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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 01/14/2022.
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
January 21, 2016
Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System
Authorized for Public Release
(This page is intentionally blank.)
January 21, 2016
Monetary Policy Strategies
The top panel of the first exhibit, “Policy Rules and the Staff Projection,”
provides near-term prescriptions for the federal funds rate from four policy rules: the
Taylor (1993) rule, the Taylor (1999) rule, an inertial version of the Taylor (1999) rule,
and a first-difference rule.1 These prescriptions take as given the staff’s baseline
projections for real activity and inflation in the near term, shown in the middle panels.
Reflecting the modest changes in the outlook for the output gap and inflation, the
prescriptions of the four simple rules are only slightly lower than those reported in the
December Tealbook. The Taylor (1993) and Taylor (1999) rules call for sizable
adjustments in the policy rate to values of about 2¼ percent over the near term. By
contrast, both the inertial Taylor (1999) rule and the first-difference rule prescribe a level
of the federal funds rate within the current target range in the first quarter of 2016
because these rules place considerable weight on keeping the federal funds rate close to
its previous quarterly value.
The bottom panel of the first exhibit reports the Tealbook-consistent estimate of a
medium-term notion of the equilibrium real federal funds rate that is generated using the
FRB/US model. This Tealbook-consistent FRB/US r* is an estimate of the real federal
funds rate that, if maintained over a 12-quarter period, would make the output gap equal
to zero in the final quarter of that period.2 Reflecting the slightly weaker outlook for the
GDP gap and inflation, the current estimate of r*, at 1.30 percent, is slightly lower than
the current-quarter estimate of 1.48 percent derived from the staff’s outlook in December.
The panel also reports the average of the real federal funds rate in the Tealbook baseline
projection for the same 12-quarter period used to compute r*.3 This average is 0.43
1
The appendix to this section provides details on each of the four rules. Starting with this
Tealbook, all nominal and real federal funds rates reported in the Monetary Policy Strategies section are
expressed on the same 360-day basis as the published federal funds rate. Previously, most rates were
expressed on a compounded 365-day basis. The change in methodology has only a marginal effect on the
reported values.
2
The Tealbook-consistent FRB/US r* differs in concept and interpretation from two other notions
of the equilibrium real federal funds rate reported by staff in the Tealbook and supporting materials, namely
the “real natural rate” based on DSGE models, and the “longer-run equilibrium real rate” that pins down
the intercepts of the simple policy rules. See the accompanying box “The Equilibrium Real Rate in the
Longer Run” for a discussion of these concepts.
3
While r* and the average projected real federal funds rate are calculated over the same
12-quarter period, they need not be associated with the same macroeconomic outcomes even when their
Page 1 of 50
Strategies
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Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Strategies
The Equilibrium Real Rate in the Longer Run
The equilibrium level of the real federal funds rate in the longer run is the rate that is
consistent with the economy operating at its full potential once the cyclical effects of
economic shocks have abated. This “longer‐run equilibrium real rate,” along with the
Committee’s inflation objective, determines the longer‐run level of the nominal federal
funds rate and other interest rates in the staff’s suite of economic models. In particular,
the longer‐run equilibrium real rate corresponds to the intercept of simple policy rules
considered in the Monetary Policy Strategies section of Tealbook B.1
Since June 2014, the staff has, in several steps, lowered its assumption for the longer‐run
equilibrium real rate from 2 percent to 1¼ percent. 2 The median and range of the longer‐
run level of the real federal funds rate implied by FOMC participants’ projections reported
in the Summary of Economic Projections has also declined. These revisions are consistent
with a decline in the longer‐run equilibrium real rate identified in econometric studies that
model the co‐movements of variables like inflation, interest rates, output, and
unemployment.3 The estimates in these studies are meant to isolate low‐frequency
variation in real interest rates—due to changes in risk preferences, longer‐term potential
output growth, or other factors—as opposed to fluctuations due to the business cycle and
other shorter‐lived influences.
As an illustration, the figure below shows the estimated path of the longer‐run equilibrium
real rate from Johannsen and Mertens (2015) along with uncertainty bands. The figure also
shows estimates of the longer‐run equilibrium real rate from Laubach and Williams (2015)
as well as a measure of the actual real federal funds rate. The estimated longer‐run
equilibrium real rates from the Johannsen‐Mertens and Laubach‐Williams models are not
the same because the models use different data to infer slack in the economy and because
of different model restrictions and estimation methods. The actual real rate fluctuates
1
The longer‐run equilibrium real rate differs in interpretation from the “real natural rate” and the
“Tealbook‐consistent FRB/US r*.” The real natural rate is a short‐term, model‐based rate that would
prevail in the absence of nominal rigidities. The Tealbook‐consistent FRB/US r* is the real federal funds
rate that, if maintained, would close the output gap in 12 quarters in the FRB/US model. Both measures
fluctuate in response to transitory shocks to aggregate supply or demand. As economic disturbances
dissipate, these measures converge to the level of the longer‐run equilibrium real rates assumed in the
models. See the memo “r*: Concepts, Measures, and Uses” by Christopher Gust and others sent to the
FOMC on October 13, 2015 for discussion of different equilibrium rates.
2
Over the same period, the staff has marked down its assumptions for the longer‐run rate of real
GDP growth. See the Tealbook A boxes “Changes to the Longer‐Run Outlook” from June 2014 and
“Changes to Interest Rates in the Longer Run” from March 2015.
3
For example, James D. Hamilton and others, “The Equilibrium Real Funds Rate: Past, Present, and
Future,” NBER Working Paper No. 21476, August 2015. Benjamin K. Johannsen and Elmar Mertens,
Summary of Results, “Shadow Rates of Interest, Macroeconomic Trends, and Time‐Varying Uncertainty,”
sent to the FOMC on October 14, 2015. Michael T. Kiley, “What Can the Data Tell Us About the Equilibrium
Real Interest Rate?” Finance and Economics Discussion Series, Board of Governors of the Federal Reserve
System, 2015 Thomas Laubach and John Williams, “Measuring the Natural Rate of Interest Redux,”
Hutchins Center Working Papers, November 2, 2015. Lubick, Thomas A. and Christian Matthes,
“Calculating the Natural Rate of Interest: A Comparison of Two Alternative Approaches,” Economic Brief:
Federal Reserve Bank of Richmond, October 2015.
