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Prefatory Note
The attached document represents the most complete and accurate version available
based on original files from the FOMC Secretariat at the Board of Governors of the
Federal Reserve System.
Please note that some material may have been redacted from this document if that
material was received on a confidential basis. Redacted material is indicated by
occasional gaps in the text or by gray boxes around non-text content. All redacted
passages are exempt from disclosure under applicable provisions of the Freedom of
Information Act.
Content last modified 01/05/2018.
Authorized for Public Release
Class I FOMC – Restricted Controlled (FR)
Report to the FOMC
on Economic Conditions
and Monetary Policy
Book B
Monetary Policy:
Strategies and Alternatives
March 8, 2012
Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
March 8, 2012
The top panel of the exhibit, “Policy Rules and the Staff Projection,” provides
near-term prescriptions for the federal funds rate from five selected policy rules: the
Taylor (1993) rule; the Taylor (1999) rule; the outcome-based rule; the first-difference
rule; and the nominal income targeting rule.1 The first four of these rules have appeared
regularly in previous Tealbooks, while a nominal income targeting rule has recently been
introduced in two staff memos for the Committee.2 As shown in the left-hand columns,
prescriptions for the federal funds rate from most of the rules remain at the effective
lower bound in both the second and third quarters of this year.3 The exceptions are the
prescriptions from the Taylor (1993) rule, which embeds a relatively low response to the
output gap, and the first-difference rule, which responds to the change in the output gap
rather than its level. The Taylor (1993) rule prescribes policy rates around 130 basis
points for the next two quarters, and the first-difference rule prescribes a rate just above
the effective lower bound over that period. The right-hand columns display the rule
prescriptions that arise in the absence of the lower-bound constraint. Of these, the lowest
near-term values for the federal funds rate, around 110 basis points, come from the
Taylor (1999) rule, which responds strongly to the output gap. Compared with the
January Tealbook, the staff foresees a narrower output gap and slightly higher inflation
rates over the near term, as shown in the bottom two panels and discussed below.
Consequently, the unconstrained near-term prescriptions from all rules have increased.
1
This Tealbook includes a changed format for “Monetary Policy Strategies.” See the accompanying
box for discussion of the new format.
2
See Christopher Erceg, Michael Kiley, and David López-Salido, “Alternative Monetary Policy
Frameworks,” memo sent to the Committee on October 6, 2011, and Christopher Erceg, Matteo Iacoviello,
Michael Kiley, and David López-Salido, “Simple Rules and Optimal Policies in Staff Models,” memo sent
to the Committee on March 3, 2012. The nominal GDP target here is assumed to jump off from a 2007:Q4
base that is equal to potential nominal GDP; the jumping-off point for the nominal GDP target in the
previous memos was based instead on the actual level of nominal GDP. Formulas for each rule and more
details about the nominal income targeting base appear in Explanatory Note A.
3
In this Tealbook, the estimates of the long-run equilibrium real interest rate embedded in the
outcome-based rule and the two Taylor rules have been standardized to equal 2¼ percent, which conforms
to the assumption about this rate used in the staff projection. Without this adjustment, the rules would not
return inflation to the 2 percent goal in the long run. This adjustment by itself raises the unconstrained
Taylor (1993) and Taylor (1999) prescriptions by 25 basis points. In contrast, the adjustment has lowered
the long-run intercept of the outcome-based rule by somewhat more than 25 basis points, while it has a
smaller downward effect on the short-term prescriptions from the rule. To facilitate comparison, the new
values of the intercepts of the rules have been applied both to the “Current Tealbook” and “Previous
Tealbook” numbers displayed in the exhibit.
Page 1 of 52
Strategies
Monetary Policy Strategies
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March 8, 2012
Strategies
The New Format of “Monetary Policy Strategies”
The format of the “Monetary Policy Strategies” section in this Tealbook has been
changed to sharpen the focus of the section on strategic issues of most interest
to the Committee. In particular, the material on the equilibrium federal funds
rate and market‐based policy expectations has been trimmed, while the
discussion of the implications of various policy rules for the economy and policy
has been broadened.
In the revised format, the first exhibit in this section, titled “Policy Rules and the
Staff Projection,” provides a summary of the near‐term prescriptions for the
federal funds rate from several benchmark policy rules, including the Taylor
(1993) rule, the Taylor (1999) rule, the first‐difference rule, and the outcome‐
based rule. In addition, the prescriptions table now includes a nominal income
targeting rule similar to that presented in a staff memo last October, which found
that the rule generated outcomes over time that compared favorably with those
of several other rules.1 The new format allows for a more transparent discussion
of the implications of changes in the staff forecast for monetary policy, whereas
the previous emphasis on various measures of the equilibrium real federal funds
rate (r*) often put the focus on features of the specific models used to calculate
those rates. That said, the Tealbook‐consistent measure of r* based on the
FRB/US model will continue to be included as a memo item. In order to help
explain the changes in the rules’ prescriptions, the first exhibit also includes plots
of the staff baseline forecasts for the output gap and inflation.
The new second exhibit, titled “Policy Rule Simulations,” augments the near‐
term policy rule prescriptions in the first exhibit with dynamic simulations of key
variables (the nominal and real federal funds rates, unemployment, and four‐
quarter PCE inflation) based on the simple policy rules and the FRB/US model
under rational expectations. Confining the coverage of simple policy rules to an
analysis of their near‐term policy rate prescriptions was a shortcoming of the
previous version of “Monetary Policy Strategies,” as it did not adequately reflect
the Committee’s need to consider how its strategy for setting policy over time—
and the public’s expectations regarding how that strategy will play out—is likely
to influence the longer‐run evolution of real activity and inflation.
The third exhibit in the revised “Monetary Policy Strategies” format considers
optimal monetary policy. The exhibit (titled “Constrained vs. Unconstrained
Optimal Monetary Policy”) displays optimal control simulations using the FRB/US
model, both with and without the effective lower bound imposed on the federal
funds rate. The optimal control trajectory from the previous Tealbook with the
lower bound imposed is also provided in order to highlight the implications of
1
See Christopher Erceg, Michael Kiley, and David López‐Salido, “Alternative Monetary
Policy Frameworks,” memo sent to the Committee on October 6, 2011.
Page 2 of 52
March 8, 2012
changes in the staff’s assessment of the economic fundamentals. The current
Tealbook baseline projection is included in the exhibit, providing a further basis
for comparison. As in the “Policy Rule Simulations” exhibit, simulated values up
to 2020 are plotted for four variables (the real and nominal funds rates,
unemployment, and four‐quarter PCE inflation).
The fourth exhibit, “Outcomes under Alternative Policies,” tabulates key results
from the second and third exhibits in order to facilitate comparisons of the
implications of the various rules. (This table may be helpful to Committee
participants as they develop their contributions to the Summary of Economic
Projections.)
The fifth and final exhibit is planned to appear four times a year (subsequent to
this Tealbook, the exhibit will generally appear in Tealbooks prepared for two‐
day meetings of the Committee). The exhibit will provide a vehicle for periodic
updates of policy‐related topics of interest to the Committee. The subject matter
of the exhibit in the current Tealbook is “Optimal Monetary Policy: Commitment
vs. Discretion.” Possible topics for future Tealbooks include optimal control
under different weights on the Committee’s policy goals, and simple policy rule
and optimal control simulations that are conditioned on alternatives to the staff’s
baseline outlook for the economy.
Page 3 of 52
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Authorized for Public Release
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Class I FOMC - Restricted Controlled (FR)
March 8, 2012
The top panel of the exhibit also reports the estimate of short-run r*—the real
Strategies
federal funds rate that, if maintained, would return output to its potential in twelve
quarters—generated by the FRB/US model when conditioned on the staff’s outlook for
the economy (that is, the “Tealbook-consistent” estimate). Primarily reflecting the
upward revision in the staff’s outlook for real activity, the r* estimate has increased by 30
basis points, from 3.2 percent to 2.9 percent; however, it remains well below the
estimated actual real federal funds rate of 1.7 percent.
The bottom half of the exhibit, titled “Key Elements of the Staff Projection,”
depicts the Tealbook baseline projection for the output gap and core inflation. As
detailed in Book A of the Tealbook, the staff projects a narrower output gap and higher
inflation than it did in January. Core inflation runs somewhat below 2 percent for the
current decade; however, convergence to the 2 percent goal occurs more quickly under
the current projection than in the previous projection.4
The next exhibit, “Policy Rule Simulations,” reports dynamic simulations that
incorporate the endogenous responses of inflation and the output gap to the different
paths of the federal funds rate prescribed by the constrained versions of the five policy
rules described above. These simulations are generated using the FRB/US model,
assuming that each policy rule is implemented from here forward and that private agents
fully understand and anticipate the implications of each rule for real activity and inflation
in the future, relative to baseline. In contrast, the previous exhibit gave near-term
prescriptions from the same rules, but took staff projections for inflation and the output
gap as given. For comparison, the exhibit also displays the Tealbook baseline paths,
which are conditioned on the prescriptions of the outcome-based rule.
Both the Taylor (1993) and the first-difference rules imply an earlier increase in
the federal funds rate than the other rules. Because the Taylor (1993) rule does not
respond strongly to the level of the output gap, this rule implies an immediate departure
of the funds rate from its effective lower bound. For the next few years, the Taylor
(1993) rule features a considerably tighter monetary policy than the other rules, with a
higher unemployment path and inflation below 2 percent even in 2020. The firstdifference rule also implies a somewhat higher nominal funds rate than the other rules.
4
The same is broadly true of headline inflation, as shown in the “Tealbook baseline” results in the next
exhibit.
Page 4 of 52
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March 8, 2012
Strategies
Policy Rules and the Staff Projection
Near-Term Prescriptions of Selected Policy Rules
Constrained Policy
Unconstrained Policy
2012Q2
2012Q3
2012Q2
2012Q3
Taylor (1993) rule
Previous Tealbook
1.38
0.65
1.27
0.45
1.38
0.65
1.27
0.45
Taylor (1999) rule
Previous Tealbook
0.13
0.13
0.13
0.13
-1.10
-2.18
-1.14
-2.34
Outcome-based rule
Previous Tealbook Outlook
0.13
0.13
0.13
0.13
-0.05
-0.30
-0.20
-0.77
First-difference rule
Previous Tealbook Outlook
0.14
0.13
0.20
0.13
0.14
-0.07
0.20
-0.22
Nominal income targeting rule
Previous Tealbook Outlook
0.13
0.13
0.13
0.13
-0.55
-0.75
-1.04
-1.40
Memo: Equilibrium and Actual Real Federal Funds Rate
Current
Tealbook
Previous
Tealbook
-2.9
-1.7
-3.2
-1.6
Tealbook-consistent FRB/US r* estimate
Actual real federal funds rate
Key Elements of the Staff Projection
GDP Gap
3.0
2.0
PCE Prices ex. Food and Energy
Percent
3.0
Current Tealbook
Previous Tealbook
1.0
0.0
0.0
-1.0
-1.0
-2.0
-2.0
-3.0
-3.0
-4.0
-4.0
-5.0
-5.0
-6.0
-6.0
-7.0
-7.0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Four-quarter percent change
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
2.0
1.0
-8.0
3.0
-8.0
0.0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
0.0
Note: For rules which have the lagged policy rate as a right-hand-side variable, the lines denoted "Previous Tealbook
Outlook" report rule prescriptions based on the previous Tealbook’s staff outlook, but jumping off from the average value
for the policy rate thus far in the quarter.
