Monetary Policy Report

For use at 11:00 a.m. EDT June 17, 2022 M P r onetary olicy ePort June 17, 2022 Board of Governors of the Federal Reserve System L t etter of ransmittaL Board of Governors of the Federal Reserve System Washington, D.C., June 17, 2022 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, Chair S L -r g m P S tatement on onger un oaLS and onetary oLicy trategy Adopted effective January 24, 2012; as reaffirmed effective January 25, 2022 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. Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Monetary policy plays an important role in stabilizing the economy in response to these disturbances. The Committee’s primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate. The Committee judges that the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past. Owing in part to the proximity of interest rates to the effective lower bound, the Committee judges that downward risks to employment and inflation have increased. The Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals. The maximum level of employment is a broad-based and inclusive goal that is not directly measurable and changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. 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 shortfalls of employment from its maximum level, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. 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 judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee’s ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time. Monetary policy actions tend to influence economic activity, employment, and prices with a lag. In setting monetary policy, the Committee seeks over time to mitigate shortfalls of employment from the Committee’s assessment of its maximum level and deviations of inflation from its longer-run goal. Moreover, sustainably achieving maximum employment and price stability depends on a stable financial system. 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 Committee’s employment and inflation objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation 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 review these principles and to make adjustments as appropriate at its annual organizational meeting each January, and to undertake roughly every 5 years a thorough public review of its monetary policy strategy, tools, and communication practices. C ontents Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Recent Economic and Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Special Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Part 1: Recent Economic and Financial Developments . . . . . . . . . . . . . . . . . . . . . 5 Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Financial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69 List of Boxes Developments in Global Supply Chains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Developments in Employment and Earnings across Groups . . . . . . . . . . . . . . . . . . . . . . . . . 14 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Global Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Monetary Policy in Foreign Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Monetary Policy Rules in the Current Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Developments in the Federal Reserve’s Balance Sheet and Money Markets . . . . . . . . . . . . . . 49 Forecast Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 note: This report reflects information that was publicly available as of 4 p.m. EDT on June 15, 2022. Unless otherwise stated, the time series in the figures extend through, for daily data, June 14, 2022; for monthly data, May 2022; and, for quarterly data, 2022:Q1. 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 23, 36, and 42, note that the S&P/Case-Shiller U.S. National Home Price Index, 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 © 2022 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 In the first part of the year, inflation remained Recent Economic and Financial well above the Federal Open Market Developments Committee’s (FOMC) longer-run objective of 2 percent, with some inflation measures Inflation. Consumer price inflation, as rising to their highest levels in more than measured by the 12-month change in the 40 years. These price pressures reflect supply price index for personal consumption and demand imbalances, higher energy and expenditures (PCE), rose from 5.8 percent food prices, and broader price pressures, in December 2021 to 6.3 percent in April, its including those resulting from an extremely highest level since the early 1980s and well tight labor market. In the labor market, above the FOMC’s objective of 2 percent. demand has remained strong, and supply This increase was driven by an acceleration of has increased only modestly. As a result, the retail food and energy prices, reflecting further unemployment rate fell noticeably below the increases in commodity prices due to Russia’s median of FOMC participants’ estimates of invasion of Ukraine. The 12-month measure its longer-run normal level, and nominal wages of inflation that excludes the volatile food and continued to rise rapidly. Although overall energy categories (so-called core inflation) economic activity edged down in the first rose initially and then fell back to 4.9 percent quarter, household spending and business fixed in April, unchanged from last December. investment remained strong. The most recent Three-month measures of core inflation have indicators suggest that private fixed investment softened since December but remain far may be moderating, but consumer spending above levels consistent with price stability. remains strong. Measures of near-term inflation expectations continued to rise markedly, while longer-term In response to sustained inflationary pressures expectations moved up by less. and a strong labor market, the FOMC has been adjusting its policies and communications The labor market. Demand for labor continued since last fall. At its March meeting, the to outstrip available supply across many parts FOMC raised the target range for the federal of the economy, and nominal wages continued funds rate off the effective lower bound to ¼ to to increase at a robust pace. While labor ½ percent. The Committee continued to raise demand remained very strong, labor supply the target range in May and June, bringing increased only modestly. As a result, the labor it to 1½ to 1¾ percent following the June market tightened further between December meeting, and indicated that ongoing increases and May, with job gains averaging 488,000 per are likely to be appropriate. The Committee month and the unemployment rate falling ceased net asset purchases in early March and from 3.9 percent to 3.6 percent—just above the began reducing its securities holdings in June. bottom of its range over the past 50 years. The Committee is acutely aware that high Economic activity. Real gross domestic inflation imposes significant hardship, product (GDP) is reported to have surged at a especially on those least able to meet the 6.9 percent annual rate in the fourth quarter of higher costs of essentials. The Committee’s 2021 and then to have declined at a 1.5 percent commitment to restoring price stability— annual rate in the first quarter. The large which is necessary for sustaining a strong labor swings in growth rates reflected fluctuations market—is unconditional. in the volatile expenditure categories of net 2 SUMMARy exports and inventory investment. Abstracting expected inflation, the ongoing supply from these volatile components, growth in disruptions related to COVID-19, and Russia’s private domestic final demand (consumer invasion of Ukraine—the financial system spending plus residential and business fixed has been resilient, though portions of the investment—a measure that tends to be more commodities markets temporarily experienced stable and better reflects the strength of elevated levels of stress. The drop in equity overall economic activity) was strong in the prices and rising bond spreads suggest that first quarter, supported by some unwinding valuation pressures in corporate securities of supply bottlenecks and a further reopening markets have eased some from their previously of the economy. The most recent indicators elevated levels, but real estate prices have suggest that private fixed investment may be risen further this year. While business and moderating, but consumer spending remains household debt has been growing solidly, the strong. As a result, real GDP appears on track ratio of credit to GDP has decreased to near to rise moderately in the second quarter. pre-pandemic levels and most indicators of credit quality remained robust, suggesting that Financial conditions. Financial conditions have vulnerabilities from nonfinancial leverage are tightened significantly this year. The expected moderate. Large bank capital ratios dipped path of the federal funds rate over the next few in the first quarter, but overall leverage in the years shifted up substantially, and yields on financial sector appears moderate and little nominal Treasury securities across maturities changed this year. Recent strains experienced have risen considerably since late February in markets for stablecoins—digital assets that amid sustained inflationary pressures and aim to maintain a stable value relative to a associated expectations for further monetary national currency or other reference assets— policy tightening. Equity prices were volatile and other digital assets have highlighted the and declined sharply, on net, while corporate structural fragilities in that rapidly growing bond yields increased substantially and spreads sector. A few signs of funding pressures increased notably, partly reflecting some emerged amid the geopolitical tensions, concerns about the future corporate credit particularly in commodities markets. However, outlook. Mortgage rates also rose sharply. In broad funding markets proved resilient, turn, tighter financial conditions may have and with direct exposures of U.S. financial begun to weigh on some financing activity. On institutions to Russia and Ukraine being small, the business side, nonfinancial corporate bond financial spillovers have been limited to date. issuance was solid in the first quarter but slowed somewhat in April and May, with speculative- International developments. Economic grade bond issuance being particularly activity has continued to recover in many weak. That said, the growth of bank loans to foreign economies, albeit with new significant businesses picked up, and business credit quality headwinds from Russia’s invasion of Ukraine has remained strong thus far. For households, and COVID lockdowns in China. These mortgage originations declined materially. headwinds have, on net, pushed commodity Nevertheless, mortgage credit remained prices higher, worsened supply disruptions, and broadly available for a wide range of potential lowered household and business confidence, borrowers. For other consumer loans (such as thus damping the rebound in foreign economic auto loans and credit cards), credit standards activity. As in the United States, consumer eased somewhat further or changed little, and price inflation abroad is high and has credit outstanding grew briskly. continued to rise in many economies, boosted by higher energy, food, and other commodity Financial stability. Despite experiencing prices as well by supply chain constraints. In a series of adverse shocks—higher-than- response, many foreign central banks have MONETARy POLICy REPORT: JUNE 2022 3 raised policy rates, and some have started to with those principles, the Committee reduce the size of their balance sheets. announced in May its specific plans for significantly reducing its securities holdings Foreign financial conditions have tightened and that these reductions would begin on notably since the beginning of the year, in part June 1.1 reflecting the tightening in foreign monetary policy and concerns about persistently high The Committee acutely recognizes the inflation. Sovereign bond yields in many significant hardship caused by elevated advanced foreign economies rose. Foreign inflation, especially on those least able to meet risky asset prices declined, also driven by the higher costs of essentials. The Committee downside risks to the growth outlook amid is strongly committed to restoring price the lockdowns in China and Russia’s invasion stability, which is necessary for sustaining a of Ukraine. The trade-weighted value of the strong labor market. dollar appreciated notably. Special Topics Monetary Policy Labor market disparities. The labor market In response to significant ongoing inflation recovery over the past year and a half has pressures and the tightening labor market, the been robust and widespread as the labor Committee has been adjusting its policies and market effects of the pandemic have eased, communications since last fall. The Committee with particularly strong improvement among wound down net purchases of securities and groups that had suffered the most. As a result, began reducing those securities holdings more employment and earnings of nearly all major rapidly than expected, and also initiated a swift demographic groups are near or above their increase in interest rates. Adjustments to both levels before the pandemic, and employment interest rates and the balance sheet are playing rates are again near multidecade highs. a role in firming the stance of monetary policy However, there remain notable differences in in support of the Committee’s maximum- employment and earnings across groups that employment and price-stability goals. predate the pandemic. Interest rate policy. In March, after holding Developments in global supply chains. Supply the federal funds rate near zero since the chain bottlenecks remain a major impediment onset of the pandemic, the FOMC raised the for domestic and foreign firms. While U.S. target range for that rate to ¼ to ½ percent. manufacturers have been recording solid The Committee raised the target range again output growth for more than a year, order in May and June, bringing it to the current backlogs and delivery times remain high, and range of 1½ to 1¾ percent, and conveyed producer prices have risen rapidly. Further its anticipation that ongoing increases in the risks to global supply chains abound. In target range will be appropriate. China, COVID-19 lockdowns drove the largest monthly declines in industrial production there Balance sheet policy. The Federal Reserve since early 2020 while also disrupting internal began reducing its monthly net asset purchases and international freight transportation. In last November and accelerated the reductions addition, the war in Ukraine continues to put in December, bringing net purchases to an end in early March. In January, the FOMC 1. See the May 4, 2022, press release regarding the issued a set of principles regarding its planned Plans for Reducing the Size of the Federal Reserve’s approach for significantly reducing the size of Balance Sheet, available at https://www.federalreserve. the Federal Reserve’s balance sheet. Consistent gov/newsevents/pressreleases/monetary20220504b.htm. 4 SUMMARy upward pressure on energy and food prices banks have tightened monetary policy. and has raised the risk of disruption in the Policy tightening started last year as some supply of inputs to some manufacturing emerging market central banks, particularly industries. those in Latin America, were concerned that sharp increases in inflation could become Monetary policy rules. Simple monetary policy entrenched in inflation expectations. Since rules, which relate a policy interest rate to a fall 2021, many central banks in the advanced small number of other economic variables, foreign economies have also started tightening can provide useful guidance to policymakers. monetary policy or are expected to do so soon, Many simple policy rules prescribed strongly and several central banks that had expanded negative values for the federal funds rate their balance sheets over the past two years are during the pandemic-driven recession. now allowing them to shrink. With inflation running well in excess of the Committee’s 2 percent longer-run objective, a Developments in the Federal Reserve’s balance strong U.S. economy, and tight labor market sheet. Following the conclusion of net asset conditions, the simple monetary policy rules purchases, the balance sheet remained stable considered here call for raising the target range at around $9 trillion. Alongside the removal of for the federal funds rate significantly. policy accommodation—through actual and expected increases in the policy rate—plans Global inflation. Inflation abroad rose rapidly for shrinking the size of the balance sheet over the past year, reflecting soaring food and were announced in May and were initiated commodity prices, pandemic-related supply in June. Despite the size of the balance sheet disruptions, and demand imbalances between remaining steady, reserve balances fell, in goods and services. The price pressures have large part because of increasingly elevated been amplified by the war in Ukraine and take-up at the overnight reverse repurchase COVID-19 lockdowns in China. Although agreement (ON RRP) facility, which reached a the recent inflation surge was concentrated in record high of $2.2 trillion. In an environment volatile components, such as food and energy, of ample liquidity, limited Treasury bill price increases have broadened to core goods supply, and low repurchase agreement rates, and services. the ON RRP facility continued to serve its intended purpose of helping to provide a floor Global monetary policy. With inflation under short-term interest rates and to support rising sharply across the globe, many central effective implementation of monetary policy. 5 P 1 art r e f d eCent ConomiC and inanCiaL eveLoPments Domestic Developments Inflation continued to run high . . . After surging 5.8 percent over 2021—the 1. Change in the price index for personal consumption largest increase since 1981—the price index expenditures for personal consumption expenditures (PCE) Monthly Percent change from year earlier continued to post notable increases so far 7.0 this year, and the change over the 12 months 6.5 6.0 ending in April stood at 6.3 percent (figure 1). 5.5 This pace is well above the FOMC’s longer-run 5.0 4.5 objective of 2 percent. 4.0 3.5 . . . reflecting further large increases in Trimmed mean 3.0 2.5 food and energy prices . . . 2.0 1.5 Grocery prices increased at a very rapid pace Excluding foodTotal 1.0 and energy .5 of 10 percent over the 12 months ending in 0 April, more than 4 percentage points faster 2014 2015 2016 2017 2018 2019 2020 2021 2022 than over the 12 months ending in December NOTE: The data extend through April 2022. and the highest reading since 1981 (figure 2). SOURCE: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Bureau of Economic Analysis; all via Haver Analytics. Food commodity prices (such as wheat and corn), which had already increased last year, have risen further since Russia’s invasion of Ukraine. At the same time, high fuel costs, supply chain bottlenecks, and high wage growth have also pushed up processing, packaging, and transportation costs for food. The PCE price index for energy increased 30 percent over the 12 months ending in April, 2. Personal consumption expenditures price indexes Percent change from year earlier Percent change from year earlier Monthly Percent change from year earlier 60 12 8 50 10 40 8 6 Housing 30 6 services 4 20 Food and 4 beverages 10 2 e S x e e rv n i e c r e g s y 2 + + and housing + _0 _0 _0 10 2 Goods ex food, Energy beverages, and 2 20 4 energy 2018 2019 2020 2021 2022 2018 2019 2020 2021 2022 NOTE: The data are monthly and extend through April 2022. NOTE: The data extend through April 2022. SOURCE: Bureau of Economic Analysis via Haver Analytics. SOURCE: Bureau of Economic Analysis via Haver Analytics. 6 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 3. Spot and futures prices for crude oil about the same pace as over the 12 months ending in December. Large increases in crude Weekly Dollars per barrel oil and natural gas commodity prices have 160 boosted consumer prices for gasoline and natural gas. 140 Brent spot price 120 . . . which, in turn, partly reflected rising 100 prices of commodities and imports 80 Because of Russia’s invasion of Ukraine, oil 60 24-month-ahead futures contracts 40 prices rose sharply in early March, reaching eight-year highs (figure 3). Prices remain 20 elevated and volatile, boosted by a European 2007 2010 2013 2016 2019 2022 Union embargo of Russian oil imports NOTE: The data are weekly averages of daily data and extend through but weighed down at times by concerns June 10, 2022. about global economic growth. In addition, SOURCE: ICE Brent Futures via Bloomberg. producers in other countries are struggling to ramp up oil production. 4. Spot prices for commodities Weekly Week ending January 3, 2014 = 100 Nonfuel commodity prices also surged after the invasion, with large increases in the 180 prices of both agricultural commodities and 160 industrial metals (figure 4). Although the price of industrial metals has declined recently, 140 agricultural prices remain elevated. Ukraine Industrial metals 120 and Russia are notable exporters of wheat, 100 Russia is a major exporter of fertilizer, and higher energy prices are spilling over into the 80 Agriculture and livestock agricultural sector. Export restrictions and 60 unfavorable weather conditions in several countries have also boosted agricultural prices. 