Page 2 of 50
January 21, 2016
around the estimated values of the longer‐run equilibrium real rate, as would be expected
due to variations in inflation and the stance of monetary policy. The real federal funds rate
was well below the two estimates of the longer‐run equilibrium real rate from late 2008
through 2014, indicating that monetary policy was providing stimulus to speed the pace at
which the output gap was closing over time and inflation was moving toward 2 percent.
The actual real rate has increased somewhat in recent years even as the estimates of the
longer‐run equilibrium rate have trended down, suggesting that the stance of monetary
policy has become less accommodative.
The studies cited above report substantial uncertainty about the longer‐run equilibrium
real rate. As the figure illustrates, the uncertainty bands around the longer‐run equilibrium
real rate in the Johannsen‐Mertens model are typically large (as they are in other model
frameworks) and, indeed, are recently the widest they have been during the period shown.
The recent increase in uncertainty arose because, from the model’s perspective, economic
conditions during the Great Recession and its wake have been extraordinary and because
the effective lower bound limits the information content of nominal interest rates.
Uncertainty about the longer‐run equilibrium real rate implies ambiguity about the
appropriate cumulative rise in policy rates during the normalization process. The risk that
equilibrium real rates going forward could be lower than currently estimated is especially
pertinent, because such a scenario would increase the probability that policy will be
constrained by the effective lower bound in the future, with adverse consequences for
macroeconomic outcomes.
Estimates of the longer‐run equilibrium real rate
Notes: For the Johannsen‐Mertens model, at each date, the parameters of the model and the longer‐run
equilibrium real rate are jointly estimated using data up to that date. For the Laubach‐Williams model, the
parameters are estimated on the entire data sample but the estimates of longer‐run equilibrium real rate
use data only up to the date of interest. Shaded regions are 50 and 90 percent uncertainty bands from the
Johannsen‐Mertens model. The realized real federal funds rate is measured as the nominal federal funds
rate less the four‐quarter change in core PCE prices. Shaded vertical bars are NBER recession dates.
Page 3 of 50
Strategies
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Authorized for Public Release
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January 21, 2016
Strategies
Policy Rules and the Staff Projection
Near−Term Prescriptions of Selected Policy Rules1
(Percent)
2016:Q1
2016:Q2
Taylor (1993) Rule
Previous Tealbook
2.34
2.45
2.26
2.41
Taylor (1999) Rule
Previous Tealbook
2.28
2.45
2.31
2.54
Inertial Taylor (1999) Rule
Previous Tealbook outlook
0.48
0.52
0.76
0.82
First−difference rule
Previous Tealbook outlook
0.27
0.36
0.40
0.53
*
Key Elements of the Staff Projection
PCE Prices Excluding Food and Energy
GDP Gap
Percent
Percent
Four−quarter average
3.0
Current Tealbook
Previous Tealbook
2.5
2
2.0
1
1.5
0
1.0
−1
2015
2016
2017
2018
2019
2020
2021
0.5
−2
2015
2016
2017
2018
2019
2020
2021
0.0
Real Federal Funds Rate Estimates2
(Percent)
Tealbook−consistent FRB/US r*
Average projected real federal funds rate3
Current real federal funds rate
Current
Tealbook
Current Quarter Estimate
as of Previous Tealbook
Previous
Tealbook
1.30
0.43
−0.97
1.48
0.49
1.24
0.27
−1.16
*
1. Starting with the January 2016 Tealbook, this exhibit reports nominal and real federal funds rates on the same 360−day basis as the
published federal funds rate instead of on a compounded 365−day basis. For rules that have a 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
realized value for the policy rate last quarter.
2. The "Tealbook−consistent FRB/US r*" is the level of the real federal funds rate that, if maintained over a 12−quarter period in the
FRB/US model, sets the output gap equal to zero in the final quarter of that period. The "current real federal funds rate" is the
difference between the federal funds rate and the trailing four−quarter change in core PCE. The "average projected real federal funds rate"
is the average of the real federal funds rate under the Tealbook baseline projection calculated over the same 12−quarter period as the
Tealbook−consistent FRB/US r*.
Page 4 of 50
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January 21, 2016
percent, 0.87 percentage point below the estimate of r*. The panel further reports a
from the December Tealbook.4
The second exhibit, “Policy Rule Simulations,” reports dynamic simulations of
the FRB/US model under the Taylor (1993) rule, the Taylor (1999) rule, and a firstdifference rule. These simulations reflect the endogenous responses of inflation and the
output gap when the federal funds rate follows the paths implied by the different policy
rules.5 The results for each rule presented in these and subsequent simulations depend
importantly on the assumptions that policymakers will adhere to the rule in the future and
that market participants as well as price and wage setters fully understand the policy rule
that will be pursued and its implications for real activity and inflation.
The second exhibit also displays the implications of following the baseline
monetary policy assumptions in the current staff forecast. The federal funds rate is
assumed to follow the prescriptions of the inertial version of the Taylor (1999) rule. The
federal funds rate increases about 25 basis points per quarter for the next three years,
reaching about 3¼ percent by the end of 2018. The pace of tightening subsequently
slows, and the federal funds rate peaks at around 4 percent in 2021—consistent with the
high projected level of resource utilization around that time—before eventually returning
to its longer-run normal level of 3¼ percent.
The Taylor (1993) and Taylor (1999) rules call for a sharp tightening of policy
starting this quarter and produce paths for the real federal funds rate that lie significantly
above the Tealbook baseline path over the next few years. The sharp tightening reflects,
in part, these rules’ constant intercept terms, which are consistent with an equilibrium
longer-run real federal funds rate of 1¼ percent. These rules lead to less pronounced
undershooting of the natural rate of unemployment than the baseline policy in coming
years. The Taylor (1999) rule prescribes somewhat higher policy rates than the
values are identical. The reason is that, in the r* simulations, the real federal funds rate is held constant
over the entire 12-quarter period whereas, in the Tealbook baseline, the real federal funds rate can vary
over time. Distinct paths of real short-term rates can, in turn, generate different paths for inflation and
economic activity, even if they have the same 12-quarter average.
4
The current real federal funds rate is constructed as the difference between the midpoint of the
prevailing target range for the federal funds rate and the trailing four-quarter change in the core PCE price
index.
5
Because of these endogenous responses, prescriptions from the dynamic simulations can differ
from those shown in the top panel of the first exhibit.
