Monetary Policy Report

For use at 11:00 a.m. EDT June 16, 2023 M P r onetary olicy ePort June 16, 2023 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 16, 2023 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 31, 2023 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. cc oonntteennttss 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 International Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Part 2: Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Part 3: Summary of Economic Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 List of Boxes Developments in Employment and Earnings across Demographic Groups . . . . . . . . . . . . . . 11 Recent Developments in Bank Lending Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Developments Related to Financial Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Developments in the Federal Reserve’s Balance Sheet and Money Markets . . . . . . . . . . . . . . 42 Monetary Policy Rules in the Current Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Forecast Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Note: This report reflects information that was publicly available as of 4 p.m. EDT on June 14, 2023. Unless otherwise stated, the time series in the figures extend through, for daily data, June 13, 2023; for monthly data, May 2023; and, for quarterly data, 2023: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 24, 36, and 43, 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 © 2023 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, omis- sions, or interruptions of any index or the data included therein . 1 s ummary Although inflation has moderated somewhat Recent Economic and Financial since the middle of last year, it remains well Developments above the Federal Open Market Committee’s (FOMC) objective of 2 percent. The labor Inflation. Consumer price inflation, as market continues to be very tight, with robust measured by the 12-month change in the price job gains and the unemployment rate near index for personal consumption expenditures historically low levels, though nominal wage (PCE), was 4.4 percent in April, down from growth has shown some signs of easing its peak of 7.0 percent last June but still well and job vacancies have declined. Real gross above the FOMC’s 2 percent objective. Core domestic product (GDP) growth was modest PCE price inflation—which excludes volatile in the first quarter, despite a pickup in food and energy prices and is generally consumer spending. Bringing inflation back to considered a better guide to the direction of 2 percent will likely require a period of below- future inflation—is also off its peak but was trend growth and some softening of labor still 4.7 percent over the 12 months ending in market conditions. April. As supply chain bottlenecks have eased and demand has stabilized, increases in core In response to high inflation, the FOMC goods prices slowed considerably over the continued to increase interest rates and reduce past year. Within core services prices, housing its securities holdings. The FOMC has raised services inflation has been high, but the the target range for the federal funds rate a monthly changes have started to ease in recent further 75 basis points since the start of the months, consistent with the slower increases in year, bringing the range to 5 to 5¼ percent. rents for new tenants that have been observed In determining the extent of additional policy since the second half of last year. For other firming that may be appropriate to return core services, price inflation remains elevated inflation to 2 percent over time, the FOMC and has not shown signs of easing, and indicated that it will take into account the prospects for slowing inflation may depend in cumulative tightening of monetary policy, part on a further easing of tight labor market the lags with which monetary policy affects conditions. Measures of longer-term inflation economic activity and inflation, and economic expectations are within the range of values and financial developments. The Federal seen in the decade before the pandemic and Reserve also continued to reduce its holdings continue to be broadly consistent with the of Treasury and agency mortgage-backed FOMC’s longer-run objective of 2 percent, securities; these holdings have declined by suggesting that high inflation is not becoming about $420 billion since January, further entrenched. tightening financial conditions. The labor market. The labor market has The Federal Reserve is acutely aware that remained very tight, with job gains averaging high inflation imposes significant hardship, 314,000 per month during the first five months especially on those least able to meet the of the year and the unemployment rate higher costs of essentials. The FOMC is remaining near historical lows. Labor demand strongly committed to returning inflation to its has eased in many sectors of the economy but 2 percent objective. continues to exceed the supply of available 2 SUMMARy workers, with job vacancies still elevated. rebounded as well but was still subdued by Labor supply has improved, with a pickup in historical standards. While business credit immigration and an improvement in the labor quality remains strong, some indicators of force participation rate, particularly among future business defaults are somewhat elevated. prime-age workers. Nominal wage gains For households, mortgage originations continued to slow in the first half of 2023, but remained weak, although consumer loans they remain above the pace consistent with (such as auto loans and credit cards) 2 percent inflation over the longer term, given grew further. After having risen last year, prevailing trends in productivity growth. delinquency rates leveled off in the first quarter for auto loans and continued to increase for Economic activity. After the strong rebound credit card loans. in 2021 from the pandemic-induced recession, economic activity lost momentum last year, Financial stability. Despite concerns about and growth in the first quarter of this year profitability at some banks, the banking was modest as financial conditions continued system remains sound and resilient. Most to tighten. Real consumer spending grew at a measures of valuation pressures in corporate solid pace in the first quarter but appears to be securities markets remained near the middle moderating as consumer financing conditions of their historical distributions. By contrast, have tightened and consumer confidence has valuation pressures in commercial and remained low. Real business fixed investment residential real estate markets continued to growth continued to slow in the first quarter, be elevated. Borrowing by households and likely reflecting tighter financial conditions and businesses grew a bit more slowly than GDP, weaker output growth, while manufacturing leaving vulnerabilities arising from household output has been roughly unchanged so far and business debt largely unchanged at this year after having declined in the fourth moderate levels. In the banking sector, heavy quarter. Activity in the housing sector reliance on uninsured deposits, declining continued to contract in response to elevated fair values of long-duration fixed-rate assets mortgage rates, but several indicators appear associated with higher interest rates, and poor to have bottomed out. risk management led to the failure of three domestic banks. Broad bank equity prices Financial conditions. Financial conditions have fell sharply as market participants reassessed tightened further since January. The FOMC the strength of some banks with similar has raised the target range for the federal funds risk profiles to those that failed. However, rate a further 75 basis points since January, the broader banking sector maintained and the market-implied expected path of the substantial loss-absorbing capacity and ample federal funds rate over the next year shifted liquidity. In the nonbank financial sector, up. Though yields on longer-term nominal leverage at hedge funds remained elevated, Treasury securities were little changed, on net, and structural vulnerabilities associated with over this period, the relatively high level of funding risk persisted at some money market interest rates has weighed on financing activity. funds and certain mutual funds. (See the box Business loans at banks grew since the start “Developments Related to Financial Stability” of 2023, but the pace of growth continued in Part 1.) to slow as banks tightened standards and average borrowing costs rose. Investment- International developments. Following a grade corporate bond issuance rebounded to slowdown at the end of 2022, foreign activity a brisk pace in May, following a slowdown in rebounded early this year. This rebound was March and April. Speculative-grade issuance driven in part by strong growth in China, as MONETARy POLICy REPORT: JUNE 2023 3 the lifting of COVID-19 restrictions unleashed Balance sheet policy. The Federal Reserve pent-up demand, though recent indicators has continued the process of significantly suggest that momentum is slowing. Europe reducing its holdings of Treasury and agency showed resilience to the energy price shock securities in a predictable manner.1 Beginning stemming from Russia’s war against Ukraine. in June of last year, principal payments from Foreign headline inflation continued to fall, securities held in the System Open Market driven by declines in retail energy prices. Account (SOMA) have been reinvested only However, while energy inflation has moderated to the extent that they exceeded monthly caps. in many foreign economies, both food and core The Federal Reserve has reduced its securities inflation remain elevated. holdings by about $420 billion since January. This decrease in assets was partially offset by Since January, several major foreign central liquidity provisions to the banking system banks continued tightening their monetary following the banking-sector stresses in March. policies, communicating concerns about elevated inflation and tight labor markets. Special Topics That said, some central banks also emphasized the need to be cautious in their approach, Employment and earnings across groups. given the lags of monetary policy and the Strong labor demand over the past two years uncertainty about the outlook for growth and has particularly benefited historically more inflation. The trade-weighted exchange value disadvantaged workers. As a result, many of of the U.S. dollar is a touch lower. the disparities in employment and wages across racial, ethnic, sex, and education groups, Monetary Policy which had been exacerbated by the pandemic, have narrowed—in some cases to historically In response to high inflation, the FOMC narrow ranges. Despite this narrowing, there continued to increase the target range for the remain significant disparities in absolute levels federal funds rate and reduce its securities of employment and wages across groups. (See holdings this year. Adjustments to both the box “Developments in Employment and interest rates and the balance sheet are playing Earnings across Demographic Groups” in a role in firming the stance of monetary policy Part 1.) in support of the Federal Reserve’s maximum- employment and price-stability goals. Bank stress and lending. Bank lending conditions have tightened notably over the Interest rate policy. The FOMC continued past year, and bank loan growth has slowed, to increase the target range for the federal following the tightening of monetary policy funds rate, bringing it to the current range of that started in early 2022. Banking-sector 5 to 5¼ percent. In light of the cumulative strains in March 2023 reportedly led to tightening of monetary policy and the lags further tightening in lending conditions at with which monetary policy affects economic some banks. Results from the April 2023 activity and inflation, the FOMC slowed Senior Loan Officer Opinion Survey on Bank the pace of policy tightening relative to last Lending Practices show that banks expect to year. The FOMC will determine meeting by meeting the extent of additional policy firming 1. See the May 4, 2022, press release regarding the that may be appropriate to return inflation to Plans for Reducing the Size of the Federal Reserve’s 2 percent over time, based on the totality of Balance Sheet, available on the Board’s website at https:// incoming data and their implications for the www.federalreserve.gov/newsevents/pressreleases/ outlook for economic activity and inflation. monetary20220504b.htm. 4 SUMMARy further tighten their lending standards over window, and other credit extensions, the the remainder of 2023, with some banks Federal Reserve’s total assets have increased reporting concerns about their liquidity since March. Take-up in the overnight reverse positions, deposit outflows, and funding costs. repurchase agreement (ON RRP) facility Economic research suggests that tighter credit remained elevated, as low rates on repurchase conditions at banks can have adverse effects agreements persisted amid still abundant on economic activity, but different studies liquidity and limited Treasury bill supply. find effects that vary in scope, magnitude, and The ON RRP facility continued to serve its timing. In terms of scope, the effects are also intended purpose of helping to provide a floor likely to differ across borrowers, economic under short-term interest rates and supporting sectors, and geographic areas, and they may effective implementation of monetary policy. be larger for sectors that depend more heavily (See the box “Developments in the Federal on bank credit, such as the commercial real Reserve’s Balance Sheet and Money Markets” estate and the small business sectors. (See the in Part 2.) box “Recent Developments in Bank Lending Conditions” in Part 1.) Monetary policy rules. Simple monetary policy rules, which prescribe a setting for the policy Federal Reserve’s balance sheet and money interest rate based on a small number of markets. The Federal Reserve continued other economic variables, can provide useful to reduce the size of its SOMA portfolio. guidance to policymakers. Since 2021, inflation However, in March, amid banking-sector has run well above the FOMC’s 2 percent developments, borrowing from the discount longer-run objective, and labor market window increased, and the Federal Reserve conditions have been very tight over the past implemented a new facility, the Bank Term year. As a result, simple monetary policy rules Funding Program (BTFP), to make additional have called for elevated levels of the federal funding available to eligible depository funds rate. (See the box “Monetary Policy institutions. As a result of Federal Reserve Rules in the Current Environment” in Part 2.) lending through the BTFP, the discount 5 P 1 art r e f d ecent conomic and inanciaL eveLoPments Domestic Developments Inflation has continued to decline but remains elevated, and progress has been uneven across categories Inflation, as measured by the 12-month 1. Personal consumption expenditures price indexes change in the price index for personal consumption expenditures (PCE), continued Monthly Percent change from year earlier to step down, on net, in recent months, Total 7 receding from its peak of 7.0 percent in June 6 of last year to 4.4 percent in April, although it remained well above the Federal Open 5 Market Committee’s (FOMC) longer-run 4 objective of 2 percent (figure 1). Core PCE 3 prices—which exclude volatile food and energy Trimmed 2 prices—rose 4.7 percent over the 12 months mean 1 Excluding food to April, down from the 5.4 percent peak and energy 0 early last year but little changed since the end of the year, with outcomes that have 2015 2016 2017 2018 2019 2020 2021 2022 2023 varied widely across spending categories. NOTE: The data extend through April 2023. SOURCE: For trimmed mean, Federal Reserve Bank of Dallas; for all The trimmed mean measure of PCE prices else, Bureau of Economic Analysis; all via Haver Analytics. from the Federal Reserve Bank of Dallas also remained elevated, increasing 4.8 percent over the 12 months to April, little changed since 2. Spot and futures prices for crude oil last fall. Weekly Dollars per barrel Consumer energy prices have declined so far this year, while food prices have 140 flattened out recently Brent spot price 120 After declining in the second half of last 100 year, oil prices have edged down further so 80 far this year (figure 2). The lower oil prices 24-month-ahead 60 appear to reflect weaker prospects for global futures contracts growth. Meanwhile, prospects for supply 40 have been mixed, with production cuts 20 announced by OPEC (Organization of the Petroleum Exporting Countries) partly offset 2019 2020 2021 2022 2023 by the unexpected resilience of Russian oil NOTE: The data are weekly averages of daily data and extend through June 9, 2023. production. Gasoline prices have edged down SOURCE: ICE Brent Futures via Bloomberg. so far this year, and prices for natural gas and heating oil have declined more noticeably. All told, the PCE energy price index in April was 6 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 3. Subcomponents of personal consumption expenditures price indexes Food and energy Components of core prices Percent change from year earlier Percent change from year earlier Monthly Percent change from year earlier 70 14 10 60 12 Food and 50 10 8 beverages 40 8 6 30 6 Housing 20 4 services 4 10 2 + + Services 2 0 0 ex. energy – – and housing + 10 2 _0 20 Energy 4 Goods ex. food, beverages, and 2 30 6 energy 2015 2016 2017 2018 2019 2020 2021 2022 2023 2015 2016 2017 2018 2019 2020 2021 2022 2023 NOTE: The data are monthly and extend through April 2023. SOURCE: Bureau of Economic Analysis via Haver Analytics. 4. Spot prices for commodities more than 6 percent below its level 12 months earlier (figure 3). Weekly Week ending January 3, 2014 = 100 Food prices have flattened out in recent 180 months, as prices of many agricultural 160 commodities and livestock have come down 140 from the highs reached at the start of Russia’s Industrial metals 120 war on Ukraine (figure 4). Partly reflecting these declines, grocery store price increases 100 slowed to an annual rate of 2.6 percent over 80 Agriculture the six months ending in April, down sharply and livestock 60 from the 11 percent pace recorded over the previous six months. This moderation brought 2015 2017 2019 2021 2023 the 12-month change down to 6.9 percent NOTE: The data are weekly averages of daily data and extend through in April, a rate that is still quite elevated but June 9, 2023. SOURCE: For industrial metals, S&P GSCI Industrial Metals Spot well below the increase of nearly 12 percent Index; for agriculture and livestock, S&P GSCI Agriculture & Livestock Spot Index; both via Haver Analytics. recorded at the end of last year (as shown in figure 3). Prices of both energy and food products are of particular importance for lower-income households, for which such necessities account for a large share of expenditures. Core goods price increases continue to soften as supply bottlenecks ease and import price inflation falls . . . Outside of food and energy goods and services, recent inflation performance has MONETARy POLICy REPORT: JUNE 2023 7 varied markedly across the core spending 5. Suppliers’ delivery times categories. Prices for core goods increased Monthly Diffusion index 2.6 percent over the 12 months ending in April, substantially below the 6.3 percent 80 increase recorded 12 months earlier but still well above the average rate observed during Manufacturing 70 the years before the pandemic (figure 3). Over the past year, supply chain issues have 60 diminished, other capacity constraints have eased, and demand appears to have stabilized. 