Page 5 of 52
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Strategies
Policy Rule Simulations
Nominal Federal Funds Rate
7
6
Real Federal Funds Rate
Percent
7
Taylor (1993) rule
Taylor (1999) rule
Nominal income targeting rule
First-difference rule
Tealbook baseline
6
5
Percent
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
5
4
4
3
3
2
2
1
1
0
0
-1
4
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
-1
-3
Unemployment Rate
-3
PCE Inflation
11
Percent
11
10
10
9
9
8
3.0
Four-quarter average
Percent
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
8
7
7
6
6
5
5
4
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
4
0.0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Note: The policy rule simulations in this exhibit are based on rules that respond to core inflation. This choice
of rule specification was made in light of the tendency for current and near-term core inflation rates to outperform
headline inflation rates as predictors of the medium-term behavior of headline inflation.
Page 6 of 52
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March 8, 2012
The unemployment rate is therefore persistently higher—and inflation lower—under this
The remaining rules—the Taylor (1999) rule, the nominal income targeting rule
and the Tealbook baseline (outcome-based rule)—keep the policy rate at the lower bound
at least through early 2014.5 Under the nominal income targeting rule, the initial
tightening of the funds rate occurs at the end of 2014, and policy is firmed more
gradually thereafter than under the other rules. This more accommodative policy is
reflected in a more rapid decline in unemployment than that experienced under the other
rules and in inflation hovering just over 2 percent for much of the current decade. The
Taylor (1999) rule, on the other hand, produces conditions that are substantially similar to
those of the Tealbook baseline (the outcome-based rule), including a convergence of
inflation to the 2 percent goal at the end of 2020.6
The implications of the staff’s revisions to economic fundamentals can be seen in
the next exhibit, “Constrained vs. Unconstrained Optimal Monetary Policy,” which
compares optimal control simulations derived for this Tealbook with those shown in
January.7 In these simulations, policymakers are assumed to place equal weights on
5
As noted earlier, the staff revised the intercepts of the two Taylor rules, the outcome-based rule, and
nominal income rule to ensure that all incorporate the same longer-run value of the equilibrium real funds
rate implicit in the extended staff projection. In addition, as discussed in Book A of the Tealbook, the staff
revised its historical estimates of potential GDP and the output gap. These technical revisions have varying
implications for the date of the first tightening of the federal funds rate depicted in these simulations. In the
case of the outcome-based rule, the effects of the two revisions on the funds rate path roughly offset each
other. In the case of the two Taylor rules, however, both technical revisions work in the direction of raising
the prescribed path of the funds rate. In the case of the Taylor (1999) rule, this upward shift advances the
initial date of tightening by three quarters beyond what the revisions to the projected paths of labor market
slack and inflation would have called for. For the nominal income targeting rule, the historical revisions to
potential output and the change in the rule’s intercept advanced the onset of tightening by one quarter.
Finally, the first-difference rule is essentially unaffected by these technical revisions, because it has no
intercept term and responds to the change in—and not the level of— the output gap.
6
It is perhaps surprising that the outcome-based and Taylor (1999) rules lead to such similar paths for
the federal funds rate. These two rules have similar longer-run properties, especially with respect to the
response to the level of the output gap. However, their short-run responses are usually more distinct.
Currently, two opposing forces lead to the similar funds rate prescriptions: On the one hand, the outcomebased rule includes an output-gap change term, which, because of rapid output gains in 2014 and 2015,
tends to prescribe increases in the funds rate relative to the Taylor (1999) rule. On the other hand, the
outcome-based rule includes lags of the federal funds rate, whose presence tends to slow the pace of
increase of the funds rate. In this particular instance, these two forces almost exactly offset each other,
leading, on net, to similar funds rate prescriptions.
7
The staff’s baseline forecast incorporates the effects of the Federal Reserve’s large-scale asset
purchase programs, as well as the effects of the maturity extension program and the modifications
announced in September to the Federal Reserve’s reinvestment policies. The optimal policy simulations
Page 7 of 52
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rule than in the baseline projection.
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March 8, 2012
Strategies
Constrained vs. Unconstrained Optimal Monetary Policy
Nominal Federal Funds Rate
Real Federal Funds Rate
Percent
8
8
6
Current Tealbook: Constrained
Previous Tealbook: Constrained
Current Tealbook: Unconstrained
Tealbook baseline
6
4
Percent
4
2
2
0
0
-2
-2
-4
-4
-6
-6
4
2
2
0
0
-2
-2
-4
-4
-6
4
2012
2014
2016
2018
2020
-6
-8
Unemployment Rate
2014
2016
2018
2020
-8
PCE Inflation
11
Percent
11
10
10
9
9
8
Four-quarter average
3.0
Percent
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
8
7
7
6
6
5
5
4
2012
2012
2014
2016
2018
2020
4
0.0
Page 8 of 52
2012
2014
2016
2018
2020
0.0
Authorized for Public Release
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March 8, 2012
keeping headline PCE inflation close to a 2 percent inflation goal, on keeping the
unemployment, and on minimizing changes in the federal funds rate. The simulations
indicate that the optimal path for the federal funds rate does not rise appreciably above
zero until the fourth quarter of 2015, about two quarters earlier than in the January
Tealbook.8
The optimal control policy keeps the funds rate lower for longer than any of the
other policy approaches. As a consequence, this policy would promote a faster pace of
economic recovery than in the staff’s baseline outlook, as well as an inflation rate in the
medium run that is closer to the FOMC’s goal of 2 percent. Specifically, in the optimal
control simulation, the gap between the unemployment rate and the staff’s estimate of the
effective natural rate of unemployment is just about closed by the end of 2015, with
inflation running a little above 2 percent.9 These better outcomes occur because
policymakers respond to the lower bound constraint by promising to keep interest rates
low for an extended period of time; because the policy is assumed to be completely
credible, it boosts inflation expectations and reduces real rates over the early part of the
simulation.
If the nominal federal funds rate could fall below zero, the funds rate, under the
optimal unconstrained policy, would decrease to 2.4 percent by mid 2013, and not turn
positive until early 2015. Under these hypothetical conditions, the unemployment rate
would decline more rapidly than under the constrained policy and would then remain
roughly stable at 5¼ percent after 2015. With the unemployment rate stabilized, inflation
would settle in at around 2 percent in 2019, about one year earlier than in the constrained
simulations.
therefore also incorporate the effects of these balance sheet policies, but they assume that no further
balance sheet policies are undertaken.
8
Although the loss function uses headline inflation instead of core inflation, the real federal funds rate
shown in the upper right panel of the exhibit is calculated as the difference between the nominal funds rate
and a four-quarter moving average of core PCE inflation. Core PCE inflation is used to compute the real
rate because it provides a less volatile measure of inflation expectations than a four-quarter moving average
of headline inflation.
9
Reflecting the transitory effects of extended unemployment benefits, the staff’s estimate of the
effective natural rate of unemployment falls from 6¼ percent in the first quarter of 2012 to 5¾ percent by
the end of 2015, and then declines further until it reaches 5¼ percent by the end of 2017.
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unemployment rate close to the staff’s estimate of the effective natural rate of
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March 8, 2012
The next exhibit, “Outcomes under Alternative Policies,” tabulates the simulation
Strategies
results under the selected policy rules described above for key variables, including core
inflation.
The final exhibit, “Optimal Monetary Policy: Commitment vs. Discretion,”
displays simulations of the FRB/US model using two different concepts of optimality.
Under the first concept (commitment), policymakers can choose conditional policies
today that effectively constrain the Committee’s policy choices in future periods; under
the second concept (discretion), policymakers are assumed to be unable to bind the policy
decisions of future Committees and so choose policy today subject to the expected
optimizing behavior of future policymakers. The commitment policy corresponds to the
optimal control concept presented in the third exhibit, and so the red lines in this exhibit
trace the same paths as in the constrained case (the green line) in the third exhibit. In the
case of discretion, results are presented both with and without the effective lower bound
imposed on the funds rate.
As can be seen from the unconstrained simulations under discretionary policy,
policymakers would like to provide additional stimulus by cutting the current funds rate
today. With that option closed, they therefore might consider a substitute strategy of
promising to keep the funds rate lower in the future. Under discretion, however,
policymakers’ ability to influence private sector expectations regarding the funds rate and
other variables is greatly circumscribed because they cannot credibly bind future
policymakers to carry out the original plan. In particular, the federal funds rate leaves the
lower bound sooner under discretion than under commitment, resulting in a higher
trajectory for unemployment and a lower trajectory for inflation than can be achieved
under commitment.10 By the end of 2020, however, inflation is close to 2 percent under
both commitment and discretion.
In judging these simulations, it should be kept in mind that the exercises take the
staff’s baseline assumption about SOMA portfolio policy as given and so treat the funds
rate as the sole instrument that the Committee adjusts in response to the state of the
economy. If policymakers wished to provide additional policy stimulus but saw little
remaining scope to lower private sector expectations of the funds rate path because of
limits on their ability to commit to future policy, they could still provide stimulus by
expanding the Federal Reserve’s holdings of securities.
10
For further discussion of the different properties of commitment and discretion, see the box in Book
B of the December 2010 Tealbook, “The Role of Commitment in Optimal Policy Simulations.”
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Outcomes under Alternative Policies
2011
Measure and scenario
2012 2013 2014 2015 2016
H2
Unemployment rate1
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
8.7
8.7
8.7
8.7
8.7
8.7
8.2
8.3
8.2
8.2
8.1
8.1
7.8
8.2
7.8
8.0
7.5
7.4
7.5
8.0
7.5
7.8
6.9
6.7
6.9
7.3
6.9
7.3
6.2
5.9
6.2
6.5
6.2
6.5
5.5
5.2
Total PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
1.7
1.7
1.7
1.7
1.7
1.7
1.8
1.7
1.8
1.7
2.1
2.1
1.4
1.2
1.4
1.2
1.8
1.9
1.4
1.2
1.4
1.2
1.8
1.9
1.5
1.3
1.5
1.3
1.9
2.0
1.6
1.4
1.6
1.4
2.0
2.1
Core PCE prices
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
1.7
1.7
1.7
1.7
1.7
1.7
1.7
1.6
1.7
1.6
2.0
2.0
1.6
1.4
1.6
1.4
2.0
2.1
1.6
1.4
1.6
1.4
2.0
2.1
1.6
1.4
1.6
1.4
2.0
2.1
1.7
1.5
1.7
1.5
2.1
2.2
Federal funds rate1
Extended Tealbook baseline
Taylor (1993)
Taylor (1999)
First-difference
Nominal income targeting
Constrained optimal control
0.1
0.1
0.1
0.1
0.1
0.1
0.1
1.2
0.1
0.1
0.1
0.1
0.1
1.1
0.1
0.2
0.1
0.1
0.8
1.5
0.7
1.2
0.3
0.1
2.1
2.2
2.0
2.3
1.4
0.3
3.0
3.0
3.0
3.3
2.5
2.0
1. Percent, average for the final quarter of the period.
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(Percent change, annual rate, from end of preceding period except as noted)
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Strategies
Optimal Monetary Policy: Commitment vs. Discretion
Nominal Federal Funds Rate
8
6
Real Federal Funds Rate
Percent
8
Optimal policy: Commitment, constrained
Optimal policy: Discretion, constrained
Optimal policy: Discretion, unconstrained
4
6
Percent
4
2
2
0
0
-2
-2
-4
-4
-6
-6
4
2
2
0
0
-2
-2
-4
-4
-6
4
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
-6
-8
Unemployment Rate
-8
PCE Inflation
11
Percent
11
10
10
9
9
8
3.0
Four-quarter average
Percent
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
8
7
7
6
6
5
5
4
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
4
0.0
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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
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March 8, 2012
Monetary Policy Alternatives
This Tealbook presents three policy alternatives—labeled A, B, and C—for the
Committee’s consideration. Of course, the Committee could blend various components
of the statements, including alternative characterizations of recent and prospective
economic conditions as well as policy choices, to construct its desired statement.