Page 5 of 50
Strategies
measure of the current real federal funds rate which, at –0.97 percent, is little changed
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January 21, 2016
Strategies
Policy Rule Simulations
Unemployment Rate
Nominal Federal Funds Rate
Percent
Percent
6.0
6
Taylor (1993) rule
Taylor (1999) rule
First−difference rule
Tealbook baseline
Staff's estimate of the natural rate
5
4
5.5
3
2
5.0
1
0
2015
2016
2017
2018
2019
2020
2021
4.5
Real Federal Funds Rate
Percent
3
2
2015
2016
2017
2018
2019
2020
2021
4.0
1
PCE Inflation
0
Percent
Four−quarter average
3.0
−1
2.5
2015
2016
2017
2018
2019
2020
2021
−2
2.0
Real 10−year Treasury Yield
Percent
3
1.5
1.0
2
0.5
1
0.0
0
2015
2016
2017
2018
2019
2020
2015
2021
2016
2017
2018
2019
2020
2021
−0.5
Note: Starting with the January 2016 Tealbook, this exhibit reports nominal and real federal funds rates on the same 360−
day basis as the published federal funds rate instead of on a compounded 365−day basis. 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 50
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January 21, 2016
Taylor (1993) rule over the period shown because it places more weight on the output
unemployment rate and a lower trajectory of inflation than the Taylor (1993) rule.
In contrast to the Taylor-type rules, the first-difference rule prescribes a pace of
increases in the federal funds rate that is similar to the Tealbook baseline through 2018.
At that point, the federal funds rate levels off under the first-difference rule whereas it
keeps rising for a time under the Tealbook baseline. This divergence occurs because the
first-difference rule, which responds to the expected change in the output gap rather than
to its level, reacts to the slower pace of economic growth projected late in the decade.
The lower path of the federal funds rate in the medium run under the first-difference rule,
in conjunction with expectations of higher price and wage inflation in the future, leads to
lower long-term real rates and thus to higher levels of resource utilization and inflation in
the short run. The first-difference rule generates outcomes for the unemployment rate
over the forecast period that are markedly below the staff’s estimate of the natural rate
and the unemployment rate paths generated under the other policy rules. Relative to the
other simple policy rules, inflation runs a bit closer to the Committee’s 2 percent longerrun inflation objective over the next few years before overshooting the target by a greater
margin and for a longer time later on.
The third exhibit, “Optimal Control Policy under Commitment,” compares
optimal control simulations for this Tealbook’s outlook with those reported in December.
Policymakers are assumed to place equal weights on keeping headline PCE inflation
close to the Committee’s 2 percent goal, on keeping the unemployment rate close to the
staff’s estimate of the natural rate of unemployment, and on minimizing changes in the
federal funds rate. The concept of optimal control that is employed here corresponds to a
commitment policy under which the plans that policymakers make today are assumed to
constrain future policy choices.6 In contrast with the simple rules discussed above, the
optimal control policy is cognizant that headwinds are currently putting downward
pressure on equilibrium real rates.
Reflecting the modest revision in the staff’s outlook for inflation and resource
utilization, the optimal control path for the real federal funds rate is only slightly below
6
The results for optimal control policy under discretion (in which policymakers cannot credibly
commit to carrying out a plan involving policy choices that would be suboptimal at the time that these
choices have to be implemented) are similar.
Page 7 of 50
Strategies
gap. As a consequence, the Taylor (1999) rule also generates a higher trajectory of the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Strategies
Optimal Control Policy under Commitment
Unemployment Rate
Nominal Federal Funds Rate
Percent
Percent
6
Optimal control (current Tealbook)
Optimal control (previous Tealbook)
Tealbook baseline
6.0
Staff's estimate of the natural rate
5
4
5.5
3
2
5.0
1
0
2015
2016
2017
2018
2019
2020
2021
4.5
Real Federal Funds Rate
Percent
3
2015
2
1
2016
2017
2018
2019
2020
2021
4.0
PCE Inflation
Percent
Four−quarter average
0
3.0
−1
2.5
2015
2016
2017
2018
2019
2020
2021
−2
2.0
Real 10−year Treasury Yield
Percent
3
1.5
1.0
2
0.5
1
0.0
0
2015
2016
2017
2018
2019
2020
2021
2015
2016
2017
2018
2019
2020
2021
−0.5
Note: Starting with the January 2016 Tealbook, this exhibit reports nominal and real federal funds rates on the same 360−
day basis as the published federal funds rate instead of on a compounded 365−day basis.
Page 8 of 50
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Class I FOMC - Restricted Controlled (FR)
January 21, 2016
the path derived in December. In the current Tealbook baseline projection,
several years. Under the preferences embedded in this implementation of optimal
control, policymakers judge this undershooting of the natural rate to be costly, leading
them to tighten policy more than in the Tealbook baseline.7 Accordingly, the path for the
real federal funds rate is almost 1 percentage point higher, on average, than the Tealbook
baseline path over the period shown. The trajectory for the real 10-year Treasury yield,
shown in the lower-left panel, is also higher. The tighter policy under optimal control
results in a path of the unemployment rate that runs substantially closer to the staff’s
estimate of the natural rate of unemployment; headline PCE inflation is also slightly
lower than in the Tealbook baseline over the simulation period, consistent with lower
levels of resource utilization.
The final two exhibits, “Outcomes under Alternative Policies” and “Outcomes
under Alternative Policies, Quarterly,” tabulate the simulation results for key variables
under the policy rules described earlier.
7
In optimal control, the assumption that policymakers place less weight on the unemployment gap
falling below the staff’s estimate of the natural rate than posited under the standard case can result in
policymakers favoring a more accommodative policy than the Tealbook baseline. See the Monetary Policy
Strategies section of the October 2015 Tealbook B for an illustration.