50 Nonmanufacturing Transportation costs have also moved down 40 over the past year, and suppliers’ delivery times have improved (figure 5). Core goods inflation 2015 2016 2017 2018 2019 2020 2021 2022 2023 has also been held down this year by the net Note: Values greater than 50 indicate that more respondents decline in nonfuel import prices (figure 6). This reported longer delivery times relative to a month earlier than reported decline likely reflects the earlier appreciation shorter delivery times. SourCe: Institute for Supply Management, Report on Business, via of the dollar and decreases in prices for Haver Analytics. commodities such as industrial metals. 6. Nonfuel import price index . . . while core services price inflation Monthly Percent change from year earlier remains elevated 8 By contrast, core services price inflation 6 remains elevated. Housing services prices 4 have continued to rise especially rapidly, up 2 8.4 percent over the 12 months ending in April + (figure 3). However, the monthly changes have _0 started to ease in recent months, consistent 2 with the moderate increases observed since last 4 autumn in market rents on new housing leases 2015 2017 2019 2021 2023 to new tenants (figure 7). Because prices for housing services measure the rents paid by all NOTE: The data extend through April 2023. SOURCE: Bureau of Labor Statistics via Haver Analytics. tenants (and the equivalent rent implicitly paid 7. Housing rents by all homeowners)—including those whose leases have not yet come up for renewal—they Monthly Percent change from month earlier tend to adjust slowly to changes in rental market conditions and should therefore be 2.5 CoreLogic expected to continue to decelerate over the single-family 2.0 detached year ahead. By contrast, prices for other core Zillow 1.5 services—a broad group that includes services 1.0 such as travel and dining, financial services, .5 and car repair—rose 4.6 percent over the + _0 12 months ending in April and have not yet PCE housing .5 shown signs of slowing. However, the nascent services RealPage 1.0 softening of labor demand and improvements in labor supply, over time, should help slow 2019 2020 2021 2022 2023 core services price inflation as labor cost NOTE: CoreLogic data extend through March 2023, and personal growth moderates. consumption expenditures (PCE) data extend through April 2023. Zillow, CoreLogic, and RealPage measure market-rate rents–that is, rents for a new lease by a new tenant. SOURCE: Bureau of Economic Analysis, PCE, via Haver Analytics; CoreLogic, Inc.; Zillow, Inc.; RealPage, Inc.; Federal Reserve Board staff calculations. 8 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Measures of longer-term inflation expectations have been generally stable, while shorter-term expectations have been volatile and remained somewhat elevated The generally held view among economists and policy analysts is that inflation expectations influence actual inflation by affecting wage- and price-setting decisions. Since the end of last year, movements in the survey-based measures of expected inflation over a longer horizon have been mixed, but they remained within the range of values seen during the 8. Measures of inflation expectations decade before the pandemic and appear broadly consistent with the FOMC’s longer- Percent run 2 percent inflation objective. Expected 5.5 inflation over the next 5 to 10 years, as Michigan survey, next 12 months 5.0 measured in the University of Michigan 4.5 Surveys of Consumers, has edged up from its 4.0 average level in the fourth quarter of 2022 but 3.5 was still within the range of values observed 3.0 before the pandemic (figure 8). Expected 2.5 inflation over the next 10 years in the Survey 2.0 of Professional Forecasters, conducted by SPF, 6 to 10 years ahead SPF, 10 years ahead 1.5 Michigan survey, the Federal Reserve Bank of Philadelphia, next 5 to 10 years 1.0 has moved down since the end of last year, 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 reflecting a decline in the expectations for NOTE: The Survey of Professional Forecasters (SPF) data are inflation over the next few years. Over the quarterly, begin in 2007:Q1, and extend through 2023:Q2. The data for the Michigan survey are monthly. five years beginning five years from now, the SOURCE: University of Michigan Surveys of Consumers; Federal median forecaster in the survey continued Reserve Bank of Philadelphia, SPF. to expect PCE price inflation to average 2 percent. Furthermore, inflation expectations over a shorter horizon—which tend to more closely follow observed inflation—have moved down since the middle of last year. In the Michigan survey, the median value for inflation expectations over the next year was 4.2 percent in May, below the peak rate of 5.4 percent last spring but still quite elevated. Expected inflation for the next year, as measured in the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, has also declined, on net, over this period and has retraced more than half of its earlier increase. MONETARy POLICy REPORT: JUNE 2023 9 Market-based measures of longer-term 9. Inflation compensation implied by Treasury inflation compensation, which are based on Inflation-Protected Securities financial instruments linked to inflation, are Daily Percent also broadly in line with readings seen in the years before the pandemic and consistent with 4.0 inflation returning to 2 percent. For example, 3.5 the measure of inflation compensation over the 5-to-10-year 3.0 next five years implied by Treasury Inflation- 2.5 Protected Securities has declined slightly 2.0 since the end of last year, while the measure 1.5 5-year of inflation compensation for the period 5 to 1.0 10 years ahead has increased slightly (figure 9). .5 0 The labor market has continued to 2011 2013 2015 2017 2019 2021 2023 strengthen NOTE: The data are at a business-day frequency and are estimated from smoothed nominal and inflation-indexed Treasury yield curves. Payroll employment gains averaged 314,000 SOURCE: Federal Reserve Bank of New York; Federal Reserve Board per month during the first five months of staff calculations. this year, down from the 400,000 per month 10. Nonfarm payroll employment average pace last year but still quite robust (figure 10). Employment gains have been Monthly Thousands of jobs spread somewhat less evenly across industries this year than in 2022.2 Employment in 800 the leisure and hospitality and the health 700 services sectors, as well as in state and 600 local governments, continued to increase 500 robustly over the first half of this year, 400 while employment growth in construction, 300 manufacturing, and retail trade—industries 200 that are more sensitive to interest rate 100 increases—has moderated. Employment gains from the Bureau of Labor Statistics’ (BLS) 2021 2022 2023 household survey also have been robust, on NOTE: The data shown are a 3-month moving average of the change in average, since the end of last year, about in line nonfarm payroll employment. SOURCE: Bureau of Labor Statistics via Haver Analytics. with the payroll survey. 11. Civilian unemployment rate The unemployment rate has remained near historically low levels (figure 11). At Monthly Percent 3.7 percent in May, the jobless rate was close 16 to its level right before the pandemic and has 14 been fluctuating within a narrow range since 12 early last year. Unemployment rates among various age, educational attainment, gender, 10 and ethnic and racial groups are also near their 8 6 4 2. The share of industries expanding their employment each month, on average, was 60 percent 2 during the first half of this year, down from 69 percent in 2022 and just slightly above the 57 percent average rate 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 observed between 1991 and 2019. SOURCE: Bureau of Labor Statistics via Haver Analytics. 10 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS respective historical lows (figure 12). (The box “Developments in Employment and Earnings across Demographic Groups” provides further details.) Labor demand has eased but remains very strong . . . Demand for labor remained very strong in the first half of 2023. The Job Openings and Labor Turnover Survey indicated that there were around 10 million job openings at the end of April—down about 2 million from the all-time high recorded in March 2022 but still around 3 million above pre-pandemic levels. An alternative measure of job vacancies constructed by Federal Reserve Board staff using job postings data from the large online job board Indeed also shows that vacancies have continued to move gradually lower through the first half of 2023 but have remained well above pre-pandemic levels. Many employers report having scaled back their hiring plans somewhat, though levels of anticipated hiring remain high by historical 12. 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 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 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 2023 11 Developments in Employment and Earnings across Demographic Groups Strong labor demand over the past two years, with seen further improvements, on net, for Black or African plentiful job openings and low levels of layoffs, has American workers: The prime-age Black employment- pushed the unemployment rate down to its lowest level to-population (EPOP) ratio stands near a historical in 50 years . Just as previous economic expansions high, and the prime-age Black–white employment gap have tended to narrow long-standing differences in recently hit a series low (not shown) .2 Similarly, both employment and wages across demographic groups, men and women aged 25 to 54 with a high school many of these gaps are now in historically narrow degree or less saw much larger employment declines ranges as a result of today’s very tight labor market . in early 2020 than prime-age workers with at least One notable exception is employment differences some college education, but by the end of 2022, across age groups, as persistently elevated retirement these gaps had almost entirely returned to their 2019 rates since the onset of the COvID-19 pandemic have levels, as shown in the right panel of fi gure A . For kept employment for older age groups (as a share of the prime-age women as a whole, the employment rate population) below pre-pandemic levels . has risen briskly in recent months and currently stands Among prime-age workers, the tight labor market at a historical high, bolstered by a historically high conditions of the past two years have reversed participation rate . the pandemic-induced widening of the gaps in Differences in employment dynamics between employment across racial, ethnic, and education groups since the start of the pandemic stem from groups . As shown in the left panel of fi gure A, Black a mixture of demand and supply factors . On the or African American and Hispanic or Latino workers labor demand side, the leisure and hospitality sector saw much larger employment declines in early 2020 experienced severe losses in 2020 but has seen a than Asian and white workers . By mid-2022, however, strong rebound in employment in the past two years . employment in each of these groups had recovered (continued on next page) to or surpassed its pre-pandemic level .1 This year has 2 . The recent rise in the prime-age Black EPOP ratio has 1 . This discussion defi nes the pre-pandemic baseline been driven by both a rapid rise in the prime-age Black employment-to-population (EPOP) ratio for each group as that participation rate above its pre-pandemic level and a falling of group’s average EPOP ratio over 2019 . the Black unemployment rate to a historical low . A. Prime-age employment-to-population ratios compared with the 2019 average ratio, by group Race and ethnicity Sex and educational attainment Monthly Percentage points Monthly Percentage points 4 Men, some college or more 4 Asian Women, some college or more White + + _0 _0 4 4 Men, high school or less 8 8 Black or African American 12 12 Hispanic or Latino Women, high school or less 16 16 2019 2020 2021 2022 2023 2019 2020 2021 2022 2023 NOTE: Prime age is 25 to 54. All series are seasonally adjusted by the Federal Reserve Board staff. SOURCE: Bureau of Labor Statistics; U.S. Census Bureau, Current Population Survey; Federal Reserve Board staff calculations. 12 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments in Employment and Earnings (continued) Because workers with a high school degree or less B. Employment-to-population ratios relative to 2019 are historically more than twice as likely as workers average, by age with a college degree to be employed in leisure and hospitality, part of this group’s unusually large Monthly Percentage points employment decline and rebound is likely attributable 3 to the fl uctuations in labor demand from this sector .3 + Additionally, transportation and warehousing, the _0 sector with the largest increase in labor demand during 3 Ages 55+ the pandemic, disproportionately employs Black Ages 25 to 54 6 workers and workers with a high school degree or less . As this sector has largely maintained its pandemic- 9 era employment gains, these groups’ employment 12 rates have also benefi ted disproportionately . On the 15 labor supply side, with schools having generally Ages 16 to 24 returned to in-person education for the past two 18 years, childcare constraints have eased, allowing 2019 2020 2021 2022 2023 many parents, particularly mothers, to reenter the NOTE: Data are adjusted to account for the effect of the population workforce . Furthermore, labor supply and demand control adjustments incorporated into the published data each January. factors may be combining to facilitate employment See Federal Reserve Bank of Atlanta (2023), “Population Control for historically marginalized workers . For instance, Adjustment’s Impact on Labor Force Data: The 2023 Edition,” Policy Hub: Macroblog, February 9, https://www.atlantafed.org/blogs/macro greater availability of telework, along with strong labor blog/2023/02/09/population-control-adjustments-impact-on-labor- demand, is likely pulling more people with disabilities force-data--2023-edition. into employment—a group whose EPOP ratio has risen SOURCE: Federal Reserve Bank of Atlanta; Bureau of Labor Statistics; U.S. Census Bureau, Current Population Survey; Federal Reserve Board sharply over the past two years and stands roughly staff calculations. 3 percentage points above its pre-pandemic level . While labor supply among prime-age workers Although the pandemic-induced widening of appears to have largely normalized, differential effects employment gaps across racial, ethnic, and educational of the pandemic on labor supply across age groups groups has reversed, considerable gaps remain . For persist . Despite experiencing larger losses at the outset example, while the prime-age EPOP ratio among Blacks of the pandemic, workers aged 16 to 24 and 25 to 54 recently reached an all-time high, it remains about have now surpassed their pre-pandemic EPOP ratios 3 .5 percentage points below that of whites, and the (see fi gure B) . The EPOP ratio for those aged 55 and EPOP ratio of college-educated, prime-age people is over, however, has shown little net improvement since about 13 percentage points higher than that of prime- late 2021 and currently stands about 2 percentage age people with high school degrees or less . points below its pre-pandemic level . The lower EPOP The tight labor market conditions of the past two ratio for that group is entirely attributable to a lower years have led to strong growth in nominal wages . labor force participation rate, which in turn largely However, increases in the prices of goods and services refl ects an increase in retirements since the onset of the pandemic .4 over this period have outpaced the nominal wage gains experienced by many workers . As a result, many workers’ real wages shrank in late 2021 and for much 3 . Similarly, Black or African American, Hispanic or of 2022, and real wage growth has remained quite Latino, and Asian workers are also overrepresented in the slow since then . The real wages of the least advantaged leisure and hospitality industry relative to white workers, groups, however, have held up better during this although these differences are smaller than differences by education . See Guido Matias Cortes and Eliza Forsythe (2023), period . As shown in the upper panels of fi gure C, real “Heterogeneous Labor Market Impacts of the COvID-19 wages for workers with a high school degree or less Pandemic,” ILR Review, vol . 76 (January), pp . 30–55 . (continued) 4 . For an analysis on the increase in retirements following the pandemic, see Joshua Montes, Christopher Smith, and Juliana Dajon (2022), “ ‘The Great Retirement Boom’: The Series 2022-081 (Washington: Board of Governors of the Pandemic-Era Surge in Retirements and Implications for Future Federal Reserve System, November), https://doi .org/10 .17016/ Labor Force Participation,” Finance and Economics Discussion FEDS .2022 .081 . MONETARy POLICy REPORT: JUNE 2023 13 C. Median real wage growth, by group Educational attainment Race Monthly Percent Monthly Percent 3 3 2 2 White Associate’s degree High school 1 1 Nonwhite + + _0 _0 1 1 Bachelor’s degree 2 2 2019 2020 2021 2022 2023 2019 2020 2021 2022 2023 Wage quartiles Sex Monthly Percent Monthly Percent 3rd quartile 1st quartile 4 3 3 2 2nd quartile 2 Women 4th quartile 1 1 + + _0 _0 1 Men 1 2 2 3 2019 2020 2021 2022 2023 2019 2020 2021 2022 2023 NOTE: The data extend through April 2023. Series show 12-month moving averages of the median percent change in the hourly wage of individuals observed 12 months apart, deflated by the 12-month moving average of the 12-month percent change in the personal consumption expenditures price index. In the bottom-left panel, workers are assigned to wage quartiles based on the average of their wage reports in both Current Population Survey outgoing rotation group interviews; workers in the lowest 25 percent of the average wage distribution are assigned to the 1st quartile, and those in the top 25 percent are assigned to the 4th quartile. SOURCE: Federal Reserve Bank of Atlanta, Wage Growth Tracker; Bureau of Labor Statistics; U.S. Census Bureau, Current Population Survey. and for nonwhite workers shrank less through early distribution (see the lower-left panel) .6 There has 2022 and have grown more since then .5 This pattern been less of a difference in the real wage growth largely refl ects the fact that real wage growth has been patterns of men versus women, which have largely consistently stronger at the lower end of the income moved in tandem over the past few years (see the lower-right panel) . 5 . In order to reduce noise due to sampling variation, which can be pronounced when considering disaggregated groups’ 6 . The tightening of labor market conditions during wage changes, the series shown in fi gure C are the 12-month the previous expansion also resulted in stronger real moving averages of the groups’ median 12-month real wage wage growth for workers in the bottom income quartile, change . Thus, by construction, these series lag the actual real refl ecting the tendency of less advantaged workers to benefi t wage changes . disproportionately from tight labor market conditions . 