2014 2015 2016 2017 2018 2019 2020 2021 2022 (See the box “Developments in Global Supply NOTE: The data are weekly averages of daily data and extend through June 10, 2022. Chains.”) SOURCE: For industrial metals, S&P GSCI Industrial Metals Index Spot; for agriculture and livestock, S&P GSCI Agriculture & Livestock Spot Index; both via Haver Analytics. With commodity prices surging and foreign goods prices on the rise, import prices 5. Nonfuel import price index increased significantly (figure 5). Monthly 12-month percent change Excluding food and energy prices, 8 monthly inflation readings have softened since the turn of the year but remain 6 far above levels consistent with price 4 stability 2 + Supply chain issues, hiring difficulties, and _0 other capacity constraints have prevented 2 the supply of products from rising quickly 4 enough to satisfy continued strong demand, resulting in large price increases for many 2014 2015 2016 2017 2018 2019 2020 2021 2022 goods and services over the past year. After NOTE: The data extend through April 2022. SOURCE: Bureau of Labor Statistics via Haver Analytics. excluding consumer food and energy prices, MONETARy POLICy REPORT: JUNE 2022 7 the 12-month measure of core PCE inflation rose initially and then fell back to 4.9 percent in April, unchanged from December. That said, monthly core inflation readings have softened noticeably since the start of the year, with the three-month measure of core PCE inflation falling from an annual rate of 6.0 percent last December to 4.0 percent in April. In particular, inflation stepped down for durable goods, likely reflecting some easing in supply constraints. Nevertheless, the recent inflation readings have been mixed, remain far above levels consistent with price stability, and are far from conclusive evidence on the direction of inflation. Unlike durable goods price inflation, core services inflation has not declined significantly. Housing service prices continue to rise at a brisk pace, and increased demand for travel is markedly pushing up inflation rates for lodging and airfares. More generally, rapid growth of labor costs is putting upward pressure on the prices of all labor-intensive services. 6. Measures of inflation expectations Measures of near-term inflation expectations continued to rise markedly, Percent while longer-term expectations moved up 5.5 by less Michigan survey, next 12 months 5.0 The first half of 2022 saw further increases in CIE, projected onto 4.5 expectations of inflation for the year ahead in Michigan, next 5 to 10 years 4.0 3.5 surveys of both consumers and professional 3.0 forecasters (figure 6). In the University of 2.5 Michigan Surveys of Consumers, the median 2.0 value for inflation expectations over the CIE, projected onto SPF, 10 years ahead 1.5 next year jumped to 5.4 percent in March, 10-year SPF M ne i x c t h 5 ig t a o n 1 s 0 u y rv e e a y rs , 1.0 its highest level since November 1981, and 2006 2008 2010 2012 2014 2016 2018 2020 2022 has moved sideways since then. A portion of the upward movement so far this year NOTE: The Survey of Professional Forecasters (SPF) data are quarterly, begin in 2007:Q1, and extend through 2022:Q2. The data for likely reflects the war in Ukraine and the the Index of Common Inflation Expectations (CIE) and the Michigan survey are monthly and extend through June 2022; the June data for the accompanying increases in the prices of Michigan survey and the CIE are preliminary. commodities, especially those related to energy SOURCE: University of Michigan Surveys of Consumers; Federal Reserve Bank of Philadelphia, SPF; Federal Reserve Board, CIE; and food. Federal Reserve Board staff calculations. Longer-term expectations, which are more likely to influence actual inflation over time, moved up by less and remained above pre- pandemic levels. The Michigan survey’s median inflation expectation for the next 8 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments in Global Supply Chains Bottlenecks in global production and transportation mixed for bottlenecks in the transportation of goods. remain a major impediment for both domestic and The number of ships waiting for berths at West Coast foreign fi rms. Russia’s invasion of Ukraine and the ports has declined noticeably, as port throughput has widespread COvID-19 lockdowns in China have remained high, although manufacturers continue to cite exacerbated strains in global supply networks and logistics and transportation constraints as reasons for have led to greater uncertainty about the timing of lower output. improvement in supply conditions. (continued) Despite this turbulence in the global supply network, U.S. manufacturers have been recording solid output growth for more than a year. There have B. Suppliers’ delivery times and order backlogs been gains in domestic motor vehicle production, as the supply of semiconductors has recovered Monthly Diffusion index somewhat (fi gure A). In addition, survey results suggest shorter supplier delivery times and lower order 80 backlogs relative to their late 2021 levels (fi gure B). Delivery times 70 Notwithstanding these improvements, backlogs and delivery times for the sector remain elevated, and light 60 vehicle assemblies are still a bit below pre-pandemic 50 levels, with low dealer inventories continuing to constrain sales. For some materials that had previously 40 Order backlogs been in short supply—such as lumber and steel— 30 prices have declined from notable highs. Even so, the overall producer price index for manufacturing 20 in April was more than 18 percent above its year- earlier level (fi gure C). Progress has been similarly 2007 2012 2017 2022 NOTE: Values greater than 50 indicate that more respondents reported longer delivery times or order backlogs relative to a month earlier than reported shorter delivery times or order backlogs. SOURCE: Institute for Supply Management, ISM Manufacturing Report A. U.S. light motor vehicle production on Business. Monthly January 2020 = 100 110 C. Producer price index for manufacturing Monthly Percent change from year earlier 100 20 90 15 80 10 70 5 + _0 Feb. Apr. Jun. Aug. Oct. Dec. Feb. Apr. 2021 2022 5 NOTE: The data extend through April 2022. The data are adjusted 10 using Federal Reserve Board seasonal factors. SOURCE: Ward’s Automotive Group, AutoInfoBank and Intelligence Data Query; Chrysler Group LLC, North American Production Data; 2017 2018 2019 2020 2021 2022 General Motors Corporation, GM Motor Vehicle Assembly Production Data. SOURCE: Bureau of Labor Statistics via Haver Analytics. MONETARy POLICy REPORT: JUNE 2022 9 Risks to supply chain conditions abound, including The invasion of Ukraine by Russia is causing those arising from COvID-19 lockdowns in China economic hardship. For instance, the confl ict has beginning in mid-March and the ongoing war in disrupted global commodity markets in which Ukraine Ukraine.1 Committed to their zero-COvID strategy, and Russia account for signifi cant shares of global Chinese authorities ratcheted up restrictions quickly exports. Notably, energy prices have soared, as in the face of rising cases of the Omicron variant, (continued on next page) which included a complete lockdown of Shanghai. The containment strategy managed to reduce case counts, allowing authorities to begin relaxing some E. China’s purchasing managers index: Supplier delivery times citywide restrictions in late April. The lockdowns drove the largest monthly declines in Chinese activity since Monthly Diffusion index early 2020, with industrial production dropping about 13 percent between February and April (fi gure D) 70 before recovering some in May. With severely disrupted domestic logistics, supplier delivery times increased 65 sharply in April and continued increasing in May, but not as strongly (fi gure E). Chinese international trade 60 was also hit, contracting in the three months before April (fi gure F). As Chinese production continues to 55 recover, the associated rebound in trade fl ows may further strain international transportation networks. 50 2019 2020 2021 2022 1. The July 1 expiration of the contract between NOTE: The series is seasonally adjusted. Values greater than 50 dockworkers and West Coast port operators poses an indicate that more respondents reported longer delivery times relative to a month earlier than reported shorter delivery times. additional risk for shipping-related disruption. SOURCE: Caixin; S&P Global; both via Haver Analytics. D. Chinese industrial production and retail sales F. Nominal trade growth in China Monthly Percent change Monthly Percent change 12 Exports 200 Industrial production 8 150 4 + Imports 100 _0 4 50 + 8 Retail sales _0 12 50 16 Jan. Mar. May July Sept. Nov. Jan. Mar. May Jan. Mar. May July Sept. Nov. Jan. Mar. May 2021 2022 2021 2022 NOTE: Industrial production data are adjusted using Federal Reserve NOTE: All series are seasonally adjusted at an annual rate using Board seasonal factors. Retail sales data are seasonally adjusted by the Federal Reserve Board seasonal factors. The data are 3-month moving National Bureau of Statistics of China. averages. SOURCE: National Bureau of Statistics of China via Haver Analytics; SOURCE: General Administration of Customs, China, via Haver Federal Reserve Board staff calculations. Analytics. 10 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments in Global Supply Chains (continued) increasing geopolitical tensions have put the supply (fi gure G). The global transportation system has also of Russian oil and gas to Europe at risk. Indeed, proved mostly resilient to the war, with signs of further Russian energy exports have already been falling amid strain in only a couple of sectors. Oil tanker charter embargos on Russian oil, self-sanctioning by some rates spiked, boosted by a rise in demand as oil started companies, transportation diffi culties, and Russia’s to move to new markets, while truck transportation decision to halt gas deliveries to several European prices rose further, refl ecting higher diesel fuel costs. countries. The prices of several nonfuel commodities that are vital inputs to some manufacturing industries jumped in the early days of the confl ict, including neon gas (an input in semiconductor chip production), G. Purchasing managers index: Supplier delivery times palladium (an input in semiconductors and catalytic Monthly Diffusion index converters), nickel (an input in electric vehicles’ batteries), and platinum. However, prices have 90 United Kingdom since retreated to near pre-invasion levels as major 85 disruptions have failed to materialize thus far. Finally, 80 blocked shipping routes in the Black Sea have severed 75 the region’s agricultural exports, disrupting global food 70 markets. As a result, prices of corn, wheat, sunfl ower 65 oil, and fertilizer have climbed to record-high levels, 60 raising concerns of food insecurity across the globe. 55 Further aggravating the situation, a number of countries 50 introduced export bans on some food commodities to 45 Euro area contain rising domestic food prices. 40 Thus far, the war appears to have had more limited 2019 2020 2021 2022 effects on other aspects of global supply chains. The effect on supplier delivery times across Europe NOTE: The series are seasonally adjusted. Values greater than 50 indicate that more respondents reported longer delivery times relative to has been muted, suggesting that the repercussions a month earlier than reported shorter delivery times. for manufacturers in the region have been relatively SOURCE: For the United Kingdom, S&P Global and the Chartered Institute of Procurement & Supply; for the euro area, S&P Global; all via modest so far outside of the shifts in commodity prices Haver Analytics. MONETARy POLICy REPORT: JUNE 2022 11 5 to 10 years rose to 3.3 percent in the June preliminary reading. If confirmed, this reading would be near the top of the range from the past 25 years. Nevertheless, it remains well below the corresponding measure of 1-year- ahead inflation expectations. In the second- quarter Survey of Professional Forecasters, the median expectation for 10-year PCE inflation edged up to 2.4 percent, reflecting noticeable upward revisions to expected inflation this year and next but little change thereafter; the median expectation for 6 to 10 years ahead held steady at 2 percent. Market-based measures of longer-term inflation compensation, which are based on financial instruments linked to inflation, 7. Inflation compensation implied by Treasury are sending a similar message. A measure Inflation-Protected Securities of consumer price index (CPI) inflation Daily Percent compensation 5 to 10 years ahead implied by Treasury Inflation-Protected Securities is 4.0 little changed (on balance) since late 2021 and 3.5 remains well below the corresponding measure 5-to-10-year 3.0 of inflation compensation over the next 5 years 2.5 (figure 7). 2.0 1.5 5-year The Index of Common Inflation Expectations, 1.0 which is produced by Federal Reserve Board .5 staff and synthesizes information from a large 0 range of near-term as well as longer-term 2010 2012 2014 2016 2018 2020 2022 expectation measures, edged up in the first half NOTE: The data are at a business-day frequency and are estimated of this year and now stands at the high end of from smoothed nominal and inflation-indexed Treasury yield curves. the range from the past 20 years. SOURCE: Federal Reserve Bank of New York; Federal Reserve Board staff calculations. The labor market continued to tighten 8. Nonfarm payroll employment Payroll employment expanded an average of 488,000 per month in the first five months of Monthly Millions of jobs the year (figure 8). Payroll gains so far this year 155 have been broad based across industries, with 150 the leisure and hospitality sector continuing to see the largest gains as people continued their 145 return to activities that had been cut back by 140 the pandemic. 135 The increase in payrolls was accompanied 130 by further declines in the unemployment 125 rate, which fell 0.3 percentage point over the first five months of the year to 3.6 percent 2006 2008 2010 2012 2014 2016 2018 2020 2022 in May, just above the bottom of its range SOURCE: Bureau of Labor Statistics via Haver Analytics. 12 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 9. Civilian unemployment rate over the past 50 years (figure 9). The decline in the unemployment rate has been Monthly Percent fairly broad based across age, educational 16 attainment, gender, and ethnic and racial groups (figure 10). These declines have 14 helped employment of nearly all major 12 demographic groups recover to near or above 10 their levels before the pandemic. (See the box 8 “Developments in Employment and Earnings 6 across Groups.”) 4 While labor demand remained very 2 strong, labor supply increased only 2006 2008 2010 2012 2014 2016 2018 2020 2022 modestly and stayed below SOURCE: Bureau of Labor Statistics via Haver Analytics. pre-pandemic levels Demand for labor continued to be very strong in the first half of the year. At the end of April, there were 11.4 million job openings—60 percent above pre-pandemic levels and down a bit from the all-time high recorded in March. Meanwhile, the supply of labor rose only gradually and remained below pre-pandemic levels. The labor force participation rate (LFPR), which measures the share of people 10. Unemployment rate, by race and ethnicity Monthly Percent 20 18 Black or African American 16 14 12 Hispanic or Latino 10 White 8 6 Asian 4 2 2006 2008 2010 2012 2014 2016 2018 2020 2022 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. Small sample sizes preclude reliable estimates for Native Americans and other groups for which monthly data are not reported by the Bureau of Labor Statistics. SOURCE: Bureau of Labor Statistics via Haver Analytics. MONETARy POLICy REPORT: JUNE 2022 13 either working or actively seeking work, 11. Labor force participation rate and edged up just 0.1 percentage point in the employment-to-population ratio first five months of the year—following a Monthly Percent 0.4 percentage point improvement last year— to 62.3 percent in May (figure 11).2 68 66 Labor force participation rate 64 Despite these improvements, the LFPR 62 remains 1.1 percentage points below its Employment-to- population ratio 60 February 2020 level.3 About one-half of 58 this decline in the participation rate was 56 to be expected even in the absence of the 54 pandemic, as additional members of the 52 large baby-boom generation have reached 50 retirement age. In addition, several pandemic- 2006 2008 2010 2012 2014 2016 2018 2020 2022 related factors appear to be continuing to NOTE: The labor force participation rate and the employment- hold down the participation rate, including to-population ratio are percentages of the population aged 16 and over. a pandemic-induced surge in retirements SOURCE: Bureau of Labor Statistics via Haver Analytics. (beyond that implied by the aging of the baby boomers) and, to a diminishing extent, increased caregiving responsibilities and some continuing concerns about contracting COVID-19. In addition to subdued participation, a second factor constraining the size of the labor force has been a marked slowing in population growth since the start of the pandemic. Over 2020 and 2021, the working-age (16 and over) population grew by 0.4 percent per year on average—notably less than the 0.9 percent 2. The Bureau of Labor Statistics incorporated new population estimates beginning with the January 2022 employment report. This development resulted in a one-time jump in the estimate of the aggregate LFPR of about 0.3 percentage point due to a change in the age distribution of the population. Accordingly, the 0.4 percentage point increase in the published measure from December to May overstates the improvement in the LFPR by about 0.3 percentage point. 3. This shortfall in the LFPR corresponds to a shortfall in the labor force of about 2.8 million persons. (This calculation holds the LFPR constant at its February 2020 level and assumes population growth equal to the actual growth observed since February 2020.) 14 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments in Employment and Earnings across Groups Labor market gains have been robust over the Employment for Blacks and Hispanics not only past year and a half as the economy continues to declined by more than that for whites and Asians recover from the effects of the pandemic. Historically, early in the pandemic, but also recovered more economic downturns have tended to exacerbate quickly since the end of last year (fi gure A, upper- long-standing differences in employment and earnings right panel). In addition, men and women with high across demographic groups, especially for minorities school degrees or less saw larger declines and a faster and for those with less education, and this pattern was recovery (fi gure A, lower-left panel). Similarly, gaps in especially true early on in the pandemic. However, employment between prime-age mothers and non- as pandemic-related factors have eased and the labor mothers that widened through 2020 have essentially market has recovered, groups with larger employment closed (fi gure A, lower-right panel). By April 2022, declines early in the pandemic have had especially employment for all of those groups was near or above large increases lately. Now employment and real its pre-pandemic level. earnings of nearly all major demographic groups are These differences in the timing of the employment near or above their levels before the pandemic, and recovery across different demographic groups partly employment rates are again near multidecade highs. refl ect the evolution of the pandemic’s effect on the Different age groups have had very different labor market. For instance, social-distancing restrictions employment experiences over the course of the and concerns about contracting or spreading pandemic.1 Early in the pandemic, the employment-to- COvID-19 had likely inhibited employment in in- population (EPOP) ratio for people aged 16 to 24 not person services. As these restrictions and concerns only declined by much more than that for people of have waned, employment of groups more commonly prime age (25 to 54) and those aged 55 to 64, but also employed in in-person services, such as those with less recovered much more quickly (see fi gure A, upper- education and some minority groups, has recovered left panel).2 Conversely, employment recovered more quickly.3 Further, the closing of many schools and slowly for prime-age people throughout 2020 and childcare facilities for the 2020–21 school year due nearly all of 2021. But in late 2021 and early 2022, to elevated levels of COvID cases likely held back the prime-age EPOP rose quickly, such that now all the employment recovery of parents, as many families three of these age groups’ EPOP ratios have essentially faced uncertainties about the consistent availability recovered to their pre-pandemic levels. The EPOP ratio of in-person education for school-age children and for those aged 65 and over, however, remains about childcare for younger children. The effects appear to 1 percentage point below its pre-pandemic level—a have been particularly acute for mothers, especially level it has maintained through much of the pandemic. Black and Hispanic mothers, as well as those with less The lower EPOP ratio for that group is entirely (continued) attributable to a lower labor force participation rate, which in turn largely refl ects an increase in retirements since the onset of the pandemic. 