Page 9 of 50
Strategies
unemployment falls well below the staff’s estimate of the natural rate over the next
Authorized for Public Release
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January 21, 2016
Outcomes under Alternative Policies
Strategies
(Percent change, annual rate, from end of preceding period except as noted)
2015
Measure and policy
2016
2017
2018
2019
H2
Real GDP
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
1.2
1.2
1.2
1.2
1.2
1.2
2.4
2.2
2.1
2.5
2.6
2.2
2.0
1.9
1.8
2.0
2.3
1.6
1.8
1.9
1.9
1.8
2.1
1.7
1.7
1.9
1.8
1.7
1.9
1.7
Unemployment Rate²
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
5.0
5.0
5.0
5.0
5.0
5.0
4.7
4.9
4.9
4.7
4.6
4.8
4.6
4.8
4.9
4.6
4.4
4.9
4.6
4.7
4.8
4.5
4.3
5.0
4.6
4.6
4.7
4.6
4.2
5.0
Total PCE prices
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.7
0.8
0.7
1.7
1.8
1.7
1.7
1.9
1.6
2.0
2.0
1.9
2.0
2.2
1.9
2.0
2.1
2.0
2.0
2.2
1.9
Core PCE prices
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.3
1.4
1.2
1.6
1.6
1.6
1.6
1.8
1.5
1.9
2.0
1.9
1.9
2.1
1.8
2.0
2.1
2.0
2.0
2.2
1.9
Nominal federal funds rate²
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
0.2
0.2
0.2
0.2
0.2
0.2
1.4
2.4
2.5
1.3
1.4
2.0
2.4
3.1
3.3
2.3
2.3
3.3
3.2
3.7
3.9
3.2
3.1
4.2
3.8
3.9
4.1
3.8
3.3
4.6
1. In the Tealbook baseline, the federal funds rate follows the prescriptions of the inertial Taylor (1999) rule.
2. Percent, average for the final quarter of the period.
3. Starting with the January 2016 Tealbook, this table reports nominal federal funds rates on the same 360-day basis as
the published federal funds rate instead of on a compounded 365-day basis.
Page 10 of 50
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January 21, 2016
Outcomes under Alternative Policies, Quarterly
2016
2017
Measure and policy
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Real GDP
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
2.1
2.1
2.1
2.1
2.1
2.1
1.7
1.6
1.6
1.7
1.8
1.6
1.9
1.7
1.7
1.9
2.0
1.7
2.4
2.2
2.1
2.5
2.6
2.2
2.4
2.1
2.0
2.4
2.6
2.0
2.3
2.1
2.0
2.3
2.5
1.9
2.1
2.0
1.9
2.1
2.4
1.7
2.0
1.9
1.8
2.0
2.3
1.6
Unemployment Rate²
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
4.9
4.9
4.9
4.9
4.9
4.9
4.8
4.9
4.9
4.8
4.8
4.9
4.8
4.9
4.9
4.8
4.7
4.9
4.7
4.9
4.9
4.7
4.6
4.8
4.7
4.9
4.9
4.7
4.6
4.9
4.7
4.8
4.9
4.7
4.6
4.9
4.6
4.8
4.9
4.6
4.5
4.9
4.6
4.8
4.9
4.6
4.4
4.9
Total PCE prices
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
0.7
0.7
0.7
0.7
0.7
0.7
0.3
0.3
0.3
0.3
0.3
0.3
0.3
0.4
0.3
0.4
0.4
0.3
0.7
0.7
0.7
0.7
0.8
0.7
1.4
1.4
1.4
1.4
1.5
1.3
1.7
1.7
1.6
1.7
1.8
1.6
1.7
1.7
1.7
1.7
1.9
1.6
1.7
1.8
1.7
1.7
1.9
1.6
Core PCE prices
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
1.4
1.4
1.4
1.4
1.4
1.4
1.3
1.3
1.3
1.3
1.3
1.2
1.3
1.3
1.2
1.3
1.3
1.2
1.3
1.3
1.3
1.3
1.4
1.2
1.4
1.4
1.4
1.4
1.6
1.3
1.5
1.5
1.5
1.5
1.7
1.4
1.5
1.6
1.5
1.5
1.7
1.4
1.6
1.6
1.6
1.6
1.8
1.5
Nominal federal funds rate²
Extended Tealbook baseline¹
Taylor (1993)
Taylor (1999)
Inertial Taylor (1999)
First-difference
Optimal control
0.5
2.3
2.2
0.5
0.4
0.6
0.8
2.2
2.2
0.7
0.7
1.1
1.1
2.3
2.3
1.0
1.0
1.5
1.4
2.4
2.5
1.3
1.4
2.0
1.6
2.6
2.7
1.6
1.6
2.3
1.9
2.8
2.9
1.8
1.8
2.7
2.1
2.9
3.1
2.1
2.1
3.0
2.4
3.1
3.3
2.3
2.3
3.3
1. In the Tealbook baseline, the federal funds rate follows the prescriptions of the inertial Taylor (1999) rule.
2. Percent, average for the quarter.
3. Starting with the January 2016 Tealbook, this table reports nominal federal funds rates on the same 360-day basis as the published federal funds rate instead of on a compounded 365-day basis.
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(Four-quarter percent change, except as noted)
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January 21, 2016
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Appendix
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, Rt 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 $$ (\pi_t $$ and $$ \pi_{t+3 \mid t}) $$, the output gap estimate for the
current period (gapt), and the forecast of the three-quarter-ahead annual change in the output gap
($$ \Delta^{4} g a p_{t+3 \mid t} $$).1 The value of policymakers' longer-run inflation objective, denoted $$ \pi^{L
, is 2 percent.
R} $$
Taylor (1993) rule $$ R_{t}=r^{L R}+\pi_{t}+0.5\left(\pi_{t}-\pi^{L R}\right)+0.5 gap_{t} $$ Taylor
(1999) rule $$ R_{t}=r^{L R}+\pi_{t}+0.5\left(\pi_{t}-\pi^{L R}\right)+gap_{t} $$ Inertial Taylor
(1999) rule $$ R_{t}=0.85 R_{t-1}+0.15\left(r^{L R}+\pi_{t}+0.5\left(\pi_{t}-\pi^{L R}\right)+g a p_{t}\right) $$ First-difference
rule $$ R_{t}=R_{t-1}+0.5\left(\pi_{t+3 \mid t}-\pi^{L R}\right)+0.5 \Delta^{4} g a p_{t+3 \mid t} $$
The first two of the selected rules were studied by Taylor (1993, 1999), while the inertial
version of the Taylor (1999) rule has been featured prominently in analysis by Board staff.2 The
intercepts of these rules are chosen so that they are consistent with a 2 percent longer-run
inflation objective and a longer-run real federal funds rate, denoted $$ \r^{L R} $$, of 1 1/4 percent, a value
used in the FRB/US model. The prescriptions of the first-difference rule do not depend on the
level of the output gap or the longer-run real interest rate; see Orphanides (2003).