Turning first to the draft statements’ characterizations of recent economic
conditions, they all reflect the improvement in labor market conditions, but to differing
degrees. Alternative B notes that labor market conditions “have improved further,” while
statement reiterates that the unemployment rate “remains elevated,” Alternative B states
that it has “declined notably” in recent months, and Alternative C observes that this rate
has declined notably and the pace of employment growth has “picked up.” The
statements also vary in describing the recent increase in the prices of crude oil and
gasoline, with Alternatives A and B noting that these prices “have increased lately,” and
Alternative C saying they have “increased significantly of late.” The statements differ in
their characterization of recent conditions in the housing sector as well, with Alternatives
A and B saying that this sector “remains depressed,” while Alternative C notes that
housing indicators “have improved somewhat.” By contrast, the statements are nearly
identical in their characterizations of recent economic growth (“has been expanding
moderately”), household spending and business fixed investment (“have continued to
advance), inflation (“has been subdued in recent months”), and longer-term inflation
expectations (“have remained stable”).
The alternative statements vary more significantly in their characterizations of the
economic outlook. Alternative B indicates that the Committee expects “moderate”
economic growth with the unemployment rate declining “gradually.” Alternative A says
that, absent further policy action, economic growth “would slow” and the unemployment
rate would decline “only gradually.” Meanwhile, Alternative C notes that “a gradual
increase” in the pace of economic growth is expected along with a rate of unemployment
that will “continue to decline.” Alternatives A and B observe that the recent increase in
the prices of crude oil and gasoline will push up inflation temporarily, and Alternative A
adds that the increase is likely to reduce consumers’ purchasing power. In contrast,
Alternative C says this development is likely to push inflation above its mandate-
Page 13 of 52
Alternatives
Alternative A says these conditions have improved “somewhat” further. While each
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consistent rate in the near term.1 In describing the risks to the outlook, Alternatives A
and B cite strains in global financial markets as continuing to pose significant downside
risks, although Alternative B notes that these risks have “eased somewhat.” Alternative
C makes no mention of downside risks to economic activity; instead, it states that the
Committee sees some risk that inflation “could remain elevated going forward.”
Against this backdrop, Alternative B makes no change either to the Committee’s
current guidance regarding the anticipated period of exceptionally low federal funds rates
(“at least through late 2014”) or to its balance sheet policies. Alternative A preserves the
Committee’s current forward rate guidance and provides additional policy
Alternatives
accommodation by undertaking one of two new asset purchase programs—either a
discrete program to buy an additional $500 billion of agency mortgage-backed securities
(MBS) by the end of March 2013, or an incremental and open-ended program to buy $40
billion of agency MBS per month, with adjustments as needed. Under Alternative C, the
Committee would remove some policy accommodation by adjusting both its balance
sheet policies and its forward rate guidance. Specifically, Alternative C would reduce the
size of the maturity extension program by about one-third and end it in March, three
months earlier than originally announced; Alternative C would also eliminate the date in
the Committee’s forward guidance and instead describe the time period over which the
exceptionally low range for the federal funds rate is appropriate as being linked
qualitatively to economic conditions involving projected inflation, longer-term inflation
expectations, and the state of progress toward maximum employment.
Each statement ends with a description of the Committee’s future policy
intentions. Alternatives B and C say the Committee is “prepared to adjust” its holdings
of securities as appropriate, while under Alternative A, the Committee will more broadly
“employ its tools as needed.” Alternatives A and B indicate that future actions would be
undertaken to strengthen the economic recovery; under Alternative C, the Committee’s
motivation—to “promote its objectives”—is more balanced.
The following table highlights key elements of the differences in the policy
actions associated with the alternative statements. The table is followed by complete
draft statements and then by a summary of the arguments for each alternative.
1
In light of the Committee’s statement on longer-run goals and monetary policy strategy that was
released at the conclusion of the January FOMC meeting, inflation is now described in each of the draft
statements in terms of the criterion of “the rate” the Committee judges to be “most consistent” with its dual
mandate, instead of “levels” consistent with the Committee’s dual mandate.
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Table 1: Overview of Policy Alternatives for the March 13 FOMC Statement
Selected
Elements
January
Statement
March Alternatives
A
B
C
Forward Rate Guidance
Guidance
at least through
late 2014
unchanged
only as long as inflation is
projected to remain subdued
over the medium term,
longer-term inflation
expectations continue to be
well anchored, and progress
toward maximum
employment remains
insufficient
continue its program
as announced in
September
{$400 billion;
complete by
end of June 2012}
unchanged
reduce program size to $250
billion and complete by
end of March 2012
MEP
discrete:
$500 billion of agency
MBS
by end of March 2013
Additional
Purchases
Reinvestment
Policies
none
OR
none
open-ended:
$40 billion of agency MBS
per month; will adjust
program as needed to foster
objectives
principal payments
of agency debt and
MBS into agency
MBS;
Treasuries into
Treasuries
unchanged
Future Policy Action
Future
Actions
prepared to adjust
holdings as
appropriate to…
promote stronger
economic recovery
in a context of price
stability
will employ its tools
as needed to…
unchanged
Page 15 of 52
unchanged
promote its objectives of
maximum employment and
price stability
Alternatives
Balance Sheet
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Alternatives
JANUARY FOMC STATEMENT
1.
Information received since the Federal Open Market Committee met in December
suggests that the economy has been expanding moderately, notwithstanding some
slowing in global growth. While indicators point to some further improvement in
overall labor market conditions, the unemployment rate remains elevated.
Household spending has continued to advance, but growth in business fixed
investment has slowed, and the housing sector remains depressed. Inflation has
been subdued in recent months, and longer-term inflation expectations have
remained stable.
2.
Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects economic growth over
coming quarters to be modest and consequently anticipates that the
unemployment rate will decline only gradually toward levels that the Committee
judges to be consistent with its dual mandate. Strains in global financial markets
continue to pose significant downside risks to the economic outlook. The
Committee also anticipates that over coming quarters, inflation will run at levels
at or below those consistent with the Committee's dual mandate.
3.
To support a stronger economic recovery and to help ensure that inflation, over
time, is at levels consistent with the dual mandate, the Committee expects to
maintain a highly accommodative stance for monetary policy. In particular, the
Committee decided today to keep the target range for the federal funds rate at 0 to
¼ percent and currently anticipates that economic conditions—including low rates
of resource utilization and a subdued outlook for inflation over the medium run—
are likely to warrant exceptionally low levels for the federal funds rate at least
through late 2014.
4.
The Committee also decided to continue its program to extend the average
maturity of its holdings of securities as announced in September. The Committee
is maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgage-backed securities in agency
mortgage-backed securities and of rolling over maturing Treasury securities at
auction. The Committee will regularly review the size and composition of its
securities holdings and is prepared to adjust those holdings as appropriate to
promote a stronger economic recovery in a context of price stability.
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1.
Information received since the Federal Open Market Committee met in December
January suggests that the economy has been expanding moderately,
notwithstanding some slowing in global growth. While indicators point to some
further improvement in overall labor market conditions have improved
somewhat further, the unemployment rate remains elevated. Household
spending and business fixed investment have continued to advance. but growth
in business fixed investment has slowed, and The housing sector remains
depressed. Inflation has been subdued in recent months, and although prices of
crude oil and gasoline have increased lately. Longer-term inflation
expectations have remained stable.
2.
Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, absent further
policy action, economic growth would slow over coming quarters to be modest
and consequently anticipates that the unemployment rate will would decline only
gradually toward levels that the Committee judges to be consistent with its dual
mandate. Strains in global financial markets continue to pose significant
downside risks to the economic outlook. The recent increase in oil and gasoline
prices is likely to reduce consumers’ purchasing power while pushing up
inflation temporarily. Nonetheless, the Committee also anticipates that over
coming quarters, subsequently inflation will run at levels at or below those the
rate that it judges most consistent with the Committee's its dual mandate.
3.
To support a stronger economic recovery and to help ensure that inflation, over
time, is at levels the rate most consistent with the its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary
policy. In particular, the Committee decided today to purchase an additional
$500 billion of agency mortgage-backed securities by the end of March 2013.
In addition, the Committee decided to continue its program to extend the
average maturity of its holdings of securities as announced in September. The
Committee also is maintaining its existing policies of reinvesting principal
payments from its holdings of agency debt and agency mortgage-backed
securities in agency mortgage-backed securities and of rolling over maturing
Treasury securities at auction. These programs should put downward pressure
on longer-term interest rates, provide support to mortgage markets, and help
make broader financial conditions more accommodative. The Committee will
regularly review the size and composition of its securities holdings and is
prepared to adjust those holdings as appropriate.
OR
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Alternatives
MARCH FOMC STATEMENT—ALTERNATIVE A
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3′.
To support a stronger economic recovery and to help ensure that inflation, over
time, is at levels the rate most consistent with the its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary
policy. In particular, the Committee decided today to purchase additional
agency mortgage-backed securities, initially at a rate of $40 billion per
month. The Committee will adjust the pace of purchases and determine the
ultimate size of the program as needed to foster its objectives. In addition,
the Committee decided to continue its program to extend the average maturity of
its holdings of securities as announced in September. The Committee also is
maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgage-backed securities in agency
mortgage-backed securities and of rolling over maturing Treasury securities at
auction. These programs should put downward pressure on longer-term
interest rates, provide support to mortgage markets, and help make broader
financial conditions more accommodative. The Committee will regularly
review the size and composition of its securities holdings and is prepared to adjust
those holdings as appropriate.
4.
The Committee also decided to keep the target range for the federal funds rate at 0
to ¼ percent and currently anticipates that economic conditions—including low
rates of resource utilization and a subdued outlook for inflation over the medium
run—are likely to warrant exceptionally low levels for the federal funds rate at
least through late 2014.
5.
The Committee will employ its tools as needed to promote a stronger economic
recovery in a context of price stability.
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1.
Information received since the Federal Open Market Committee met in December
January suggests that the economy has been expanding moderately,
notwithstanding some slowing in global growth. While indicators point to some
further improvement in overall Labor market conditions have improved further;
the unemployment rate has declined notably in recent months but remains
elevated. Household spending and business fixed investment have continued to
advance. but growth in business fixed investment has slowed, and The housing
sector remains depressed. Inflation has been subdued in recent months, and
although prices of crude oil and gasoline have increased lately. Longer-term
inflation expectations have remained stable.
2.
Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects moderate economic
growth over coming quarters to be modest and consequently anticipates that the
unemployment rate will decline only gradually toward levels that the Committee
judges to be consistent with its dual mandate. Strains in global financial markets,
while having eased somewhat, continue to pose significant downside risks to the
economic outlook. The recent increase in oil and gasoline prices will push up
inflation temporarily, but the Committee also anticipates that over coming
quarters subsequently inflation will run at levels at or below those the rate that
it judges most consistent with the Committee's its dual mandate.
3.
To support a stronger economic recovery and to help ensure that inflation, over
time, is at levels the rate most consistent with the its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary
policy. In particular, the Committee decided today to keep the target range for the
federal funds rate at 0 to ¼ percent and currently anticipates that economic
conditions—including low rates of resource utilization and a subdued outlook for
inflation over the medium run—are likely to warrant exceptionally low levels for
the federal funds rate at least through late 2014.
4.
The Committee also decided to continue its program to extend the average
maturity of its holdings of securities as announced in September. The Committee
is maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgage-backed securities in agency
mortgage-backed securities and of rolling over maturing Treasury securities at
auction. The Committee will regularly review the size and composition of its
securities holdings and is prepared to adjust those holdings as appropriate to
promote a stronger economic recovery in a context of price stability.
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Alternatives
MARCH FOMC STATEMENT—ALTERNATIVE B
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MARCH FOMC STATEMENT—ALTERNATIVE C
Information received since the Federal Open Market Committee met in December
January suggests that the economy has been expanding moderately, notwithstanding
some slowing in global growth. While indicators point to some further improvement
in overall labor market conditions, Although the unemployment rate remains
elevated, it has declined notably and the pace of employment growth has picked
up. Household spending and business fixed investment have continued to advance,
but growth in business fixed investment has slowed, and indicators of conditions in
the housing sector remains depressed have improved somewhat. Inflation has been
subdued in recent months, and longer-term inflation expectations have remained
stable. However, prices of crude oil and gasoline have increased significantly of
late.
2.
Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects a gradual increase in the
pace of economic growth over coming quarters to be modest and consequently
anticipates that the unemployment rate will continue to decline only gradually
toward levels that the Committee judges to be consistent with its dual mandate.
Strains in global financial markets continue to pose significant downside risks to the
economic outlook. The Committee also anticipates that over coming quarters, the
recent increase in oil and gasoline prices is likely to push inflation will run at
levels at or below those above the rate that the Committee judges most consistent
with the Committee's its dual mandate. Moreover, the Committee sees some risk
that inflation could remain elevated going forward given the current degree of
policy accommodation.
3.
To support a stronger the economic recovery and to help ensure that inflation, over
time, is at levels the rate most consistent with the its dual mandate, the Committee
expects to maintain a highly accommodative stance for monetary policy. The
Committee also decided today to continue its reduce from $400 billion to $250
billion the program to extend the average maturity of its holdings of securities as
that was announced in September and to complete this program by the end of
March. In particular, The Committee also decided today to keep the target range for
the federal funds rate at 0 to ¼ percent and currently anticipates that economic
conditions—including low rates of resource utilization and a subdued outlook for
inflation over the medium run—are likely to warrant this exceptionally low levels
range for the federal funds rate at least through late 2014 will be appropriate only
as long as inflation is projected to remain subdued over the medium term,
longer-term inflation expectations continue to be well anchored, and progress
toward maximum employment remains insufficient.
4.
The Committee is also maintaining its existing policies of reinvesting principal
payments from its holdings of agency debt and agency mortgage-backed securities in
agency mortgage-backed securities and of rolling over maturing Treasury securities at
auction. The Committee will regularly review the size and composition of its
securities holdings and is prepared to adjust those holdings as appropriate to promote
a stronger economic recovery in a context of its objectives of maximum
employment and price stability.
Alternatives
1.
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THE CASE FOR ALTERNATIVE B
Participants may view the recent information on economic activity as somewhat
better than expected, on balance, particularly the improvement in labor market
conditions. Indeed, the Committee may see the recent data as consistent with a forecast
of moderate economic growth over coming quarters, accompanied by a gradual decline in
the rate of unemployment toward mandate-consistent levels. Even though the recent
increase in the prices of crude oil and gasoline is likely to boost inflation temporarily,
members may expect that inflation will fall back to rates no higher than the Committee’s
2 percent longer-run inflation goal. Similarly, the rise in oil prices may reduce
policymakers may expect this effect to be small. And while strains in global financial
markets—particularly those associated with Europe’s fiscal and financial problems—
appeared to ease somewhat over the intermeeting period, policymakers may still see them
as posing significant downside risks to the economic outlook. On balance, while the
Committee may be encouraged by the better tone of recent data on economic activity, it
may see the economy as progressing along a trajectory that is roughly in line with the one
anticipated at the January meeting, and so wish to issue a statement like that of
Alternative B, which would update the Committee’s characterization of economic
activity to reflect the improved tenor of the incoming data but would not alter the
Committee’s balance sheet policies or forward rate guidance.
In light of the notable improvement in labor market conditions in recent months—
an improvement that is coupled with some signs of life in the housing sector and a
continuation of growth in household and business spending—some participants may
judge that the economic expansion is now well established and gaining momentum.
Moreover, these policymakers may see a risk that, with economic growth likely to pickup
and monetary policy extremely accommodative, the recent increase in oil and gasoline
prices could pose a risk to the Committee’s inflation goal over the medium term. Against
this backdrop, some policymakers might wish to issue a statement at this meeting that
pulls forward the anticipated date of policy firming. The Committee has emphasized that
the date associated with its forward guidance is conditional on evolving economic
conditions and will be adjusted accordingly. Specifying an earlier expected date for the
liftoff of the target federal funds rate could be attractive to participants who are
concerned that a significant gap is opening up between the date given in the Committee’s
January statement and their own evolving views on the economic outlook and the
Page 21 of 52
Alternatives
households’ real incomes and so weigh on consumer spending for a time, but
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appropriate path for the federal funds rate. However, other participants may judge that
the economic outlook is not fundamentally different than it was at the time of the January
meeting and see the change in economic conditions as insufficient to warrant revising the
date, and so they might prefer to reiterate that the Committee intends to keep the funds
rate low “at least through late 2014.” Given that uncertainty regarding the economic
outlook is currently quite high, even policymakers who think that the outlook has
improved may prefer to wait for additional information to confirm the growing strength
of the expansion before making a date change that might have to be reversed later. In
addition, the Committee may conclude that a change in the expected date of liftoff will be
more clearly understood by the public when the Committee’s post-meeting statement is
Alternatives
accompanied by the additional information provided by the Summary of Economic
Projections, as will be the case at the April meeting. Moreover, while the combination of
the outcomes-based rule—which reflects the Committee’s average behavior in past
decades—and the staff forecast suggests that the FOMC is likely to raise the target range
for the federal funds rate in mid-2014, the Committee might be inclined to maintain the
exceptionally low range for the federal funds rate longer than it would if its ability to
stimulate the economy by reducing the funds rate had not been constrained by the zero
lower bound for an extended period.
Even in light of the recent data, policymakers may see a substantial degree of
resource slack remaining over the medium term and view inflation as unlikely to rise
much above 2 percent, even temporarily. If so, the Committee might conclude that
further policy accommodation would be helpful in speeding progress toward its
objectives. Such a view would reflect a judgment that the unemployment rate remains
very high and the pace of employment growth, although having picked up, is only slowly
restoring the jobs lost during the recession. Moreover, activity in the housing sector
remains depressed even if it is no longer declining, consumer spending has been
somewhat uneven, and the recovery once again appears vulnerable to an adverse shock
from higher oil prices. However, the Committee may judge that with the economy
expanding moderately, it is appropriate to wait for additional information regarding
spending and employment, as well as the effects of the recent increase in oil and gas
prices, before making a decision regarding additional policy accommodation. Or, if
members judge that the Committee has only limited scope to provide further policy
accommodation and see downside risks to the outlook as still significant, they may
choose to forgo additional policy accommodation at this time in order to preserve
sufficient scope for possible action in the future, perhaps in case the risk of deflation
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rises. The Committee may also believe that, in current circumstances, the marginal
benefit of additional asset purchases is unlikely to outweigh the costs and risks that would
accompany such a program. In particular, some participants may be concerned that
additional asset purchases could complicate the Federal Reserve’s ability to exit from its
extraordinarily accommodative policy stance when the time comes, or could generate
distortions in the functioning of markets for Treasury securities or agency MBS.
A statement along the lines of Alternative B would be in line with the
expectations of financial market participants. According to the Desk’s latest survey,
many primary dealers expect the Committee to update its characterization of economic
conditions, referencing not only recent improvements in labor markets but also the recent,
first increase in the target federal funds rate will most likely occur in the third quarter of
2014, one quarter later than in the January survey and roughly in line with readings
derived from market interest rates. Moreover, while the dealers reportedly place some
odds on the Committee altering its forward rate guidance at some point over this year—
with somewhat greater odds seen on the date being pulled in versus pushed out—they see
essentially no chance of such a change occurring at this meeting. Therefore, if the
Committee issued a statement like that of Alternative B, interest rates along the maturity
spectrum would likely be little changed. Equity prices and the foreign exchange value of
the dollar would probably also exhibit little response.
THE CASE FOR ALTERNATIVE A
Some policymakers may judge that, with well-anchored longer-run inflation
expectations, the deviation of employment from the Committee’s assessment of its
maximum level is still sufficiently large to warrant more aggressive policy action at this
time, as in Alternative A. Indeed, the unconstrained optimal control simulations and
most of the unconstrained near-term policy rule prescriptions presented in the “Monetary
Policy Strategies” section of the Tealbook call for a greater degree of policy
accommodation at this time. Moreover, members may expect that, absent further policy
action, the pace of economic growth over coming quarters would slow and the
unemployment rate would decline only gradually toward mandate-consistent levels.
With the slack in labor markets having been high for so long, the Committee may be
concerned that a significant erosion in workers’ attachment to the labor force is under
way, and it may want to guard against the risk that a stubbornly high level of long-term
Page 23 of 52
Alternatives
but likely temporary, rise in energy prices. On balance, the dealers anticipate that the
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unemployment will weigh on both final demand and potential output, along the lines of
the “Lost Decade” alternative simulation in Tealbook Book A. In addition, some
members may be concerned that household income gains have been modest and that the
recent run-up in energy prices will be a further drag on consumers’ purchasing power.
Furthermore, while strains in global financial markets appear to have eased somewhat of
late, the Committee may remain concerned that policymakers in Europe face a number of
difficulties in resolving the situation, and that the potential for spillovers to U.S. financial
markets and the U.S. economy is still significant. Policymakers may even place some
odds on an adverse outcome in Europe driving the U.S. economy into a new downturn,
along the lines of the “European Crisis with Severe Spillovers” simulation. With the
Alternatives
recent run-up in oil and gasoline prices expected to push up inflation only temporarily,
and inflation expectations well anchored, participants may not see inflation risks as a
reason to delay taking action. Moreover, the Committee has several tools at its disposal
to manage the removal of policy accommodation, and so members may be confident that
undertaking additional asset purchases at this time would not undermine the Federal
Reserve’s ability to implement an effective exit strategy when appropriate.