3. Before the pandemic, Blacks and Hispanics were A closer look at the prime-age group shows that less likely to be employed in jobs that could be performed there has been considerable heterogeneity in the pace remotely, and women and Blacks were more likely to be employed in occupations that involved greater face-to-face of the employment recovery across race and ethnicity, interactions; for example, see Laura Montenovo, Xuan Jiang, educational attainment, and parental status. Felipe Lozano Rojas, Ian M. Schmutte, Kosali I. Simon, Bruce A. Weinberg, and Coady Wing (2020), “Determinants of Disparities in COvID-19 Job Losses,” NBER Working Paper Series 27132 (Cambridge, Mass.: National Bureau of 1. The January 2022 employment report incorporates Economic Research, May; revised June 2021), https://www. population controls that showed that the working-age nber.org/system/files/working_papers/w27132/w27132.pdf. population was both larger and younger over the past Other research shows that even after accounting for decade than the Census Bureau had previously estimated. workers’ job characteristics, Hispanic and nonwhite workers Those population controls had meaningful effects on the experienced a higher rate of job loss relative to other aggregate EPOP ratio, but much smaller effects at the levels of workers; see Guido Matias Cortes and Eliza Forsythe (2021), disaggregation examined in this discussion. “The Heterogeneous Labor Market Impacts of the Covid-19 2. This discussion defi nes the pre-pandemic baseline Pandemic,” unpublished paper, August, http://publish.illinois. EPOP ratio for each group as that group’s average EPOP ratio edu/elizaforsythe/files/2021/08/Cortes_Forsythe_Covid-demo_ over 2019. revision_8_1_2021.pdf. MONETARy POLICy REPORT: JUNE 2022 15 education.4 However, with schools having generally year, these childcare burdens likely eased, allowing provided in-person education for the 2021–22 school many parents to reenter the workforce. (continued on next page) 4. The increase in the share of mothers of school-age children who reported being out of the labor force due to caregiving closely tracked the degree to which schools were See Joshua Montes, Christopher Smith, and Isabel Leigh fully closed to in-person learning over the 2020–21 school (2021), “Caregiving for Children and Parental Labor Force year, and districts that serve more Blacks and Hispanics Participation during the Pandemic,” FEDS Notes (Washington: were less likely to provide fully in-person education during Board of Governors of the Federal Reserve System, the 2020–21 school year, which may account for some November 5), https://www.federalreserve.gov/econres/notes/ of the larger and more persistent declines in labor force feds-notes/caregiving-for-children-and-parental-labor-force- attachment for Black and Hispanic mothers over this period. participation-during-the-pandemic-20211105.htm. A. Changes in employment-to-population ratio compared with the 2019 average ratio, by group Age group Race and ethnicity: Prime age Monthly Percentage points Monthly Percentage points 55 to 64 2 4 + 65+ _0 Asian + 2 2 _0 4 White 2 25 to 54 6 Black or 4 8 African American 6 10 8 12 10 16 to 24 14 Hispanic or Latino 12 16 14 2019 2020 2021 2022 2019 2020 2021 2022 Educational attainment: Prime age Parental status: Prime-age women Monthly Percentage points Monthly Percentage points Women, college 4 2 Men, college or more 2 + or more + _0 _0 2 Nonparents 2 4 4 6 Parents Men, high school 8 6 or less 10 8 Women, high school 12 or less 10 14 12 16 2019 2020 2021 2022 2019 2020 2021 2022 NOTE: Prime age is 25 to 54. The age groups 16 to 24 and prime age show seasonally adjusted data published by the Bureau of Labor Statistics, whereas all other groups’ data are seasonally adjusted by the Federal Reserve Board staff. SOURCE: Bureau of Labor Statistics; Federal Reserve Board staff calculations from Current Population Survey microdata. 16 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments in Employment and Earnings across Groups (continued) Although the gaps in employment outcomes time real earnings for women versus men is slightly across groups that widened during the pandemic have smaller in 2022:Q1 than it was in 2019, as is the gap diminished, the considerable gaps that existed before in median real earnings between Black and white full- the pandemic remain. For example, the EPOP ratio for time workers.6 whites of prime age remains more than 3 percentage points above those for prime-age Black and Hispanic B. Growth in median full-time usual weekly earnings people; the EPOP ratio of college-educated, prime-age from 2019 to 2022:Q1 people is about 15 percentage points higher than that of prime-age people with high school degrees or less; and the EPOP ratio for prime-age mothers is about Real (PCE) Nominal 5 percentage points below that of non-mothers—all Overall similar in size to the gaps that existed before the Men Women pandemic. Less than high school The broad-based nature of the labor market recovery High school Some college is also apparent in workers’ earnings, which have Bachelor’s or more grown rapidly as employment surged in 2021 and early 16–24 25–54 2022. As of 2022:Q1, the median full-time worker’s 55–64 65+ usual weekly earnings had grown 12.3 percent relative White to pre-pandemic levels—implying real earnings growth Black or African Ame A ri s c ia a n n Hispanic or Latino of 3.1 percent (fi gure B).5 Although this earnings growth has been widespread, it has been largest for women, 0 2 4 6 8 10 12 14 16 Percent change relative to 2019 average minorities, young workers, and workers with less than a high school education. The growth in earnings for some NOTE: The percent change as of 2022:Q1 is relative to the 2019 average of the median usual weekly earnings for full-time workers in each group. Real demographic groups has been suffi ciently robust to earnings growth deflates the nominal earnings growth by the average growth in shrink some pre-pandemic disparities in real earnings the personal consumption expenditures (PCE) price index as of 2022:Q1 relative to its 2019 average level. The overall earnings, as well as those for men between groups. For instance, the gap in median full- and women, use seasonally adjusted data, but the other groups’ earnings are not seasonally adjusted. The key identifies bars in order from left to right. SOURCE: For median usual weekly earnings, Bureau of Labor Statistics; for the PCE price index, Bureau of Economic Analysis. 5. Just as with the change in the EPOP ratio, each group’s pre-pandemic baseline is defi ned as the group’s average median usual weekly earnings in 2019. The reported growth in 6. Some of a group’s earnings growth relative to 2019 may real usual weekly earnings defl ates nominal earnings growth refl ect lingering pandemic-related compositional shifts in the by total PCE (personal consumption expenditures) infl ation. group’s full-time workers. Additionally, real earnings growth If, instead, the CPI were used to defl ate nominal earnings, accounts for aggregate infl ation, but some demographic then reported real earnings growth since 2019 would be groups may be disproportionately exposed to infl ation due 2 percentage points lower—but even when using the CPI to to differences in groups’ consumption patterns—implying defl ate nominal earnings, real earnings have risen for most lower real earnings growth for groups with greater exposure to groups since 2019. infl ation. MONETARy POLICy REPORT: JUNE 2022 17 average rate over the previous five years.4 The slowing in population growth over 2020–21 was due to both a sharp decline in net immigration and a spike in COVID-related deaths.5 Had the population increased over 2020–21 at the same rate as over the previous five years, the labor force would have been about 1¾ million larger as of the second quarter of this year.6 As a result, labor markets remained extremely tight . . . Reflecting very strong demand for workers alongside still-subdued supply, a wide range of indicators have continued to point to an extremely tight labor market despite the fact that the level of payroll employment in May remained about 820,000 below the level in February 2020.7 The number of total available jobs, measured by total employment plus posted job openings, continued to far exceed the number of available workers, measured by the size of the labor force.8 The gap was 4. Population forecasts just before the onset of the pandemic also projected faster population growth for 2021–22 than has been realized. For example, the Congressional Budget Office projected 0.8 percent growth per year in 2021–22 in its January 2020 budget and economic projections; see Congressional Budget Office (2020), The Budget and Economic Outlook: 2020 to 2030 (Washington: CBO, January), https://www.cbo. gov/publication/56020. Before 2015, population growth was even higher. For example, the average growth rate in the working-age population between 1980 and 2014 was 1.2 percent per year. 5. The effect of COVID-related deaths on the labor force, however, was relatively smaller, because these deaths have been concentrated among older individuals, who tend to have low LFPRs. 6. This calculation uses the actual LFPR in May 2022 and multiplies it by the level of the population that would have been realized in that month had population growth over 2020–21 been the same as the growth observed over 2015–19. 7. After adjusting for population growth since the beginning of the pandemic, the shortfall in payrolls relative to their pre-pandemic level was about 2.3 million in May. 8. The labor force includes all people aged 16 and older who are classified as either employed or unemployed. 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 12. Ratio of job openings to job seekers and quits rate about 5½ million at the end of April, near the highest level on record.9 The share of workers Percent of employment Ratio quitting jobs each month, an indicator of the 2.4 availability of attractive job prospects, was 3.2 2.1 2.9 percent at the end of April, near the all- 2.8 Nonfarm quits rate 1.8 time high reported in November (figure 12). 2.4 1.5 Initial claims for unemployment benefits 2.0 1.2 remain near the lowest levels observed in .9 the past 50 years. Households’ and small 1.6 .6 businesses’ perceptions of labor market 1.2 tightness were near or above the highest Vacancy-to- .3 .8 unemployment ratio levels observed in the history of these series. 0 And, finally, employers continued to report 2006 2008 2010 2012 2014 2016 2018 2020 2022 widespread hiring difficulties. NOTE: The data are monthly and extend through April 2022. The vacancy-to-unemployment ratio data are the ratio of job openings to unemployed. That said, some possible signs of modest SOURCE: Bureau of Labor Statistics, Job Openings and Labor easing of labor market tightness have recently Turnover Survey. appeared. For example, as noted in the next section, some measures of wage growth appear to have moderated. And in the June 2022 Beige Book, employers in some Federal Reserve Districts reported some signs of modest improvement in worker availability. 13. Measures of change in hourly compensation . . . and nominal wages continued to Percent change from year earlier increase at a robust pace Compensation per hour, 10 business sector Reflecting very tight labor market conditions, 8 nominal wages continued to rise at historically Atlanta Fed’s Wage Growth Tracker 6 rapid rates. For example, the employment 4 cost index (ECI) of total compensation rose 4.8 percent over the 12 months ending in 2 + March, well above 2.8 percent from a year Employment cost index, Average hourly earnings, _0 earlier (figure 13). The most recent readings private sector private sector 2 include a surge in bonuses, which may reflect the challenges of retaining and hiring workers. 2014 2016 2018 2020 2022 In addition, wage growth as computed by NOTE: Business-sector compensation is on a 4-quarter percent change the Federal Reserve Bank of Atlanta, which basis. For the private-sector employment cost index, change is over the 12 months ending in the last month of each quarter; for private-sector tracks the median 12-month wage growth average hourly earnings, the data are 12-month percent changes; for the Atlanta Fed’s Wage Growth Tracker, the data are shown as a 3-month of individuals responding to the Current moving average of the 12-month percent change. Population Survey, picked up markedly this SOURCE: Bureau of Labor Statistics; Federal Reserve Bank of Atlanta, Wage Growth Tracker; all via Haver Analytics. year and rose more than 6 percent in May, well above the 3 to 4 percent pace reported over the previous few years. 9. Another usual indicator of the gap between available jobs and available workers is the ratio of job openings to unemployment. At the end of April, this indicator showed that there were 1.9 job openings per unemployed person. MONETARy POLICy REPORT: JUNE 2022 19 That said, there are some signs that nominal wage growth may be leveling off or moderating. The growth of wages and salaries as measured by the ECI moderated from 5.6 percent at an annual rate in the second half of last year to 5.2 percent early this year. And even as payroll employment continued to grow rapidly and the unemployment rate continued to fall, the three-month change in average hourly earnings declined from about 6 percent at an annual rate late last year to 4.5 percent in May, with the moderation in earnings growth particularly notable for employees in the sectors that experienced especially strong wage growth last year, such as leisure and hospitality. Following a period of solid growth, labor productivity softened The extent to which sizable wage gains raise firms’ unit costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. Considerable 14. Change in business-sector output per hour uncertainty remains around the ultimate effects of the pandemic on productivity. Percent, annual rate From 2019 through 2021, productivity growth 4 in the business sector picked up (albeit by 3 less than compensation growth), averaging about 2¼ percent at an annual rate—about 2 1 percentage point faster than the average pace 1 of growth over the previous decade (figure 14). + Some of this pickup in productivity growth _0 might reflect persistent factors. For example, 1 the pandemic resulted in a high rate of new business formation, the widespread adoption 1949– 1974– 1996– 2004– 2009– 2019– 2022 73 95 2003 08 18 21 of remote work technology, and a wave of NOTE: Changes are measured from Q4 of the year immediately labor-saving investments. preceding the period through Q4 of the final year of the period, except 2022 changes, which are calculated from 2021:Q1 to 2022:Q1. SOURCE: Bureau of Labor Statistics via Haver Analytics. The latest reading, however, showed a decline in business-sector productivity in the first quarter of this year. While quarterly productivity data are notoriously volatile, this decline nevertheless highlights the possibility that some of the earlier productivity gains could prove transitory, perhaps reflecting worker effort initially surging in response to employment shortages and hiring difficulties 20 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS and then subsequently returning to more normal levels.10 If the gap between wage growth and productivity growth remains comparably wide in the future, the result will be significant upward pressure on firms’ labor costs. Gross domestic product declined in the first quarter of 2022 after having surged 15. Real gross domestic product in the fourth quarter of 2021 . . . Quarterly Trillions of chained 2012 dollars Real gross domestic product (GDP) is reported to have surged at a 6.9 percent annual rate in 20.0 the fourth quarter of 2021—and then to have 19.5 declined at a 1.5 percent annual rate in the first 19.0 quarter—because of fluctuations in net exports 18.5 and inventory investment (figure 15). These two categories of expenditures are volatile even 18.0 in normal times, and they have been even more 17.5 so in recent quarters. Some improvement in 17.0 supply chain conditions late last year appears to have enabled firms to rebuild depleted 2015 2016 2017 2018 2019 2020 2021 2022 inventories; inventory investment surged in SOURCE: Bureau of Economic Analysis via Haver Analytics. the fourth quarter and then moderated to a still-elevated pace in the first quarter, thereby weighing on GDP growth. Other measures of activity, including employment, industrial production, and gross domestic income, indicate continued growth in the first quarter. . . . while growth in consumer spending and business investment was solid in the first quarter After abstracting from these volatile components, growth in private domestic final demand (consumer spending plus residential and business fixed investment—a measure that tends to be more stable and better reflects the strength of overall economic activity) was solid in the first quarter, supported by some unwinding of supply bottlenecks and a further reopening of the economy. The most recent spending data and other indicators suggest that private fixed investment may be 10. The November 2021 Beige Book reported that many employers were planning to increase hiring because of concerns that their current workforce was being overworked. MONETARy POLICy REPORT: JUNE 2022 21 moderating, but consumer spending remains 16. Real personal consumption expenditures strong and drag from inventory investment Trillions of chained 2012 dollars Trillions of chained 2012 dollars and net exports may be dissipating. As a result, private domestic final demand and real 6.0 9.5 GDP appear on track to rise moderately in the 5.5 9.0 second quarter. 5.0 8.5 Real consumer spending growth 4.5 8.0 Goods remained strong . . . 4.0 7.5 3.5 Real consumer spending—that is, spending 3.0 Services 7.0 after adjusting for inflation—continued to 2.5 6.5 grow briskly, supported by a partial unwinding of supply bottlenecks and continued 2006 2008 2010 2012 2014 2016 2018 2020 2022 normalization of spending patterns as the NOTE: The data are monthly and extend through April 2022. pandemic fades. For example, spending SOURCE: Bureau of Economic Analysis via Haver Analytics. on motor vehicles grew markedly in the 17. Wealth-to-income ratio first quarter, reflecting improvements in both domestic and foreign production, and Quarterly Ratio spending on services (especially at restaurants) 8.5 grew briskly. 8.0 That said, consumer spending growth has 7.5 moderated from its very rapid pace from 7.0 early 2021 as fiscal support has declined 6.5 from historical highs, some households have 6.0 likely depleted excess savings accumulated 5.5 during the pandemic, and inflation has eroded 5.0 households’ purchasing power. 2006 2008 2010 2012 2014 2016 2018 2020 2022 The composition of spending remains more NOTE: The series is the ratio of household net worth to disposable tilted toward goods and away from services personal income. SOURCE: For net worth, Federal Reserve Board, Statistical Release than it was before the pandemic. Real goods Z.1, “Financial Accounts of the United States”; for income, Bureau of Economic Analysis via Haver Analytics. spending is still well above its trend, while real spending on services remains below trend 18. Personal saving rate (figure 16). Nevertheless, the composition continued to shift back toward services. While Monthly Percent goods spending was only modestly higher in 36 April compared with its average from late last 32 year, services spending rose significantly. 28 24 . . . supported by high levels of wealth 20 16 Household wealth grew by roughly $30 trillion 12 between late 2019 and late 2021 because of 8 rises in equity and house prices along with 4 the elevated rate of saving in 2020 and 2021 0 (figures 17 and 18). Since the beginning of the 2006 2008 2010 2012 2014 2016 2018 2020 2022 year, wealth has declined because of the drop NOTE: The data extend through April 2022. in equity prices. Nevertheless, wealth remains SOURCE: Bureau of Economic Analysis via Haver Analytics. 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 19. Consumer credit flows well above pre-pandemic levels, providing continuing support for consumer spending. Billions of dollars, monthly rate Student loans Consumer financing conditions were 40 Auto loans generally accommodative, especially for Credit cards Apr. 30 borrowers with stronger credit scores 20 Financing has been generally available to 10 support consumer spending. Following a + Q1 _0 period of widespread reported easing last year, standards on credit card loans eased somewhat 10 further in the first quarter, whereas those on 20 auto and other consumer loans changed little. Partly reflecting higher credit card purchase 2008 2010 2012 2014 2016 2018 2020 2022 volumes, credit card balances grew rapidly in SOURCE: Federal Reserve Board, Statistical Release G.19, “Consumer Credit.” recent months (figure 19). Even so, many credit card users still have ample unused credit. Auto loans grew briskly during the first quarter, 20. Private housing starts and permits consistent with the concurrent rebound in Monthly Millions of units, annual rate auto sales. 2.0 1.8 Meanwhile, borrowing costs rose. However, 1.6 they remain below pre-pandemic levels for Single-family starts 1.4 credit cards and auto loans, partly reflecting 1.2 strong consumer credit quality. Indeed, 1.0 delinquency rates on consumer loans remain .8 Single-family .6 low relative to historical averages despite some permits .4 recent increases among nonprime borrowers. .2 Multifamily starts 0 Housing construction remained high but 2006 2008 2010 2012 2014 2016 2018 2020 2022 may be moderating . . . NOTE: The data extend through April 2022. New single-family construction has remained SOURCE: U.S. Census Bureau via Haver Analytics. well above pre-pandemic levels. However, new construction may be softening, with 21. Mortgage rates single-family permits turning down some in Weekly Percent March and April (figure 20). As in the past year, still-tight supplies of materials, labor, 5.5 and other inputs may still be restraining new 5.0 construction. Also, builders have become distinctly less optimistic about prospects for 4.5 housing sales, perhaps owing to the sharp rise 4.0 in mortgage rates (figure 21). 