Near-term prescriptions from the four policy rules are calculated using Tealbook
projections for inflation and the output gap. For the rules that include the lagged policy rate as a
right-hand-side variable—the inertial Taylor (1999) rule and the first-difference rule—the lines
labeled “Previous Tealbook outlook” report prescriptions derived from the previous Tealbook
projections for inflation and the output gap, while using the same lagged funds rate value as in the
prescriptions computed for the current Tealbook. When the Tealbook is published early in a
quarter, this lagged funds rate value is set equal to the actual value of the lagged funds rate in the
previous quarter, and prescriptions are shown for the current quarter. When the Tealbook is
published late in a quarter, the prescriptions are shown for the next quarter, and the lagged policy
rate, for each of these rules, including those that use the “Previous Tealbook outlook,” is set equal
1 Starting with this Tealbook, all nominal and real federal funds rates reported in the Monetary
Policy Strategies section are expressed on the same 360-day basis as the published federal funds rate.
Previously, most rates were expressed on a compounded 365-day basis. The change in methodology has
only a marginal effect on the reported values.
2 See, for example, Erceg and others (2012).
Authorized for Public Release
to the average value for the policy rate thus far in the quarter. For the subsequent quarter, these
rules use the lagged values from their simulated, unconstrained prescriptions.
REAL FEDERAL FUNDS RATE ESTIMATES
The bottom panel of the exhibit, “Policy Rules and the Staff Projection,” provides an
estimate of one notion of the equilibrium real federal funds rate, r*. This measure is an estimate
of the real federal funds rate that, if maintained over a 12-quarter period (beginning in the current
quarter), makes the output gap equal to zero in the final quarter of that period using the output
projection from FRB/US, the staff's large-scale econometric model of the U.S. economy. This
“Tealbook-consistent FRB/US r*” depends on broad array of economic factors, some of which
take the form of projected values of the model's exogenous variables. It 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.
The “current real federal funds rate” reported in the panel is constructed as the difference
between the midpoint of the prevailing target range for the federal funds rate and the trailing fourquarter change in the core PCE price index.
The “average projected real federal funds rate” reported in the panel is the average of the
real federal funds rate under the Tealbook baseline projection calculated over the same
12-quarter period as the Tealbook-consistent FRB/US r*. The average projected real federal
funds rate and r* need not be associated with the same macroeconomic outcomes even when their
values are identical. The reason is that, in the r* simulations, the real federal funds rate is held
constant over the entire 12-quarter period to close the output gap at the end of this timeframe
whereas, in the Tealbook baseline, the real federal funds rate can vary over time. Distinct paths
of real short-term rates can, in turn, generate different paths for inflation and economic activity.
FRB/US MODEL SIMULATIONS
The exhibits of “Monetary Policy Strategies” that report results from simulations of
alternative policies are derived from dynamic simulations of the FRB/US model. Each simulated
policy rule is assumed to be in force over the whole period covered by the simulation; this period
extends several decades beyond the time horizon shown in the exhibits. The simulations are
conducted under the assumption that market participants as well as price and wage setters have
perfect foresight, and are predicated on the staff's extended Tealbook projection, which includes
the macroeconomic effects of the Committee's large-scale asset purchase programs. When the
Tealbook is published early in a quarter, all of the simulations begin in that quarter. However,
when the Tealbook is published late in a quarter, all of the simulations begin in the subsequent
quarter.
Authorized for Public Release
COMPUTATION OF THE OPTIMAL CONTROL POLICY UNDER COMMITMENT
The optimal control simulations posit that policymakers minimize a discounted sum of
weighted squared deviations of four-quarter headline PCE inflation [math] from the Committee's
2 percent objective, of squared deviations of the unemployment rate from the staff's estimate of
the natural rate (this difference is also known as the unemployment rate gap, ugapt), and of
squared changes in the federal funds rate. The resulting loss function, shown below, embeds the
assumptions that policymakers discount the future using a quarterly discount factor [math]
and place equal weights on squared deviations of inflation, the unemployment gap, and federal
funds rate changes (that is, [math]).
[math]
The optimal control policy is the path for the federal funds rate that minimizes the above
loss function in the FRB/US model, subject to the effective lower bound constraint on nominal
interest rates, under the assumption of perfect foresight, and conditional on the staff's extended
Tealbook projection. Policy tools other than the federal funds rate are taken as given and
subsumed within the Tealbook baseline. The path chosen by policymakers today is assumed to
be credible, meaning that decision makers in the model see this path as being a binding
commitment on the future Committees; the optimal control policy takes as given the lagged value
of the federal funds rate but is otherwise unconstrained by policy decisions made prior to the
simulation period. The discounted losses are calculated over a period that ends sufficiently far
into the future that extending that period farther would not affect the policy prescriptions shown
in the exhibits.
References
Erceg, Christopher, Jon Faust, Michael Kiley, Jean-Philippe Laforte, David Lopez-Salido,
Stephen Meyer, Edward Nelson, David Reifschneider, and Robert Tetlow (2012). “An
Overview of Simple Policy Rules and Their Use in Policymaking in Normal Times and
Under Current Conditions.” Memo sent to the Committee on July 18, 2012.
Orphanides, Athanasios (2003). “Historical Monetary Policy Analysis and the Taylor Rule,”
Journal ofMonetary Economics, Vol. 50 (July), pp. 983-1022.
Taylor, John B. (1993). “Discretion versus Policy Rules in Practice,” Carnegie-Rochester
Conference Series on Public Policy, Vol. 39 (December), pp. 195-214.
Taylor, John B. (1999). “A Historical Analysis of Monetary Policy Rules,” in John B. Taylor,
ed., Monetary Policy Rules. University of Chicago Press, pp. 319-341.
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January 21, 2016
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January 21, 2016
Monetary Policy Alternatives
Data released during the intermeeting period show that the labor market continued
to improve, with total nonfarm payroll employment rising an average 284,000 per month
in the fourth quarter of 2015; by contrast, spending indicators suggest that GDP growth
slowed significantly last quarter. Part of the slowdown in economic growth appears to
reflect temporary factors, including a sizable decline in inventory investment and
unseasonably warm weather that reduced households’ consumption of energy services.