With the housing sector still depressed, the Committee may see particular value in
purchasing additional agency MBS at this time, with the aim of putting downward
pressure on longer-term interest rates generally and providing support to mortgage
markets more specifically. In turn, the more accommodative conditions in mortgage
markets would likely help strengthen housing demand and thereby contribute to the
stabilization of house prices, which would support household balance sheets and
consumer confidence. Alternative A presents two variants of a program to purchase
additional agency MBS. The Committee could decide to undertake a large, discrete
purchase program—as it has done in the past—by announcing, as in paragraph 3 of the
statement, that it will purchase up to $500 billion of agency MBS by the end of March
2013. Or the Committee could choose to implement an incremental, open-ended
purchase program, described in paragraph 3′ of the statement. Under this approach, the
Committee would specify an initial monthly rate of purchases, such as $40 billion per
month, and say that it would adjust the pace of purchases and determine the ultimate size
of the program as needed to foster its objectives. In general, the Committee may prefer to
implement a large, discrete purchase program if it believes that it can reasonably calibrate
the size of the program needed to promote its objectives, and it can manage the removal
of such accommodation should circumstances warrant. In contrast, members may opt for
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an open-ended purchase program if they believe that more flexibility is needed to tailor
the ultimate size of the purchase program to evolving economic conditions.2
A statement along the lines of Alternative A would surprise financial market
participants. Although the respondents to the Desk’s survey put the probability of
additional asset purchases being initiated within the next year at about 50 percent, they
see a much lower chance of an announcement of such a step at this meeting. Longerterm interest rates would likely decline following a statement like that of Alternative A,
with the effects of announcing a discrete $500 billion purchase program probably
somewhat larger than announcing an open-ended program, owing to its greater initial
clarity about the ultimate size of the program. Equity prices would probably increase,
THE CASE FOR ALTERNATIVE C
Some policymakers may judge that recent information bearing on the outlook for
economic activity and inflation indicates that the economic recovery is now on a firmer
footing and that a somewhat less accommodative stance of policy may be appropriate to
limit the risks of an undesirable increase in inflation. If so, the Committee might prefer a
statement like that of Alternative C. Some members may see the incoming economic
data as pointing to a stronger economic expansion than had been anticipated.
Notwithstanding the still-elevated rate of unemployment, labor market conditions have
improved noticeably in recent months, including a pickup in employment growth and a
continued downtrend in new claims for unemployment insurance. Household spending
and business fixed investment have continued to advance, and even indicators of
conditions in the housing sector have improved somewhat. In recent surveys, consumers
have generally reported somewhat greater confidence. Conditions in broad financial
markets have also improved lately, with higher equity prices, lower risk spreads, and a
noticeable decline in market volatility.
2
As reported in the January Tealbook, an LSAP program consisting of purchases of an additional $500
billion of agency MBS would be expected to reduce the unemployment rate by about ¼ percentage point
and to increase inflation by somewhat less. While the corresponding economic effects of an open-ended
purchase program are not readily quantifiable, such an announcement would also be expected to put
downward pressure on longer-term interest rates, provide support to mortgage markets, and help make
broader financial conditions more accommodative. For a more complete discussion, please refer to the
memo, “Possible Large-Scale Asset Purchase Program” (by Michelle Ezer, Josh Frost, Matthew Raskin,
Julie Remache, and Nate Wuerffel of the Federal Reserve Bank of New York and Seth Carpenter, Jane
Ihrig , Elizabeth Klee, Canlin Li, and Min Wei of the Federal Reserve Board) that was sent to the
Committee on January 18, 2012.
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Alternatives
and the foreign exchange value of the dollar would likely decline.
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Looking ahead, the Committee may expect a pickup in the pace of economic
growth over coming quarters while the unemployment rate continues to decline, perhaps
along the lines of the “Virtuous Circle” alternative simulation. Moreover, the Committee
may see the recent easing of strains in financial markets as being consistent with stronger
economic growth abroad than previously thought, with positive spillovers to the U.S.
economy, such as in the “Faster European Recovery” alternative simulation. At the same
time, however, the prices of crude oil and gasoline have increased significantly of late.
The Committee may interpret the combination of these developments as being likely to
boost inflation above the rate it sees as most consistent with its dual mandate, perhaps
rapidly and substantially, with adverse effects on inflation expectations and output, as in
Alternatives
the “Oil Price Increase” or the “Virtuous Circle with Inflation Breakout” alternative
simulations. Against this backdrop, policymakers may conclude that, without a reduction
in the degree of policy accommodation currently in place, such a rise in actual inflation
could undermine confidence in the FOMC’s commitment to its inflation target and so
lead to higher expected inflation. If the Committee now sees the economic expansion as
durable and inflation risks as tilted to the upside, it may decide that the time has come to
begin withdrawing policy accommodation.
Under Alternative C, the Committee would reduce policy accommodation along
two dimensions. First, policymakers would scale back the maturity extension program
from $400 billion to $250 billion and complete it by the end of March, three months
sooner than originally announced in September. Second, the Committee would change
its forward rate guidance from a specification that offers a particular calendar date
through which the Committee expects economic conditions to warrant the current low
range for the target federal funds rate to one that describes in greater detail the economic
conditions that justify maintaining the current low range but does not include a date.
Such a change may be warranted if policymakers think that referencing a particular date
in its forward guidance is problematic, perhaps because it could be misinterpreted as a
commitment about the Committee’s future policy decisions. Alternatively, participants
may be concerned that it is not clear to the public how the date in the forward guidance
was chosen, how the date relates to the participants’ quarterly federal funds rate
projections made public in the Summary of Economic Projections, or how the Committee
is likely to adjust the date over time as economic conditions evolve. Of course, if the
Committee were not as adverse to providing a date in the statement, it could leave the
form of the forward rate guidance unchanged, but move up the date indicated, perhaps to
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“through early 2013,” in order to signal a likely need to move toward tighter policy
sooner rather than later.
One possible version of forward rate guidance that both abstracts from a calendar
date and emphasizes the conditional nature of the Committee’s future policy actions is
given in paragraph 3. Under this option, policymakers would describe the period of time
over which it anticipated that an exceptionally low range for the funds rate would be
appropriate by providing qualitative information about the economic conditions that
would have to prevail for the Committee to keep the funds rate at is effective lower
bound. The economic conditions would be described along three dimensions—projected
inflation (which would need to “remain subdued over the medium term”), longer-term
progress toward maximum employment (which would need to “remain insufficient”).
Assuming this construct was communicated to the public effectively, the public would
appropriately modify its assessment of the Committee’s likely timing of adjustment to the
target funds rate as the combination of these conditions comes to be seen as either more
or less likely to be met going forward.
A statement along the lines of Alternative C would come as a great surprise to
financial market participants. According to the Desk’s survey, very few of the primary
dealers expect the Committee will adjust any of the elements of its statement in the
direction of policy tightening this year, and none anticipate such changes at this meeting.
With market participants currently expecting the first increase in the federal funds rate
target to occur sometime in the third quarter of 2014, the actions announced in paragraph
3 of Alternative C would likely cause participants to price in a much faster exit from the
current accommodative policy stance, leaving market interest rates higher, especially in
the two- to three-year sector of yield curve. Equity prices would fall, and the foreign
exchange value of the dollar would likely rise. Alternatively, if the Committee issued a
statement that retained the current structure of the forward rate guidance but pulled the
expected date of liftoff nearer, the effects in markets would probably be somewhat
smaller, depending, of course, on the revised date that was specified.
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Alternatives
inflation expectations (which would need to “continue to be well anchored”), and
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LONG-RUN PROJECTIONS OF THE BALANCE SHEET AND MONETARY BASE
The staff has prepared three scenarios for the Federal Reserve’s balance sheet that
correspond to the policy alternatives A, B, and C. The scenario for Alternative A
incorporates the $500 billion agency MBS purchase program included in paragraph 3 of
the draft statement for that alternative. This scenario is also consistent with the openended purchase program in paragraph 3’ of that statement if purchases last, and are
expected to last, for one year. Projections under each scenario are based on assumptions
about the trajectory of various components of the balance sheet. Details of these
assumptions, as well as projections for each major component of the balance sheet, can
Alternatives
be found in Explanatory Note D.
For the balance sheet scenario that corresponds to Alternative B, the Committee is
assumed to complete the maturity extension program (MEP) that it announced in
September, purchasing a total of $400 billion (par value) of Treasury securities with
remaining maturities of six years or more and selling the same par amount of securities
with remaining maturities of three years or less by the end of June 2012. The Committee
also continues to reinvest principal payments from its holdings of agency debt and MBS
into agency MBS, while principal from maturing Treasury securities is reinvested at
auction according to the Desk’s current practice (that is, reinvesting roughly
proportionally across all Treasury securities that are being issued on the date the
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securities mature). These policy choices would keep System Open Market Account
(SOMA) securities holdings roughly constant at about $2.6 trillion until mid-2014. In
this scenario, consistent with the statement language that the federal funds rate will be at
exceptionally low levels “at least through late 2014,” we assume that the first increase in
the target funds rate is in October 2014.1 Based on this lift off date, all reinvestment is
assumed to cease in April 2014, six months before the first increase in the target federal
funds rate, and as a result, the balance sheet begins to contract. In April 2015, the
Committee begins to sell its remaining holdings of agency MBS and agency debt
securities at a pace that reduces the amount of these securities in the portfolio to zero in
five years—that is, by March 2020.2 The combination of no reinvestment and the sale of
balance sheet then begins to expand, with increases in SOMA holdings essentially
matching the growth of Federal Reserve capital and notes in circulation. The balance
sheet reaches a size of $2 trillion by the end of 2020. The size of the balance sheet
normalizes at nearly the same time under Alternative B as it did in the January Tealbook.
From March 2018 onward, under all scenarios, the paths for total assets in the current
projections align with the baseline path in the January Tealbook.
In the scenario for Alternative A, the Committee is assumed not only to complete
the MEP and continue the current reinvestment strategy but also to purchase an additional
$500 billion of agency MBS, at a pace of about $40 billion per month beginning in April
2012 and extending through March 2013. In this scenario, total assets peak at $3.4
trillion in June 2013. As in Alternative B, reinvestment ends in April 2014, the target
federal funds rate lifts off in October 2014, sales of agency securities commence in April
2015, and holdings of agency securities fall to zero over five years.5 The additional
1
This date of the federal funds liftoff is the same as in the January Alternative B balance sheet
projection, but later than the April 2014 date assumed in the current Tealbook financial projection.
2
Given the maturity schedule of the agency debt securities held in the SOMA, the volume of sales
necessary to reduce holdings of these securities to zero over the five-year period is minimal.
3
The tools to drain reserve balances (reverse repurchase agreements and the Term Deposit Facility) are
not modeled in any of the scenarios presented. Use of these tools would result in a shift in the composition
of Federal Reserve liabilities—a decline in reserve balances and a corresponding increase in reverse
repurchase agreements or term deposits—but would not produce an overall change in the size of the
balance sheet.
4
The projected timing of the normalization of the size of the balance sheet depends importantly on the
level of reserve balances that is assumed to be necessary to conduct monetary policy; currently we assume
that level of reserve balances to be $25 billion. A higher demand for reserve balances would, all else equal,
lead to an earlier normalization of the size of the balance sheet.