3.5 . . . while home sales fell amid low 3.0 inventories and rising mortgage rates 2.5 Home sales stepped down substantially from 2014 2016 2018 2020 2022 the very high levels prevailing late last year NOTE: The data are contract rates on 30-year, fixed-rate conventional and are now close to pre-pandemic levels home mortgage commitments and extend through June 9, 2022. SOURCE: Freddie Mac Primary Mortgage Market Survey. MONETARy POLICy REPORT: JUNE 2022 23 (figure 22). Some of this decline may have 22. New and existing home sales reflected further reductions in inventories Millions, annual rate Millions, annual rate of existing homes to historically low levels early in the year. In addition, the sharp 7.0 1.4 increases in mortgage rates may have begun to 6.5 1.2 moderate housing demand. Even so, financing 6.0 Existing home sales conditions in the residential mortgage market 5.5 1.0 remained accommodative for borrowers who 5.0 .8 met standard loan criteria, and the terms of 4.5 .6 mortgage credit for households with lower 4.0 .4 credit scores continued to ease toward pre- 3.5 pandemic levels. Listings, sales, and price data New home sales .2 3.0 suggest that so far, demand remains strong 2006 2008 2010 2012 2014 2016 2018 2020 2022 relative to the pace at which homes are being made available for sale. For example, the share NOTE: The data are monthly and extend through April 2022. New home sales include only single-family sales. Existing home sales include of homes off market within two weeks remains single-family, condo, and co-op sales. SOURCE: For new home sales, U.S. Census Bureau; for existing home elevated, and as of April, several measures of sales, National Association of Realtors; all via Haver Analytics. national house prices were up about 20 percent from a year earlier, though less in real terms 23. Real prices of existing single-family houses (figure 23). Quarterly 2005:Q1 = 100 Business fixed investment rose strongly 130 in the first quarter but may now be 120 moderating 110 Zillow index Investment in equipment and intangibles S&P/Case-Shiller 100 national index surged at a 12½ percent annual rate in the 90 first quarter (figure 24). Investment demand 80 remained strong, as worker shortages and CoreLogic 70 high-capacity utilization in manufacturing price index 60 likely maintained strong incentives for firms to automate production and boost capital 2006 2008 2010 2012 2014 2016 2018 2020 2022 expenditures. In turn, strong investment NOTE: Series are deflated by the personal consumption expenditures price index. demand continued to boost equipment prices SOURCE: Bureau of Economic Analysis via Haver Analytics; in an environment of constrained supply, CoreLogic Home Price Index; Zillow, Inc., Real Estate Data; S&P/Case-Shiller U.S. National Home Price Index. The S&P/Case-Shiller but there have been initial signs that supply 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 constraints may have begun to ease. In Contents page.) particular, since late last year, shipments of capital goods have begun to catch up with orders. The most recent indicators suggest that the growth of investment in equipment and intangibles will slow significantly in the second quarter, possibly reflecting drag from tighter financial conditions. Investment in nonresidential structures declined moderately in the first quarter after falling more rapidly over the second half of 24 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 24. Real business fixed investment 2021, and it appears on track to decline again in the second quarter. Declines in spending on Billions of chained 2012 dollars Billions of chained 2012 dollars nondrilling structures have been only partly Equipment and 2,600 offset by rapid increases in drilling investment, 650 intangible capital 2,400 which reflect the recent rise in energy prices. 600 2,200 550 Business financing conditions tightened 2,000 somewhat but remained generally 500 1,800 accommodative 1,600 450 1,400 Credit remained available to most nonfinancial 400 Structures 1,200 corporations, but financing conditions 350 1,000 tightened somewhat, especially for lower- rated firms. Gross nonfinancial corporate 2007 2010 2013 2016 2019 2022 bond issuance was solid in the first quarter NOTE: Business fixed investment is known as “private nonresidential fixed investment” in the national income and product accounts. The data but slowed somewhat in April and May, with are quarterly. SOURCE: Bureau of Economic Analysis via Haver Analytics. speculative-grade bond issuance particularly weak. Leveraged loan issuance also declined notably in May, partly reflecting weakening demand from retail investors. The growth of business loans at banks picked up from the subdued pace of last year, reflecting stronger loan originations as well as a moderation in loan forgiveness associated with the Paycheck Protection Program. Credit also remained broadly available to small businesses. The share of small firms reporting that it was more difficult to obtain loans (compared with three months earlier) remained low by historical standards. Loan origination data through April were consistent with credit availability being comparable with pre-pandemic levels amid gradually 25. Real imports and exports of goods recovering demand for small business credit. and services Most measures of loan performance remained largely stable; through April, default and Quarterly Billions of chained 2012 dollars delinquency rates remained below their pre- 4,000 pandemic levels. 3,750 3,500 Imports The strong U.S. demand has partly been 3,250 met through a rapid rise in imports 3,000 2,750 Exports 2,500 Driven by the continued strength in domestic 2,250 economic activity, including still-strong 2,000 demand for goods consumption, U.S. imports 1,750 continued to grow at a rapid pace, surging well 1,500 above their pre-pandemic trend (figure 25). 2008 2010 2012 2014 2016 2018 2020 2022 High levels of imported goods have kept SOURCE: Bureau of Economic Analysis via Haver Analytics. international logistics channels operating MONETARy POLICy REPORT: JUNE 2022 25 under high pressure, which has continued to 26. U.S. trade and current account balances impair the timely delivery of goods to U.S. Quarterly Percent of nominal GDP customers. Real goods exports have only + recovered to pre-pandemic levels. Real exports _0 and imports of services remain subdued, 1 reflecting a slow recovery of international 2 travel. Given the recent strength of imports 3 relative to the milder recovery in exports, the 4 nominal trade deficit widened further as a Trade share of GDP (figure 26). 5 6 The support to economic activity Current account 7 provided by federal fiscal actions continued to diminish . . . 2001 2004 2007 2010 2013 2016 2019 2022 NOTE: GDP is gross domestic product. Current account balance data In response to the pandemic, the federal extend through 2021:Q4. SOURCE: Bureau of Economic Analysis via Haver Analytics. government enacted fiscal policies to address the economic consequences of the pandemic. Because the boost to spending from these policies ended last year, the effects on demand are likely waning this year and weighing on GDP growth. . . . and, in turn, the budget deficit has fallen sharply from pandemic highs, and the growth of federal debt has moderated The Congressional Budget Office estimates that fiscal policies enacted since the start of the pandemic will increase federal deficits roughly $5.4 trillion by the end of fiscal year 2030, with the largest deficit effects having occurred in fiscal 2020 and 2021.11 These policies, combined with the effects of the automatic stabilizers—the reduction in tax receipts and increase in transfers that occur as a consequence of depressed economic 11. For more information, see Congressional Budget Office (2020), “The Budgetary Effects of Laws Enacted in Response to the 2020 Coronavirus Pandemic, March and April 2020,” June, https://www.cbo.gov/system/files/2020- 06/56403-CBO-covid-legislation.pdf; Congressional Budget Office (2021), “The Budgetary Effects of Major Laws Enacted in Response to the 2020–21 Coronavirus Pandemic, December 2020 and March 2021,” September, https://www.cbo.gov/system/files/2021-09/57343- Pandemic.pdf; and Congressional Budget Office (2021), “Senate Amendment 2137 to H.R. 3684, the Infrastructure Investment and Jobs Act, as Proposed on August 1, 2021,” August 9, https://www.cbo.gov/system/ files/2021-08/hr3684_infrastructure.pdf. 26 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 27. Federal receipts and expenditures activity—caused the federal deficit to surge to 15 percent of nominal GDP in fiscal 2020 and Annual Percent of nominal GDP remain elevated at 12½ percent in fiscal 2021. 32 But with pandemic fiscal programs having 30 largely ended and receipts surging, the deficit 28 has fallen sharply thus far in fiscal 2022 relative 26 to fiscal 2021 and, by the end of the fiscal year, Expenditures 24 is expected to be close to the deficits prevailing 22 just before the pandemic (figure 27). Receipts 20 18 As a result of the fiscal support enacted during 16 the pandemic, federal debt held by the public 14 jumped to around 100 percent of nominal 1997 2002 2007 2012 2017 2022 GDP in fiscal 2020—the highest debt-to- NOTE: Through 2021, the receipts and expenditures data are on a GDP ratio since 1947 (figure 28). But with unified-budget basis and are for fiscal years (October to September); gross domestic product (GDP) is for the 4 quarters ending in Q3. For deficits falling and economic growth having 2022, receipts and expenditures are for the 12 months ending in May; rebounded, the debt-to-GDP ratio has since GDP is the average of 2021:Q4 and 2022:Q1. SOURCE: Department of the Treasury, Financial Management Service; receded slightly from its recent peak. Office of Management and Budget and Bureau of Economic Analysis via Haver Analytics. State and local government budget 28. Federal government debt and net interest outlays positions are remarkably strong . . . Percent of nominal GDP Percent of nominal GDP Federal policymakers provided a historic Net interest outlays level of fiscal support to state and local 3.5 on federal debt 120 governments during the pandemic, with 3.0 100 aid totaling about $1 trillion. This aid has more than covered pandemic-related budget 2.5 80 shortfalls in the aggregate. Moreover, following 2.0 60 the pandemic-induced slump, total state tax 1.5 40 collections—pushed up by the economic 1.0 20 expansion—rose appreciably in 2021 and Debt held by the public continued to grow rapidly in early 2022 .5 0 (figure 29). In turn, this recovery in revenues 1902 1922 1942 1962 1982 2002 2022 has led some state governments to enact or NOTE: The data for net interest outlays are annual, begin in 1948, and consider enacting tax cuts. At the local level, extend through 2021. Net interest outlays are the cost of servicing the property taxes have continued to rise apace, debt held by the public. Federal debt held by the public equals federal debt less Treasury securities held in federal employee defined-benefit and the typically long lags between changes retirement accounts, evaluated at the end of the quarter. The data for federal debt are annual from 1901 to 1951 and quarterly thereafter. GDP in the market value of real estate and changes is gross domestic product. in tax collections suggest that property tax SOURCE: For GDP, Bureau of Economic Analysis; for federal debt, Congressional Budget Office and Federal Reserve Board, Statistical revenues will rise quite substantially going Release Z.1, “Financial Accounts of the United States.” forward, given the rise in house prices. . . . but hiring and construction outlays have continued to lag Despite the return to in-person schooling and the strong fiscal position of state and local governments, state and local government payrolls continued to expand only modestly in the first half of 2022. Employment levels MONETARy POLICy REPORT: JUNE 2022 27 have regained about 60 percent of their sizable 29. State and local tax receipts pandemic losses, falling well short of the Percent change from year earlier recovery in private payrolls (figure 30). One reason for this disparity appears to be that 30 public-sector wages have not kept pace with Total state taxes 25 the rapid gains in the private sector, which may 20 be inhibiting the ability of these governments 15 to staff back up to pre-pandemic levels. Property taxes 10 Meanwhile, real construction outlays by state and local governments continued to decline 5 + in the first half of the year and are currently _0 about 15 percent below pre-pandemic levels. 5 2012 2014 2016 2018 2020 2022 Financial Developments NOTE: State tax data are year-over-year percent changes of 12-month moving averages, begin in June 2012, extend through April 2022, and are aggregated over all states except Wyoming, for which data are not The expected level of the federal funds available. Revenues from Washington, D.C., are also excluded. Data are missing for March 2022 to April 2022 for New Mexico and Oregon and rate over the next few years shifted up April 2022 for Nevada, as these states have longer reporting lags than substantially others. Property tax data are year-over-year percent changes of 4-quarter moving averages, begin in 2012:Q2, extend through 2021:Q4, and are primarily collected by local governments. In March, May, and June, the FOMC raised SOURCE: Monthly State Government Tax Revenue Data via Urban Institute; U.S. Census Bureau, Quarterly Summary of State and Local the target range for the federal funds rate a Government Tax Revenue. total of 1½ percentage points. The expected path of the federal funds rate over the next few 30. State and local government payroll employment years also shifted up substantially since late February (figure 31). Economic data releases Monthly Millions of jobs and FOMC communications were viewed 20.5 by market participants as implying tighter monetary policy than previously expected. 20.0 Market-based measures suggest that investors 19.5 anticipate the federal funds rate to exceed 3.6 percent by the end of this year, which is 19.0 about 2 percentage points higher than the level 18.5 expected in late February. The same measures suggest that the federal funds rate is expected 18.0 to peak at about 4 percent in mid-2023 before gradually declining to about 3.1 percent by 2006 2008 2010 2012 2014 2016 2018 2020 2022 the end of 2025, which is about 1.4 percentage SOURCE: Bureau of Labor Statistics via Haver Analytics. points higher than the end-2025 rate expected in late February. Similarly, according to the results of the Survey of Primary Dealers and the Survey of Market Participants, both conducted by the Federal Reserve Bank of New York in April, the median of respondents’ projections for 28 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 31. Market-implied federal funds rate path the most likely path of the federal funds rate shifted up significantly since January.12 Quarterly Percent 4.5 Before late February, the expected path of 4.0 the federal funds rate had started to increase June 14, 2022 3.5 notably in the third quarter of last year, in 3.0 anticipation of increases in the target range. February 25, 2022 2.5 Consistent with the rise in the expected 2.0 path of the federal funds rate, yields on 1.5 Treasury securities and corporate bonds, as 1.0 well as mortgage rates, all started to increase .5 materially at a similar time. Meanwhile, 0 broad equity price indexes have declined 2022 2023 2024 2025 2026 on net. Overall, these moves in asset prices NOTE: The federal funds rate path is implied by quotes on overnight suggest tightening of financial conditions even index swaps—a derivative contract tied to the effective federal funds rate. The implied path as of February 25, 2022, is compared with that as of before the initial increase in the target range June 14, 2022. The path is estimated with a spline approach, assuming a term premium of 0 basis points. The February 25, 2022, path extends of the federal funds rate occurred in March through 2026:Q1 and the June 14, 2022, path through 2026:Q2. (figure 32). SOURCE: Bloomberg; Federal Reserve Board staff estimates. 32. Financial market indicators Yields on U.S. nominal Treasury securities also rose considerably Daily Percent Yields on nominal Treasury securities across 7 maturities have risen considerably since late Investment-grade corporate 6 February (figure 33). After a brief dip in Mortgage rate 5 late February, following Russia’s invasion 4 of Ukraine, yields rose steadily amid higher 3 inflationary pressures and associated 2 expectations for monetary policy tightening. 10-year Treasury 1 The increases in nominal Treasury yields 0 were primarily accounted for by rising real yields. Uncertainty about longer-term 2015 2016 2017 2018 2019 2020 2021 2022 interest rates—as measured by the implied NOTE: Investment-grade corporate reflects the effective yield of the volatility embedded in the prices of near-term ICE Bank of America Merrill Lynch triple-B U.S. Corporate Index (C0A4). The mortgage rate is contract rates on 30-year, fixed-rate options on 10-year interest rate swaps—also conventional home mortgage commitments. Mortgage rate data extend through June 9, 2022. increased significantly, reportedly reflecting, SOURCE: Department of the Treasury via Haver Analytics; Freddie in part, an increase in uncertainty about the Mac Primary Mortgage Market Survey; ICE Data Indices, LLC, used with permission. policy outlook. 33. Yields on nominal Treasury securities Yields on other long-term debt increased Daily Percent substantially 5-year 4 Across credit categories, corporate bond yields have increased substantially and 10-year 3 2 12. The results of the Survey of Primary Dealers and the Survey of Market Participants are available 2-year 1 on the Federal Reserve Bank of New York’s website at https://www.newyorkfed.org/markets/primarydealer_ 0 survey_questions.html and https://www.newyorkfed.org/ markets/survey_market_participants, respectively. 2012 2014 2016 2018 2020 2022 SOURCE: Department of the Treasury via Haver Analytics. MONETARy POLICy REPORT: JUNE 2022 29 spreads over yields on comparable-maturity 34. Corporate bond yields, by securities rating, and Treasury securities have increased notably municipal bond yield since late February. Corporate bond yields Daily Percent and spreads are somewhat above the historical median values of their respective Investment-grade corporate 12 High-yield corporate historical distributions since the mid-1990s 10 (figure 34). Municipal bond yields also 8 increased significantly while spreads increased somewhat since late February. Spreads on 6 municipal bonds are now moderately above 4 their historical medians. On net, corporate 2 bond spreads are moderately above their pre- Municipal 0 pandemic levels, and municipal bond spreads are near levels prevailing shortly before the 2010 2012 2014 2016 2018 2020 2022 pandemic. While the widening of corporate NOTE: Investment-grade corporate reflects the effective yield of the bond spreads since late February appears ICE Bank of America Merrill Lynch (BofAML) triple-B U.S. Corporate Index (C0A4). High-yield corporate reflects the effective yield of the ICE to partly reflect a deterioration in market BofAML High Yield Index (H0A0). Municipal reflects the yield to worst expectations of future credit quality, corporate of the ICE BofAML U.S. Municipal Securities Index (U0A0). SOURCE: ICE Data Indices, LLC, used with permission. and municipal credit quality thus far in 2022 have remained strong. So far this year, defaults have been low, and upgrades of bond ratings have outpaced downgrades in both markets. 35. Yield and spread on agency mortgage-backed securities Since late February, yields on agency mortgage-backed securities (MBS)—an Percent Basis points important pricing factor for home mortgage 250 rates—increased significantly, as longer-term 5 Yield Treasury yields increased and spreads over 200 4 comparable-maturity Treasury securities 150 widened (figure 35). MBS spreads increased as 3 market participants’ expectations of a gradual 100 reduction in the Federal Reserve’s balance 2 50 sheet shifted to a faster reduction. Spread 1 0 Broad equity price indexes declined sharply, on net, amid substantial volatility 2012 2014 2016 2018 2020 2022 NOTE: The data are daily. Yield shown is for the uniform mortgage-backed securities 30-year current coupon, the coupon rate at Broad equity price indexes were volatile and which new mortgage-backed securities would be priced at par, or face, declined sharply, on net, amid sustained value, for dates after May 31, 2019; for earlier dates, the yield shown is for the Fannie Mae 30-year current coupon. Spread shown is to the inflation pressures and expectations of average of the 5-year and 10-year nominal Treasury yields. SOURCE: Department of the Treasury; J.P. Morgan. Courtesy of J.P. monetary policy tightening, as well as Morgan Chase & Co., Copyright 2022. heightened uncertainty regarding Russia’s invasion of Ukraine and the economic outlook (figure 36). Bank stock prices also declined on net. One-month option-implied volatility on the S&P 500 index—the VIX—rose notably to elevated levels in the days following Russia’s invasion of Ukraine. The VIX trended down for some time only to increase again and 30 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 36. Equity prices remain elevated since late April amid a notable deterioration in risk sentiment (figure 37). (For Daily December 31, 2010 = 100 a discussion of financial stability issues, see 400 the box “Developments Related to Financial Stability.”) 