections on the uncertainty around the economic projections, of the federal funds rate are quite wide. It should figure 1 provides information on the range of views be noted, however, that these confidence intervals across FOMC participants. A comparison of figure 1 are not strictly consistent with the projections for with figures 4.A through 4.C shows that the dispersion the federal funds rate, as these projections are not of the projections across participants is much smaller forecasts of the most likely quarterly outcomes but than the average forecast errors over the past 20 years. 63 a bbreviations AFE advanced foreign economy CBO Congressional Budget Office CDFI community development financial institution C&I commercial and industrial CPI consumer price index EME emerging market economy FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product IP industrial production JOLTS Job Openings and Labor Turnover Survey LFPR labor force participation rate LIBOR London interbank offered rate MBS mortgage-backed securities MMF money market fund ON RRP overnight reverse repurchase agreement OPEC Organization of the Petroleum Exporting Countries PCE personal consumption expenditures repo repurchase agreement SEP Summary of Economic Projections SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices SOMA System Open Market Account TGA Treasury General Account TIPS Treasury Inflation-Protected Securities VIX implied volatility for the S&P 500 index For use at 11:00 a.m. EST February 7, 2020 M P r onetary olicy ePort February 7, 2020 Board of Governors of the Federal Reserve System

Federal Reserve (2020, February 6). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20200207

@misc{wtfs_monetary_policy_report_20200207,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2020},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20200207},
  note = {Retrieved via When the Fed Speaks corpus}
}