5
Under Reserve Bank accounting, losses on the SOMA portfolio are only realized when securities are
sold. Under the current projections, even under Alternative A, which has the highest level of sales, losses
Page 29 of 52
Alternatives
agency securities normalizes the size of the balance sheet by October 2017.3,4 The
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purchases of agency MBS under Alternative A postpone the normalization of the size of
the balance sheet until March 2018, five months later than under Alternative B.
For the scenario that corresponds to Alternative C, the Committee continues its
current reinvestment policy but scales back the MEP to $250 billion and completes these
operations by the end of March 2012. In this scenario, the federal funds rate is assumed
to lift off at the beginning of 2013, twenty one months earlier than assumed in the other
alternatives and, correspondingly, reinvestment of principal from maturing or prepaying
securities ends earlier, in mid-2012.6 Sales of agency securities also commence earlier, in
mid-2013. The size of the balance sheet is normalized in mid-2016, about sixteen months
sooner than under Alternative B, primarily reflecting the earlier assumed liftoff date for
Alternatives
the federal funds rate and thus the earlier halt to reinvestment of principal and the earlier
start of asset sales.
On the liability side of the balance sheet, the forecasted path for reserve balances
for Alternative B is roughly unchanged from the previous Tealbook’s baseline. Under
Alternative A, reserve balances peak at $2 trillion—noticeably higher than in Alternative
B—because of the new asset purchase program.
In the scenario corresponding to Alternative B, the monetary base is projected to
expand slightly in 2012 and then shrink through the fourth quarter of 2017, primarily
reflecting a decline in reserve balances that results from the assumed policy actions
beginning in 2014 to remove policy accommodation and normalize the balance sheet.
Starting in the first quarter of 2018, after reserve balances are assumed to have stabilized
at $25 billion, the monetary base expands again, in line with the growth of Federal
Reserve notes in circulation and Reserve Bank capital. The monetary base under
Alternative A expands in the near term along with the rise in reserve balances that comes
from the additional asset purchases. As the balance sheet is normalized in this scenario,
it follows a path similar to that in Alternative B. Under Alternative C, the monetary base
are projected to be smaller than net earnings. Considerable uncertainty surrounds these projections,
however, and under plausible assumptions, losses could exceed earnings; in that case, remittances to the
Treasury would cease, and a deferred asset would be booked.
6
To simplify the projections, the prepayment paths for agency MBS holdings and the premiums
calculated under Alternative C match those for Alternative B. This simplifying assumption likely
overstates somewhat both prepayments on MBS, which are reinvested into new MBS, and the net
premiums on securities in the SOMA portfolio under Alternative C. As a result, the size of the balance
sheet is likely somewhat larger, and the date of normalization is likely a little later than would be the case if
the interest rate path was recalibrated based on this scenario.
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begins to contract sooner than under the baseline because of the assumed earlier liftoff,
and at a faster pace because, under Alternative C, the smaller MEP leaves a larger
quantity of shorter-term securities in the portfolio, which are allowed to mature.
Growth Rates for the Monetary Base
Alternative B Alternative A Alternative C
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
23.3
57.6
97.8
74.4
42.1
35.9
27.0
2.0
-10.6
-4.5
-8.0
-4.5
9.2
18.0
11.3
-31.7
-13.7
16.2
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
36.8
69.3
21.0
-5.9
6.4
-7.4
6.0
-4.5
Percent, annual rate
Monthly
23.3
23.3
57.6
57.6
97.8
97.8
74.4
74.4
42.1
42.1
35.9
35.9
27.0
27.0
2.0
2.0
-10.6
-10.6
-4.5
-4.5
-8.0
-8.0
-4.5
-4.5
9.2
9.2
18.0
18.0
11.5
10.6
-31.2
-33.9
-8.8
-16.9
30.0
13.1
Memo :
January
Tealbook
23.3
57.6
97.8
74.4
42.1
35.9
27.0
2.0
-10.6
-4.5
-8.0
-4.5
5.8
22.7
4.0
-38.5
-2.2
18.3
Quarterly
2010
0.9
2011
32.9
2012
0.1
2013
-0.3
2014
-2.0
2015
-10.7
2016
-19.8
Note: Not seasonally adjusted.
36.8
69.3
21.0
-5.9
6.5
-4.7
22.4
14.3
36.8
69.3
21.0
-5.9
6.4
-9.4
-1.5
-16.3
36.8
69.3
21.0
-5.9
5.5
-8.1
5.6
5.5
Annual - Q4 to Q4
0.9
0.9
32.9
32.9
9.9
-5.2
8.9
-7.3
-2.2
-13.8
-11.4
-15.7
-20.2
-15.0
0.9
32.9
2.1
0.9
-4.8
-11.4
-19.8
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Alternatives
Date
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March 8, 2012
DEBT, BANK CREDIT, AND MONEY FORECASTS
The staff projects that domestic nonfinancial sector debt will increase at an annual
rate of 4¾ percent over the first half of this year, reflecting continued rapid expansion in
federal government debt and a modest rise in private nonfinancial debt. For the
remainder of the forecast period, debt is expected to increase at a 4 percent pace, on
average, as federal debt advances less rapidly and private debt accelerates gradually.
Nonfinancial business debt expands at a moderate pace over the forecast period, due to
favorable financing conditions and increasing capital expenditures. We project growth of
household debt to remain fairly sluggish throughout the forecast period, reaching only 1½
percent in 2013. Despite historically low mortgage rates, we expect home mortgage debt
Alternatives
to contract this year and to be about flat next year, consistent with tight mortgage lending
standards and further projected declines in house prices. Meanwhile, consumer credit
rises at a moderate pace through the first half of this year and then accelerates gradually
over the remainder of the forecast period, supported by projected increases in spending
on consumer durables and improvements in credit availability.
The staff expects that commercial bank credit will increase at a pace somewhat
below nominal GDP growth over the forecast period. Core loans—the sum of
commercial and industrial (C&I), real estate, and consumer loans—expand modestly
during 2012 and 2013, consistent with the anticipated gradual improvement in economic
activity, credit quality, and banks’ willingness to lend over that period. Among the core
loan categories, C&I loans are expected to register strong growth over the forecast
period, continuing the brisk expansion in this loan category observed over recent months.
In contrast, commercial real estate loans are projected to contract through mid-2013—and
only edge up thereafter—as high vacancy rates and depressed prices for commercial
properties and the poor credit quality of existing loans are likely to depress activity in this
sector. As for lending to households, residential real estate loans on banks’ books are
expected to move up only slightly over the forecast period, while consumer loans
increase somewhat over the next two years. Banks’ securities holdings are projected to
rise at a moderate pace, with growth slowing somewhat in 2013, given slower deposit
growth and a stronger expansion in bank loans in 2013 relative to 2012.
The staff forecasts that M2 will rise at a pace that is a bit above that of nominal
income in 2012. Uncertainty about European financial developments likely prompted
investors to boost their portfolio allocations in M2 assets early this year; however, staff
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anticipates that money will grow about in line with nominal income over the remainder of
the year. As risk aversion fades further and the domestic recovery solidifies, investors
are likely to slowly shift their portfolios toward higher-yielding non-M2 assets;
consequently, after this year, the rise in M2 is expected to slow to a pace appreciably
below that of nominal GDP. The expansion of M2 in 2013 is also restrained by the
expiration of unlimited FDIC insurance on noninterest-bearing transaction accounts at the
end of 2012. Turning to the components of M2, liquid deposits are expected to expand
moderately until the first quarter of 2013 and then slow somewhat for the remainder of
the forecast period. By contrast, retail money funds and small time deposits are projected
to contract through 2013, as investors continue to shift to alternative assets with higher
pace early this year on strong international demand for U.S. currency associated with
country-specific political and economic concerns. Currency growth is projected to
gradually return to a pace consistent with its historical average by mid-2013.
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Alternatives
returns and greater liquidity. Meanwhile, currency is expected to rise at a fairly brisk
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March 8, 2012
Growth Rates for M2
Alternatives
(Percent, seasonally adjusted annual rate)
Monthly Growth Rates
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Tealbook Forecast*
15.6
2.5
2.2
4.2
4.2
4.2
4.1
4.1
4.1
4.3
4.3
4.3
Quarterly Growth Rates
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
7.9
3.5
4.2
4.3
1.8
1.8
2.6
2.7
Annual Growth Rates
2012
2013
5.1
2.2
* This forecast is consistent with nominal GDP and interest rates in the Tealbook forecast.
Actual data through January 2012; projections thereafter.
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March 8, 2012
DIRECTIVE
The directive that was issued in January is given on the next page, followed by
drafts for a March directive that correspond to each of the policy alternatives.
Regarding the instructions for managing the size of the SOMA, the directives for
Alternatives B and C would instruct the Desk to leave the total face value of domestic
securities in the SOMA about unchanged. Under Alternative A, the Committee would
instruct the Desk either to execute purchases of agency MBS in order to raise the total
face value of the domestic securities holdings to about $3.1 trillion by the end of March
2013, or to purchase agency MBS in order to raise the face value of holdings of domestic
About the instructions for managing the composition of the SOMA, the directives
for Alternatives A and B would instruct the Desk to take appropriate steps to complete by
the end of June 2012 the $400 billion maturity extension program that was announced
last September. The directive for Alternative C would instead instruct the Desk to reduce
the amounts of purchases and sales associated with the maturity extension program to
$250 billion each and to complete these operations by the end of March. Each of the
draft directives would instruct the Desk to continue the current practice of rolling over
maturing Treasury securities at auction and of reinvesting principal payments on all
agency debt and agency MBS in agency MBS.
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Alternatives
securities by approximately $40 billion per month until instructed otherwise.
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March 8, 2012
January 2012 Directive
The Federal Open Market Committee seeks monetary and financial conditions
that will foster price stability and promote sustainable growth in output. To further its
long-run objectives, the Committee seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it began in September to purchase, by the end of
June 2012, Treasury securities with remaining maturities of approximately 6 years to 30
years with a total face value of $400 billion, and to sell Treasury securities with
remaining maturities of 3 years or less with a total face value of $400 billion. The
Committee also directs the Desk to maintain its existing policies of rolling over maturing
Alternatives
Treasury securities into new issues and of reinvesting principal payments on all agency
debt and agency mortgage-backed securities in the System Open Market Account in
agency mortgage-backed securities in order to maintain the total face value of domestic
securities at approximately $2.6 trillion. The Committee directs the Desk to engage in
dollar roll transactions as necessary to facilitate settlement of the Federal Reserve's
agency MBS transactions. The System Open Market Account Manager and the Secretary
will keep the Committee informed of ongoing developments regarding the System's
balance sheet that could affect the attainment over time of the Committee's objectives of
maximum employment and price stability.
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March 2012 Directive—Alternative A
The Federal Open Market Committee seeks monetary and financial conditions
that will foster price stability and promote sustainable growth in output. To further its
long-run objectives, the Committee seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it began in September to purchase, by the end of
June 2012, Treasury securities with remaining maturities of approximately 6 years to 30
years with a total face value of $400 billion, and to sell Treasury securities with
remaining maturities of 3 years or less with a total face value of $400 billion. [ The
Committee also directs the Desk to execute purchases of agency mortgage-backed
domestic securities held in the System Open Market Account to approximately $3.1
trillion. | The Committee also directs the Desk to execute purchases of agency
mortgage-backed securities in order to increase the total face value of domestic
securities held in the System Open Market Account by approximately $40 billion
per month. ] The Committee also directs the Desk to maintain its existing policies of
rolling over maturing Treasury securities into new issues and of reinvesting principal
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities in order to maintain the total face
value of domestic securities at approximately $2.6 trillion. The Committee directs the
Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate
settlement of the Federal Reserve's agency MBS transactions. The System Open Market
Account Manager and the Secretary will keep the Committee informed of ongoing
developments regarding the System's balance sheet that could affect the attainment over
time of the Committee's objectives of maximum employment and price stability.