14 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS standards.3 Initial claims for unemployment insurance moved up notably in the first two months of the year but appear to have flattened out more recently at a relatively low level.4 Continued claims have been rising 13. Labor force participation rate gradually, on net, since the turn of the year but Monthly Percent have remained at a relatively low level as well. 67 . . . and labor supply has improved . . . 66 Meanwhile, the supply of labor continued to 65 improve. The labor force participation rate, 64 which measures the share of people either 63 working or actively seeking work, moved up, 62 on net, during the first five months of this year, 61 though it is still roughly 1 percentage point 60 below its February 2020 level (figure 13).5 The decline in overall participation reflects both the 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 unusually large increase in retirements among Note: The labor force participation rate is a percentage of the population aged 16 and over. Data from 2012–22 are adjusted for the older workers during the pandemic as well as January 2023 updated population controls. See Federal Reserve Bank the normal effects of population aging. Labor of Atlanta (2023), “Population Control Adjustment’s Impact on Labor Force Data: The 2023 Edition,” Policy Hub: Macroblog, February 9, force participation for prime-age workers has https://www.atlantafed.org/blogs/macroblog/2023/02/09/population- risen markedly this year and recently surpassed control-adjustments-impact-on-labor-force-data--2023-edition. Data before 2012 are adjusted for the January 2022 updated population its pre-pandemic level, while the rate for teens controls. See Bureau of Labor Statistics (2022), “Adjustments to has flattened out after having moved above Household Survey Population Estimates in January 2022,” Current Population Survey technical documentation (Washington: BLS, its pre-pandemic level last year. Participation February), https://www.bls.gov/cps/population-control-adjustments- has increased for all racial groups over the 2022.pdf. SourCe: Bureau of Labor Statistics via Haver Analytics; Federal past year. (For a discussion of employment Reserve Bank of Atlanta; Federal Reserve Board staff calculations. rates across demographic groups, see the box “Developments in Employment and Earnings across Demographic Groups.”) 3. For example, the (net) share of employers planning to increase payrolls in coming months, as reported by both the staffing firm ManpowerGroup and the National Federation of Independent Business, has moved down over the past year but remains elevated. 4. The data on initial claims have been affected this year by some instances of fraudulent claims, which have been removed from the estimates after they were uncovered. In addition, the large swings in the data during the pandemic have made it more challenging to seasonally adjust claims in recent years. 5. This labor force participation rate (LFPR) estimate and figure 13 adjust the historical data to account for the updated population estimates produced by the Census Bureau and incorporated by the BLS in its January 2022 Employment Situation report. Without making an adjustment for these updated population estimates, the LFPR would erroneously appear to have improved more since the onset of the pandemic and to be only about ¾ percentage point below its pre-pandemic level. MONETARy POLICy REPORT: JUNE 2023 15 Labor supply has also been boosted over the past year by faster population growth, largely reflecting the rebound in immigration.6 After having slowed to an average increase of 0.5 percent per year in 2020 and 2021 because of the COVID-related increase in mortality and restrictions on immigration, population growth bounced back in 2022 and is estimated to have been at an annual rate of 0.7 percent so far this year, about the same as the average growth rate in 2018 and 2019 but still well below the average growth rate observed between 1990 and 2015. . . . but the labor market remains very tight 14. Available jobs versus available workers With the easing in labor demand and improvement in labor supply so far this year, Monthly Millions the labor market has become somewhat less tight than it was last year, but it nonetheless 175 remains very tight. The number of total 170 available jobs (measured by total employment 165 plus job openings) continues to far exceed 160 Available workers the number of available workers (measured 155 by the size of the labor force). This jobs– 150 workers gap was around 4 million in May, Available jobs 145 below the peak of 6 million recorded in 140 April 2022 but still very elevated by historical 135 standards (figure 14).7 Similarly, households’ 2002 2005 2008 2011 2014 2017 2020 2023 and small businesses’ perceptions of labor market tightness have come down from their Note: Available jobs are employment plus job openings as of the end of the previous month. Available workers are the labor force. recent peaks but remain high. In addition, Data from 2012–22 are adjusted for the January 2023 updated many employers surveyed for the Federal population controls. See Federal Reserve Bank of Atlanta (2023), “Population Control Adjustment’s Impact on Labor Force Data: The Reserve’s May 2023 Beige Book reported some 2023 Edition,” Policy Hub: Macroblog, February 9, https://www. easing of hiring and retention difficulties but a tlantafed.org/blogs/macroblog/2023/02/09/population- c ontrol-adjustments-impact-on-labor-force-data--2023-edition. generally continued to report difficulty finding Data before 2012 are adjusted for the January 2022 updated popula- workers across a wide range of skill levels tion controls. See Bureau of Labor Statistics (2022), “Adjustments to Household Survey Population Estimates in January 2022,” Current and industries.8 Other measures suggest labor Population Survey technical documentation (Washington: B LS, February), https://www.bls.gov/cps/population-control- adjustments-2022.pdf. 6. The population estimate refers to the civilian SourCe: Bureau of Labor Statistics; Job Openings and Labor noninstitutional population aged 16 and older. This Turnover Survey; both via Haver Analytics; Federal Reserve Bank of population estimate adjusts the historical data to account Atlanta; Federal Reserve Board staff calculations. for the updated population estimates produced by the Census Bureau and incorporated by the BLS in its January 2022 Employment Situation report. 7. The ratio of job openings to unemployment shows that there were 1.7 job openings per unemployed person in May 2023. For comparison, this ratio averaged 1.2 in 2019 and 0.6 over the 10-year period from 2010 to 2019. 8. See the May 2023 Beige Book, available on the Board’s website at https://www.federalreserve.gov/ monetarypolicy/files/BeigeBook_20230531.pdf. 16 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS market tightness has eased more substantially over the past year. For example, the share of workers quitting jobs each month, an indicator of the availability of attractive job prospects, has continued to decline this year and has 15. Measures of change in hourly compensation retraced nearly all of the increase between the start of the pandemic and its all-time peak in Percent change from year earlier late 2021. 10 Average hourly earnings, Wage growth has slowed but remains private sector 8 elevated 6 Nominal wage growth continued to show Atlanta Fed’s Wage Growth Tracker 4 signs of slowing in the first part of 2023 but remained elevated (figure 15). Total hourly 2 Employment cost index, compensation as measured by the employment private sector 0 cost index increased 4.8 percent over the 12 months ending in March, a strong gain 2013 2015 2017 2019 2021 2023 but a step-down from the peak increase Note: For the private-sector employment cost index, change is over the of 5.5 percent observed early last year. 12 months ending in the last month of each quarter; for private-sector Increases in average hourly earnings (a less 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 comprehensive measure of compensation) moving average of the 12-month percent change. SourCe: Bureau of Labor Statistics; Federal Reserve Bank of Atlanta, have slowed as well, rising 4.3 percent over Wage Growth Tracker; all via Haver Analytics. the 12 months to May, down from 5.5 percent over the preceding 12 months. Wage growth as measured by the Federal Reserve Bank of Atlanta’s Wage Growth Tracker, which reports the median 12-month wage growth of individuals responding to the Current Population Survey, was 6.0 percent in May, below its peak last summer but well above the 3 to 4 percent pace reported over the few years before the pandemic. A similar measure constructed by Federal Reserve Board staff using data from the payroll processing firm ADP, which has a much larger sample than the Wage Growth Tracker, has shown a more noticeable decline since last summer. Following a period of strong growth, labor productivity weakened over the past year The extent to which nominal wage gains raise firms’ costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. As measured by the BLS, productivity rose at a rapid average pace of 3 percent over 2020 and 2021, but it MONETARy POLICy REPORT: JUNE 2023 17 declined last year and early this year as output 16. U.S. labor productivity growth in the nonfarm business sector fell Quarterly 2012:Q1 = 100 short of growth in hours worked (figure 16). In retrospect, much of the strong productivity 116 growth in 2020 and 2021 seems to have been 114 the result of temporary pandemic-related 112 110 factors, and thus the declines since then may 108 reflect a normalization as productivity moves 106 back toward its trend. In 2021, as the economy 104 reopened, firms struggled to hire workers, 102 and many firms temporarily operated with 100 overstretched workforces.9 Subsequently, the 98 slowdown in aggregate demand growth over 2011 2013 2015 2017 2019 2021 2023 the past year allowed many firms to catch up in their hiring, and the level of productivity in NOTE: The data are output per hour in the nonfarm business sector. SOURCE: Bureau of Labor Statistics via Haver Analytics. the first quarter of this year was roughly back in line with its pre-pandemic trend.10 The pace of future productivity growth remains very uncertain. Productivity growth averaged only about 1 percent per year during the expansion that preceded the pandemic recession, and it is possible that the economy has remained in that low-productivity growth regime while experiencing large gyrations in aggregate demand and hiring induced by the pandemic. However, it also seems possible that the high rate of new business formation, widespread adoption of remote- work technology, and the wave of labor- saving investments that the pandemic brought about—as well as continued improvement in and adoption of artificial intelligence and robotics—could boost productivity growth above that pace in coming years. 9. In 2020, significant composition effects were also boosting labor productivity, as pandemic-induced employment losses were largest in lower-productivity services sectors. Employment composition looks to have largely normalized by 2021. 10. Consistent with this view, the Beige Books published during the fall of last year reported that many employers cited concerns that their workforce was being overworked as an important reason for hiring; see the November 2022 Beige Book, available on the Board’s website at https://www.federalreserve.gov/ monetarypolicy/files/BeigeBook_20221130.pdf. 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Momentum in gross domestic product has slowed After the strong rebound in 2021 from the pandemic-induced recession, economic 17. Change in real gross domestic product and gross domestic income activity lost momentum last year, and growth in the first quarter of this year was modest Percent, annual rate as financial conditions continued to tighten. Gross domestic product Real gross domestic product (GDP) rose Gross domestic income 6 at an annual rate of 1.3 percent in the first 4 quarter, following an increase of less than 1.0 percent over the four quarters of 2022 Q1 2 (figure 17).11 Among the components of + _0 GDP, growth in consumer spending picked up in the first quarter, reflecting unusually 2 warm weather, a pickup in vehicle sales as the 4 shortages eased, and a decline in energy prices that boosted households’ purchasing power 2013 2015 2017 2019 2021 2023 amid dour sentiment and tightening credit NOTE: The key identifies bars in order from left to right. conditions. The sharp retrenchment in the SOURCE: Bureau of Economic Analysis via Haver Analytics. housing sector that began last year in response to the rise in mortgage rates has moderated noticeably, while business investment growth has slowed. Finally, manufacturing output has been little changed, on net, so far this year, following a decline in the fourth quarter of last year, despite a rebound in motor vehicle production. Surveys of manufacturers point to continued weakness in coming months, as the diffusion indexes of new orders from various manufacturing surveys remained in contractionary territory, and backlogs of existing orders continued to decline. Consumer spending growth has been resilient but appears to be moderating . . . Consumer spending adjusted for inflation grew at a robust 3.8 percent rate in the first quarter, although the increase reflected a large gain in January that appears to have been partly attributable to temporary factors. For 11. Real gross domestic income (GDI) has been notably weaker than GDP over the past year, although both series measure the same economic concept, and any difference between the two figures reflects measurement error. GDI is reported to have declined at an annual rate of 2.3 percent in the first quarter of this year after having edged down 0.2 percent over the four quarters of 2022, in contrast to the increases in GDP and employment. MONETARy POLICy REPORT: JUNE 2023 19 example, mild weather in some parts of the 18. Real personal consumption expenditures country boosted spending on services, and Trillions of chained 2012 dollars Trillions of chained 2012 dollars motor vehicle sales moved up sharply despite the tightening credit conditions, as a rebound 6.0 9.5 in vehicle production alleviated some pent-up 5.5 9.0 demand. All told, real consumer spending on 5.0 goods has trended sideways since mid-2021 8.5 4.5 following its surge during 2020 and early 2021, 8.0 Goods 4.0 while real spending on services has continued 7.5 to grow but appears to be decelerating 3.5 (figure 18). These data suggest that consumers’ 3.0 Services 7.0 spending habits have been returning toward 2.5 6.5 their pre-pandemic patterns, albeit very slowly. 2007 2009 2011 2013 2015 2017 2019 2021 2023 . . . as consumer confidence remains low NOTE: The data are monthly and extend through April 2023. SOURCE: Bureau of Economic Analysis via Haver Analytics. and the saving rate edges up toward more typical levels 19. Indexes of consumer sentiment The fundamentals for household spending remain quite soft, despite some recent Monthly 2018 average = 100 improvements, and appear to support only 110 Michigan survey modest spending growth this year. The 100 University of Michigan index of consumer 90 sentiment remains very low by historical 80 70 standards (figure 19). Although real disposable 60 personal income (DPI) increased robustly Conference Board 50 in the first quarter, it has been roughly 40 unchanged since the end of 2021 owing 30 to the rise in prices, higher tax payments, 20 and reduced transfers. Household wealth 10 has declined since the end of 2021 and is 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 providing less support to consumer spending, SOURCE: University of Michigan Surveys of Consumers; Conference especially for households with low incomes Board. that may have exhausted their excess savings accumulated earlier in the pandemic. The 20. Personal saving rate saving rate, which fell sharply in 2021 and the first half of 2022 as real DPI declined and Monthly Percent excess savings were spent, began to increase 36 in the second half of 2022 as real DPI started 32 to rebound (figure 20). Households may be 28 restraining consumer spending growth this 24 year to continue raising the saving rate toward 20 its pre-pandemic average level. 16 12 Consumer financing conditions have 8 tightened 4 0 Consumer financing conditions have tightened 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 in the wakes of the monetary policy tightening NOTE: The data extend through April 2023. and the recent banking-sector developments. SOURCE: Bureau of Economic Analysis via Haver Analytics. 20 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 21. Consumer credit flows Interest rates on credit cards and auto loans have increased over the past year and are Billions of dollars, monthly rate now higher than the levels observed in 2018 Student loans 30 at the peak of the previous monetary policy Auto loans 25 tightening cycle. In addition, banks reported Credit cards Apr. 20 tighter lending standards across consumer 15 credit products in the second half of 2022 10 and early 2023, in part reflecting increases 5 + in delinquency rates, concerns about further _0 Q1 future deterioration in credit performance, and 5 higher funding costs in the banking sector. 10 (See the box “Recent Developments in Bank 15 Lending Conditions.”) 