Both core and headline inflation continued to run below 2 percent, and longer-term
Since the start of the year, global financial market turbulence intensified in
reaction to economic and financial developments in China, resulting in a tightening of
financial conditions and a further decline in oil prices that added to downward pressure
on inflation. Reflecting these developments, the expected path for the federal funds rate
flattened over the intermeeting period. The Desk’s Survey of Primary Dealers and its
Survey of Market Participants currently point to two or three 25 basis point increases in
the federal funds rate this year, compared to three or four increases at the time of the
December meeting. Most respondents see a negligible probability that the Committee
will raise the target range for the federal funds rate in January and about a 35 percent
chance that the Committee will raise the target range for the federal funds rate in March.
Against this backdrop, the issues before the Committee as it considers its January
postmeeting statement include not only whether to make an adjustment in the target range
for the federal funds rate but also whether to change its assessment of the medium-term
economic outlook or the risks to that outlook. A change in the outlook or balance of risks
would likely be read as signaling a change in the likelihood of an adjustment to the target
range in March and possibly thereafter.
The draft statements presented below—labeled Alternative A, Alternative B, and
Alternative C—offer different assessments of the outlook for inflation, and of the risks
surrounding the economic outlook, along with corresponding policy choices. Regarding
those choices, alternatives A and B leave the current target range for the federal funds
rate unchanged. Alternative B is meant to indicate that the Committee will continue to
assess the implication of incoming information for the economic outlook and thus for
appropriate monetary policy, and that the Committee does not yet have a strong
Page 17 of 50
Alternatives
inflation compensation declined further.
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January 21, 2016
predisposition regarding its decision at the March meeting. By noting downside risks to
the outlook and the Committee’s expectation for inflation to remain below 2 percent for
longer than previously projected, Alternative A signals that a near-term increase in the
target range is unlikely. Alternative C raises the target range for the federal funds rate to
½ to ¾ percent, emphasizing the ongoing improvement in the labor market as well as the
lag with which policy actions affect future outcomes.1
With regard to the labor market, Alternatives B and C both characterize job gains
as strong and note that labor market conditions improved further. Alternative B refers to
“some additional decline in underutilization of labor resources,” while instead Alternative
C refers to “some additional increase in utilization of labor resources.” Both alternatives
Alternatives
note that economic growth slowed late last year, with Alternative C more explicitly
pointing to temporary factors as part of the explanation for this slowdown. Alternative A
puts more emphasis on the slowdown in economic growth than on the improvement in
labor markets and omits any reference to a change in the utilization of labor resources.
All three alternatives indicate the Committee’s expectation that, with gradual adjustments
in policy, economic activity will expand at a moderate pace and labor market indicators
will continue to strengthen.
All three of the draft statements acknowledge that inflation has continued to run
below the Committee’s objective, that measures of inflation compensation declined
further, and that survey-based measures of longer-term inflation expectations are little
changed, on balance, in recent months. With respect to the outlook for inflation, all three
alternatives state that inflation is expected to remain low in the near term in part due to
further declines in energy prices. Both Alternatives A and B say that inflation is expected
to rise to 2 percent over the medium term with Alternative A adding that inflation is
anticipated to remain below 2 percent longer than the Committee previously projected.
Alternatives B and C reaffirm December’s statement that the risks to the outlook
for economic activity and the labor market are balanced. Alternative B offers the
cautionary note that the Committee “is closely monitoring global economic and financial
developments and assessing their implications for the labor market and inflation.” In lieu
of this sentence, alternative C indicates only that the Committee is monitoring global
1
Alternatively, the Committee might view the language in the draft statement for Alternative C as
premature in present circumstances but might nonetheless discuss whether this language, especially
paragraphs 2, 3, and 4, would be appropriate when the time arrives to next raise the target range for the
federal funds rate again.
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January 21, 2016
economic and financial developments. In addition, with respect to inflation, Alternative
C takes a different approach by stating that “the Committee remains reasonably confident
that inflation will rise to 2 percent over the medium term,” and by retaining the sentence
from the December statement that says “the Committee continues to monitor inflation
developments closely.” Alternative A characterizes the risks to the outlook for the labor
market and inflation as “tilted to the downside” in light of global economic and financial
developments and also offers the option to characterize them as “tilted slightly to the
downside.”
The three alternatives retain the December statement’s language that “the
Committee expects that economic conditions will evolve in a manner that will warrant
remain below its longer-run level “for some time.” The three alternatives also retain the
December statement’s language that the Committee anticipates continuing to reinvest
until normalization of the level of the federal funds rate “is well under way.”
The next pages contain the December postmeeting statement, the three draft
statements, and summaries of the arguments for each alternative. These elements are
followed by the draft implementation note regarding the decisions taken by the Federal
Reserve to implement the monetary policy stance announced by the Committee that
would be issued if the Committee decides either to maintain the current setting of the
target range for the federal funds rate, as in Alternative A and Alternative B, or instead
decides to raise the target range for the federal funds rate, as in Alternative C. Regardless
of the Committee’s choice of policy alternative, and as in December, the implementation
note, which contains the Committee’s domestic policy directive to the Desk, will be
released with the Committee’s postmeeting statement.
Page 19 of 50
Alternatives
only gradual increases in the federal funds rate” and that the federal funds rate is likely to
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January 21, 2016
DECEMBER 2015 FOMC STATEMENT
Alternatives
1. Information received since the Federal Open Market Committee met in October
suggests that economic activity has been expanding at a moderate pace. Household
spending and business fixed investment have been increasing at solid rates in recent
months, and the housing sector has improved further; however, net exports have been
soft. A range of recent labor market indicators, including ongoing job gains and
declining unemployment, shows further improvement and confirms that
underutilization of labor resources has diminished appreciably since early this year.
Inflation has continued to run below the Committee’s 2 percent longer-run objective,
partly reflecting declines in energy prices and in prices of non-energy imports.
Market-based measures of inflation compensation remain low; some survey-based
measures of longer-term inflation expectations have edged down.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will continue to
expand at a moderate pace and labor market indicators will continue to strengthen.
Overall, taking into account domestic and international developments, the Committee
sees the risks to the outlook for both economic activity and the labor market as
balanced. Inflation is expected to rise to 2 percent over the medium term as the
transitory effects of declines in energy and import prices dissipate and the labor
market strengthens further. The Committee continues to monitor inflation
developments closely.