350 300 Markets for Treasury securities, mortgage- 250 backed securities, corporate and S&P 500 index 200 municipal bonds, and equities generally 150 functioned in an orderly way, but some Dow Jones bank index 100 measures of liquidity deteriorated 50 Liquidity conditions in the market for Treasury securities, which had deteriorated 2012 2014 2016 2018 2020 2022 somewhat since late 2021, in part as a result SOURCE: S&P Dow Jones Indices LLC via Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.) of heightened interest rate risk, worsened further in late February following Russia’s 37. S&P 500 volatility invasion of Ukraine. Market depth—a gauge of the ability to transact in large volumes at Daily Percent quotes posted by market makers—for Treasury 90 securities fell and remains at historically low 80 levels. Bid-ask spreads increased somewhat. 70 However, trading volumes remained within 60 normal ranges, suggesting that market 50 VIX functioning was not materially impaired. 40 The decreases in depth were the greatest for 30 bonds with shorter maturities because the 20 prices of those securities are more sensitive to 10 Expected volatility expectations for monetary policy over the near 0 term. The market for MBS has functioned 2010 2012 2014 2016 2018 2020 2022 in an orderly way since late February, even NOTE: The VIX is a measure of implied volatility that represents the as some measures of liquidity conditions expected annualized change in the S&P 500 index over the following 30 days. The expected volatility series shows a forecast of 1-month deteriorated. Measures of market functioning realized volatility, using a heterogeneous autoregressive model based on 5-minute S&P 500 returns. in corporate and municipal bond markets SOURCE: Cboe Volatility Index® (VIX®) via Bloomberg; Refinitiv indicated that the markets have remained DataScope; Federal Reserve Board staff estimates. liquid and trading conditions have stayed stable since late February without substantive disruptions around the time of Russia’s invasion of Ukraine. Transaction costs in the corporate bond market and in the municipal bond market have both picked up somewhat since late February, and in the corporate bond market, bid-ask spreads are modestly above pre-pandemic levels. Transaction costs remain fairly low by historical standards.. Liquidity in equity markets has declined since late 2021 in part because of rising uncertainty about the outlook for monetary policy as well as Russia’s invasion of Ukraine and has remained MONETARy POLICy REPORT: JUNE 2022 31 Developments Related to Financial Stability This discussion reviews vulnerabilities in the U.S. previously very elevated levels but were still above fi nancial system. The framework used by the Federal their historical median. Corporate-to-Treasury spreads Reserve Board for assessing the resilience of the U.S. widened but remained below their historical median. fi nancial system focuses on fi nancial vulnerabilities Spreads on leveraged loans were little changed, and in four broad areas: asset valuations, business and leveraged loan issuance remained solid. House prices household debt, leverage in the fi nancial sector, and continued to rise at a rapid pace that further outstripped funding risks. With infl ation running higher than rent growth. Commercial real estate prices also rose expected, the invasion of Ukraine, and the pandemic’s further, with some price indexes surpassing their continued effects on supply chains and consumer 2006 peaks. demand patterns, uncertainty about the economic The rapid growth of nominal GDP outpaced the outlook increased, and prices of some fi nancial assets growth of total debt of nonfi nancial businesses and fl uctuated widely. Treasury yields increased markedly, households. The ratio of the aggregate debt owed by and valuation pressures in corporate securities markets the private nonfi nancial sector to nominal GDP further eased, but real estate prices have risen further this year declined to near pre-pandemic levels (fi gure A). Net despite a rise in mortgage rates. While business and leverage of large nonfi nancial businesses held stable at household debt has been growing solidly, the ratio of (continued on next page) private nonfi nancial credit to gross domestic product (GDP) decreased to near pre-pandemic levels and most indicators of credit quality remained robust. Large bank A. Private nonfinancial-sector credit-to-GDP ratio capital ratios dipped in the fi rst quarter, but overall leverage in the fi nancial sector appears moderate Quarterly Ratio and little changed this year. A few signs of funding pressures emerged amid the escalation of geopolitical 1.8 tensions. However, broad funding markets proved resilient, and with direct exposures of U.S. fi nancial 1.6 institutions to Russia and Ukraine being small, fi nancial 1.4 spillovers have been limited to date. Nevertheless, the effect of high infl ation, supply chain disruptions, and 1.2 the ongoing geopolitical tensions remain substantial sources of uncertainty with the potential to further 1.0 stress the fi nancial system. valuation measures based on current expectations .8 of cash fl ows decreased in some markets but continued to be high relative to historical norms. Refl ecting a less 1982 1987 1992 1997 2002 2007 2012 2017 2022 accommodative monetary policy stance associated NOTE: The shaded bars indicate periods of business recession as with elevated infl ation and a tight labor market, yields defined by the National Bureau of Economic Research: January 1980–July 1980, July 1981–November 1982, July 1990–March 1991, on Treasury securities increased markedly and reached March 2001–November 2001, December 2007–June 2009, and February somewhat above their pre-pandemic levels. Broad 2020–April 2020. GDP is gross domestic product. equity prices fl uctuated widely and declined sharply. SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; Bureau of Economic Analysis, national Prices relative to earnings forecasts declined from income and product accounts; Federal Reserve Board staff calculations. 32 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability (continued) below pre-pandemic levels, supported by ample cash have been directly affected by the Russia–Ukraine holdings. Fueled by strong earnings and low borrowing confl ict, but loan exposures of large U.S. banks to costs, the ratio of earnings to interest expenses for the these fi rms and borrowers in Ukraine and Russia are median fi rm among public nonfi nancial businesses rose small. However, several indirect channels—heightened to its highest level in two decades, indicating that large volatility in asset markets; new disruptions in payment, fi rms were better able to service debt. However, for clearing, or settlement systems; and interconnections fi rms in industries hit hardest by the pandemic, leverage with large European banks—could adversely affect the remains elevated and interest coverage ratios are lower. U.S. economy and fi nancial system. The fi nancial position of many households continued to Funding risks at domestic banks and broker- improve. Household debt relative to nominal GDP as dealers are low, but structural vulnerabilities persist at well as mortgage, auto, and credit card delinquencies some money market funds (MMFs), bond funds, and were in the bottom range of the levels observed over stablecoins. Banks relied only modestly on short-term the past 20 years. Household credit growth has been wholesale funding, and the share of high-quality liquid almost exclusively among prime-rated borrowers, assets at banks remained historically high. Assets including for residential mortgages. Nonetheless, under management at prime and tax-exempt MMFs some households remained fi nancially strained and have continued to decline, but these funds remain a vulnerable to adverse shocks during this period of structural vulnerability due to their susceptibility to heightened uncertainty. runs. In December 2021, the Securities and Exchange vulnerabilities from fi nancial-sector leverage are Commission proposed reforms to MMFs, including well within their historical range. Risk-based capital the adoption of swing pricing for certain fund types, ratios at domestic bank holding companies declined increased liquidity requirements, and other measures some in the fi rst quarter of 2022 but remained well meant to make them more resilient to redemptions. The above regulatory requirements. Banks increased loan Russian invasion of Ukraine does not appear to have loss provisions to refl ect higher uncertainty about left a material imprint on broader short-term funding the economic outlook and continued to report that markets. Trading conditions in those markets have been rising interest rates will support their profi tability stable, issuance continued, and spreads remained well going forward. However, higher interest rates cause below the levels reached in March 2020. Although losses in the market value of banks’ long-term fi xed- depth in markets for Treasury securities and some rate assets. Leverage remained high at life insurance commodity and equity derivatives has been low by companies and was likely somewhat elevated at hedge historical standards, those markets have functioned funds, though the most comprehensive data for hedge normally after the initial shock to the nickel market. funds are considerably lagged. vulnerabilities of most Elevated market volatility—particularly in commodity U.S. fi nancial institutions to the Russian invasion of markets—caused central counterparties (CCPs) to make Ukraine appear to be limited. Some nonbank fi nancial larger margin calls. To date, clearing members have intermediaries—such as commodity trading fi rms— (continued) MONETARy POLICy REPORT: JUNE 2022 33 been able to meet these margin calls, and, in general, infl ation and greater-than-expected increases in interest CCPs effectively managed the increased risks and rates could negatively affect domestic economic higher trading volumes. activity, asset prices, credit quality, and fi nancial The aggregate value of stablecoins—digital assets conditions more generally. As concerns over cyber risk that aim to maintain a stable value relative to a have increased, U.S. government agencies and their national currency or other reference assets—grew private-sector partners have been stepping up their rapidly over the past year to more than $180 billion efforts to protect the fi nancial system and other critical in March 2022. The stablecoin sector remained highly infrastructures. These risks, if realized, could interact concentrated, with the three largest stablecoin issuers— with fi nancial vulnerabilities and pose additional risks Tether, USD Coin, and Binance USD—constituting to the U.S. fi nancial system. more than 80 percent of the total market value. The collapse in the value of certain stablecoins and Invasion of Ukraine and Commodity Markets recent strains experienced in markets for other digital assets demonstrate the fragility of such structures. Russia’s invasion of Ukraine and subsequent More generally, stablecoins that are not backed by international sanctions disrupted global trade in safe and suffi ciently liquid assets and are not subject commodities, leading to surging prices and heightened to appropriate regulatory standards create risks to volatility in agriculture, energy, and metals markets. investors and potentially to the fi nancial system, These markets include spot and forward markets for including susceptibility to potentially destabilizing runs. physical commodities as well as futures, options, These vulnerabilities may be exacerbated by a lack of and swaps markets that involve an array of fi nancial transparency regarding the riskiness and liquidity of intermediaries and infrastructures. Stresses in fi nancial assets backing stablecoins. In addition, the increasing markets linked to commodities could disrupt the use of stablecoins to meet margin requirements for effi cient production, processing, and transportation levered trading in other cryptocurrencies may amplify of commodities by interfering with the ability of volatility in demand for stablecoins and heighten commodity producers, consumers, and traders to redemption risks. The President’s Working Group hedge risks. Such stresses can also increase liquidity on Financial Markets, the Federal Deposit Insurance and credit risks for fi nancial institutions that are active Corporation, and the Offi ce of the Comptroller of the in commodity markets. To date, however, fi nancial Currency have made recommendations to address market stresses do not appear to have exacerbated prudential risks posed by stablecoins. the negative effects on broader economic activity A routine survey of market contacts on salient or created substantial pressure on key fi nancial shocks to fi nancial stability highlights several important intermediaries, including banks. Since the invasion, for risks. Stresses in Europe related to Russia’s invasion of most commodities, futures trading volumes and open Ukraine or in emerging markets could spill over to the interest—the number of contracts outstanding at the United States. In addition, higher or more persistent end of the day—have remained in normal ranges. 34 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS at low levels since then. Market depth based on the S&P 500 futures is below pre-pandemic levels and currently in the bottom decile of its historical distribution since 2018. Short-term funding market conditions remained stable . . . Conditions in money markets have been stable and orderly. Increases in the target range for the federal funds rate fully passed through to market overnight rates. The effective federal funds rate and other unsecured overnight rates have been a few basis points below the interest rate on reserve balances since late February. The Secured Overnight Financing Rate has been at or below the offering rate at the overnight reverse repurchase agreement (ON RRP) facility, given ample liquidity and a limited supply of Treasury bills. Softness in repurchase agreement rates contributed to ongoing increases in ON RRP take-up, which reached an average of around $2.1 trillion per day in June. Russia’s invasion of Ukraine does not appear to have left a material imprint in the broad U.S. dollar funding markets to date. In late February and early March, spreads on some longer-tenor commercial paper and negotiable certificates of deposit increased notably amid uncertainties around monetary policy tightening and Russia’s invasion of Ukraine. These spreads have broadly narrowed since mid-March. 38. Ratio of total commercial bank credit to nominal gross domestic product Weighted average maturities for money market Quarterly Percent funds (MMFs) stand at low levels, as MMFs tend to adjust their portfolios toward shorter- 80 tenor instruments to position for rising interest rates around monetary policy tightening cycles. 75 70 Bank credit expanded in the first quarter amid strong loan demand 65 Strong loan growth pushed the ratio of bank 60 credit to GDP higher in the first quarter 55 (figure 38). The acceleration in growth was broad based, with balance growth accelerating 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 for most major loan categories. Growth SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and was particularly strong for commercial and Liabilities of Commercial Banks in the United States”; Bureau of Economic Analysis via Haver Analytics. industrial and credit card loans, for which MONETARy POLICy REPORT: JUNE 2022 35 demand continued to strengthen in the first quarter according to the April 2022 Senior Loan Officer Opinion Survey on Bank Lending Practices. More recently, loan growth moderated somewhat in May amid higher rates and a more uncertain economic outlook 39. Profitability of bank holding companies but remained strong. Bank profitability also remained strong but fell somewhat in the Percent, annual rate Percent, annual rate first quarter, in part as a result of declines 2.0 30 in investment banking revenue and the Return on assets 1.5 fading boost to profitability from the release 20 1.0 in previous quarters of loan loss reserves 10 .5 accumulated in 2020 (figure 39). Nevertheless, + + _0 _0 higher interest rates and strong loan demand .5 Return on equity 10 are expected to support bank profitability in 1.0 the near term. Delinquency rates on bank 20 1.5 loans remained low. 30 2.0 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 International Developments NOTE: The data are quarterly. SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies. Economic activity continued to recover abroad . . . Economic activity continued to recover in many foreign economies in the first quarter, albeit at a slower pace than last year’s 40. Unemployment rate in selected advanced foreign strong performance. The still-robust growth economies in many foreign economies reflected the recovery in many parts of the world from Monthly Percent previous pandemic shocks amid progress on 14 vaccinations and a greater ability to cope Euro area with outbreaks without extensive lockdowns. 12 Moreover, unemployment rates in many 10 advanced foreign economies (AFEs) continued Canada 8 to decline and are now below their pre- 6 pandemic levels (figure 40). 4 More recently, headwinds from the war in United Kingdom Japan 2 Ukraine and COVID-19 lockdowns in China weighed on the foreign recovery. The slowing 2006 2008 2010 2012 2014 2016 2018 2020 2022 of activity has been particularly sharp in NOTE: The data for the United Kingdom extend through March 2022 and are centered 3-month averages of monthly data. The data for the China, with recent indicators plunging amid euro area and Japan extend through April 2022. COVID-related mobility restrictions. In SOURCE: For the United Kingdom, Office for National Statistics; for Japan, Ministry of Health, Labour and Welfare; for the euro area, Europe, recent indicators also show a sharp Statistical Office of the European Communities; for Canada, Statistics Canada; all via Haver Analytics. slowing, reflecting lower real incomes, reduced confidence of households and businesses in the economy, and continued supply chain disruptions. 36 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS . . . while foreign inflation remained on the rise in most economies . . . As in the United States, inflation in many foreign economies has continued to rise. Soaring energy prices have remained a major driver of higher inflation in AFEs, and rising food prices accounted for most of the increase in inflation in emerging market economies (EMEs). Food and energy price rises have made up the bulk of the increase, though supply chain disruptions have contributed as well, and inflationary pressures have broadened as elevated input costs are increasingly passed through to prices of goods and services. (See the box “Global Inflation.”) . . . and many foreign central banks are tightening monetary policy In response to elevated inflation and broadening price pressures, many AFE central banks increased policy rates, and some started to reduce the size of their balance sheets. Concerns over the persistence of inflationary pressures led several EME central banks, primarily those in Latin America, to raise their policy rates further. Several central banks in emerging Asia, where inflation had been more subdued but has recently begun to rise, also started to raise policy rates. (See the box “Monetary Policy in Foreign Economies.”) 41. Nominal 10-year government bond yields in selected advanced foreign economies Financial conditions abroad tightened since the beginning of the year . . . Weekly Percent As central banks raised interest rates or 6 signaled that they would do so soon, market- United Kingdom 5 based policy expectations and sovereign 4 bond yields rose significantly in many AFEs Germany Canada 3 (figure 41). The rise in sovereign bond yields 2 reflects increases in both real yields, arising 1 from less accommodative central bank + _0 communications, and inflation compensation. Since the start of the year, short- and medium- 1 term inflation compensation measures in 2006 2008 2010 2012 2014 2016 2018 2020 2022 the euro area rose more than in many other NOTE: The data are weekly averages of daily benchmark yields and AFEs, reflecting the region’s larger exposure extend through June 10, 2022. SOURCE: Bloomberg. to the inflationary pressures stemming from Russia’s invasion of Ukraine. Sovereign bond MONETARy POLICy REPORT: JUNE 2022 37 Global Infl ation Over the past year, infl ation increased rapidly in The recent surge in foreign infl ation was mainly many foreign economies, refl ecting soaring commodity concentrated in volatile components, such as food and prices, pandemic-related supply disruptions, and energy prices, with these components contributing imbalances between demand for goods and services much more to infl ation in recent months than in pre- (fi gure A). More recently, the war in Ukraine and the pandemic years (fi gure B). In particular, energy prices renewals of COvID-19 lockdowns in China have accounted for almost half of the 12-month headline amplifi ed infl ationary pressures, particularly through infl ation rate for the advanced foreign economies (AFEs) higher food and energy prices. in April. Meanwhile, food prices are driving infl ation in emerging market economies, largely due to the war A. Consumer price inflation in foreign economies and its threat to already fragile food security in these economies. Monthly 12-month percent change Price pressures have recently broadened to core infl ation, as elevated input costs have been increasingly 8 passed through to prices of goods and services that have not been directly affected by supply disruptions 6 and soaring commodity prices. This broadening EMEs ex China of infl ationary pressure is refl ected in increases in 4 the share of categories of core goods and services prices rising more than 3 percent in most major AFEs 2 (fi gure C). Furthermore, the rebalancing of demand AFEs ex Japan + _0 away from goods toward services—which would have reduced upward pressures on prices of goods—has 2 been slower than expected so far, contributing to the persistence of infl ation pressures. 