2011 2013 2015 2017 2019 2021 2023 NOTE: The key identifies bars in order from top to bottom. Credit card After having risen last year, delinquency rates balances were little changed in 2011 and 2012, and student loan balances were little changed in 2023:Q1. leveled off in the first quarter for auto loans SOURCE: Federal Reserve Board, Statistical Release G.19, “Consumer and continued to increase for credit card Credit.” loans. Among nonprime borrowers, the share 22. Mortgage interest rates of delinquent balances for auto loans and Weekly Percent that for credit cards are above pre-pandemic levels, although these borrowers represent 8 small shares of both markets. Despite the 7 tighter financial conditions, consumer credit 6 continued to expand during the past several months (figure 21). Total credit card balances 5 across the credit score distribution have 4 increased, and auto loans have continued to 3 expand at a steady pace. 2 Housing market activity appears to have 2015 2017 2019 2021 2023 bottomed out NOTE: The data are contract rates on 30-year, fixed-rate conventional Following a steep decline in housing activity home mortgage commitments and extend through June 8, 2023. SOURCE: Freddie Mac Primary Mortgage Market Survey. last year, many measures of activity appear 23. New and existing home sales to have bottomed out in recent months. Mortgage rates have been little changed, on Millions, annual rate Millions, annual rate net, so far this year after rising sharply last 1.6 7.0 year (figure 22). With higher mortgage rates 6.6 and the large home price increases having 1.4 6.2 greatly reduced affordability and depressed 1.2 Existing home sales 5.8 homebuying sentiment, activity in the housing 1.0 5.4 market has remained far below its recent peak .8 5.0 so far this year. 4.6 .6 4.2 .4 Existing home sales have edged up this year, New home sales 3.8 .2 3.4 albeit from very low levels, as demand appears to have stabilized at a lower level consistent 2007 2009 2011 2013 2015 2017 2019 2021 2023 with the higher mortgage rates (figure 23). NOTE: The data are monthly and extend through April 2023. New Meanwhile, the supply of existing homes home sales include only single-family sales. Existing home sales include single-family, condo, and co-op sales. for sale has remained quite low. New home SOURCE: For new home sales, U.S. Census Bureau; for existing home sales, National Association of Realtors; all via Haver Analytics. MONETARy POLICy REPORT: JUNE 2023 21 Recent Developments in Bank Lending Conditions Bank lending conditions have tightened notably given the large increase in bank deposits experienced over the past year, and bank loan growth has slowed . during the COvID-19 pandemic .2 Tighter credit standards and terms at banks are a Bank credit conditions have tightened further since normal part of the monetary policy tightening cycle, but March . As detailed in the box “Developments Related the recent stress in the banking sector has reportedly to Financial Stability,” some parts of the banking system led to additional tightening in credit conditions at came under severe stress late in the week of March 6, some banks .1 which led to large deposit outfl ows and depressed Rising interest rates, in response to elevated bank stock prices . Policy interventions by the Federal infl ation, and uncertainty about the economic outlook Reserve and other agencies helped mitigate the strains have increased borrowing costs and tightened bank in the banking system, and deposit outfl ows slowed credit conditions since the second quarter of 2022 . In considerably, but the episode reportedly left an imprint addition, deposit outfl ows have reduced an important on bank lending conditions, especially for mid-sized source of funding for banks, as investors have shifted and small banks . toward higher-yielding alternative investment vehicles, The Senior Loan Offi cer Opinion Survey on Bank such as money market funds (MMFs) . These outfl ows Lending Practices (SLOOS) provides evidence on bank refl ect banks raising their deposit rates relatively slowly lending conditions . Figure A shows that banks reported in response to policy tightening, and the spreads having tightened lending standards across most loan between MMF yields and bank deposit rates widening (continued on next page) sharply . Despite these outfl ows, bank deposits have remained elevated relative to the pre-pandemic levels, 2 . For a discussion of bank deposit growth during the 1 . For evidence on the relationship between tighter COvID-19 pandemic, see Andrew Castro, Michele Cavallo, monetary policy and credit conditions, see Ben Bernanke and Rebecca Zarutskie (2022), “Understanding Bank Deposit and Mark Gertler (1995), “Inside the Black Box: The Credit Growth during the COvID-19 Pandemic,” FEDS Notes Channel of Monetary Policy Transmission,” Journal of (Washington: Board of Governors of the Federal Reserve Economic Perspectives, vol . 9 (Fall), pp . 27–48 . System, June 3), https://doi .org/10 .17016/2380-7172 .3133 . A. Changes in standards and demand across loan categories for domestic respondents Quarterly Percent 100 Jan. 2023 SLOOS 80 60 Standards 40 20 + _0 20 40 Demand 60 1993 1998 2003 2008 2013 2018 2023 NOTE: Series shows the net share of banks reporting tighter standards or stronger demand, aggregated across loan categories weighting by the size of banks’ portfolios in the Call Report at the end of the previous quarter. For the black curve, positive (negative) values indicate banks reporting tighter (easier) standards; for the blue curve, positive (negative) values indicate banks reporting stronger (weaker) demand. The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: March 2001 to November 2001, December 2007 to June 2009, and February 2020 to April 2020. Data for 2023:Q1 correspond to results for the April 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS). SOURCE: Federal Reserve Board (FRB), SLOOS; FRB staff calculations. 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Recent Developments in Bank Lending Conditions (continued) categories since the beginning of the policy tightening B. Changes in standards across commercial real estate cycle and well before the emergence of banking- loans for domestic respon dents sector stresses in March . Banks reported additional tightening in the April 2023 SLOOS and indicated that Quarterly Percent they expect to further tighten their lending standards 100 over the remainder of 2023 . While banks continued to Jan. 2023 SLOOS cite concerns over credit quality, collateral values, and 80 the macroeconomic outlook as reasons for tightening 60 or expecting to tighten their lending standards, some 40 banks also reported concerns about their liquidity positions, deposit outfl ows, and funding costs as 20 + reasons for tightening their lending standards in the fi rst _0 quarter and expecting to tighten over the remainder of 20 2023 . Current and expected tightening, and concerns about liquidity, deposits, and funding costs, were more 40 frequently reported by the mid-sized and small banks 2013 2015 2017 2019 2021 2023 relative to the largest banks . This evidence suggests that the recent banking-sector stress and related concerns NOTE: Series shows the net share of banks reporting tighter standards for commercial real estate loans. Individual bank responses have been about deposit outfl ows and funding costs contributed to weighted by the outstanding amount of the relevant loan category on its tightening and expected tightening in lending standards balance sheet at the end of the previous quarter based on Call Report data. Positive (negative) values indicate banks reporting tighter (easier) and terms at some banks beyond what these banks standards. The shaded bar with a top cap indicates a period of business would have reported absent the banking-sector stress .3 recession as defined by the National Bureau of Economic Research: From a sectoral perspective, commercial real estate February 2020 to April 2020. Data for 2023:Q1 correspond to results for the April 2023 Senior Loan Officer Opinion Survey on Bank Lending (CRE) loans have registered the most frequent reports Practices (SLOOS). of tightening in lending standards over the past year SOURCE: Federal Reserve Board (FRB), SLOOS; FRB staff calculations. (fi gure B) . Similarly, in the April survey, a large fraction of banks reported expecting further tightening in CRE lending, especially among mid-sized and small banks . In addition, banks reported tightening over a broad tightening in standards for CRE loans, in the recent range of terms for CRE loans in the past year, with earnings calls, banks attributed increased loan loss the most frequently reported changes pertaining to provisioning, in part, to concerns about the worsening wider spreads of loan rates over banks’ cost of funds outlook for CRE loan quality . In turn, while demand and lower loan-to-value ratios . Consistent with the for loans was reported to have weakened for most loan categories in the April SLOOS, this fi nding was more widely reported for CRE loans . Banks have been 3 . In the April SLOOS, the largest banks are defi ned as reporting weaker demand for CRE loans since those with total domestic assets of $250 billion or more as mid-2022 . of December 31, 2022, mid-sized banks as those with assets between $50 billion and $250 billion, and banks in the small, Consistent with the tightening standards, as well as or other, category as those with assets under $50 billion . See with the weakening loan demand, growth in core loans Board of Governors of the Federal Reserve System (2023), on banks’ books has been decelerating since late 2022 . Senior Loan Offi cer Opinion Survey on Bank Lending Commercial and industrial (C&I) and CRE loan growth Practices (Washington: Board of Governors, April), https:// www .federalreserve .gov/data/sloos/sloos-202304 .htm . (continued) MONETARy POLICy REPORT: JUNE 2023 23 at banks has slowed, and C&I loan balances have even Bank-dependent sectors and communities, declined in recent months . Growth of residential real especially those that depend on small and mid-sized estate and consumer loans has continued to be solid banks, are likely the most affected by the current but has also decelerated . tightening in bank credit conditions . The “Financial Tighter credit conditions at banks can weigh on Accounts of the United States” show that the share economic activity, but the extent of their effects is of bank loans in aggregate outstanding credit to uncertain and may vary across borrowers . Economic households and businesses has declined notably research has shown that banks perform a key role since the late 1970s, from more than one-half in those in aggregating funding and developing relationships years to about one-third in recent years—a decline with borrowers, and thus disruptions in banks’ ability accompanied by the expansion of the market for to provide credit can negatively affect borrowers’ corporate bonds and the growth in other sources of economic well-being .4 Several papers document the nonbank lending . effects of bank credit tightening on aggregate economic But many businesses and households still rely activity .5 Although different studies fi nd effects that primarily on banks; for instance, while large businesses differ in magnitude and timing, a broad range of can access many nonbank sources of credit, small research highlights the potential for material adverse businesses mostly borrow from banks, often the small effects on economic activity from an acute tightening in and mid-sized banks that service the geographic bank credit availability . The economic research has also areas where these businesses are located . Therefore, shown that the size of the effects varies by borrower tightening credit conditions can lead to reduced type, geographic region, and economic sector .6 investment and employment at many small businesses . The CRE sector—which, as noted earlier, has seen a sharp tightening in standards, especially at mid-sized and small banks—also depends heavily on bank lending . Banks hold about 60 percent of total CRE 4 . See, for instance, Ben S . Bernanke (1983), “Nonmonetary mortgages, with smaller banks accounting for a notable Effects of the Financial Crisis in the Propagation of the Great share .7 Finally, banks still hold the majority of credit Depression,” American Economic Review, vol . 73 (June), card loans and a sizable portion of auto loans . pp . 257–76; and Ben S . Bernanke (2018), “The Real Effects of Disrupted Credit: Evidence from the Global Financial Crisis,” Brookings Papers on Economic Activity, Fall, pp . 251–322, https://www .brookings .edu/wp-content/uploads/2018/09/ Bernanke_final-draft .pdf . 5 . See, in particular, the SLOOS-based analysis by William (August), pp . 983–1014; Joe Peek and Eric S . Rosengren F . Bassett, Mary Beth Chosak, John C . Driscoll, and Egon (2000), “Collateral Damage: Effects of the Japanese Bank Crisis Zakrajšek (2014), “Changes in Bank Lending Standards and on Real Activity in the United States,” American Economic the Macroeconomy,” Journal of Monetary Economics, vol . 62 Review, vol . 90 (March), pp . 30–45; and Gabriel Chodorow- (March), pp . 23–40 . Other examples include Mark A . Carlson, Reich (2014), “The Employment Effects of Credit Market Thomas King, and Kurt Lewis (2011), “Distress in the Financial Disruptions: Firm-Level Evidence from the 2008–9 Financial Sector and Economic Activity,” B.E. Journal of Economic Crisis,” Quarterly Journal of Economics, vol . 129 (February), Analysis and Policy, vol . 11 (1), pp . 1–31; and Ben Bernanke, pp . 1–59 . Mark Gertler, and Simon Gilchrist (1996), “The Financial 7 . See the box “Financial Institutions’ Exposure to Accelerator and the Flight to Quality,” Review of Economic Commercial Real Estate Debt” in Board of Governors of the and Statistics, vol . 78 (February), pp . 1–15 . Federal Reserve System (2023), Financial Stability Report 6 . Among others, see Diana Hancock and James A . Wilcox (Washington: Board of Governors, May), pp . 16–17, https:// (1998), “The ‘Credit Crunch’ and the Availability of Credit to www .federalreserve .gov/publications/files/financial-stability- Small Business,” Journal of Banking and Finance, vol . 22 report-20230508 .pdf . 24 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 24. Real prices of existing single-family houses sales have also moved up somewhat, allowing homebuilders to continue to reduce their Monthly January 2005 = 100 inventories of unsold new homes. The rise 150 in demand, together with tight supplies, has S&P/Case-Shiller national index 140 supported house prices, which now appear to 130 be increasing again and are only slightly below 120 Zillow index their peak from the middle of 2022 (figure 24). 110 100 Despite the rebound in new home sales, single- 90 family housing starts have remained low this 80 year, as homebuilders continue to focus on CoreLogic 70 price index completing homes already in the construction 60 pipeline (figure 25). Single-family starts are 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 well below their 2021 highs, though multifamily NOTE: Series are deflated by the personal consumption expenditures starts have held up, likely supported by a shift price index. CoreLogic is not seasonally adjusted. The data for S&P/Case-Shiller extend through March 2023, and the data for Zillow in demand toward rental units in response to and CoreLogic extend through April 2023. the decline in purchase affordability. SOURCE: Bureau of Economic Analysis via Haver Analytics; CoreLogic Home Price Index; Zillow, Inc., Real Estate Data; S&P/Case-Shiller U.S. National Home Price Index. The S&P/Case-Shiller Capital spending growth has slowed further index is a product of S&P Dow Jones Indices LLC and/or its affiliates. (For Dow Jones Indices licensing information, see the note on the Contents page.) Business investment in equipment and intangible capital slowed in the first quarter 25. Private housing starts and permits after having expanded only modestly in the fourth quarter of last year, likely reflecting Monthly Millions of units, annual rate tighter financial conditions and weaker output 1.4 growth overall (figure 26). In particular, Single-family starts 1.2 investment in equipment declined in the fourth 1.0 quarter of last year and the first quarter of this .8 year, while investment in intangibles—including Single-family .6 software as well as research and development— permits decelerated. By contrast, investment in .4 nonresidential structures—which tends to .2 Multifamily starts respond with a lag to economic conditions— 0 stepped up from its very low level. The strength has been concentrated in the manufacturing 2007 2009 2011 2013 2015 2017 2019 2021 2023 sector, while demand for categories such as NOTE: The data extend through April 2023. SOURCE: U.S. Census Bureau via Haver Analytics. office buildings has remained relatively weak. Business financing conditions remained restrictive, but credit generally stayed available Credit remained available to most nonfinancial corporations but at generally elevated interest rates and under tighter financial conditions more broadly. Banks tightened lending standards on commercial and industrial loans and commercial real estate loans over the first quarter, and business loan growth at banks continued to decelerate. Issuance of leveraged loans has been low thus far this year, MONETARy POLICy REPORT: JUNE 2023 25 particularly following the recent stress in the 26. Real business fixed investment banking system. By contrast, credit remained Billions of chained 2012 dollars Billions of chained 2012 dollars broadly available to large nonfinancial businesses through corporate bond markets; Equipment and 2,600 650 intangible capital investment-grade corporate bond yields are 2,400 600 little changed, on net, since the beginning of 2,200 the year, and issuance of investment-grade 550 2,000 bonds stayed solid outside of a temporary 500 1,800 slowdown amid the onset of the banking- 1,600 450 sector stresses. Issuance of speculative-grade 1,400 400 bonds also picked up but remained subdued Structures 1,200 relative to pandemic-era levels. Credit 350 1,000 quality has continued to be strong for most 2005 2008 2011 2014 2017 2020 2023 nonfinancial firms, though expectations of credit defaults in corporate bonds remain NOTE: Business fixed investment is known as “private nonresidential fixed investment” in the national income and product accounts. The data elevated, particularly for lower-rated firms. are quarterly. SOURCE: Bureau of Economic Analysis via Haver Analytics. For small businesses, which are more reliant on bank financing than large businesses, credit also remained available but under tighter financing conditions. Surveys indicate that credit supply for small businesses has tightened this year, and interest rates on small business loans have risen notably.12 Nevertheless, the volume of loan originations to small businesses has stayed within the range observed in the two years before the pandemic. Loan default and delinquency rates have risen notably over the past year and have returned to levels about in line with those observed before the pandemic. 27. Real imports and exports of goods and services Trade has picked up slightly Quarterly Billions of chained 2012 dollars After declining in the second half of last year, real imports have increased only modestly this 4,000 3,750 year, in line with the modest gains in domestic 3,500 demand for goods (figure 27). Exports have Imports 3,250 rebounded more strongly, driven by a pickup 3,000 in foreign growth but restrained by the past 2,750 appreciation of the dollar. On balance, the Exports 2,500 reported change in net exports was neutral on 2,250 2,000 GDP growth in the first quarter of this year 1,750 1,500 12. The National Federation of Independent Business’s 2007 2009 2011 2013 2015 2017 2019 2021 2023 member poll indicates that the share of respondents SOURCE: Bureau of Economic Analysis via Haver Analytics. reporting credit was more difficult to obtain than three months before has been rising since late 2021. Similarly, the Senior Loan Officer Opinion Survey on Bank Lending Practices released in April showed that banks have tightened lending standards on small business loans. 