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Alternatives
securities by the end of March 2013 in order to increase the total face value of
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March 8, 2012
March 2012 Directive—Alternative B
The Federal Open Market Committee seeks monetary and financial conditions
that will foster price stability and promote sustainable growth in output. To further its
long-run objectives, the Committee seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue the maturity extension program it began in September to purchase, by the end of
June 2012, Treasury securities with remaining maturities of approximately 6 years to 30
years with a total face value of $400 billion, and to sell Treasury securities with
remaining maturities of 3 years or less with a total face value of $400 billion. The
Committee also directs the Desk to maintain its existing policies of rolling over maturing
Alternatives
Treasury securities into new issues and of reinvesting principal payments on all agency
debt and agency mortgage-backed securities in the System Open Market Account in
agency mortgage-backed securities in order to maintain the total face value of domestic
securities at approximately $2.6 trillion. The Committee directs the Desk to engage in
dollar roll transactions as necessary to facilitate settlement of the Federal Reserve's
agency MBS transactions. The System Open Market Account Manager and the Secretary
will keep the Committee informed of ongoing developments regarding the System's
balance sheet that could affect the attainment over time of the Committee's objectives of
maximum employment and price stability.
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March 2012 Directive—Alternative C
The Federal Open Market Committee seeks monetary and financial conditions
that will foster price stability and promote sustainable growth in output. To further its
long-run objectives, the Committee seeks conditions in reserve markets consistent with
federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to
continue modify the maturity extension program it began in September so as to purchase,
by the end of June March 2012, Treasury securities with remaining maturities of
approximately 6 years to 30 years with a total face value of $400 $250 billion, and to sell
Treasury securities with remaining maturities of 3 years or less with a total face value of
$400 $250 billion. The Committee also directs the Desk to maintain its existing policies
payments on all agency debt and agency mortgage-backed securities in the System Open
Market Account in agency mortgage-backed securities in order to maintain the total face
value of domestic securities at approximately $2.6 trillion. The Committee directs the
Desk to engage in dollar roll transactions as necessary to facilitate settlement of the
Federal Reserve's agency MBS transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System's balance sheet that could affect the attainment over time of the
Committee's objectives of maximum employment and price stability.
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Alternatives
of rolling over maturing Treasury securities into new issues and of reinvesting principal
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Explanatory Notes
A. Policy Rules Used in “Monetary Policy Strategies”
The table below gives the expressions for the selected policy rules used in “Monetary
Policy Strategies.” In the table, ܴ௧ denotes the nominal federal funds rate for quarter t, while the
right-hand-side variables include the staff’s projection of trailing four-quarter core PCE inflation
for the current quarter and three quarters ahead (ߨ௧ and ߨ௧ାଷ|௧ ), the output gap estimate for the
current period as well as its one quarter ahead forecast (gapt and gapt+1|t) and the forecast of the
three-quarter-ahead annual change in the output gap (i.e., 4gapt+3|t). The value of policymakers’
long-run inflation objective, denoted π*, is 2 percent. The nominal income targeting rule
responds to the nominal income gap, which is defined as 100 times the difference between
nominal income ݊ݕ௧ , (the log of the level of nominal GDP) and a target value ݊ݕ௧ כ, (the log of
potential nominal GDP), where potential nominal GDP is defined as potential real GDP
multiplied by a price target equal to the actual GDP deflator in the fourth quarter of 2007 and
growing thereafter at a steady rate of 2 percent per year.1
Taylor (1993) rule
ܴ௧ ൌ 2.25 ߨ௧ 0.5ሺߨ௧ െ ߨ כሻ 0.5݃ܽ௧
Taylor (1999) rule
ܴ௧ ൌ 2.25 ߨ௧ 0.5ሺߨ௧ െ ߨ כሻ ݃ܽ௧
ܴ௧ ൌ 1.2ܴ௧ିଵ െ 0.39ܴ௧ିଶ 0.19ሾ0.79 1.73ߨ௧
3.66݃ܽ௧ െ 2.72݃ܽ௧ିଵ ሿ
First-difference rule
ܴ௧ ൌ ܴ௧ିଵ 0.5൫ߨ௧ାଷ|௧ െ ߨ כ൯ 0.5Δସ ݃ܽ௧ାଷ|௧
Nominal income
targeting rule
ܴ௧ ൌ 0.75ܴ௧ିଵ 0.25ሺ2.25 ߨ כ ݊ ݕ௧ െ ݊ ݕ௧ כሻ
The first two of the selected rules were studied by Taylor (1993, 1999). The outcomebased rule uses policy reactions estimated using real-time data over the sample
1988:Q12006:Q4. The intercept of the outcome-based rule was chosen so that the real interest
rate consistent with normal resource utilization over the medium term implied by the rule
corresponded to the 2¼ percent rate that is embedded in the FRB/US model. The intercepts of
the Taylor (1993, 1999) rules are set at 2¼ percent—instead of Taylor’s original value of 2
1
See Christopher Erceg, Michael T. Kiley, and J. David López-Salido (2011) for analysis of this rule.
The nominal GDP targeting rule in “Monetary Policy Strategies” differs slightly from the rule studied in
that memo in setting the target equal to potential nominal GDP (rather than applying a growth rate to actual
nominal GDP for the final quarter of 2007) and in having an interest-rate smoothing coefficient of 0.75 (a
more standard value than the 0.9 value employed in the memo). Background on the relationship between
simple interest-rate rules and nominal income targeting is provided in Bennett T. McCallum and Edward
Nelson (1999) and Athanasios Orphanides (2003).
Page 41 of 52
Explanatory Notes
Outcome-based rule
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percent—for the same reason. The 2¼ percent real rate estimate also enters the long-run intercept
of the nominal income targeting rule. The prescriptions of the first-difference rule do not depend
on assumptions regarding r* or the level of the output gap; see Orphanides (2003).
Near-term prescriptions from these rules are calculated using Tealbook projections for
inflation and the output gap. The first-difference rule, the estimated outcome-based rule, and the
nominal income targeting rule include the lagged policy rate as a right-hand-side variable. When
the Tealbook is published early in the quarter, the lines denoted “Previous Tealbook” report rule
prescriptions based on the previous Tealbook’s staff outlook, jumping off from the actual value of
the lagged funds rate in the previous quarter. When the Tealbook is published late in the quarter,
the lines denoted “Previous Tealbook Outlook” report rule prescriptions based on the previous
Tealbook’s staff outlook, but jumping off from the average value for the policy rate thus far this
quarter.
REFERENCES
Erceg, Christopher, Michael Kiley, and David López-Salido (2011). “Alternative
Monetary Policy Frameworks.” Memo sent to the Committee on October 6, 2011.
McCallum, Bennett T., and Edward Nelson (1999). “Nominal Income Targeting in an
Open-Economy Optimizing Model,” Journal of Monetary Economics, Vol. 43(June), pp. 553–
578.
Explanatory Notes
Orphanides, Athanasios (2003). “Historical Monetary Policy Analysis and the Taylor
Rule,” Journal of Monetary Economics, Vol. 50 (July), pp. 9831022.
Taylor, John B. (1993). “Discretion versus Policy Rules in Practice,” Carnegie-Rochester
Conference Series on Public Policy, Vol. 39 (December), pp. 195214.
Taylor, John B. (1999). “A Historical Analysis of Monetary Policy Rules,” in John B.
Taylor, ed., Monetary Policy Rules. University of Chicago Press, pp. 319341.
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B. Estimates of the Equilibrium and Actual Real Rates
An estimate of the equilibrium real rate appears as a memo item in the first exhibit,
“Policy Rules and the Staff Projection.” The concept of the short-run equilibrium real rate
underlying the estimate corresponds to the level of the real federal funds rate that is consistent
with output reaching potential in twelve quarters using the projection for the economy of
FRB/US, the staff’s large-scale econometric model of the U.S. economy. This estimate depends
on a very broad array of economic factors, some of which take the form of projected values of the
model’s exogenous variables. The estimate reported is the “Tealbook-consistent” estimate of r*,
which is generated after the paths of exogenous variables in the FRB/US model are adjusted so
that they match those in the extended Tealbook forecast. Model simulations then determine the
value of the real federal funds rate that closes the output gap conditional on the exogenous
variables in the extended baseline forecast.
Explanatory Notes
The estimated actual real federal funds rate reported in the exhibit is constructed as the
difference between the federal funds rate and the trailing four-quarter change in the core PCE
price index. The federal funds rate is specified as the target federal funds rate on the Tealbook
Book B publication date.
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March 8, 2012
C. FRB/US Model Simulations
Explanatory Notes
The second, third, and fifth exhibits of “Monetary Policy Strategies” report results from
simulations of the FRB/US model using a set of simple policy rules as well as optimal control.
These are computed using dynamic simulations of the FRB/US model, implemented as though
the rule were followed over the period covered by the simulation. For the optimal control
simulations, the dotted line labeled “Previous Tealbook” is based on the current specification of
the policy rule, applied to the previous Tealbook projection.
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D. Long-Run Projections of the Balance Sheet and Monetary Base
This explanatory note presents the assumptions underlying the projections provided in the
section titled “Long-Run Projections of the Balance Sheet and Monetary Base,” as well as
projections for each major component of the balance sheet.
GENERAL ASSUMPTIONS
The balance sheet projections are constructed at a monthly frequency from March 2012
to December 2020. The few balance sheet items that are not discussed below are assumed to be
constant over the projection period at the level observed on February 29, 2011. The projections
for all major asset and liability categories under each scenario are summarized in the tables that
follow the bullet points.
The Tealbook projections for the scenarios corresponding to Alternatives A and B
assume that the target federal funds rate begins to increase in October 2014, consistent with the
statements’ language that the federal funds rate will be at exceptionally low levels “at least
through late 2014.” This date of liftoff is the same as that used in the January Tealbook for the
Alternative A and B balance sheet projections, but later than that assumed in the March Tealbook
financial projection.2 The projection for the scenario corresponding to Alternative C assumes the
target rate lifts off in January 2013. The balance sheet projections assume that no use of shortterm draining tools is necessary to achieve the projected path for the federal funds rate.3
Treasury Securities, Agency Mortgage-Backed Securities (MBS), and Agency Debt
Securities
The assumptions under Alternative B are:
o
Over the nine months beginning in October 2011, the FOMC is assumed to
purchase $400 billion in par value of Treasury securities with remaining
maturities of six years or more and sell the same par amount of Treasury
securities with remaining maturities of three years or less. The FOMC will
reinvest the proceeds from principal payments on its agency securities holdings
2
The federal funds rate remains below 25 basis points through September 2014, then moves up
gradually over time and converges to the March Tealbook financial projections by 2019. The projected
path of the 10-year Treasury yield in each alternative is the March Tealbook financial projection adjusted
for the expectations effect of a later target federal funds rate lift off (see the box on “Forward Rate
Guidance and Policy Expectations” from the January Tealbook Book B) and for the term premium effect
associated with a larger SOMA portfolio than would be projected using the current Tealbook’s lift off date.