2016 2017 2018 2019 2020 2021 2022 Persistent and widening price pressures are also NOTE: The advanced foreign economy (AFE) aggregate is the average evident in increases in market- and survey-based of Canada, the euro area, and the United Kingdom, weighted by U.S. infl ation expectations, although these expectations goods imports. The emerging market economy (EME) aggregate is the generally remain anchored in historical ranges average of Brazil, Chile, Colombia, Hong Kong, India, Indonesia, Malaysia, Mexico, Philippines, Singapore, South Korea, Taiwan, and (fi gure D). Even though such increases in infl ation Thailand, weighted by U.S. goods imports. The inflation measure is the expectations might be a welcome development for Harmonised Index of Consumer Prices for the euro area and the consumer price index for other economies. economies such as Japan and the euro area that have SOURCE: Haver Analytics. experienced persistently below-target infl ation in recent decades, many foreign central banks have been tightening monetary policy amid broadened price pressures and tight labor markets. (continued on next page) 38 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Global Infl ation (continued) B. Foreign consumer price inflation components Advanced foreign economies ex Japan Emerging market economies ex China Percent Percent Energy Energy Food 8 Food 8 Core Core 7 7 6 6 5 5 4 4 3 3 2 2 1 1 2017–19 avg. April 2022 2017–19 avg. 2022:Q2 NOTE: The advanced foreign economy (AFE) aggregate is the average of Canada, the euro area, and the United Kingdom, weighted by U.S. goods imports. The emerging market economy (EME) aggregate is the average of Argentina, Brazil, Chile, Colombia, Hong Kong, India, Israel, Mexico, Russia, Saudi Arabia, Singapore, South Korea, and the 5 original member countries of the Association of Southeast Asian Nations, weighted by U.S. goods imports. The inflation measure is the Harmonised Index of Consumer Prices for the euro area and the consumer price index for other economies. The key identifies bars in order from top to bottom. The data are 12-month percent changes for AFEs and 4-quarter percent changes for EMEs. SOURCE: Haver Analytics. C. Diffusion index for foreign core prices D. 5-to-10-year inflation swaps Monthly Share of prices rising more than 3 percent Daily Percent 70 5 60 United Kingdom United Kingdom 4 50 3 40 Euro area 2 30 1 20 Canada Japan + 10 _0 Euro area 0 1 2016 2017 2018 2019 2020 2021 2022 2012 2014 2016 2018 2020 2022 NOTE: The data use the 12-month rise in prices. The prices of items are NOTE: The euro-area and United Kingdom data have been adjusted weighted according to their usual weights in the consumer price index using an interpolated price index to mitigate rollover jumps at and the Harmonised Index of Consumer Prices. The data extend through month-ends. The United Kingdom’s inflation swaps are based on the April 2022. retail price index (RPI). RPI inflation is, on average, 75 to 100 basis SOURCE: Haver Analytics; Federal Reserve Board staff calculations. points higher than consumer price index inflation. The data are at a business-day frequency. SOURCE: Bloomberg; Haver Analytics; Federal Reserve Board staff calculations. MONETARy POLICy REPORT: JUNE 2022 39 Monetary Policy in Foreign Economies With infl ation rising sharply across the globe, central followed with additional rate hikes in subsequent banks have broadly shifted toward tighter monetary meetings, taking its policy rate to 1 percent in May. The policy. Policy tightening started last year, as some Bank of Canada (BOC) began raising its policy rate in emerging market central banks—particularly those in March with a 25 basis point hike. In response to sharply Latin America—increased policy rates out of concern that higher infl ation and the view that economic slack in sharp increases in infl ation could become entrenched the Canadian economy had been absorbed, the BOC in infl ation expectations. Among the advanced foreign followed with hikes of 50 basis points each in April economies (AFEs), central banks of some smaller and June, bringing the policy rate to 1.5 percent. As economies (New Zealand and Norway) with particularly infl ation concerns grew more widespread, the Reserve strong recoveries were the fi rst to hike their policy rates Bank of Australia (RBA) and the Swedish Riksbank last autumn, while policy expectations for some major pivoted sharply to hike rates in May, and the European AFE central banks began to rise sharply (fi gure A). Central Bank (ECB) recently stated that it intends to start Last December, the Bank of England (BOE) raised raising its policy rate in July. its policy rate from 0.1 percent to 0.25 percent, citing Supporting the overall thrust toward tighter global a strong labor market and rising infl ation. This year, monetary policy, several AFE central banks that had with U.K. infl ation picking up more sharply, the BOE expanded their balance sheets over the past two years are now allowing them to shrink. In recent months, the BOE, the BOC, the RBA, and the Swedish Riksbank have A. 12-month policy expectations for selected advanced foreign economies begun to shrink their balance sheets by stopping full reinvestments of maturing government bond holdings. Weekly Basis points The BOE has indicated that it will consider accelerating the pace of balance sheet reduction by selling U.K. 400 government bonds; it will provide an update in 350 August on a strategy for possible future bond sales. 300 After tapering its purchases in recent months, the ECB 250 announced it will end net asset purchases as of July 1. Canada 200 Not all major foreign central banks have been 150 tightening monetary policy. The Bank of Japan (BOJ) 100 has maintained its overnight policy rate at negative 50 United Kingdom + 0.1 percent, given its outlook that Japanese infl ation _0 Japan will remain subdued in the medium term. The BOJ also 50 Euro area vowed to continue purchasing Japanese government 100 bonds to defend its current yield curve control target 2016 2017 2018 2019 2020 2021 2022 band around 0 percent for the 10-year nominal yield. In NOTE: The data are weekly averages of daily 12-month market-implied addition, the People’s Bank of China recently increased central bank policy rates. The 12-month policy rates are implied by its monetary stimulus through reductions in reserve quotes on overnight index swaps tied to the policy rates. The data extend requirement ratios and some key benchmark interest through June 10, 2022. SOURCE: Bloomberg; Federal Reserve Board staff estimations. rates amid a weakening of economic activity in China. 40 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 42. Equity indexes for selected foreign economies spreads over German bund yields for euro- area peripheral countries recently widened Weekly Week ending January 8, 2016 = 100 significantly. These moves partially retraced 150 following an unscheduled meeting of the European Central Bank (ECB) on June 15, 140 where the ECB indicated that it would take Euro area 130 action to address potential fragmentation in 120 euro-area sovereign bond markets. 110 100 Concerns about persistently high inflation 90 and associated monetary policy tightening China Japan 80 across countries, as well as Russia’s invasion of Ukraine and COVID lockdowns in 2016 2017 2018 2019 2020 2021 2022 China, weighed on foreign risky asset prices NOTE: The data are weekly averages of daily data and extend through (figure 42). Equities in many AFEs have June 10, 2022. SOURCE: For the euro area, Dow Jones Euro Stoxx Index; for Japan, declined since the beginning of the year. Tokyo Stock Price Index; for China, Shanghai Composite Index; all via Bloomberg. (For Dow Jones Indices licensing information, see the note Equity declines were particularly strong in the on the Contents page.) euro area, given the region’s trade and financial 43. Emerging market mutual fund flows linkages to Russia and concerns over the possibility of the conflict spreading to other Billions of dollars parts of Europe. Euro-area corporate bond Equity fund flows Bond fund flows 100 spreads have widened since the beginning of 75 the year and are well above their pre-pandemic levels. 50 25 + Financial conditions in EMEs have tightened _0 since the beginning of the year but are not 25 particularly tight relative to historical norms. 50 EME-dedicated funds have experienced 75 net outflows so far this quarter, reversing the inflows in the first quarter of this year 2012 2014 2016 2018 2020 2022 (figure 43). Outflows have been concentrated NOTE: The bond and equity fund flows data are quarterly sums of weekly data from December 29, 2011, to June 8, 2022. Weekly data span Thursday in Asia, especially China. Since Russia’s through Wednesday, and the quarterly values are sums over weekly data for weeks ending in that quarter. The fund flows data exclude funds located in invasion of Ukraine, investment funds that China. SOURCE: EPFR Global. focus on emerging Europe have experienced particularly rapid outflows. EME sovereign bond spreads widened considerably. European emerging market equities and Chinese equities declined significantly, the latter amid COVID- related lockdowns and related supply chain constraints as well as continued regulatory uncertainty. Latin American equities, supported in part by rising commodity prices, declined by less than other emerging markets. MONETARy POLICy REPORT: JUNE 2022 41 . . . and the dollar appreciated notably 44. U.S. dollar exchange rate indexes Since the beginning of the year, the broad Weekly Week ending December 27, 2019 = 100 dollar index—a measure of the trade-weighted Dollar appreciation 115 value of the dollar against foreign currencies— EME dollar index 110 has risen notably amid safe-haven flows and AFE dollar index 105 increases in U.S. yields (figure 44). The dollar 100 appreciated more against AFE currencies 95 than EME currencies, as rising commodity 90 prices supported Latin American currencies. 85 The Chinese renminbi depreciated against the 80 dollar amid growth concerns related to the lockdowns in China and weaker-than-expected Broad dollar index 75 Chinese data releases. Among AFE currencies, 2014 2016 2018 2020 2022 the dollar appreciated particularly strongly NOTE: The data, which are in foreign currency units per dollar, are against the Japanese yen, largely reflecting the weekly averages of daily values of the broad dollar index, advanced foreign economies (AFE) dollar index, and emerging market economies widening U.S.–Japanese yield differential. (EME) dollar index. The weekly data extend through June 10, 2022. As indicated by the leftmost arrow, increases in the data reflect U.S. dollar appreciation and decreases reflect U.S. dollar depreciation. SOURCE: Federal Reserve Board, Statistical Release H.10, “Foreign Exchange Rates.” 43 P 2 art m P onetary oLiCy The Federal Open Market Committee ended net asset purchases in early March and has swiftly raised the target range for the announced its plans for significantly reducing federal funds rate and anticipates that the size of the Federal Reserve’s balance sheet ongoing increases in the target range will in May.13 Consistent with the Principles for be appropriate Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in January, With inflation far too high, well above the the May statement outlined the Committee’s Federal Open Market Committee’s (FOMC) intention to reduce the Federal Reserve’s 2 percent objective, and with tight labor securities holdings over time in a predictable market conditions, the Committee raised manner primarily by adjusting the amounts the target range for the federal funds rate reinvested of principal payments received from off the effective lower bound in March. The securities held in the System Open Market Committee continued to raise the target Account (SOMA).14 Specifically, beginning in range in May and June, bringing it to 1½ to June, principal payments from securities held 1¾ percent following the June meeting in the SOMA will be reinvested to the extent (figure 45). The Committee has also indicated that they exceed monthly caps. For Treasury that it anticipates that ongoing increases in the securities, the cap is initially set at $30 billion target range will be appropriate. per month and after three months will increase The Committee ceased net purchases of Treasury securities and agency mortgage- 13. See the May 4, 2022, press release regarding the backed securities in early March and Plans for Reducing the Size of the Federal Reserve’s Balance Sheet, available at https://www.federalreserve. began the process of significantly gov/newsevents/pressreleases/monetary20220504b.htm. reducing its securities holdings on June 1 14. See the January 26, 2022, press release regarding the Principles for Reducing the Size of the Reflecting the need to firm the stance of Federal Reserve’s Balance Sheet, available at https:// monetary policy amid elevated inflation and www.federalreserve.gov/newsevents/pressreleases/ tight labor market conditions, the Committee monetary20220126c.htm. 45. 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 2021 2022 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. 44 PART 2: MONETARy POLICy to $60 billion per month. For agency debt and provide useful benchmarks for the FOMC. agency mortgage-backed securities, the cap Although simple rules cannot capture the is initially set at $17.5 billion per month and complexities of monetary policy and many after three months will increase to $35 billion practical considerations make it undesirable per month. for the FOMC to adhere strictly to the prescriptions of any specific rule, some Reductions in securities holdings will slow and principles of good monetary policy can then stop when reserve balances are somewhat be illustrated by these policy rules (see the above the level the Committee judges to be box “Monetary Policy Rules in the Current consistent with efficient implementation of Environment”). policy in an ample-reserves regime. Once balance sheet runoff has ceased, reserve Changes to the policy rate were balances will likely continue to decline implemented smoothly, and the size of at a slower pace—reflecting growth in the Federal Reserve’s balance sheet was other Federal Reserve liabilities—until the roughly stable Committee judges that reserve balances are As in the previous tightening cycle and at the level required for implementing policy consistent with the implementation of efficiently in an ample regime, at which point monetary policy in an ample-reserves regime, reserve management purchases of securities the Federal Reserve used its administered would likely begin to maintain ample reserves. rates—the interest rate on reserve balances The Committee also noted that it is prepared (IORB) and the offering rate at the overnight to adjust any of the details of its approach to reverse repurchase agreement (ON RRP) reducing the size of the balance sheet in light facility—to implement increases to the target of economic and financial developments. range for the policy rate. The administered rates were effective in raising the effective The FOMC will continue to monitor the federal funds rate and other short-term interest implications of incoming information for rates with the Committee’s target range. the economic outlook The Committee is strongly committed to The Federal Reserve’s balance sheet was returning inflation to its 2 percent objective. In roughly stable at $9 trillion, or 36 percent assessing the appropriate stance of monetary of U.S. nominal GDP, from February policy, the Committee will continue to monitor through May, and the process to significantly the implications of incoming information reduce securities holdings began on June 1 for the economic outlook. The Committee’s (figure 46).15 Reserve balances have fallen assessments will take into account a wide from their all-time highs of a little over range of information, including readings on $4 trillion to around $3.3 trillion because of inflation and inflation expectations, wages, increasing take-up at the ON RRP. (See the other measures of labor market conditions, box “Developments in the Federal Reserve’s financial and international developments, and Balance Sheet and Money Markets.”) public health. 15. Although balance sheet reduction started on In addition to considering a wide range of June 1, the actual reduction in securities holdings has economic and financial data and information been negligible thus far given the timing of principal gathered from business contacts and other payments. informed parties around the country, such All of the Federal Reserve’s emergency credit and as participants in conversations held as part liquidity facilities are closed and balances have continued to decline as facilities’ assets mature or prepay. A list of of the Fed Listens initiative, policymakers credit and liquidity facilities established by the Federal routinely consult prescriptions for the policy Reserve in response to COVID-19 is available on the interest rate provided by various monetary Board’s website at https://www.federalreserve.gov/ policy rules. These rule prescriptions can funding-credit-liquidity-and-loan-facilities.htm. MONETARy POLICy REPORT: JUNE 2022 45 46. Federal Reserve assets and liabilities Weekly Trillions of dollars 10 Other assets 8 Credit and liquidity facilities Agency debt and mortgage-backed securities holdings 6 Treasury securities held outright 4 2 + _0 2 4 Federal Reserve notes in circulation 6 Deposits of depository institutions Capital and other liabilities 8 10 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 NOTE: “Other assets” includes repurchase agreements, FIMA (Foreign and International Monetary Authorities) repurchase agreements, and unamortized premiums and discounts on securities held outright. “Credit and liquidity facilities” consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns Companies, Inc., and AIG; and other credit and liquidity facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Term Asset-Backed Securities Loan Facility, the Primary and Secondary Market Corporate Credit Facilities, the Paycheck Protection Program Liquidity Facility, the Municipal Liquidity Facility, and the Main Street Lending Program. “Agency debt and mortgage-backed securities holdings” includes agency residential mortgage-backed securities and agency commercial mortgage-backed securities. “Capital and other liabilities” includes reverse repurchase agreements, the U.S. Treasury General Account, and the U.S. Treasury Supplementary Financing Account. The key identifies shaded areas in order from top to bottom. The data extend through June 8, 2022. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” n (uLR) a t 46 PART 2: MONETARy POLICy Monetary Policy Rules in the Current Environment Simple interest rate rules relate a policy interest fi gure A shows a “balanced-approach (shortfalls)” rate, such as the federal funds rate, to a small number rule, which represents one simple way to illustrate of other economic variables—typically including the the Committee’s focus on shortfalls from maximum current deviation of infl ation from its target value employment.2 These rules embody key design and a measure of resource slack in the economy. principles of good monetary policy, including that the Policymakers consult policy rate prescriptions derived policy rate should be adjusted forcefully enough over from a variety of policy rules as part of their monetary time to ensure a return of infl ation to the central bank’s policy deliberations without mechanically following the longer-run objective and to anchor longer-term infl ation prescriptions of any particular rule. expectations at levels consistent with that objective. Recently, infl ation has run well above the All fi ve rules feature the difference between infl ation Committee’s 2 percent longer-run objective, the and the FOMC’s longer-run objective of 2 percent. The U.S. economy has been very strong, and labor fi ve rules use the unemployment rate gap, measured market conditions have been very tight. Against as the difference between an estimate of the rate of this background, the simple monetary policy rules unemployment in the longer run (uLR) and the current t considered in this discussion have called for raising the unemployment rate; the fi rst-difference rule includes federal funds rate signifi cantly. Starting in March, the the change in the unemployment rate gap rather than Federal Open Market Committee (FOMC) began raising its level.3 All but the fi rst-difference rule include an the target range for the federal funds rate and indicated (continued) that it anticipates that ongoing increases in the target range will be appropriate. The FOMC also began the rule is based on a rule suggested by Athanasios Orphanides process of signifi cantly reducing the size of the Federal (2003), “Historical Monetary Policy Analysis and the Taylor Rule,” Journal of Monetary Economics, vol. 50 (July), pp. 983– Reserve’s balance sheet. 