26 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS after having contributed about 1½ percentage points to annualized GDP growth in the second half of last year.13 The current account deficit as a share of GDP has been little changed since the second half of 2022 but remains wider than before the pandemic. The support to economic activity from federal fiscal actions has been roughly neutral so far this year The temporary policies the federal government enacted during the pandemic to alleviate hardship and support the economic recovery likely boosted GDP growth in 2020 and 2021 and then imparted a drag on GDP growth last year as the effects on spending waned. With the unwinding of the pandemic-related fiscal support having largely subsided by the end of last year, the contribution of discretionary changes in fiscal policy to GDP growth has been roughly neutral so far this year. The budget deficit fell sharply from pandemic highs, causing growth in federal debt to moderate Fiscal policies enacted since the start of the pandemic, combined with the effects of automatic stabilizers—the reduction in tax receipts and the increase in transfers that occur because of subdued economic activity— 28. Federal receipts and expenditures caused the federal deficit to surge to 15 percent Annual Percent of nominal GDP of GDP in fiscal year 2020 and to more than 12 percent in fiscal 2021 (figure 28).14 However, 32 30 13. Revised estimates of monthly imports and exports 28 from the annual revision to the Census Bureau’s trade 26 Expenditures data, which was published after the most recent GDP 24 report, suggest net exports made a positive contribution 22 to GDP growth in the first quarter. Receipts 20 14. For more information, see Congressional Budget 18 Office (2020), “The Budgetary Effects of Laws Enacted in 16 Response to the 2020 Coronavirus Pandemic, March and 14 April 2020,” June, https://www.cbo.gov/system/files/2020- 06/56403-CBO-covid-legislation.pdf; Congressional 1998 2003 2008 2013 2018 2023 Budget Office (2021), “The Budgetary Effects of Major NOTE: Through 2022, the receipts and expenditures data are on a Laws Enacted in Response to the 2020–2021 Coronavirus unified-budget basis and are for fiscal years (October to September); gross domestic product (GDP) is for the 4 quarters ending in Q3. For Pandemic, December 2020 and March 2021,” September, 2023, receipts and expenditures are for the 12 months ending in May; https://www.cbo.gov/system/files/2021-09/57343- GDP is the average of 2022:Q4 and 2023:Q1. Pandemic.pdf; and Congressional Budget Office SOURCE: Department of the Treasury, Financial Management Service; Office of Management and Budget and Bureau of Economic Analysis via (2021), “Senate Amendment 2137 to H.R. 3684, the Haver Analytics. Infrastructure Investment and Jobs Act, as Proposed on MONETARy POLICy REPORT: JUNE 2023 27 with pandemic-related fiscal support fading 29. Federal government debt and net interest outlays and receipts on the rise, the deficit fell to Percent of nominal GDP Percent of nominal GDP 5.5 percent of GDP in 2022. Net interest outlays 3.5 on federal debt 120 As a result of the unprecedented fiscal 3.0 100 support enacted early in the pandemic, federal debt held by the public jumped roughly 2.5 80 20 percentage points to 100 percent of GDP 2.0 60 in fiscal 2020—the highest debt-to-GDP ratio 1.5 40 since 1947 (figure 29). The debt-to-GDP ratio 1.0 20 has moved down since fiscal 2020 owing to the Debt held by the public rapid growth in nominal GDP. However, with .5 0 interest rates on the rise, net interest outlays have recently picked up and are expected to 1903 1923 1943 1963 1983 2003 2023 continue to grow over the next few years. NOTE: The data for net interest outlays are annual, begin in 1948, and extend through 2022. Net interest outlays are the cost of servicing the debt held by the public. Federal debt held by the public equals federal State and local government budget debt less Treasury securities held in federal employee defined-benefit retirement accounts, evaluated at the end of the quarter. The data for positions remain strong . . . federal debt are annual from 1901 to 1951 and a 4-quarter moving average thereafter. GDP is gross domestic product. SOURCE: For GDP, Bureau of Economic Analysis via Haver Federal policymakers provided a historically Analytics; for federal debt, Congressional Budget Office and Federal high level of fiscal support to state and local Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.” governments during the pandemic, leaving the sector in a strong budget position overall. 30. State and local tax receipts In addition, total state tax collections rose Percent change from year earlier appreciably in 2021 and 2022, pushed up by the economic recovery (figure 30). In response 30 to their strong budget positions, lawmakers cut Total state taxes 25 state taxes by roughly $16 billion in state fiscal 20 2023, according to the National Association of 15 State Budget Officers. Property taxes 10 At the local level, property taxes have 5 + continued to rise, and the typically long lags _0 between changes in the market value of real 5 estate and changes in taxable assessments suggest that property tax revenues will 2013 2015 2017 2019 2021 2023 continue to grow despite the recent sharp NOTE: State tax data are year-over-year percent changes of 12-month moving averages, begin in June 2012, extend through March 2023, and deceleration in house prices. are aggregated over all states except Wyoming, for which data are not available. Revenues from Washington, D.C., are also excluded. The data for January 2023 to March 2023 are missing for New Mexico, and the . . . and growth in employment has data for March 2023 are missing for Nevada, as these states have longer picked up while growth in construction reporting lags than others. Property tax data are year-over-year percent changes of 4-quarter moving averages, begin in 2012:Q2, extend through outlays has been solid 2022:Q4, and are primarily collected by local governments. SOURCE: Monthly State Government Tax Revenue Data via Urban Institute; U.S. Census Bureau, Quarterly Summary of State and Local Growth in state and local employment has Government Tax Revenue. continued to pick up in recent quarters while growth in construction outlays has stayed solid, with both measures now appearing to better reflect the strong budget positions August 1, 2021,” August 9, https://www.cbo.gov/system/ files/2021-08/hr3684_infrastructure.pdf. 28 Part 1: recent economic and Financial develoPments 31. State and local government payroll employment of state and local governments (figure 31). Although both measures remain below their Monthly Millions of jobs pre-pandemic levels, growth has improved notably as the headwinds from the big increase 20.5 in retirements earlier in the pandemic and construction-sector bottlenecks have waned. 20.0 19.5 Financial Developments 19.0 The expected level of the federal funds rate over the next year shifted up 18.5 The FOMC raised the target range for the 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 federal funds rate a further 75 basis points since January. Market-based measures of the SOURCE: Bureau of Labor Statistics via Haver Analytics. path of the federal funds rate expected to 32. Market-implied federal funds rate path prevail through the start of 2025 also rose over this period, while market-implied expectations Quarterly Percent for late 2025 and 2026 are little changed on 5.5 net (figure 32).15 The market-implied policy 5.0 path declined significantly in March, reflecting 4.5 investors’ view that the emergence of strains June 13, 2023 4.0 in parts of the banking sector could result in a less restrictive path for the federal funds rate, December 30, 2022 3.5 but retraced much of the decline on stronger- 3.0 than-expected economic data and signs of 2.5 stabilization in the banking sector. According 2.0 to these market-based measures, investors anticipate that the federal funds rate will 2022 2023 2024 2025 2026 2027 decline gradually from slightly above current NOTE: The federal funds rate path is implied by quotes on overnight index swaps—a derivative contract tied to the effective federal funds rate. levels starting late this year and reach a trough The implied path as of December 30, 2022, is compared with that as of June 13, 2023. The path is estimated with a spline approach, assuming a of about 3.1 percent toward the end of 2025. term premium of 0 basis points. The December 30, 2022, path extends Meanwhile, a measure based on the Blue Chip through 2026:Q4 and the June 13, 2023, path through 2027:Q2. SOURCE: Bloomberg; Federal Reserve Board staff estimates. Financial Forecasts published in the beginning of June suggested that the expected policy rate 33. Yields on nominal Treasury securities path over 2023 had increased moderately since January, bringing it to a level about in line with Daily Percent market-implied expectations at the time of 6 the survey. 5 Yields on longer-term U.S. nominal Treasury 4 securities were little changed on net 10-year 5-year 3 Yields on longer-term nominal Treasury 2 securities were little changed, on net, since 2-year 1 the start of the year (figure 33). Meanwhile, 0 15. These measures are based on market prices for 2015 2016 2017 2018 2019 2020 2021 2022 2023 overnight index swaps for the effective federal funds rate SOURCE: Department of the Treasury via Haver Analytics. and are not adjusted for term premiums. MONETARy POLICy REPORT: JUNE 2023 29 short-term Treasury yields rose, reflecting expectations for a higher near-term path for the federal funds rate. Yields across maturities rose early in the year amid strong economic data and inflation readings, fell sharply on the onset of banking-sector strains in early March, and partially retraced since then. 34. Corporate bond yields, by securities rating, and municipal bond yield Yields on other long-term debt fluctuated Daily Percent with Treasury yields Investment-grade corporate 12 After increasing substantially last year, High-yield corporate 10 investment-grade corporate bond yields were little changed, on net, since January, 8 while those for speculative-grade bonds 6 declined moderately (figure 34). Spreads on 4 corporate bonds to comparable-maturity Treasury securities decreased early in the 2 Municipal year, reversed following the onset of the 0 banking-sector strains, and then narrowed again. On net, spreads for investment-grade 2015 2016 2017 2018 2019 2020 2021 2022 2023 corporate bonds are little changed since the Note: Investment-grade corporate reflects the effective yield of the ICE Bank of America Merrill Lynch (BofAML) triple-B U.S. Corporate Index turn of the year, while those for speculative- (C0A4). High-yield corporate reflects the effective yield of the ICE BofAML High Yield Index (H0A0). Municipal reflects the yield to worst grade bonds narrowed moderately, bringing of the ICE BofAML U.S. Municipal Securities Index (U0A0). both to levels slightly below their historical SourCe: ICE Data Indices, LLC, used with permission. medians. Meanwhile, municipal bond spreads to comparable-maturity Treasury securities widened slightly since the beginning of the year. Spreads on investment-grade municipal bonds are now elevated by historical standards, while spreads on speculative-grade municipal 35. Yield and spread on agency mortgage-backed securities bonds remain fairly low relative to their historical distribution. Overall, corporate and Percent Basis points municipal credit quality remained strong, with defaults staying very low in both markets. 7 250 6 200 Yields on agency mortgage-backed securities 5 (MBS)—an important pricing factor for home Yield 150 mortgage rates—rose further since January 4 100 (figure 35). The MBS spread remained elevated 3 relative to pre-pandemic levels, at least partly Spread 50 2 due to high interest rate volatility, which 1 0 reduces the value of holding MBS. 2015 2016 2017 2018 2019 2020 2021 2022 2023 Broad equity price indexes increased NOTE: The data are daily. Yield shown is for the uniform moderately mortgage-backed securities 30-year current coupon, the coupon rate at which new mortgage-backed securities would be priced at par, or face, Since the beginning of the year, the S&P 500 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 average index increased moderately on net (figure 36). of the 5-year and 10-year nominal Treasury yields. SOURCE: Department of the Treasury; J.P. Morgan. Courtesy of J.P. The S&P 500 index declined in March, Morgan Chase & Co., Copyright 2023. 30 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS 36. Equity prices following the onset of banking concerns, but quickly made a full recovery and continued Daily December 31, 2010 = 100 to rise. Meanwhile, equity prices for small-cap 400 firms are little changed, on net, since early March and are modestly higher over the year 350 to date. Equity prices of financial firms and 300 S&P 500 index banks plummeted as the banking sector came 250 under stress and remained depressed relative to 200 the beginning of the year. One-month option- 150 implied volatility on the S&P 500 index—the Dow Jones bank index 100 VIX—spiked in early March but quickly 50 retraced and ended the period moderately lower. The VIX is now near its lowest point 2015 2016 2017 2018 2019 2020 2021 2022 2023 since before the pandemic (figure 37). (For SOURCE: S&P Dow Jones Indices LLC via Bloomberg. (For Dow a discussion of financial stability issues, see Jones Indices licensing information, see the note on the Contents page.) the box “Developments Related to Financial Stability.”) 37. S&P 500 volatility Major asset markets functioned Daily Percent in an orderly way, but liquidity 90 has remained low 80 70 Treasury market liquidity remained low by 60 historical standards, consistent with ongoing 50 economic uncertainty and high interest rate VIX 40 volatility. Liquidity conditions deteriorated 30 notably in March, but they subsequently 20 recovered and are little changed, on net, since 10 Expected volatility the beginning of the year. Market depth—a 0 measure of the availability of contracts to 2015 2016 2017 2018 2019 2020 2021 2022 2023 trade at best quoted prices—for Treasury Note: The VIX is an option-implied volatility measure that represents securities remains near historically low levels, the expected annualized variability of the S&P 500 index over the particularly for short-term Treasury securities. following 30 days. The expected volatility series shows a forecast of 1-month realized volatility, using a heterogeneous autoregressive model However, market functioning has continued to based on 5-minute S&P 500 returns. be orderly. Regarding equity market liquidity, SourCe: Cboe Volatility Index® (VIX®) via Bloomberg; Refinitiv DataScope; Federal Reserve Board staff estimates. market depth based on the S&P 500 futures improved modestly since January but remained somewhat low compared with pre-COVID levels. Corporate and municipal secondary bond markets continued to function well; transaction costs in these markets were fairly low by historical standards. In the market for Treasury bills, yields on Treasury bills maturing in early June moved up sharply in May on mounting concerns about the debt ceiling. Those increases were reversed as the debt ceiling situation was resolved. Market participants have focused lately on the MONETARy POLICy REPORT: JUNE 2023 31 Developments Related to Financial Stability This discussion reviews vulnerabilities in the U .S . A. Private nonfinancial-sector credit-to-GDP ratio fi nancial system . The framework used by the Federal Reserve Board for assessing the resilience of the U .S . Quarterly Ratio fi nancial system focuses on fi nancial vulnerabilities in four broad areas: asset valuations, business and 1.8 household debt, leverage in the fi nancial sector, and funding risks . Since the previous Monetary Policy 1.6 Report, three sizable domestic banks failed following 1.4 substantial deposit outfl ows prompted by concerns over poor management of interest rate risk and liquidity 1.2 risk . As stress in the banking sector materialized in March 2023, fi nancial market volatility increased, and 1.0 there were sharp declines in the equity prices of some banks that experienced sizable outfl ows of uninsured .8 deposits . In order to prevent broader spillovers in the banking system, the Federal Reserve, together with 1983 1988 1993 1998 2003 2008 2013 2018 2023 the Federal Deposit Insurance Corporation and the NOTE: The shaded bars with top caps indicate periods of business Department of the Treasury, took decisive actions to recession as defined by the National Bureau of Economic Research: January 1980 to July 1980, July 1981 to November 1982, July 1990 to protect bank depositors and support the continued March 1991, March 2001 to November 2001, December 2007 to June fl ow of credit to households and businesses .1 Following 2009, and February 2020 to April 2020. GDP is gross domestic product. these actions, fi nancial markets normalized, outfl ows SOURCE: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; Bureau of Economic Analysis, national of bank deposits slowed, and the banking system as a income and product accounts; Federal Reserve Board staff calculations. whole remains sound and resilient . However, ongoing stresses in the banking sector may weigh on credit gross domestic product outpaced the growth of total conditions in the period ahead and increase uncertainty debt of nonfi nancial businesses and households; as a about the economic outlook . result, the ratio of private nonfi nancial-sector debt to Despite notable volatility in fi nancial markets, GDP fell further toward its pre-pandemic level (fi gure A) . vulnerabilities stemming from asset valuations were Although there are signs that business debt growth has about in line with history . Corporate bond spreads, slowed in recent months, measures of nonfi nancial measured as the difference in yields between corporate business leverage remained elevated relative to their bonds and comparable-maturity Treasury securities, historical levels . Nevertheless, large businesses maintain stayed near moderate levels . valuation pressures in their ability to service debt, supported by robust earnings leveraged loan markets were little changed from the and a sizable share of liabilities that are relatively March report and remained in line with historical insensitive to changes in interest rates . The fi nancial averages . Equity price growth outpaced growth in position of households generally remains strong . earnings forecasts since the previous report, pushing the Household debt grew slower than GDP, and most of the forward price-to-earnings ratio a touch higher to a level growth was concentrated among prime-rated borrowers . well above its historical median . Despite weakening Households’ required debt payments relative to their conditions in the commercial sector in recent months, disposable income increased slightly, but their debt valuations continued to be stretched in commercial as service ratios remain at modest levels . Moreover, even well as residential real estate properties . in the event of higher interest rates, the extent to which With regard to vulnerabilities associated with households might face increasing mortgage interest household and business debt, the growth of nominal expenses appears limited, as most mortgages originated in recent years were fi xed rate . Nonetheless, some 1 . For more details, see the boxes “The Bank Stresses since households remained fi nancially stretched and more March 2023” and “The Federal Reserve’s Actions to Protect vulnerable to future shocks . Bank Depositors and Support the Flow of Credit to Households and Businesses” in Board of Governors of the Federal Reserve The price of U .S . bank shares came under System (2023), Financial Stability Report (Washington: Board substantial pressure following the runs by depositors of Governors, May), pp . 34–36 and pp . 