3. The Committee judges that there has been considerable improvement in labor market
conditions this year, and it is reasonably confident that inflation will rise, over the
medium term, to its 2 percent objective. Given the economic outlook, and
recognizing the time it takes for policy actions to affect future economic outcomes,
the Committee decided to raise the target range for the federal funds rate to ¼ to ½
percent. The stance of monetary policy remains accommodative after this increase,
thereby supporting further improvement in labor market conditions and a return to 2
percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to its objectives of maximum employment and 2 percent inflation.
This assessment will take into account a wide range of information, including
measures of labor market conditions, indicators of inflation pressures and inflation
expectations, and readings on financial and international developments. In light of
the current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
Page 20 of 50
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January 21, 2016
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
Alternatives
5. The Committee is maintaining its existing policy 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
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January 21, 2016
Alternatives
ALTERNATIVE A FOR JANUARY 2016 FOMC
1. Information received since the Federal Open Market Committee met in October
December suggests that the pace of expansion in economic activity has been
expanding at a moderate pace slowed late last year. Household spending and
business fixed investment have been increasing at solid moderate rates in recent
months, and the housing sector has improved further; however, net exports have been
soft and inventory investment slowed. A range of recent labor market indicators,
including ongoing job gains, and declining unemployment, shows further
improvement and confirms that underutilization of labor resources has diminished
appreciably since early this year. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting declines in energy
prices and in prices of non-energy imports. Market-based measures of inflation
compensation remain low declined further; some survey-based measures of longerterm inflation expectations have edged down are little changed, on balance, in
recent months.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will continue to
expand at a moderate pace and labor market indicators will continue to strengthen.
Overall, taking into account domestic and international developments, the Committee
sees the risks to the outlook for both economic activity and the labor market as
balanced. Inflation is expected to remain low in the near term, in part because of
the further declines in energy prices, but to rise to 2 percent over the medium term
as the transitory effects of declines in energy and import prices dissipate and the labor
market strengthens further. In light of recent global economic and financial
developments, the Committee sees the risks to the outlook for the labor market
and inflation as tilted [ slightly ] to the downside. The Committee continues to
monitor inflation developments closely.
3. The Committee judges that there has been considerable improvement in labor market
conditions this year, and it is reasonably confident that inflation will rise, over the
medium term, to its 2 percent objective. With inflation anticipated to remain
below 2 percent longer than previously projected, and in light of the risks to
Given the economic outlook, and recognizing the time it takes for policy actions to
affect future economic outcomes, the Committee decided to raise maintain the target
range for the federal funds rate to at ¼ to ½ percent. The stance of monetary policy
remains accommodative after this increase, thereby supporting to support further
improvement in labor market conditions and a return to 2 percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to its objectives of maximum employment and 2 percent inflation.
Page 22 of 50
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January 21, 2016
5. The Committee is maintaining its existing policy 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 23 of 50
Alternatives
This assessment will take into account a wide range of information, including
measures of labor market conditions, indicators of inflation pressures and inflation
expectations, and readings on financial and international developments. In light of the
current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
Authorized for Public Release
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January 21, 2016
Alternatives
ALTERNATIVE B FOR JANUARY 2016 FOMC
1. Information received since the Federal Open Market Committee met in October
December suggests that labor market conditions improved further even as
economic activity has been expanding at a moderate pace growth slowed late last
year. Household spending and business fixed investment have been increasing at
solid moderate rates in recent months, and the housing sector has improved further;
however, net exports have been soft and inventory investment slowed. A range of
recent labor market indicators, including ongoing strong job gains, and declining
unemployment, shows further improvement and confirms that points to some
additional decline in underutilization of labor resources has diminished appreciably
since early this year. Inflation has continued to run below the Committee’s 2 percent
longer-run objective, partly reflecting declines in energy prices and in prices of nonenergy imports. Market-based measures of inflation compensation remain low
declined further; some survey-based measures of longer-term inflation expectations
have edged down are little changed, on balance, in recent months.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will continue to
expand at a moderate pace and labor market indicators will continue to strengthen.
Overall, taking into account domestic and international developments, the Committee
sees the risks to the outlook for both economic activity and the labor market as
balanced. Inflation is expected to remain low in the near term, in part because of
the further declines in energy prices, but to rise to 2 percent over the medium term
as the transitory effects of declines in energy and import prices dissipate and the labor
market strengthens further. The Committee continues to monitor inflation
developments closely. While the Committee continues to see the risks to the
outlook for both economic activity and the labor market as balanced, it is closely
monitoring global economic and financial developments and assessing their
implications for the labor market and inflation.
3. The Committee judges that there has been considerable improvement in labor market
conditions this year, and it is reasonably confident that inflation will rise, over the
medium term, to its 2 percent objective. Given the economic outlook, and recognizing
the time it takes for policy actions to affect future economic outcomes, the Committee
decided to raise maintain the target range for the federal funds rate to at ¼ to ½
percent. The stance of monetary policy remains accommodative after this increase,
thereby supporting further improvement in labor market conditions and a return to 2
percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to its objectives of maximum employment and 2 percent inflation.
Page 24 of 50
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January 21, 2016
5. The Committee is maintaining its existing policy 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 25 of 50
Alternatives
This assessment will take into account a wide range of information, including
measures of labor market conditions, indicators of inflation pressures and inflation
expectations, and readings on financial and international developments. In light of
the current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Alternatives
ALTERNATIVE C FOR JANUARY 2016 FOMC
1. Information received since the Federal Open Market Committee met in October
December suggests that labor market conditions improved further. Although
economic activity has been expanding at a moderate pace growth slowed late last
year, partly reflecting temporary factors, household spending and business fixed
investment have been increasing at solid moderate rates in recent months, and the
housing sector has improved further; however, net exports have been soft. A range of
recent labor market indicators, including ongoing strong job gains, and declining
unemployment, shows further improvement and confirms that underutilization points
to some additional increase in utilization of labor resources has diminished
appreciably since early this year. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting declines in energy
prices and in prices of non-energy imports. Market-based measures of inflation
compensation remain low declined further; some survey-based measures of longerterm inflation expectations have edged down are little changed, on balance, in
recent months.
2. Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee currently expects that, with gradual
adjustments in the stance of monetary policy, economic activity will continue to
expand at a moderate pace and labor market indicators will continue to strengthen.
Overall, taking into account The Committee is monitoring global economic and
financial domestic and international developments; overall, the Committee sees the
risks to the outlook for both economic activity and the labor market as balanced.