1022. A review of policy rules is in John B. Taylor and John C. Williams (2011), “Simple and Robust Rules for Monetary Selected Policy Rules: Descriptions Policy,” in Benjamin M. Friedman and Michael Woodford, eds., Handbook of Monetary Economics, vol. 3B (Amsterdam: North-Holland), pp. 829–59. The same volume of the In many economic models, desirable economic Handbook of Monetary Economics also discusses approaches outcomes can be achieved if monetary policy other than policy rules for deriving policy rate prescriptions. responds in a predictable way to changes in economic 2. The FOMC’s revised Statement on Longer-Run Goals conditions. In recognition of this idea, economists and Monetary Policy Strategy, released in August 2020, have analyzed many monetary policy rules, including refers to “shortfalls of employment” from the Committee’s assessment of its maximum level rather than the “deviations of the well-known Taylor (1993) rule, the “balanced employment” used in the previous statement. The “balanced- approach” rule, the “adjusted Taylor (1993)” rule, and approach (shortfalls)” rule refl ects this change by prescribing the “fi rst difference” rule.1 In addition to these rules, policy rates identical to those prescribed by the balanced- approach rule at times when the unemployment rate is above its estimated longer-run level. However, when the 1. The Taylor (1993) rule was introduced in John B. Taylor unemployment rate is below that level, the balanced-approach (1993), “Discretion versus Policy Rules in Practice,” Carnegie- (shortfalls) rule is more accommodative than the balanced- Rochester Conference Series on Public Policy, vol. 39 approach rule because it does not call for the policy rate to (December), pp. 195–214. The balanced-approach rule was rise as the unemployment rate drops further. analyzed in John B. Taylor (1999), “A Historical Analysis of 3. Implementations of simple rules often use the output Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy gap as a measure of resource slack in the economy. The rules Rules (Chicago: University of Chicago Press), pp. 319–41. The described in fi gure A instead use the unemployment rate adjusted Taylor (1993) rule was studied in David Reifschneider gap because that gap better captures the FOMC’s statutory and John C. Williams (2000), “Three Lessons for Monetary goal to promote maximum employment. Movements in Policy in a Low-Infl ation Era,” Journal of Money, Credit and these alternative measures of resource utilization are highly Banking, vol. 32 (November), pp. 936–66. The fi rst-difference correlated. For more information, see the note below fi gure A. n (uLR) a t MONETARy POLICy REPORT: JUNE 2022 47 Monetary Policy Rules in the Current Environment Simple interest rate rules relate a policy interest fi gure A shows a “balanced-approach (shortfalls)” A. Monetary policy rules rate, such as the federal funds rate, to a small number rule, which represents one simple way to illustrate of other economic variables—typically including the the Committee’s focus on shortfalls from maximum current deviation of infl ation from its target value employment.2 These rules embody key design Taylor (1993) rule Rt T93 = rt LR + πt + 0.5(πt − πLR) + (ut LR − ut) and a measure of resource slack in the economy. principles of good monetary policy, including that the Policymakers consult policy rate prescriptions derived policy rate should be adjusted forcefully enough over Balanced-approach rule Rt BA = rt LR + πt + 0.5(πt − πLR) + 2(ut LR − ut) from a variety of policy rules as part of their monetary time to ensure a return of infl ation to the central bank’s policy deliberations without mechanically following the longer-run objective and to anchor longer-term infl ation Balanced-approach (shortfalls) rule Rt BAS = rt LR + πt + 0.5(πt − πLR) + 2min{(ut LR − ut), 0} prescriptions of any particular rule. expectations at levels consistent with that objective. Recently, infl ation has run well above the All fi ve rules feature the difference between infl ation Adjusted Taylor (1993) rule Rt T93adj = max{Rt T93 − Zt, ELB} Committee’s 2 percent longer-run objective, the and the FOMC’s longer-run objective of 2 percent. The First-difference rule Rt FD = Rt−1 + 0.5(πt − πLR) + (ut LR − ut) − (ut L − R 4 − ut−4) U.S. economy has been very strong, and labor fi ve rules use the unemployment rate gap, measured market conditions have been very tight. Against as the difference between an estimate of the rate of this background, the simple monetary policy rules unemployment in the longer run (u t LR) and the current ba N la o n t c e e : d R -a tT p 93 p , r R o t a B c A, h R , b tB a A l S a , n R c t e T d 93 - a a dj, p a p n ro d a R ch tF D ( s r h e o p r r t e f s a e l n ls t ) , t h a e d j v u a s l t u e e d s T o a f y t l h o e r n (1 o 9 m 93 in ), a a l n fe d d fi e r r s a t l - f d u i n ff d er s e r n a c t e e r p u r l e e s s c , r r ib es e p d e b c y ti v th el e y T . aylor (1993), considered in this discussion have called for raising the unemployment rate; the fi rst-difference rule includes Rt−1 denotes the midpoint of the target range for the federal funds rate for quarter t−1, πt is the 4-quarter price inflation for quarter t, ut is the federal funds rate signifi cantly. Starting in March, the the change in the unemployment rate gap rather than unemployment rate in quarter t, and rtLR 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 Federal Open Market Committee’s 2 percent longer-run objective, represented by πLR. Federal Open Market Committee (FOMC) began raising its level.3 All but the fi rst-difference rule include an In addition, utLR is the rate of unemployment expected in the longer run. Zt is the cumulative sum of past deviations of the federal funds rate the target range for the federal funds rate and indicated (continued) from the prescriptions of the Taylor (1993) rule when that rule prescribes setting the federal funds rate below an effective lower bound (ELB) of that it anticipates that ongoing increases in the target 12.5 basis points. The Taylor (1993) rule and other policy rules generally respond to the deviation of real output from its full capacity level. In these equations, range will be appropriate. The FOMC also began the rule is based on a rule suggested by Athanasios Orphanides 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 process of signifi cantly reducing the size of the Federal (2003), “Historical Monetary Policy Analysis and the Taylor as Okun’s law) to represent the rules in terms of the unemployment rate. The rules are implemented as responding to core personal consumption Rule,” Journal of Monetary Economics, vol. 50 (July), pp. 983– Reserve’s balance sheet. expenditures (PCE) inflation rather than to headline PCE inflation because current and near-term core inflation rates tend to outperform headline 1022. A review of policy rules is in John B. Taylor and John inflation rates as predictors of the medium-term behavior of headline inflation. C. Williams (2011), “Simple and Robust Rules for Monetary Selected Policy Rules: Descriptions Policy,” in Benjamin M. Friedman and Michael Woodford, eds., Handbook of Monetary Economics, vol. 3B (Amsterdam: North-Holland), pp. 829–59. The same volume of the estimate of the neutral real interest rate in the longer Taylor (1993) rule prescribes delaying the return of the In many economic models, desirable economic Handbook of Monetary Economics also discusses approaches run (rLR).4 policy rate to the (positive) levels prescribed by the outcomes can be achieved if monetary policy t other than policy rules for deriving policy rate prescriptions. Unlike the other simple rules featured here, the standard Taylor (1993) rule until after the economy responds in a predictable way to changes in economic 2. The FOMC’s revised Statement on Longer-Run Goals adjusted Taylor (1993) rule recognizes that the federal begins to recover. conditions. In recognition of this idea, economists and Monetary Policy Strategy, released in August 2020, have analyzed many monetary policy rules, including refers to “shortfalls of employment” from the Committee’s funds rate cannot be reduced materially below the the well-known Taylor (1993) rule, the “balanced assessment of its maximum level rather than the “deviations of effective lower bound. To make up for the cumulative Selected Policy Rules: Prescriptions employment” used in the previous statement. The “balanced- shortfall in policy accommodation following a approach” rule, the “adjusted Taylor (1993)” rule, and approach (shortfalls)” rule refl ects this change by prescribing recession during which the federal funds rate is Figure B shows historical prescriptions for the “fi rst difference” rule.1 In addition to these rules, policy rates identical to those prescribed by the balanced- constrained by its effective lower bound, the adjusted the federal funds rate under the fi ve simple rules approach rule at times when the unemployment rate is above its estimated longer-run level. However, when the considered. For each quarterly period, the fi gure reports 1. The Taylor (1993) rule was introduced in John B. Taylor unemployment rate is below that level, the balanced-approach the policy rates prescribed by the rules, taking as given (1993), “Discretion versus Policy Rules in Practice,” Carnegie- (shortfalls) rule is more accommodative than the balanced- 4. The neutral real interest rate in the longer run (r tLR) is the prevailing economic conditions and survey-based Rochester Conference Series on Public Policy, vol. 39 approach rule because it does not call for the policy rate to the level of the real federal funds rate that is expected to be estimates of uLR and rLR at the time. All of the rules (December), pp. 195–214. The balanced-approach rule was rise as the unemployment rate drops further. consistent, in the longer run, with maximum employment t t analyzed in John B. Taylor (1999), “A Historical Analysis of 3. Implementations of simple rules often use the output and stable infl ation. Like u tLR, r tLR is determined largely by considered called for a highly accommodative stance Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy gap as a measure of resource slack in the economy. The rules nonmonetary factors. The fi rst-difference rule shown in for monetary policy in response to the pandemic- Rules (Chicago: University of Chicago Press), pp. 319–41. The described in fi gure A instead use the unemployment rate fi gure A does not require an estimate of r tLR. However, this rule driven recession. The recent elevated infl ation readings adjusted Taylor (1993) rule was studied in David Reifschneider gap because that gap better captures the FOMC’s statutory has its own shortcomings. For example, research suggests that imply that the prescriptions for the federal funds rate of and John C. Williams (2000), “Three Lessons for Monetary goal to promote maximum employment. Movements in this sort of rule often results in greater volatility in employment simple policy rules in the fi rst quarter of 2022 are well Policy in a Low-Infl ation Era,” Journal of Money, Credit and these alternative measures of resource utilization are highly and infl ation relative to what would be obtained under the Banking, vol. 32 (November), pp. 936–66. The fi rst-difference correlated. For more information, see the note below fi gure A. Taylor (1993) and balanced-approach rules. (continued on next page) 48 PART 2: MONETARy POLICy Monetary Policy Rules in the Current Environment (continued) B. Historical federal funds rate prescriptions from simple policy rules Percent First-difference rule 9 6 Balanced-approach rule 3 Taylor (1993) rule + _0 Balanced-approach (shortfalls) rule 3 Adjusted Taylor (1993) rule Federal funds rate 6 9 12 15 18 2018 2019 2020 2021 2022 NOTE: The rules use historical values of core personal consumption expenditures inflation, the unemployment rate, and, where applicable, historical values of the midpoint of the target range for the federal funds rate. Quarterly projections of longer-run values for the federal funds rate and the unemployment rate used in the computation of the rules’ prescriptions are derived through interpolations of biannual projections from Blue Chip Economic Indicators. The longer-run value for inflation is set to 2 percent. The rules data are quarterly, and the federal funds rate data are the monthly average of the daily midpoint of the target range for the federal funds rate. SOURCE: Federal Reserve Bank of Philadelphia; Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff calculations. above their pre-pandemic levels, at between 4 percent effective lower bound on interest rates, which limits and 7 percent. Overall, the prescriptions of all simple the extent to which the policy rate can be lowered to rules have risen notably over the past few quarters as support the economy. This constraint was particularly infl ation readings climbed further above 2 percent. evident in the aftermath of the pandemic-driven recession, when the lower bound on the policy rate motivated the FOMC’s other policy actions to support Policy Rules: Limitations the economy. Finally, simple policy rules generally Simple policy rules are also subject to important abstract from the risk-management considerations limitations. One important limitation is that simple associated with uncertainty about economic policy rules do not take into account the other tools of relationships and the evolution of the economy. As monetary policy, such as large-scale asset purchases. a result, the usefulness of simple policy rules can be A second important limitation is that simple rules limited in unusual economic circumstances.5 respond to only a small set of economic variables and thus necessarily abstract from many of the factors that 5. For example, Taylor (1993) on page 197 noted that the FOMC considers when it assesses the appropriate “there will be episodes where monetary policy will need to setting of the policy rate. Another limitation is that be adjusted to deal with special factors. The Fed would need most simple policy rules do not take into account the more than a simple policy rule as a guide in such cases.” MONETARy POLICy REPORT: JUNE 2022 49 Monetary Policy Rules in the Current Environment (continued) Developments in the Federal Reserve’s Balance Sheet and Money Markets B. Historical federal funds rate prescriptions from simple policy rules Percent With the Federal Reserve’s net asset purchases A. Balance sheet comparison concluding in March, the size of the balance sheet has Billions of dollars First-difference rule 9 been roughly stable at $9 trillion since February 2022 June 8, February 16, Change Balanced-approach rule 6 (fi gures A and B). At its May 2022 meeting, the FOMC Assets 2022 2022 Taylor (1993) rule + 3 announced plans for signifi cantly reducing the size Total securities _0 of the Federal Reserve’s balance sheet starting June 1. Treasury securities 5,772 5,739 33 Balanced-approach (shortfalls) rule 3 Balance sheet reduction, along with increases in the Adjusted Taylor (1993) rule Agency debt and MBS 2,710 2,707 3 Federal funds rate 6 target range for the federal funds rate, fi rms the stance Net unamortized premiums 336 350 −14 9 of monetary policy. Repurchase agreements 0 0 0 12 Despite the roughly constant total size of the Loans and lending facilities balance sheet, reserves—the largest liability on the 15 PPPLF 19 28 −8 Federal Reserve’s balance sheet—have continued to fall 18 Other loans and lending signifi cantly since February 2022, refl ecting growth in facilities 37 40 −3 2018 2019 2020 2021 2022 take-up at the overnight reverse repurchase agreement Central bank liquidity swaps 0 0 0 NOTE: The rules use historical values of core personal consumption expenditures inflation, the unemployment rate, and, where applicable, historical (ON RRP) facility (fi gure C).1 In addition, the Treasury Other assets 47 48 −1 v u a n l e u m es p l o o f y m th e e n t m r id at p e o i u n s t e d o f i n th t e h e ta c rg o e m t p r u a t n a g t e io f n o r o f t h t e h e f e r d u e l r e a s’ l f p u r n es d c s r i r p a t t i e o . n Q s u ar a e r te d r e l r y i v p e r d o j t e h c r t o io u n g s h o in f t l e o r n p g o e l r a - t r i u o n n s v o a f lu b e i s a n fo n r u a th l e p r fe o d je e c r t a i l o n fu s n f d ro s m ra t B e l u a e n d C h th ip e General Account (TGA)—another volatile liability— Total assets 8,921 8,911 10 Economic Indicators. The longer-run value for inflation is set to 2 percent. The rules data are quarterly, and the federal funds rate data are the monthly rose considerably upon larger than expected tax Liabilities and capital average of the daily midpoint of the target range for the federal funds rate. receipts and peaked just short of $1 trillion on June 2 Federal Reserve notes 2,227 2,185 42 SOURCE: Federal Reserve Bank of Philadelphia; Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff calculations. before retracing the movement. Reserves held by depository Usage at the ON RRP facility has risen $496 billion institutions 3,317 3,797 −480 since February 2022 to stand at a record $2.2 trillion Reverse repurchase above their pre-pandemic levels, at between 4 percent effective lower bound on interest rates, which limits at the time of this report. Low rates on repurchase agreements and 7 percent. Overall, the prescriptions of all simple the extent to which the policy rate can be lowered to agreements—refl ecting abundant liquidity in the Foreign offi cial and rules have risen notably over the past few quarters as support the economy. This constraint was particularly international accounts 272 257 14 banking system and limited Treasury bill supply—have infl ation readings climbed further above 2 percent. evident in the aftermath of the pandemic-driven Others 2,163 1,644 519 contributed to this increasingly elevated participation. recession, when the lower bound on the policy rate U.S. Treasury General motivated the FOMC’s other policy actions to support (continued on next page) Account 627 709 −82 Policy Rules: Limitations the economy. Finally, simple policy rules generally Other deposits 247 251 −5 Simple policy rules are also subject to important abstract from the risk-management considerations 1. Reserves consist of deposits held at Federal Reserve Other liabilities and capital 69 67 1 Banks by depository institutions, such as commercial banks, limitations. One important limitation is that simple associated with uncertainty about economic savings banks, credit unions, thrift institutions, and U.S. Total liabilities and capital 8,921 8,911 10 policy rules do not take into account the other tools of relationships and the evolution of the economy. As branches and agencies of foreign banks. Reserve balances Note: MBS is mortgage-backed securities. PPPLF is Paycheck Protection Program Liquidity Facility. Components may not sum to totals because of monetary policy, such as large-scale asset purchases. a result, the usefulness of simple policy rules can be allow depository institutions to facilitate daily payment rounding. fl ows, both in ordinary times and in stress scenarios, without A second important limitation is that simple rules limited in unusual economic circumstances.5 Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Aff ecting borrowing funds or selling assets. Reserve Balances.” respond to only a small set of economic variables and thus necessarily abstract from many of the factors that 5. For example, Taylor (1993) on page 197 noted that the FOMC considers when it assesses the appropriate “there will be episodes where monetary policy will need to setting of the policy rate. Another limitation is that be adjusted to deal with special factors. The Fed would need most simple policy rules do not take into account the more than a simple policy rule as a guide in such cases.” 50 PART 2: MONETARy POLICy Developments in the Federal Reserve’s Balance Sheet and Money Markets (continued) B. Federal Reserve assets C. Federal Reserve liabilities Weekly Trillions of dollars Weekly Trillions of dollars Other assets 12 Reverse repurchase agreements 12 Loans 11 Deposits of depository institutions (reserves) 11 Central bank liquidity swaps U.S. Treasury General Account Repurchase agreements 10 Other deposits 10 Agency debt and MBS 9 Capital and other liabilities 9 Treasury securities 8 Federal Reserve notes 8 held outright 7 7 6 6 5 5 4 4 3 3 2 2 1 1 2019 2020 2021 2022 2019 2020 2021 2022 NOTE: MBS is mortgage-backed securities. The key identifies shaded areas in NOTE: “Capital and other liabilities” includes Treasury contributions. The key order from top to bottom. The data extend through June 8, 2022. identifies shaded areas in order from top to bottom. The data extend through SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting June 8, 2022 Reserve Balances.” SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” In addition, uncertainty about the magnitude and pace effective at raising and maintaining the effective federal of policy rate increases contributed to a preference funds rate within the target range during the policy rate for short-duration assets, like those provided by the adjustments that have taken place since March. ON RRP facility. The ON RRP facility is intended to Going forward, the planned balance sheet decline help keep the effective federal funds rate from falling will drain reserves from the banking system and add below the target range set by the FOMC, as institutions longer-duration assets, which will likely put upward with access to the ON RRP should be unwilling to lend pressure on short-term rates and reduce demand at funds below the ON RRP’s pre-announced offering rate. the ON RRP facility. The Committee will monitor the The facility continued to serve this intended purpose, evolution of reserves and other liabilities to ensure and the set of administered rates—interest on reserve a smooth entry into effi cient operation of monetary balances (IORB) and the ON RRP offering rate—was policy in an ample-reserves regime. 