53–54, respectively, https://www .federalreserve .gov/publications/financial-stability- report .htm . (continued on next page) 32 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Developments Related to Financial Stability (continued) on Silicon valley Bank (SvB), Signature Bank, and First In the nonbank fi nancial sector, broker-dealer Republic Bank .2 In international markets, Credit Suisse leverage has stayed near recent historically low levels . came under renewed pressure and agreed to a merger During the volatile period following the bank failures, with UBS . Despite the offi cial sector’s intervention to dealers faced elevated client fl ows and continued to support the banking system, broad bank equity prices intermediate in the Treasury securities markets and fell sharply, with the largest declines concentrated support market functioning . However, long-standing among a set of banks characterized by balance sheet concerns remained about their ability or willingness weaknesses similar to those of the failed banks—with a to intermediate in fi xed-income markets during stress . high concentration of uninsured deposits and large fair Leverage at hedge funds remained somewhat elevated, value losses on fi xed-rate assets . The Federal Reserve especially at the largest funds, though the most will continue to monitor conditions closely and is comprehensive data for hedge funds are considerably prepared to use all its tools to support the safety and lagged . Amid increased volatility in Treasury yields soundness of the U .S . banking system . following the SvB failure, hedge funds faced large Despite these stresses, the broader banking system margin calls on previously built interest rate bets remains sound and resilient, as most banks are well and unwound positions, potentially contributing to capitalized and hold ample liquidity . Risk-based capital further volatility . ratios increased at global systemically important banks Structural funding vulnerabilities persist at some (G-SIBs) to meet higher capital requirements stemming nonbanks . As short-term interest rates rose over the from an increase in their 2023 G-SIB surcharges . At past year, assets at prime money market funds (MMFs) other banks, these ratios decreased but nevertheless increased . Following the failures of SvB and Signature remained above regulatory requirements . Capital ratios Bank, prime funds experienced a jump in redemptions that do not account for the riskiness of assets but do as prime money fund and other investors reallocated include fair value losses on available-for-sale securities toward government money funds . Although outfl ows in common equity edged up in the fi rst quarter of 2023 from prime MMFs eased after a few days, the episode after having declined throughout last year, especially illustrated again that these funds are at risk of large at non–G-SIBs . Regarding liquidity, the amount of redemptions during episodes of fi nancial stress . Assets high-quality liquid assets decreased across all banks but under management at open-ended bond and bank loan remained high by historical standards . Banks’ overall mutual funds declined in the second half of 2022, and reliance on short-term wholesale funding continued measures of exposure of these funds to redemption to be low by historical standards . However, uninsured risks remained at historically high levels . Life insurers transactions and savings deposits remained well above continued to have elevated liquidity risks, as risky and pre-pandemic levels despite signifi cant declines over the illiquid assets remained a high fraction of their total past year . SvB and Signature Bank were unusual in their assets and short-term liabilities were also elevated . heavy reliance on uninsured deposits, and most banks A routine survey of market contacts on salient maintained a much more balanced mix of liabilities . shocks to fi nancial stability highlights several important risks . Some survey respondents indicated that higher interest rates could test the ability of some governments, households, and businesses to service their debt, 2 . On April 28, 2023, the Federal Reserve published a including in emerging market economies that are report examining the factors that contributed to the failure of SvB and the role of the Federal Reserve, which was the exposed to global fi nancial conditions . Ongoing stresses primary federal supervisor for the bank and its holding in the banking sector could cause a contraction in the company, Silicon valley Bank Financial Group . See Board of supply of credit to households and businesses, resulting Governors of the Federal Reserve System (2023), Review of the in a marked slowdown in economic activity and an Federal Reserve’s Supervision and Regulation of Silicon Valley increase in credit losses for some fi nancial institutions . Bank (Washington: Board of Governors, April), https://www . federalreserve .gov/publications/files/svb-review-20230428 . An escalation of Russia’s war against Ukraine or a pdf . That same day, the Federal Deposit Insurance Corporation worsening in other geopolitical risks could lead to a (FDIC) published a report examining the failure of Signature resurgence in commodity prices, with adverse spillovers Bank, whose primary federal supervisor was the FDIC; to global asset markets and economic activity, further see Federal Deposit Insurance Corporation (2023), FDIC’s Supervision of Signature Bank (Washington: FDIC, April), affecting macroeconomic and fi nancial conditions in https://www .fdic .gov/news/press-releases/2023/pr23033a .pdf. the U .S . MONETARy POLICy REPORT: JUNE 2023 33 prospect for substantial Treasury bill issuance as the Treasury rebuilds the Treasury General Account. Short-term funding market conditions remained stable Conditions in overnight bank funding and repurchase agreement, or repo, markets remained stable. Increases in the FOMC’s target range for the federal funds rate fully passed through to other overnight rates. The effective federal funds rate and other unsecured overnight rates have remained several basis points below the interest rate on reserve balances since January. The Secured Overnight Financing Rate has been at or slightly above the offering rate on the overnight reverse repurchase agreement (ON RRP) facility. There were, however, temporary dislocations in other short-term funding markets; spreads on term negotiable certificates of deposit and lower-rated nonfinancial commercial paper spiked in March but then normalized as conditions in the banking sector improved. Government money market funds (MMFs) have seen a notable increase in assets under management (AUM) since January, driven in large part by the outflow of deposits from the banking sector. Prime funds, which have seen steady inflows over the tightening cycle, experienced mild outflows in the aftermath of the banking turmoil but have since recouped those flows and continued to grow. Weighted average maturities at prime and government MMFs remain near historical lows, likely in response to the continued increase in short- term rates and fund managers’ uncertainty about the future path of interest rates. Elevated AUM, high demand for short- maturity assets at MMFs, and a limited supply of Treasury bills have all contributed to continuing elevated take-up at the Federal Reserve’s ON RRP facility. 34 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS Bank credit continued to expand but at a slower pace Growth in banks’ total loan holdings slowed 38. Ratio of total commercial bank credit to nominal gross domestic product to about a 5 percent annualized rate in the first quarter of the year, down from a 9 percent rate Quarterly Percent in the fourth quarter of 2022, reflecting the effects of higher interest rates, tighter credit 80 availability, and economic uncertainty. Bank 75 credit as a share of nominal GDP continued to fall in the first quarter, but it remained elevated 70 relative to pre-pandemic levels (figure 38). 65 Banks reported tighter standards and weaker demand for most loan categories over the 60 first quarter of 2023 in the April Senior Loan 55 Officer Opinion Survey on Bank Lending Practices, continuing trends for standards 2005 2008 2011 2014 2017 2020 2023 and demand that have been reported since SOURCE: Federal Reserve Board, Statistical Release H.8, “Assets and the middle of last year. Interest rates on bank Liabilities of Commercial Banks in the United States”; Bureau of Economic Analysis via Haver Analytics. loans continued to increase in the first quarter, reflecting higher short-term rates. Meanwhile, 39. Profitability of bank holding companies delinquency rates on bank loans remained near historical lows overall, despite increasing for Percent, annual rate Percent, annual rate consumer and real estate–backed loans. Bank 2.0 30 profitability remained robust over the first Return on assets 1.5 quarter of 2023, though net interest margins 20 1.0 edged down because of higher funding costs 10 .5 (figure 39). However, bank equity prices + + _0 _0 declined substantially since January, driven .5 Return on equity 10 by declines following the emergence of strains 1.0 in parts of the banking sector in March 20 1.5 (figure 36). (For a discussion of bank credit 30 2.0 availability, see the box “Recent Developments in Bank Lending Conditions.”) 2005 2008 2011 2014201 7 2020 2023 NOTE: The data are quarterly. SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated International Developments Financial Statements for Holding Companies. Economic activity rebounded at the start of the year Following a slowdown at the end of 2022, foreign activity rebounded early this year, driven in part by strong growth in China, as the lifting of COVID-19 restrictions unleashed pent-up demand and some fiscal stimulus was front-loaded. More recent indicators from China, however, suggest that momentum is slowing. Growth in emerging Asia excluding China has also picked up on strong private domestic consumption and increased tourism MONETARy POLICy REPORT: JUNE 2023 35 activity, which more than offset weakness in goods exports. In Europe, the effects of the energy shock stemming from Russia’s war against Ukraine were tempered in part by an unusually warm winter and successful adaptation efforts by businesses and households. The fading drag 40. Consumer price inflation in foreign economies from energy prices as they decline from their Monthly Percent change from year earlier elevated levels is now contributing to an economic recovery amid stronger consumer 10 and business confidence. That said, in many 8 parts of the globe, tighter monetary policy is starting to weigh on credit growth and 6 EMEs ex. China investment. 4 2 Headline inflation abroad continued to AFEs ex. Japan + ease, but core inflation remains sticky _0 2 Foreign headline inflation continued to fall as global energy prices have declined (figure 40). 2016 2017 2018 2019 2020 2021 2022 2023 However, despite the recent fall in global NOTE: The advanced foreign economy (AFE) aggregate is the average of Canada, the euro area, and the U.K., weighted by shares of U.S. agricultural commodity prices, food inflation non-oil goods imports. The emerging market economy (EME) aggregate in some regions (especially Europe) remains is the average of Argentina, Brazil, Chile, Colombia, Hong Kong, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Russia, Saudi elevated, likely reflecting dislocations resulting Arabia, Singapore, South Korea, Taiwan, Thailand, and Vietnam, weighted by shares of U.S. non-oil goods imports. The inflation measure from the pandemic and the war against is the Harmonised Index of Consumer Prices for the euro area and the Ukraine (figure 41). Core inflation in the consumer price index for other economies. Data extend through April 2023. foreign economies remains high, driven in part SOURCE: Federal Reserve Board staff calculations; Haver Analytics. 41. Foreign consumer price inflation components Advanced foreign economies Emerging market economies Percent Percent Energy Energy 9 9 Food Food Core 8 Core 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 2017–19 2020–21 2022:H1 2022:H2 2023:Q1 2017–19 2020–21 2022:H1 2022:H2 2023:Q1 avg. avg. avg. avg. NOTE: The advanced foreign economy aggregate is the average of Canada, the euro area, and the U.K., weighted by shares of U.S. non-oil goods imports. The emerging market economy aggregate is the average of Argentina, Brazil, Chile, Colombia, Hong Kong, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Russia, Saudi Arabia, Singapore, South Korea, Taiwan, Thailand, and Vietnam, weighted by shares of U.S. non-oil 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 show percent changes from year-ago levels. SOURCE: Federal Reserve Board staff calculations; Haver Analytics. 36 PART 1: RECENT ECONOMIC AND FINANCIAL DEvELOPMENTS by tight labor markets and pass-through from past energy price increases into other prices. Foreign central banks remain focused on reining in inflation 42. Nominal 10-year government bond yields in Central banks in most advanced foreign selected advanced foreign economies economies (AFEs) have pressed ahead with Weekly Percent rate hikes, pointing to persistently high inflation and strong labor markets. Policy 5 rate paths implied by market pricing suggest U.K. 4 that many AFE central banks are expected to hike policy rates further, though most 3 will reach a point later in the year when Canada 2 they will stop raising rates. In the emerging 1 market economies (EMEs), some central + _0 banks have already paused policy rate hikes, including Brazil, Mexico, and South Korea. Germany 1 In light of the upside risks to inflation, most major foreign central banks emphasize that 2019 2020 2021 2022 2023 additional policy tightening may be needed to NOTE: The data are weekly averages of daily benchmark yields and extend through June 9, 2023. meet their objectives. SOURCE: Bloomberg. Financial conditions abroad are relatively 43. Equity indexes for selected foreign economies little changed on net Weekly Week ending January 8, 2016 = 100 Longer-term sovereign yields in the AFEs are little changed, on net, since January 150 (figure 42). One exception is the U.K., where 140 10-year gilt yields increased notably on the Euro area 130 back of accelerating core price pressures, high 120 wage gains, and expectations shifting toward a 110 tighter stance of monetary policy. 100 90 China Major foreign equity indexes rose across Japan 80 advanced and emerging economies (figure 43). 70 Euro-area corporate credit spreads narrowed 2016 2017 2018 2019 2020 2021 2022 2023 slightly, consistent with the resilience of NOTE: The data are weekly averages of daily data and extend through economic activity in the region. Inflows into June 9, 2023. EME-focused investment funds, which had SOURCE: For the euro area, Dow Jones Euro Stoxx Index; for Japan, Tokyo Stock Price Index; for China, Shanghai Composite Index; all via strengthened at the beginning of the year, have Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.) slowed to near zero, while EME sovereign spreads were little changed. MONETARy POLICy REPORT: JUNE 2023 37 Since January, the dollar was mixed against 44. U.S. dollar exchange rate index major currencies, leaving the broad dollar Weekly Week ending December 27, 2019 = 100 index—a measure of the trade-weighted value Dollar appreciation of the dollar against foreign currencies—a 115 touch lower (figure 44). The dollar depreciated 110 significantly against the Mexican peso amid 105 resilient growth and tight monetary policy in 100 Mexico. By contrast, the dollar appreciated 95 modestly against Asian currencies amid weaker 90 external demand in the region and widening 85 interest rate differentials. 80 75 2013 2015 2017 2019 2021 2023 NOTE: The data, which are in foreign currency units per dollar, are weekly averages of daily values of the broad dollar index and extend through June 9, 2023. As indicated by the arrow, increases in the data reflect U.S. dollar appreciation and decreases reflect U.S. dollar depreciation. SOURCE: Federal Reserve Board staff calculations; Federal Reserve Board, Statistical Release H.10, “Foreign Exchange Rates.” 39 P 2 art m P onetary oLicy The Federal Open Market Committee the cumulative tightening of monetary policy, continued to increase the federal the lags with which monetary policy affects funds rate . . . economic activity and inflation, and economic and financial developments. The FOMC With inflation still well above the Federal indicated that it will continue to monitor the Open Market Committee’s (FOMC) 2 percent implications of incoming information for the objective and with labor market conditions economic outlook and would be prepared to remaining very tight, the FOMC continued adjust the stance of monetary policy if risks to raise the target range for the federal funds emerge that could impede the attainment of rate. Since January, the FOMC raised the the FOMC’s goals. target range 75 basis points, from 4¼ to 4½ percent to 5 to 5¼ percent (figure 45). . . . and has continued the process of Credit conditions had already tightened significantly reducing its holdings of in response to the FOMC’s policy actions Treasury and agency securities and appeared to tighten further following the emergence of banking-sector strains in The FOMC began reducing its securities March. In light of the cumulative tightening holdings in June 2022 and, since then, of monetary policy and the lags with which has continued to implement its plan for monetary policy affects economic activity significantly reducing the size of the Federal and inflation, the FOMC slowed the pace of Reserve’s balance sheet in a predictable policy firming relative to late 2022, raising manner.16 Since September 2022, principal the target range 25 basis points at its January, payments from securities held in the System March, and May meetings, and held the range 16. See the May 4, 2022, press release regarding the steady at its June meeting. In determining the Plans for Reducing the Size of the Federal Reserve’s extent of additional policy firming that may Balance Sheet, available on the Board’s website at https:// be appropriate to return inflation to 2 percent www.federalreserve.gov/newsevents/pressreleases/ over time, the FOMC will take into account monetary20220504b.htm. 45. Selected interest rates Daily Percent 6 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 2023 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. 40 PART 2: MONETARy POLICy Open Market Account (SOMA) have been reserve balances are somewhat above the level reinvested only to the extent that they exceeded the FOMC judges to be consistent with ample monthly caps of $60 billion per month for reserves. Once balance sheet runoff has ceased, Treasury securities and $35 billion per month reserve balances will likely continue to decline for agency mortgage-backed securities. As a at a slower pace—reflecting growth in other result of these actions, holdings of Treasury Federal Reserve liabilities—until the FOMC and agency securities in the SOMA have judges that reserve balances are at the level declined by about $420 billion since the start required for efficiently implementing monetary of January to around $7.7 trillion, a level policy. Thereafter, the FOMC will manage equivalent to about 29 percent of U.S. nominal securities holdings as needed to maintain gross domestic product (figure 46). Despite ample reserves over time. this decline in SOMA holdings, reserve balances have risen by about $330 billion The FOMC will continue to monitor the to around $3.3 trillion, mainly because of implications of incoming information for increased liquidity provision to banks and the economic outlook lower balances in the Treasury General The FOMC is strongly committed to Account. (See the box “Developments in the returning inflation to its 2 percent objective. In Federal Reserve’s Balance Sheet and Money assessing the appropriate stance of monetary Markets.”) policy, the FOMC will continue to monitor the implications of incoming information The FOMC has stated that it intends to for the economic outlook. The FOMC’s maintain securities holdings in amounts assessments will take into account a wide needed to implement monetary policy range of information, including readings on efficiently and effectively in its ample-reserves labor market conditions, inflation pressures regime. To ensure a smooth transition, and inflation expectations, and financial and the FOMC intends to slow and then stop international developments. The FOMC has reductions in its securities holdings when noted that it is also prepared to adjust any of 46. Federal Reserve assets and liabilities Weekly Trillions of dollars Other assets 9 Credit and liquidity facilities Agency debt and mortgage-backed securities holdings 6 Treasury securities held outright 3 + _0 3 Federal Reserve notes in circulation 6 Deposits of depository institutions Capital and other liabilities 9 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 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 7, 2023. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” MONETARy POLICy REPORT: JUNE 2023 41 the details of its approach to reducing the size development outreach. Policymakers also of the balance sheet in light of economic and routinely consult prescriptions for the policy financial developments. interest rate provided by various monetary policy rules. These rule prescriptions can In addition to considering a wide range of provide useful benchmarks for the FOMC. economic and financial data, the FOMC Although simple rules cannot capture all gathers information from business contacts of the complexities of monetary policy, and other informed parties around the and many practical considerations make it country, as summarized in the Beige Book. undesirable for the FOMC to adhere strictly To hear from a broad range of stakeholders in to the prescriptions of any specific rule, some the U.S. economy about how monetary policy principles of good monetary policy can affects people’s daily lives and livelihoods, be illustrated by these policy rules (see the the Federal Reserve has continued to gather box “Monetary Policy Rules in the Current insights through the Fed Listens initiative Environment”). and the Federal Reserve System’s community 42 PART 2: MONETARy POLICy Developments in the Federal Reserve’s Balance Sheet and Money Markets The Federal Open Market Committee (FOMC) available to eligible DIs to help ensure banks have the continued to reduce the size of the Federal Reserve’s ability to meet the needs of all their depositors . Driven System Open Market Account portfolio . Since the time by this increase in loans, total assets have increased of the previous report, total securities have declined $49 billion, leaving the total size of the balance sheet $226 billion to about $7 .7 trillion . Amid banking-sector at about $8 .4 trillion (fi gures A and B) . This discussion developments, depository institutions (DIs) borrowed reviews recent developments in the Federal Reserve’s from the discount window and the Federal Reserve balance sheet and money market conditions . introduced a new facility in mid-March, the Bank Term Amid banking-sector developments, discount Funding Program (BTFP), making additional funding window borrowing by DIs peaked at just over $150 billion in mid-March before declining to A. Balance sheet comparison $3 billion as other credit extensions—which consist of Billions of dollars loans that were extended to DIs that were subsequently placed into Federal Deposit Insurance Corporation June 7, March 1, 2023 2023 Change (FDIC) receivership, including DIs established by Assets the FDIC—increased to $185 billion .1 Furthermore, to support American businesses and households, Total securities the Federal Reserve Board made additional funding Treasury securities 5,162 5,336 −174 available to eligible DIs through the creation of the Agency debt and MBS 2,560 2,612 −52 new BTFP under the authority of section 13(3) of the Net unamortized premiums 298 308 −10 Federal Reserve Act, with approval of the Secretary of Repurchase agreements 0 0 0 the Treasury .2 The BTFP offers loans of up to one year in length to banks, savings associations, credit unions, Loans and lending facilities (continued) PPPLF 8 11 −3 Discount window 3 4 −1 1 . The Federal Reserve Banks’ loans to these DIs are BTFP 100 0 100 secured by pledged collateral, and the FDIC provides Other credit extensions 185 0 185 repayment guarantees . 2 . On March 12, with the announcement of the BTFP, Other loans and lending facilities 28 30 −2 changes were announced for the discount window . These Central bank liquidity swaps 0 0 0 changes included the application of the same margins used Other assets 44 38 6 Total assets 8,389 8,340 49 B. Federal Reserve assets Liabilities Weekly Trillions of dollars Federal Reserve notes 2,293 2,254 39 Other assets 12 Reserves held by depository Loans institutions 3,306 3,028 278 Central bank liquidity swaps 11 Repurchase agreements 10 Reverse repurchase agreements Agency debt and MBS 9 Foreign offi cial and Treasury securities 8 international accounts 347 367 −20 held outright 7 6 Others 2,162 2,134 28 5 U.S. Treasury General Account 77 351 −274 4 Other deposits 208 180 28 3 2 Other liabilities and capital −4 26 −30 1 Total liabilities and capital 8,389 8,340 49 2019 2020 2021 2022 2023 Note: MBS is mortgage-backed securities. PPPLF is Paycheck Protection Program Liquidity Facility. BTFP is Bank Term Funding Program. Components NOTE: MBS is mortgage-backed securities. The key identifies shaded areas in may not sum to totals because of rounding. order from top to bottom. The data extend through June 7, 2023. SourCe: Federal Reserve Board, Statistical Release H.4.1, “Factors Aff ecting SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” Reserve Balances.” MONETARy POLICy REPORT: JUNE 2023 43 and other eligible DIs against collateral such as U .S . March, as money market mutual funds diverted some Treasury securities, U .S . agency securities, and U .S . of their funds to other investments, such as Federal agency mortgage-backed securities .3 Loans under the Home Loan Bank discount notes .4 The ON RRP facility BTFP are secured by eligible collateral valued at par— is intended to help keep the effective federal funds that is, the face amount of the securities—and can be rate within the target range . The facility continued to requested until at least March 11, 2024 . Currently, serve this intended purpose, and the Federal Reserve’s the Federal Reserve has $100 billion of BTFP loans administered rates—interest on reserve balances and outstanding to eligible counterparties . Federal Reserve the ON RRP offering rate—were highly effective at lending at the discount window, under the BTFP, and maintaining the effective federal funds rate within the through other credit extensions has led to a small target range as the FOMC has tightened the stance of increase in total assets since March . monetary policy . Usage of the overnight reverse repurchase Reserve balances—the largest liability of the Federal agreement (ON RRP) facility averaged around Reserve’s balance sheet—have increased by about $2 .2 trillion since the beginning of March amid $278 billion since March 2023, driven by the increase abundant liquidity in the banking system and in Federal Reserve lending to DIs and a $274 billion limited Treasury bill supply (fi gure C) . In addition, decline in the Treasury General Account .5 uncertainty about the economic outlook—and, as a Net income of the Federal Reserve continued to be result, about the magnitude and pace of policy rate negative, and the deferred asset that the Federal Reserve increases—continued to contribute to a preference balance sheet now reports—as the Federal Reserve no for short-duration assets, like those provided by the longer has positive net income to remit to the Treasury ON RRP facility . ON RRP usage dropped slightly in the Department—grew by about $30 billion to $68 billion immediate aftermath of banking-sector stress in mid- since the previous report . The deferred asset is equal to the cumulative shortfall of net income and represents the amount of future net income that will need to be for the securities eligible for the BTFP, further increasing the realized before remittances to the Treasury resume .6 lendable value of collateral at the discount window . Negative net income and the associated deferred asset 3 . The collateral eligible under the BTFP includes any collateral that is eligible for purchase by the Federal Reserve do not affect the Federal Reserve’s conduct of monetary Banks in open market operations (see 12 C .F .R . § 201 .108(b)) . policy or its ability to meet its fi nancial obligations .7 C. Federal Reserve liabilities Weekly Trillions of dollars Reverse repurchase agreements 12 4 . In order to meet funding needs, Federal Home Loan Deposits of depository institutions (reserves) 11 U.S. Treasury General Account Banks (FHLBs) increased the supply of FHLB discount notes Other deposits 10 in the immediate aftermath of the banking-sector stress in Capital and other liabilities 9 mid-March . Federal Reserve notes 8 5 . Reserve balances consist of deposits held at the Federal 7 Reserve Banks by DIs, such as commercial banks, savings 6 banks, credit unions, thrift institutions, and U .S . branches 5 and agencies of foreign banks . Reserve balances allow DIs to 4 facilitate daily payment fl ows, both in ordinary times and in 3 stress scenarios, without borrowing funds or selling assets . 2 6 . Although remittances are suspended at the time of this 1 report, over the past decade and a half, the Federal Reserve has remitted over $1 trillion to the Treasury . 2019 2020 2021 2022 2023 7 . Net income is expected to again turn positive as interest NOTE: “Capital and other liabilities” includes Treasury contributions and is expenses fall, and remittances will resume once the temporary negative on June 7, 2023, because of the deferred asset that the Federal Reserve deferred asset falls to zero . As a result of the ongoing reports. The key identifies shaded areas in order from top to bottom. The data reduction in the size of the Federal Reserve’s balance sheet, extend through June 7, 2023. SOURCE: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting it is expected that interest expenses will fall over time in line Reserve Balances.” with the decline in the Federal Reserve’s liabilities . 44 PART 2: MONETARy POLICy Monetary Policy Rules in the Current Environment As part of their monetary policy deliberations, rules, along with a “balanced-approach (shortfalls)” A. Monetary policy rules policymakers consult the prescriptions of a variety rule, which responds to the unemployment rate only of simple interest rate rules without mechanically when it is higher than its longer-run level .2 All of these Taylor (1993) rule Rt T93 = rt LR + πt + 0.5(πt − πLR) + (ut LR − ut) following the prescriptions of any particular rule . simple rules shown embody key design principles Simple interest rate rules relate a policy interest rate, of good monetary policy, including that the policy such as the federal funds rate, to a small number of rate should be adjusted forcefully enough over time Balanced-approach rule Rt BA = rt LR + πt + 0.5(πt − πLR) + 2(ut LR − ut) other economic variables—typically including the to ensure a return of infl ation to the central bank’s current deviation of infl ation from its target value and a 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} measure of resource slack in the economy . expectations at levels consistent with that objective . Since 2021, infl ation has run well above the Federal All fi ve rules feature the difference between infl ation Adjusted Taylor (1993) rule Rt T93adj = max{Rt T93 − Zt, ELB} Open Market Committee’s (FOMC) 2 percent longer- 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) run objective, and labor market conditions have been fi ve rules use the unemployment rate gap, measured very tight over the past year . As a result, the simple as the difference between an estimate of the rate of monetary policy rules considered in this discussion unemployment in the longer run (uLR) and the current Note: RtT93, RtBA, RtBAS, RtT93adj, and RtFD represent the values of the nominal federal funds rate prescribed by the Taylor (1993), t balanced-approach, balanced-approach (shortfalls), adjusted Taylor (1993), and first-difference rules, respectively. have called for elevated levels of the federal funds rate . 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, ut is the unemployment rate in quarter t, and rtLR is the Refl ecting the continued, unacceptably high level of the change in the unemployment rate gap rather than level of the neutral real federal funds rate in the longer run that is expected to be consistent with sustaining maximum employment and inflation infl ation, the FOMC has raised the target range for the its level .3 All but the fi rst-difference rule include an at the Federal Open Market Committee’s 2 percent longer-run objective, represented by πLR. πt denotes the realized 4-quarter price inflation for quarter t. 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 federal funds rate by 5 percentage points in just over a estimate of the neutral real interest rate in the longer rate from the prescriptions of the Taylor (1993) rule when that rule prescribes setting the federal funds rate below an effective lower bound (ELB) year and has reduced its holdings of Treasury securities run (rLR) .4 of 12.5 basis points. t The Taylor (1993) rule and other policy rules generally respond to the deviation of real output from its full capacity level. In these equations, and agency debt and agency mortgage-backed (continued) 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 securities at a historically rapid pace . as Okun’s law) to represent the rules in terms of the unemployment rate. The rules are implemented as responding to core personal consumption expenditures (PCE) inflation rather than to headline PCE inflation because current and near-term core inflation rates tend to outperform headline inflation rates as predictors of the medium-term behavior of headline inflation. Box note 1 provides references for the policy rules. North-Holland), pp . 829–59 . The same volume of the Selected Policy Rules: Descriptions Handbook of Monetary Economics also discusses approaches other than policy rules for deriving policy rate prescriptions . In many economic models, desirable economic 2 . The balanced-approach (shortfalls) rule responds Unlike the other simple rules featured here, necessarily abstract from many of the factors that the outcomes can be achieved if monetary policy asymmetrically to unemployment rates above or below the adjusted Taylor (1993) rule recognizes that the FOMC considers when it assesses the appropriate responds in a predictable way to changes in economic their estimated longer-run value: When unemployment federal funds rate cannot be reduced materially setting of the policy rate . Another important limitation conditions . In recognition of this idea, economists is above that value, the policy rates are identical to those below the effective lower bound (ELB) . By contrast, is that most simple policy rules do not take into account have analyzed many monetary policy rules, including prescribed by the balanced-approach rule, whereas when unemployment is below that value, policy rates do not rise during the pandemic-induced recession, the standard the ELB on interest rates, which limits the extent to the well-known Taylor (1993) rule, the “balanced because of further declines in the unemployment rate . As a Taylor (1993) rule prescribed policy rates that which the policy rate can be lowered to support the approach” rule, the “adjusted Taylor (1993)” rule, result, the prescription of the balanced-approach (shortfalls) were sharply lower than the ELB . To make up for economy . This constraint was particularly evident and the “fi rst difference” rule .1 Figure A shows these rule in 2023:Q1 is less restrictive than that of the balanced- the cumulative shortfall in policy accommodation during the pandemic-driven recession, when the lower approach rule . 3 . Implementations of simple rules often use the output following a recession during which the federal funds bound on the policy rate motivated the FOMC’s other 1 . The Taylor (1993) rule was introduced in John B . Taylor gap as a measure of resource slack in the economy . The rules rate is constrained by its ELB, the adjusted Taylor (1993) policy actions to support the economy . Relatedly, (1993), “Discretion versus Policy Rules in Practice,” Carnegie- described in fi gure A instead use the unemployment rate gap rule prescribes delaying the return of the policy rate another limitation is that simple policy rules do not Rochester Conference Series on Public Policy, vol . 39 because that gap better captures the FOMC’s statutory goal to the (positive) levels prescribed by the standard take into account the other tools of monetary policy, (December), pp . 195–214 . The balanced-approach rule was to promote maximum employment . Movements in these Taylor (1993) rule until after the economy begins such as balance sheet policies . Finally, simple policy analyzed in John B . Taylor (1999), “A Historical Analysis of alternative measures of resource utilization tend to be highly Monetary Policy Rules,” in John B . Taylor, ed ., Monetary Policy correlated . For more information, see the note below fi gure A . to recover . rules generally abstract from the risk-management Rules (Chicago: University of Chicago Press), pp . 319–41 . The 4 . The neutral real interest rate in the longer run (r tLR) is considerations associated with uncertainty about adjusted Taylor (1993) rule was studied in David Reifschneider the level of the real federal funds rate that is expected to be economic relationships and the evolution of the Policy Rules: Limitations and John C . Williams (2000), “Three Lessons for Monetary consistent, in the longer run, with maximum employment economy . Policy in a Low-Infl ation Era,” Journal of Money, Credit and and stable infl ation . Like u tLR, r tLR is determined largely by Banking, vol . 32 (November), pp . 936–66 . The fi rst-difference nonmonetary factors . The fi rst-difference rule shown in Simple policy rules are also subject to important rule is based on a rule suggested by Athanasios Orphanides fi gure A does not require an estimate of r tLR, a feature that is limitations . One important limitation is that simple Selected Policy Rules: Prescriptions (2003), “Historical Monetary Policy Analysis and the Taylor touted by proponents of such rules as providing an element of policy rules were designed and tested under very Rule,” Journal of Monetary Economics, vol . 50 (July), pp . 983– robustness . However, this rule has its own shortcomings . For different economic conditions than those faced at Figure B shows historical quarterly prescriptions 1022 . A review of policy rules is in John B . Taylor and John example, research suggests that this sort of rule often results in present . In addition, the simple policy rules respond for the federal funds rate under the fi ve simple rules C . Williams (2011), “Simple and Robust Rules for Monetary greater volatility in employment and infl ation relative to what Policy,” in Benjamin M . Friedman and Michael Woodford, would be obtained under the Taylor (1993) and balanced- to only a small set of economic variables and thus (continued on next page) eds ., Handbook of Monetary Economics, vol . 