3
If term deposits or reverse repurchase agreements were used to drain reserves prior to raising the
federal funds rate, the composition of liabilities would change: Increases in term deposits and reverse
repurchase agreements would be matched by corresponding declines in reserve balances. Presumably,
these draining tools would be wound down as the balance sheet returns to its steady state growth path, so
that the projected paths for Treasury securities presented in the Tealbook remain valid.
Page 45 of 52
Explanatory Notes
ASSETS
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Explanatory Notes
in agency MBS. Treasury securities are rolled over at auction according to the
Desk’s current practice (that is, reinvesting roughly proportionally across all
Treasury securities that are being issued on the date the securities mature).
o
Principal payments from Treasury securities and agency MBS and agency debt
securities are reinvested until April 2014—six months prior to the assumed
increase in the target federal funds rate.4
o
The Federal Reserve begins to sell agency MBS and agency debt securities in
April 2015, roughly six months after the assumed date of the first increase in the
target federal funds rate. Holdings of agency securities are reduced over five
years and reach zero by March 2020.
o
For agency MBS, the rate of prepayment is based on staff models using estimates
of housing market factors from one of the program’s investment managers, longrun average prepayment speeds of MBS, and interest rate projections from the
Tealbook.5 The projected rate of prepayment is sensitive to these underlying
assumptions.
In the scenario corresponding to Alternative A, the Committee is assumed to begin
purchasing current coupon agency MBS in April 2012 at a rate of about $40 billion per
month through March 2013 for a total $500 billion. In addition, the Committee is
expected to complete the MEP and maintain its policies of reinvesting principal payments
from its holdings of agency securities into agency MBS and of rolling over maturing
Treasury securities at auction. As in the baseline, reinvestment ends in April 2014—six
months prior to the assumed increase in the federal funds rate—and sales of agency
securities begin in April 2015 and continue for five years.
In the scenario corresponding to Alternative C, the Committee is expected to limit its
previously announced MEP so that it purchases $250 billion in long-term securities and
sells $250 billion in short-term securities, completing operations in March 2012.
Principal payments from Treasury securities continue to be reinvested at auction, and
principal payments from agency MBS and agency debt securities are reinvested in agency
MBS until July 2012, six months prior to the assumed increase in the federal funds rate.
Sales of agency securities begin in July 2013 and continue for five years.
Because current and expected near-term rates are below the average coupon rate on
outstanding Treasury securities, the market value at which these securities are purchased
will generally exceed their face value, with a larger premium for longer-maturity
securities. As a result, although the par value of securities holdings remains constant
4
Projected prepayments of agency MBS reflect interest rates as of March 6, 2012.
Projected prepayments on the existing stock of agency MBS are from an FRBNY staff model that is
based on the prepayment model of one of the investment managers; projected prepayments associated with
agency MBS expected to be purchased in the future rely on a Board model that is based on the Bond
Market Association prepayment model.
5
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under the MEP, premiums associated with the securities, and hence total assets, will rise
by about $55 billion. Reserve balances will increase by the same amount.
The large-scale asset purchase program in Alternative A would put downward pressure
on market interest rates, in particular mortgage rates, and result in more MBS
prepayments than in the baseline. The lower path for interest rates also leads to
purchases of Treasury securities made at prices that include a greater net premium
relative to their face value than in the baseline.
The current and near-term market value of agency MBS is assumed to be four percent
above its face value. As a result, for Alternative A, premiums will rise by roughly $20
billion relative to the baseline, reflecting the $500 billion LSAP program. This will boost
total assets and reserve balances by the same amount.
The level of central bank liquidity swaps is assumed to go down gradually through April,
as the recent foreign central bank swap auctions mature, and then return to zero in May
2012.
In all scenarios, a minimum level of $25 billion is set for reserve balances. Once reserve
balances drop to this level, the Desk first purchases Treasury bills to maintain this level
of reserve balances going forward. Purchases of bills continue until such securities
comprise one-third of the Federal Reserve’s total Treasury securities holdings—about the
average share prior to the crisis. Once this share is reached, the Federal Reserve buys
coupon securities in addition to bills to maintain an approximate composition of the
portfolio of one-third bills and two-thirds coupon securities.
Credit through the Term Asset Backed Securities Loan Facility (TALF) declines to zero
by the end of 2015, reflecting loan maturities and prepayments.
The assets held by TALF LLC remain at about $1 billion through 2014 before declining
to zero the following year. Assets held by TALF LLC consist of investments of
commitment fees collected by the LLC and the U.S. Treasury’s initial funding. In this
projection, the LLC does not purchase any asset-backed securities received by the
Federal Reserve Bank of New York in connection with a decision of a borrower to not
repay a TALF loan.
The Maiden Lane II account falls to zero in March 2012, reflecting the recent multiple
sales of the assets.
The assets held by Maiden Lane LLC and Maiden Lane III LLC decline to zero gradually
over time.
LIABILITIES AND CAPITAL
Federal Reserve notes in circulation grow in line with the staff forecast for money stock
currency through the last quarter of 2013. Afterwards, Federal Reserve notes in
Page 47 of 52
Explanatory Notes
Liquidity Programs and Credit Facilities
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March 8, 2012
Explanatory Notes
circulation grow at the same rate as nominal GDP, as in the extended Tealbook
projection.
The level of reverse repurchase agreements is assumed to remain around $70 billion,
about the average level observed over the past three years.
Balances held in the U.S. Treasury’s General Account (TGA) follows recent patterns
until the assumed increase in the target federal funds rate in each alternative. At that
point, the TGA slowly drops back to its historical target level of $5 billion as it is
assumed that the Treasury will implement a new cash management system and invest
funds in excess of $5 billion. The TGA remains constant at $5 billion over the remainder
of the forecast period.
We maintain the Supplementary Financing Account (SFA) balance at its current level of
zero throughout the forecast.
Federal Reserve capital grows 15 percent per year, in line with the average rate of the
past ten years.
In general, increases in the level of Federal Reserve assets are matched by higher levels
of reserve balances. All else equal, increases in the levels of liability items, such as
Federal Reserve notes in circulation or other liabilities, or increases in the level of
Reserve Bank capital, drain reserve balances. When increases in these liability or capital
items would otherwise cause reserve balances to fall below $25 billion, purchases of
Treasury securities are assumed in order to maintain that level of reserve balances.
In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to
cover operating costs, pay dividends, and equate surplus to capital paid-in, a deferred
asset would be recorded. This deferred asset is recorded in lieu of reducing the Reserve
Bank’s capital and is reported on the liability side of the balance sheet as “Interest on
Federal Reserve notes due to U.S. Treasury.” This liability takes on a positive value
when weekly cumulative earnings have not yet been distributed to the Treasury, while
this liability takes on a negative value when earnings fall short of the expenses listed
above. In the projections, System-wide earnings are always sufficient to cover these
expenses, and this line item is set to zero.
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March 8, 2012
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative A
Billions of dollars
Feb 29, 2012
2012
2014
2016
2018
2020
2,930
3,157
3,201
2,281
1,793
1,992
108
0
0
0
0
0
0
0
0
0
0
0
108
0
0
0
0
0
11
3
1
0
0
0
11
3
1
0
0
0
31
20
16
12
7
4
0
0
0
0
0
0
31
20
16
12
7
4
2,603
2,918
2,984
2,102
1,646
1,863
1,662
1,653
1,599
1,231
1,315
1,863
Agency debt securities
101
77
39
16
2
0
Agency mortgage-backed securities
841
1,189
1,346
855
329
0
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
177
215
199
166
140
125
2,876
3,096
3,119
2,173
1,649
1,802
1,050
1,113
1,241
1,382
1,530
1,683
77
70
70
70
70
70
1,727
1,893
1,789
702
30
30
1,620
1,808
1,784
697
25
25
U.S. Treasury, General Account
63
86
5
5
5
5
Other Deposits
45
0
0
0
0
0
2
0
0
0
0
0
55
62
82
108
143
189
Total assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Lending through other credit facilities
Term Asset-Backed Securities Loan Facility (TALF)
Support for specific institutions
Credit extended to AIG
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
Securities held outright
U.S. Treasury securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
Page 49 of 52
Explanatory Notes
Selected assets
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
March 8, 2012
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative B
Billions of dollars
Feb 29, 2012
2012
2014
2016
2018
2020
2,930
2,836
2,703
1,963
1,793
1,992
108
0
0
0
0
0
0
0
0
0
0
0
108
0
0
0
0
0
11
3
1
0
0
0
11
3
1
0
0
0
31
20
16
12
7
4
0
0
0
0
0
0
31
20
16
12
7
4
2,603
2,613
2,507
1,798
1,654
1,867
1,662
1,653
1,599
1,231
1,439
1,867
Agency debt securities
101
77
39
16
2
0
Agency mortgage-backed securities
841
884
869
551
212
0
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
177
200
179
152
132
121
2,876
2,774
2,621
1,854
1,649
1,802
1,050
1,113
1,241
1,382
1,530
1,683
77
70
70
70
70
70
1,727
1,572
1,291
384
30
30
1,620
1,487
1,286
379
25
25
U.S. Treasury, General Account
63
86
5
5
5
5
Other Deposits
45
0
0
0
0
0
2
0
0
0
0
0
55
62
82
108
143
189
Total assets
Selected assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Lending through other credit facilities
Term Asset-Backed Securities Loan Facility (TALF)
Support for specific institutions
Credit extended to AIG
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
Securities held outright
Explanatory Notes
U.S. Treasury securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
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March 8, 2012
Federal Reserve Balance Sheet
End-of-Year Projections -- Alternative C
Billions of dollars
Feb 29, 2012
2012
2014
2016
2018
2020
2,930
2,666
2,101
1,608
1,792
1,991
108
0
0
0
0
0
0
0
0
0
0
0
108
0
0
0
0
0
11
3
1
0
0
0
11
3
1
0
0
0
31
20
16
12
7
4
0
0
0
0
0
0
31
20
16
12
7
4
2,603
2,469
1,940
1,476
1,681
1,890
1,662
1,598
1,382
1,237
1,681
1,890
Agency debt securities
101
77
39
16
0
0
Agency mortgage-backed securities
841
795
518
222
0
0
Net portfolio holdings of TALF LLC
1
1
1
0
0
0
177
173
144
120
104
97
2,876
2,604
2,019
1,500
1,649
1,802
1,050
1,112
1,240
1,381
1,529
1,682
77
70
70
70
70
70
1,727
1,402
690
30
30
30
1,620
1,316
685
25
25
25
U.S. Treasury, General Account
63
86
5
5
5
5
Other Deposits
45
0
0
0
0
0
2
0
0
0
0
0
55
62
82
108
143
189
Total assets
Liquidity programs for financial firms
Primary, secondary, and seasonal credit
Central bank liquidity swaps
Lending through other credit facilities
Term Asset-Backed Securities Loan Facility (TALF)
Support for specific institutions
Credit extended to AIG
Net portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC
Securities held outright
U.S. Treasury securities
Total other assets
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
Interest on Federal Reserve Notes due
to U.S. Treasury
Total capital
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
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Explanatory Notes
Selected assets
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Explanatory Notes
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March 8, 2012
@FedFRASER