51 P 3 art s e P ummary of ConomiC rojeCtions The following material was released after the conclusion of the June 14–15, 2022, meeting of the Federal Open Market Committee. In conjunction with the Federal Open Market to affect economic outcomes. The longer- Committee (FOMC) meeting held on run projections represent each participant’s June 14–15, 2022, meeting participants assessment of the value to which each variable submitted their projections of the most likely would be expected to converge, over time, outcomes for real gross domestic product under appropriate monetary policy and in the (GDP) growth, the unemployment rate, and absence of further shocks to the economy. inflation for each year from 2022 to 2024 “Appropriate monetary policy” is defined as and over the longer run. Each participant’s the future path of policy that each participant projections were based on information deems most likely to foster outcomes for available at the time of the meeting, together economic activity and inflation that best with her or his assessment of appropriate satisfy his or her individual interpretation of monetary policy—including a path for the the statutory mandate to promote maximum federal funds rate and its longer-run value— employment and price stability. and assumptions about other factors likely Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assumptions of projected appropriate monetary policy, June 2022 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2022 2023 2024 2022 2023 2024 2022 2023 2024 run run run Change in real GDP ..... 1.7 1.7 1.9 1.8 1.5–1.9 1.3–2.0 1.5–2.0 1.8–2.0 1.0–2.0 0.8–2.5 1.0–2.2 1.6–2.2 March projection ..... 2.8 2.2 2.0 1.8 2.5–3.0 2.1–2.5 1.8–2.0 1.8–2.0 2.1–3.3 2.0–2.9 1.5–2.5 1.6–2.2 Unemployment rate ..... 3.7 3.9 4.1 4.0 3.6–3.8 3.8–4.1 3.9–4.1 3.5–4.2 3.2–4.0 3.2–4.5 3.2–4.3 3.5–4.3 March projection ..... 3.5 3.5 3.6 4.0 3.4–3.6 3.3–3.6 3.2–3.7 3.5–4.2 3.1–4.0 3.1–4.0 3.1–4.0 3.5–4.3 PCE inflation .......... 5.2 2.6 2.2 2.0 5.0–5.3 2.4–3.0 2.0–2.5 2.0 4.8–6.2 2.3–4.0 2.0–3.0 2.0 March projection ..... 4.3 2.7 2.3 2.0 4.1–4.7 2.3–3.0 2.1–2.4 2.0 3.7–5.5 2.2–3.5 2.0–3.0 2.0 Core PCE inflation4 ..... 4.3 2.7 2.3 4.2–4.5 2.5–3.2 2.1–2.5 4.1–5.0 2.5–3.5 2.0–2.8 March projection ..... 4.1 2.6 2.3 3.9–4.4 2.4–3.0 2.1–2.4 3.6–4.5 2.1–3.5 2.0–3.0 Memo: Projected appropriate policy path Federal funds rate ...... 3.4 3.8 3.4 2.5 3.1–3.6 3.6–4.1 2.9–3.6 2.3–2.5 3.1–3.9 2.9–4.4 2.1–4.1 2.0–3.0 March projection ..... 1.9 2.8 2.8 2.4 1.6–2.4 2.4–3.1 2.4–3.4 2.3–2.5 1.4–3.1 2.1–3.6 2.1–3.6 2.0–3.0 Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. The March projections were made in conjunction with the meeting of the Federal Open Market Committee on March 15–16, 2022. 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 March 15–16, 2022, meeting, and one participant did not submit such projections in conjunction with the June 14–15, 2022, 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. 52 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 1. Medians, central tendencies, and ranges of economic projections, 2022–24 and over the longer run Percent Change in real GDP 6 5 Actual 4 3 2 1 0 Median of projections −1 Central tendency of projections −2 Range of projections −3 2017 2018 2019 2020 2021 2022 2023 2024 Longer run Percent Unemployment rate 7 6 5 4 3 2 1 2017 2018 2019 2020 2021 2022 2023 2024 Longer run Percent PCE inflation 7 6 5 4 3 2 1 2017 2018 2019 2020 2021 2022 2023 2024 Longer run Percent Core PCE inflation 7 6 5 4 3 2 1 2017 2018 2019 2020 2021 2022 2023 2024 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. MONETARy POLICy REPORT: JUNE 2022 53 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 2022 2023 2024 Longer run Note: Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. One participant did not submit longer-run projections for the federal funds rate. 54 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2022–24 and over the longer run Number of participants 2022 June projections 18 March projections 16 14 12 10 8 6 4 2 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 2.6− 2.8− 3.0− 3.2− 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 Percent range Number of participants 2023 18 16 14 12 10 8 6 4 2 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 2.6− 2.8− 3.0− 3.2− 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 2.6− 2.8− 3.0− 3.2− 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− 2.6− 2.8− 3.0− 3.2− 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2022 55 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2022–24 and over the longer run Number of participants 2022 June projections 18 March projections 16 14 12 10 8 6 4 2 2.8− 3.0− 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 4.5 Percent range Number of participants 2023 18 16 14 12 10 8 6 4 2 2.8− 3.0− 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 4.5 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 2.8− 3.0− 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 4.5 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 2.8− 3.0− 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 4.5 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 56 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants’ projections for PCE inflation, 2022–24 and over the longer run Number of participants 2022 June projections March projections 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 5.1− 5.3− 5.5− 5.7− 5.9− 6.1− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 Percent range Number of participants 2023 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 5.1− 5.3− 5.5− 5.7− 5.9− 6.1− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 5.1− 5.3− 5.5− 5.7− 5.9− 6.1− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 5.1− 5.3− 5.5− 5.7− 5.9− 6.1− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2022 57 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2022–24 Number of participants 2022 June projections March projections 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 Percent range Number of participants 2023 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 1.7− 1.9− 2.1− 2.3− 2.5− 2.7− 2.9− 3.1− 3.3− 3.5− 3.7− 3.9− 4.1− 4.3− 4.5− 4.7− 4.9− 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 58 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, 2022–24 and over the longer run Number of participants 2022 June projections March projections 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− 3.63− 3.88− 4.13− 4.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 Percent range Number of participants 2023 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− 3.63− 3.88− 4.13− 4.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 Percent range Number of participants 2024 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− 3.63− 3.88− 4.13− 4.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 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− 3.63− 3.88− 4.13− 4.38− 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2022 59 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 6 Median of projections 70% confidence interval 5 4 3 2 Actual 1 0 −1 −2 −3 2017 2018 2019 2020 2021 2022 2023 2024 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 June projections June projections March projections March 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 differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” 60 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 4.B. Uncertainty and risks in projections of the unemployment rate Medianprojectionandconfidenceintervalbasedonhistoricalforecasterrors Percent Unemployment rate Median of projections 7 70% confidence interval 6 Actual 5 4 3 2 1 2017 2018 2019 2020 2021 2022 2023 2024 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 June projections June projections March projections March 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 differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approxi- mately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” MONETARy POLICy REPORT: JUNE 2022 61 Figure 4.C. Uncertainty and risks in projections of PCE inflation Medianprojectionandconfidenceintervalbasedonhistoricalforecasterrors Percent PCE inflation Median of projections 7 70% confidence interval 6 5 4 3 Actual 2 1 2017 2018 2019 2020 2021 2022 2023 2024 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 June projections June projections March projections March 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 June projections June projections March projections March 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 differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as “broadly similar” to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as “broadly balanced” would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” 62 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 4.D. Diffusion indexes of participants’ uncertainty assessments Diffusion index Change in real GDP 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index Unemployment rate 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index PCE inflation 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index Core PCE inflation 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Note: For each SEP, participants provided responses to the question “Please indicate your judgment of the uncertainty attached to your projections relative to the levels of uncertainty over the past 20 years.” Each point in the diffusion indexes represents the number of participants who responded “Higher” minus the number who responded “Lower,” divided by the total number of participants. Figure excludes March 2020 when no projections were submitted. MONETARy POLICy REPORT: JUNE 2022 63 Figure 4.E. Diffusion indexes of participants’ risk weightings Diffusion index Change in real GDP 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index Unemployment rate 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index PCE inflation 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Diffusion index Core PCE inflation 1.00 0.75 0.50 0.25 0.00 −0.25 −0.50 −0.75 −1.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Note: For each SEP, participants provided responses to the question “Please indicate your judgment of the risk weighting around your projections.” Each point in the diffusion indexes represents the number of participants who responded “Weighted to the Upside” minus the number who responded “Weighted to the Downside,” divided by the total number of participants. Figure excludes March 2020 when no projections were submitted. 64 PART 3: SUMMARy OF ECONOMIC PROJECTIONS 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 Actual 2 1 0 2017 2018 2019 2020 2021 2022 2023 2024 Note: The blue and red lines are based on actual values and median projected values, respectively, of the Committee’s target for the federal funds rate at the end of the year indicated. The actual values are the midpoint of the target range; the median projected values are based on either the midpoint of the target range or the target level. The confidence interval around the median projected values is based on root mean squared errors of various private and government forecasts made over the previous 20 years. The confidence interval is not strictly consistent with the projections for the federal funds rate, primarily because these projections are not forecasts of the likeliest outcomes for the federal funds rate, but rather projections of participants’ individual assessments of appropriate monetary policy. Still, historical forecast errors provide a broad sense of the uncertainty around the future path of the federal funds rate generated by the uncertainty about the macroeconomic variables as well as additional adjustments to monetary policy that may be appropriate to offset the effects of shocks to the economy. The confidence interval is assumed to be symmetric except when it is truncated at zero - the bottom of the lowest target range for the federal funds rate that has been adopted in the past by the Committee. This truncation would not be intended to indicate the likelihood of the use of negative interest rates to provide additional monetary policy accommodation if doing so was judged appropriate. In such situations, the Committee could also employ other tools, including forward guidance and large-scale asset purchases, to provide additional accommodation. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants’ current assessments of the uncertainty and risks around their projections. * The confidence interval is derived from forecasts of the average level of short-term interest rates in the fourth quarter of the year indicated; more information about these data is available in table 2. The shaded area encompasses less than a 70 percent confidence interval if the confidence interval has been truncated at zero. MONETARy POLICy REPORT: JUNE 2022 65 Table 2. Average historical projection error ranges Percentage points Variable 2022 2023 2024 Change in real GDP1 ......... ± 1.5 ± 1.9 ± 2.3 Unemployment rate1 ......... ± 0.8 ± 1.4 ± 1.9 Total consumer prices2 ....... ± 1.0 ± 1.3 ± 1.4 Short-term interest rates3 ..... ± 0.6 ± 1.8 ± 2.3 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 2002 through 2021 that were released in the summer by various private and government forecasters. As described in the box “Forecast Uncertainty,” under certain assumptions, there is about a 70 percent probability that actual outcomes for real GDP, unemployment, consumer prices, and the federal funds rate will be in ranges implied by the average size of projection errors made in the past. For more information, see David Reifschneider and Peter Tulip (2017), “Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach,” Finance and Economics Discussion Series 2017-020 (Washington: Board of Governors of the Federal Reserve System, February), https:// dx.doi.org/10.17016/FEDS.2017.020. 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 most widely used in government and private economic forecasts. Projections are percent changes on a fourth quarter to fourth quarter basis. 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 calculated using average levels, in percent, in the fourth quarter. 66 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Forecast Uncertainty The economic projections provided by the members reported in table 2 would imply a probability of about of the Board of Governors and the presidents of 70 percent that actual GDP would expand within a the Federal Reserve Banks inform discussions of range of 1.5 to 4.5 percent in the current year, 1.1 to monetary policy among policymakers and can aid 4.9 percent in the second year, and 0.7 to 5.3 percent public understanding of the basis for policy actions. in the third year. The corresponding 70 percent Considerable uncertainty attends these projections, confi dence intervals for overall infl ation would be 1.0 however. The economic and statistical models and to 3.0 percent in the current year, 0.7 to 3.3 percent relationships used to help produce economic forecasts in the second year, and 0.6 to 3.4 percent in the third are necessarily imperfect descriptions of the real world, year. Figures 4.A through 4.C illustrate these confi dence and the future path of the economy can be affected bounds in “fan charts” that are symmetric and centered by myriad unforeseen developments and events. Thus, on the medians of FOMC participants’ projections for in setting the stance of monetary policy, participants GDP growth, the unemployment rate, and infl ation. consider not only what appears to be the most likely However, in some instances, the risks around the economic outcome as embodied in their projections, projections may not be symmetric. In particular, the but also the range of alternative possibilities, the unemployment rate cannot be negative; furthermore, likelihood of their occurring, and the potential costs to the risks around a particular projection might be tilted the economy should they occur. to either the upside or the downside, in which case Table 2 summarizes the average historical accuracy the corresponding fan chart would be asymmetrically of a range of forecasts, including those reported in positioned around the median projection. past Monetary Policy Reports and those prepared Because current conditions may differ from those by the Federal Reserve Board’s staff in advance of that prevailed, on average, over history, participants meetings of the Federal Open Market Committee provide judgments as to whether the uncertainty (FOMC). The projection error ranges shown in the attached to their projections of each economic variable table illustrate the considerable uncertainty associated is greater than, smaller than, or broadly similar to with economic forecasts. For example, suppose a typical levels of forecast uncertainty seen in the past participant projects that real gross domestic product 20 years, as presented in table 2 and refl ected in the (GDP) and total consumer prices will rise steadily at widths of the confi dence intervals shown in the top annual rates of, respectively, 3 percent and 2 percent. panels of fi gures 4.A through 4.C. Participants’ current If the uncertainty attending those projections is similar assessments of the uncertainty surrounding their to that experienced in the past and the risks around projections are summarized in the bottom-left panels the projections are broadly balanced, the numbers (continued) MONETARy POLICy REPORT: JUNE 2022 67 of those fi gures. Participants also provide judgments as on an end-of-year basis. However, the forecast errors to whether the risks to their projections are weighted should provide a sense of the uncertainty around the to the upside, are weighted to the downside, or future path of the federal funds rate generated by the are broadly balanced. That is, while the symmetric uncertainty about the macroeconomic variables as historical fan charts shown in the top panels of fi gures well as additional adjustments to monetary policy that 4.A through 4.C imply that the risks to participants’ would be appropriate to offset the effects of shocks to projections are balanced, participants may judge that the economy. there is a greater risk that a given variable will be above If at some point in the future the confi dence interval rather than below their projections. These judgments around the federal funds rate were to extend below are summarized in the lower-right panels of fi gures 4.A zero, it would be truncated at zero for purposes of through 4.C. the fan chart shown in fi gure 5; zero is the bottom of As with real activity and infl ation, the outlook the lowest target range for the federal funds rate that for the future path of the federal funds rate is subject has been adopted by the Committee in the past. This to considerable uncertainty. This uncertainty arises approach to the construction of the federal funds rate primarily because each participant’s assessment of 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 infl ation 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 fi nal 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 fi gures 4.A through 4.C provide information confi dence intervals associated with projections on the uncertainty around the economic projections, of the federal funds rate are quite wide. It should fi gure 1 provides information on the range of views be noted, however, that these confi dence intervals across FOMC participants. A comparison of fi gure 1 are not strictly consistent with the projections for with fi gures 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. rather are projections of participants’ individual assessments of appropriate monetary policy and are 69 a bbreviations AFE advanced foreign economy BOC Bank of Canada BOE Bank of England BOJ Bank of Japan CCP central counterparty COVID-19 coronavirus disease 2019 CPI consumer price index ECB European Central Bank ECI employment cost index EME emerging market economy EPOP ratio employment-to-population ratio FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product IORB interest rate on reserve balances LFPR labor force participation rate MBS mortgage-backed securities MMF money market fund ON RRP overnight reverse repurchase agreement PCE personal consumption expenditures repo repurchase agreement SOMA System Open Market Account S&P Standard & Poor’s TGA Treasury General Account USD U.S. dollar VIX implied volatility for the S&P 500 index For use at 11:00 a.m. EDT June 17, 2022 M P r onetary olicy ePort June 17, 2022 Board of Governors of the Federal Reserve System

Federal Reserve (2022, June 16). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20220617

@misc{wtfs_monetary_policy_report_20220617,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2022},
  month = {Jun},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20220617},
  note = {Retrieved via When the Fed Speaks corpus}
}