3B (Amsterdam: approach rules . MONETARy POLICy REPORT: JUNE 2023 45 A. Monetary policy rules Taylor (1993) rule Rt T93 = rt LR + πt + 0.5(πt − πLR) + (ut LR − ut) Balanced-approach rule Rt BA = rt LR + πt + 0.5(πt − πLR) + 2(ut LR − ut) Balanced-approach (shortfalls) rule Rt BAS = rt LR + πt + 0.5(πt − πLR) + 2min{(ut LR − ut), 0} Adjusted Taylor (1993) rule Rt T93adj = max{Rt T93 − Zt, ELB} First-difference rule Rt FD = Rt−1 + 0.5(πt − πLR) + (ut LR − ut) − (ut L − R 4 − ut−4) Note: RtT93, RtBA, RtBAS, RtT93adj, and RtFD represent the values of the nominal federal funds rate prescribed by the Taylor (1993), balanced-approach, balanced-approach (shortfalls), adjusted Taylor (1993), and first-difference rules, respectively. Rt−1 denotes the midpoint of the target range for the federal funds rate for quarter t−1, ut is the 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. πt denotes the realized 4-quarter price inflation for quarter t. 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 from the prescriptions of the Taylor (1993) rule when that rule prescribes setting the federal funds rate below an effective lower bound (ELB) of 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, the output gap has been replaced with the gap between the rate of unemployment in the longer run and its actual level (using a relationship known as Okun’s law) to represent the rules in terms of the unemployment rate. The rules are implemented as responding to core personal consumption expenditures (PCE) inflation rather than to headline PCE inflation because current and near-term core inflation rates tend to outperform headline inflation rates as predictors of the medium-term behavior of headline inflation. Box note 1 provides references for the policy rules. Unlike the other simple rules featured here, necessarily abstract from many of the factors that the the adjusted Taylor (1993) rule recognizes that the FOMC considers when it assesses the appropriate federal funds rate cannot be reduced materially setting of the policy rate . Another important limitation below the effective lower bound (ELB) . By contrast, is that most simple policy rules do not take into account during the pandemic-induced recession, the standard the ELB on interest rates, which limits the extent to Taylor (1993) rule prescribed policy rates that which the policy rate can be lowered to support the were sharply lower than the ELB . To make up for economy . This constraint was particularly evident the cumulative shortfall in policy accommodation during the pandemic-driven recession, when the lower following a recession during which the federal funds bound on the policy rate motivated the FOMC’s other rate is constrained by its ELB, the adjusted Taylor (1993) policy actions to support the economy . Relatedly, rule prescribes delaying the return of the policy rate another limitation is that simple policy rules do not to the (positive) levels prescribed by the standard take into account the other tools of monetary policy, Taylor (1993) rule until after the economy begins such as balance sheet policies . Finally, simple policy to recover . rules generally abstract from the risk-management considerations associated with uncertainty about economic relationships and the evolution of the Policy Rules: Limitations economy . Simple policy rules are also subject to important limitations . One important limitation is that simple Selected Policy Rules: Prescriptions policy rules were designed and tested under very different economic conditions than those faced at Figure B shows historical quarterly prescriptions present . In addition, the simple policy rules respond for the federal funds rate under the fi ve simple rules to only a small set of economic variables and thus (continued on next page) 46 PART 2: MONETARy POLICy Monetary Policy Rules in the Current Environment (continued) considered . For each quarterly period, the fi gure reports the simple rules for the federal funds rate were between the policy rates prescribed by the rules, taking as given 4 and 8 percent; these values are well above the levels the prevailing economic conditions and survey-based observed before the pandemic and refl ect, in large estimates of uLR and rLR at the time . All of the rules part, elevated infl ation readings . Since early 2022, t t considered called for a highly accommodative stance the FOMC has raised the target range for the federal for monetary policy in response to the pandemic- funds rate by 5 percentage points to attain a stance of driven recession, followed by values above the ELB monetary policy that will be suffi ciently restrictive to as infl ation picked up and labor market conditions return infl ation to 2 percent over time . strengthened . Over the past year, the prescriptions of B. Historical federal funds rate prescriptions from simple policy rules Percent First-difference rule 9 Balanced-approach rule Taylor (1993) rule 6 3 + _0 Ba (s la h n o c r e t d fa - l a ls p ) p r r u o l a e ch Adjusted Taylor (1993) rule Federal funds rate 3 6 9 12 15 18 2018 2019 2020 2021 2022 2023 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’ prescriptions 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 estimates. 47 P 3 art s e P ummary of conomic rojections The following material was released after the conclusion of the June 13–14, 2023, meeting of the Federal Open Market Committee. In conjunction with the Federal Open to affect economic outcomes. The longer- Market Committee (FOMC) meeting held run projections represent each participant’s on June 13–14, 2023, 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 2023 to 2025 “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 2023 Percent Median1 Central tendency2 Range3 Variable Longer Longer Longer 2023 2024 2025 2023 2024 2025 2023 2024 2025 run run run Change in real GDP ..... 1.0 1.1 1.8 1.8 0.7–1.2 0.9–1.5 1.6–2.0 1.7–2.0 0.5–2.0 0.5–2.2 1.5–2.2 1.6–2.5 March projection ...... 0.4 1.2 1.9 1.8 0.0–0.8 1.0–1.5 1.7–2.1 1.7–2.0 -0.2–1.3 0.3–2.0 1.5–2.2 1.6–2.5 Unemployment rate. . . . . . 4.1 4.5 4.5 4.0 4.0–4.3 4.3–4.6 4.3–4.6 3.8–4.3 3.9–4.5 4.0–5.0 3.8–4.9 3.5–4.4 March projection ...... 4.5 4.6 4.6 4.0 4.0–4.7 4.3–4.9 4.3–4.8 3.8–4.3 3.9–4.8 4.0–5.2 3.8–4.9 3.5–4.7 PCE inflation ............ 3.2 2.5 2.1 2.0 3.0–3.5 2.3–2.8 2.0–2.4 2.0 2.9–4.1 2.1–3.5 2.0–3.0 2.0 March projection ...... 3.3 2.5 2.1 2.0 3.0–3.8 2.2–2.8 2.0–2.2 2.0 2.8–4.1 2.0–3.5 2.0–3.0 2.0 Core PCE inflation4 ...... 3.9 2.6 2.2 3.7–4.2 2.5–3.1 2.0–2.4 3.6–4.5 2.2–3.6 2.0–3.0 March projection ...... 3.6 2.6 2.1 3.5–3.9 2.3–2.8 2.0–2.2 3.5–4.1 2.1–3.1 2.0–3.0 Memo: Projected appropriate policy path Federal funds rate ....... 5.6 4.6 3.4 2.5 5.4–5.6 4.4–5.1 2.9–4.1 2.5–2.8 5.1–6.1 3.6–5.9 2.4–5.6 2.4–3.6 March projection ...... 5.1 4.3 3.1 2.5 5.1–5.6 3.9–5.1 2.9–3.9 2.4–2.6 4.9–5.9 3.4–5.6 2.4–5.6 2.3–3.6 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 21–22, 2023. 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 21–22, 2023, meeting, and one participant did not submit such projections in conjunction with the June 13–14, 2023, 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. 48 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 1. Medians, central tendencies, and ranges of economic projections, 2023–25 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 2018 2019 2020 2021 2022 2023 2024 2025 Longer run Percent Unemployment rate 7 6 5 4 3 2 1 2018 2019 2020 2021 2022 2023 2024 2025 Longer run Percent PCE inflation 7 6 5 4 3 2 1 2018 2019 2020 2021 2022 2023 2024 2025 Longer run Percent Core PCE inflation 7 6 5 4 3 2 1 2018 2019 2020 2021 2022 2023 2024 2025 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 2023 49 Figure 2. FOMC participants’ assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate Percent 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2023 2024 2025 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. 50 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2023–25 and over the longer run Number of participants 2023 June projections 18 March projections 16 14 12 10 8 6 4 2 −0.4− −0.2− 0.0− 0.2− 0.4− 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− −0.3 −0.1 0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 −0.4− −0.2− 0.0− 0.2− 0.4− 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− −0.3 −0.1 0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants 2025 18 16 14 12 10 8 6 4 2 −0.4− −0.2− 0.0− 0.2− 0.4− 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− −0.3 −0.1 0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 −0.4− −0.2− 0.0− 0.2− 0.4− 0.6− 0.8− 1.0− 1.2− 1.4− 1.6− 1.8− 2.0− 2.2− 2.4− −0.3 −0.1 0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2023 51 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2023–25 and over the longer run Number of participants 2023 June projections 18 March projections 16 14 12 10 8 6 4 2 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 4.6− 4.8− 5.0− 5.2− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1 5.3 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 4.6− 4.8− 5.0− 5.2− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1 5.3 Percent range Number of participants 2025 18 16 14 12 10 8 6 4 2 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 4.6− 4.8− 5.0− 5.2− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1 5.3 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 3.2− 3.4− 3.6− 3.8− 4.0− 4.2− 4.4− 4.6− 4.8− 5.0− 5.2− 3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1 5.3 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 52 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants’ projections for PCE inflation, 2023–25 and over the longer run Number of participants 2023 June projections 18 March projections 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− 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 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− 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 Percent range Number of participants 2025 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− 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 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− 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 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2023 53 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2023–25 Number of participants 2023 June projections 18 March projections 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− 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 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− 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 Percent range Number of participants 2025 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− 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 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. 54 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 3.E. Distribution of participants’ judgments of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate, 2023–25 and over the longer run Number of participants 2023 June projections 18 March projections 16 14 12 10 8 6 4 2 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 3.63− 3.88− 4.13− 4.38− 4.63− 4.88− 5.13− 5.38− 5.63− 5.88− 6.13− 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 4.87 5.12 5.37 5.62 5.87 6.12 6.37 Percent range Number of participants 2024 18 16 14 12 10 8 6 4 2 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 3.63− 3.88− 4.13− 4.38− 4.63− 4.88− 5.13− 5.38− 5.63− 5.88− 6.13− 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 4.87 5.12 5.37 5.62 5.87 6.12 6.37 Percent range Number of participants 2025 18 16 14 12 10 8 6 4 2 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 3.63− 3.88− 4.13− 4.38− 4.63− 4.88− 5.13− 5.38− 5.63− 5.88− 6.13− 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 4.87 5.12 5.37 5.62 5.87 6.12 6.37 Percent range Number of participants Longer run 18 16 14 12 10 8 6 4 2 1.88− 2.13− 2.38− 2.63− 2.88− 3.13− 3.38− 3.63− 3.88− 4.13− 4.38− 4.63− 4.88− 5.13− 5.38− 5.63− 5.88− 6.13− 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37 4.62 4.87 5.12 5.37 5.62 5.87 6.12 6.37 Percent range Note: Definitions of variables and other explanations are in the notes to table 1. MONETARy POLICy REPORT: JUNE 2023 55 Figure 4.A. Uncertainty and risks in projections of GDP growth Median projection and confidence interval based on historical forecast errors Percent Change in real GDP 6 Median of projections 70% confidence interval 5 4 Actual 3 2 1 0 −1 −2 −3 2018 2019 2020 2021 2022 2023 2024 2025 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.” 56 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 4.B. Uncertainty and risks in projections of the unemployment rate Median projection and confidence interval based on historical forecast errors Percent Unemployment rate Median of projections 7 70% confidence interval 6 5 Actual 4 3 2 1 2018 2019 2020 2021 2022 2023 2024 2025 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 2023 57 Figure 4.C. Uncertainty and risks in projections of PCE inflation Median projection andconfidence interval based on historical forecast errors Percent PCE inflation Median of projections 7 70% confidence interval 6 5 4 Actual 3 2 1 2018 2019 2020 2021 2022 2023 2024 2025 FOMC participants’ assessments of uncertainty and risksaround theireconomic 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.” 58 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 2023 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 2023 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 2023 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 2023 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 2023 59 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 2023 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 2023 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 2023 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 2023 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. 60 PART 3: SUMMARy OF ECONOMIC PROJECTIONS Figure 5. Uncertainty and risks in projections of the federal funds rate Percent Federal funds rate 7 Midpoint of target range Median of projections 70% confidence interval* 6 5 4 Actual 3 2 1 0 2018 2019 2020 2021 2022 2023 2024 2025 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 2023 61 Table 2. Average historical projection error ranges Percentage points Variable 2023 2024 2025 Change in real GDP1 ......... ± 1.5 ± 1.9 ± 2.3 Unemployment rate1 ......... ± 0.8 ± 1.4 ± 1.9 Total consumer prices2 ....... ± 1.0 ± 1.7 ± 1.4 Short-term interest rates3 .... ± 0.7 ± 1.9 ± 2.2 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 2003 through 2022 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 calculat- ed using average levels, in percent, in the fourth quarter. 62 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 however . The economic and statistical models and 1 .0 to 3 .0 percent in the current year, 0 .3 to 3 .7 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 (GDP) and total consumer prices will rise steadily at the widths of the confi dence intervals shown in the annual rates of, respectively, 3 percent and 2 percent . top panels of fi gures 4 .A through 4 .C . Participants’ If the uncertainty attending those projections is similar current assessments of the uncertainty surrounding to that experienced in the past and the risks around their projections are summarized in the bottom-left the projections are broadly balanced, the numbers (continued) MONETARy POLICy REPORT: JUNE 2023 63 panels of those fi gures . Participants also provide appropriate monetary policy and are on an end-of- judgments as to whether the risks to their projections year basis . However, the forecast errors should provide are weighted to the upside, are weighted to the a sense of the uncertainty around the future path of downside, or are broadly balanced . That is, while the federal funds rate generated by the uncertainty the symmetric historical fan charts shown in the top about the macroeconomic variables as well as panels of fi gures 4 .A through 4 .C imply that the risks to additional adjustments to monetary policy that would participants’ projections are balanced, participants may be appropriate to offset the effects of shocks to the judge that there is a greater risk that a given variable economy . will be above rather than below their projections . These If at some point in the future the confi dence interval judgments are summarized in the lower-right panels of around the federal funds rate were to extend below fi gures 4 .A through 4 .C . zero, it would be truncated at zero for purposes of As with real activity and infl ation, the outlook the fan chart shown in fi gure 5; zero is the bottom of for the future path of the federal funds rate is subject the lowest target range for the federal funds rate that to considerable uncertainty . This uncertainty arises has been adopted by the Committee in the past . This primarily because each participant’s assessment of approach to the construction of the federal funds rate the appropriate stance of monetary policy depends fan chart would be merely a convention; it would importantly on the evolution of real activity and not have any implications for possible future policy infl ation over time . If economic conditions evolve decisions regarding the use of negative interest rates to in an unexpected manner, then assessments of the provide additional monetary policy accommodation appropriate setting of the federal funds rate would if doing so were appropriate . In such situations, the change from that point forward . The fi nal line in Committee could also employ other tools, including table 2 shows the error ranges for forecasts of short- forward guidance and asset purchases, to provide term interest rates . They suggest that the historical additional accommodation . confi dence intervals associated with projections of While fi gures 4 .A through 4 .C provide information the federal funds rate are quite wide . It should be on the uncertainty around the economic projections, noted, however, that these confi dence intervals are not fi gure 1 provides information on the range of views strictly consistent with the projections for the federal across FOMC participants . A comparison of fi gure 1 funds rate, as these projections are not forecasts of with fi gures 4 .A through 4 .C shows that the dispersion the most likely quarterly outcomes but rather are of the projections across participants is much smaller projections of participants’ individual assessments of than the average forecast errors over the past 20 years . 65 a bbreviations AFE advanced foreign economy AUM assets under management BLS Bureau of Labor Statistics BTFP Bank Term Funding Program C&I commercial and industrial COVID-19 coronavirus disease 2019 CRE commercial real estate DI depository institution DPI disposable personal income ELB effective lower bound EME emerging market economy EPOP ratio employment-to-population ratio FDIC Federal Deposit Insurance Corporation FOMC Federal Open Market Committee; also, the Committee GDP gross domestic product G-SIBs global systemically important banks MBS mortgage-backed securities MMF money market fund ON RRP overnight reverse repurchase agreement OPEC Organization of the Petroleum Exporting Countries PCE personal consumption expenditures repo repurchase agreement SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices SOMA System Open Market Account S&P Standard & Poor’s SVB Silicon Valley Bank VIX implied volatility for the S&P 500 index For use at 11:00 a.m. EDT June 16, 2023 M P r onetary olicy ePort June 16, 2023 Board of Governors of the Federal Reserve System

Federal Reserve (2023, June 15). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20230616

@misc{wtfs_monetary_policy_report_20230616,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2023},
  month = {Jun},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20230616},
  note = {Retrieved via When the Fed Speaks corpus}
}