Inflation is expected to remain low in the near term, in part because of the further
declines in energy prices; however, the Committee remains reasonably confident
that inflation will rise to 2 percent over the medium term as the transitory effects of
declines in energy and import prices dissipate and the labor market strengthens
further. The Committee continues to monitor inflation developments closely.
3. The Committee judges that there has been considerable improvement in labor market
conditions this year, and it is reasonably confident that inflation will rise, over the
medium term, to its 2 percent objective. Given the economic outlook and the
ongoing improvement in the labor market, and recognizing the time it takes for
policy actions to affect future economic outcomes, the Committee decided to raise the
target range for the federal funds rate to ¼ to ½ to ¾ percent. Even after this
increase in the target range, the stance of monetary policy remains accommodative
after this increase, thereby supporting further improvement in labor market conditions
and a return to 2 percent inflation.
4. In determining the timing and size of future adjustments to the target range for the
federal funds rate, the Committee will assess realized and expected economic
conditions relative to its objectives of maximum employment and 2 percent inflation.
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January 21, 2016
5. The Committee is maintaining its existing policy 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, and it anticipates doing so until normalization of the level of the federal
funds rate is well under way. This policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain accommodative
financial conditions.
Page 27 of 50
Alternatives
This assessment will take into account a wide range of information, including
measures of labor market conditions, indicators of inflation pressures and inflation
expectations, and readings on financial and international developments. In light of the
current shortfall of inflation from 2 percent, the Committee will carefully monitor
actual and expected progress toward its inflation goal. The Committee expects that
economic conditions will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to remain, for some time,
below levels that are expected to prevail in the longer run. However, the actual path
of the federal funds rate will depend on the economic outlook as informed by
incoming data.
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
THE CASE FOR ALTERNATIVE B
Policymakers may see the available information as suggesting that slow growth
will not persist, and that the modal outlook is still that economic activity will expand at a
moderate pace going forward, with the labor market continuing to strengthen. But the
contrast between recent labor market reports and spending indicators may have increased
policymakers’ uncertainty about the outlook for the real economy. If so, they may want
to assess the implications of the two labor market reports and the additional spending data
that will be released over the coming intermeeting period before judging whether the
medium-term outlook for the economy has changed enough to warrant a different path
for monetary policy than was conveyed by December’s postmeeting statement and
Alternatives
Summary of Economic Projections. Policymakers may also view the heightened global
financial turmoil and associated tightening in financial conditions as potentially posing
more substantial downside risks to their modal outlook, and they might want to see
whether these tighter financial conditions change further over the coming intermeeting
period. For these reasons, participants may deem it appropriate to adopt a stance of
watchful waiting and to abstain from signaling a likely next policy move. If so, they may
choose to issue a statement like Alternative B that maintains the current target range for
the federal funds rate, leaves the language about the likely future path of the federal funds
rate unchanged, and reaffirms the Committee’s medium-run outlook while
acknowledging concerns about global and financial developments.
Policymakers may continue to expect that inflation will rise to 2 percent over the
medium term, once energy and non-energy import prices stabilize and resource utilization
tightens further, provided that longer-term inflation expectations remain stable, even if
they judge that the additional declines in oil prices and the appreciation of the dollar will
push inflation lower in the near term and that headline inflation is likely to remain below
2 percent for longer than they previously anticipated. Nonetheless, policymakers may see
recent global and economic developments as potentially posing downside risks to their
medium-term inflation outlook. For this reason, too, they may favor the new language in
Alternative B, which indicates that the Committee is closely monitoring and assessing
implications of these developments for the labor market and inflation.
Some participants may judge that the recent tightening in financial conditions and
heightened risks from abroad make it unlikely that an increase in the target range will be
appropriate in March. Or they may view the low sensitivity of inflation to resource
utilization as requiring a period of unemployment well below its longer-run normal rate
Page 28 of 50
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Class I FOMC - Restricted Controlled (FR)
January 21, 2016
to ensure a return of inflation to the Committee’s longer-run goal over the medium run.
Nevertheless, they may think it is premature to signal a pause in tightening, because of
the strong ongoing job gains along with continued improvement in a broad range of labor
market indicators. Moreover, they may take some reassurance from the observation that
longer-term inflation expectations from the Michigan Surveys of Consumers edged up
recently, while the measure from the Survey of Primary Dealers remained stable. They
may also prefer to wait and monitor global economic and financial developments over the
coming intermeeting period.
Other policymakers may place little weight on the recent softness in GDP growth;
they may deem it likely that the economic expansion will prove resilient, bolstered by
utilization of labor resources that, together with stable longer-run inflation expectations,
should move inflation back to 2 percent over the medium term. If so, these policymakers
may lean toward an immediate further increase in the target range for the federal funds
rate. But with both headline and core inflation continuing to run below the Committee’s
2 percent longer-run objective, with recent dollar appreciation and declines in crude oil
prices implying that inflation will remain low in the near term, and with global economic
and financial developments potentially posing larger downside risks to the economic
outlook, these policymakers may prefer to keep their options open, and to monitor
economic data a little longer before deciding when and whether to adjust the target range
for the federal funds rate. Moreover, they may judge the language in Alternative B that
points to “gradual” increases in the federal funds rate as properly tempered by the
statement that the funds rate path “will depend on the economic outlook as informed by
incoming data.” If so, these policymakers may see Alternative B as providing the
flexibility for the expected funds rate path to steepen, if the data indicate stronger
momentum in the economy.
A statement along the lines of that in Alternative B would likely be in line with
the expectations of financial market participants. According to the Desk’s latest survey,
respondents perceive there to be almost no chance that the Committee will change the
current target range at this meeting, and most respondents expect little change in the
language concerning the likely future path of the federal funds rate or reinvestment
policy. Some survey participants responded that the statement may indicate that
downside risks to the outlook have increased, and thus they may not be too surprised by
the new language in Alternative B indicating that the Committee is closely monitoring
recent global economic and financial developments and assessing their implications for
Page 29 of 50
Alternatives
solid consumption growth. This expansion will help drive continued improvement in the
Authorized for Public Release
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January 21, 2016
the labor market and inflation. Accordingly, if the Committee issued a statement like that
in Alternative B, the response of longer-term interest rates, equity prices, and the foreign
exchange value of the dollar might be muted, although the heightened volatility in
financial markets observed in recent weeks suggests one should not have great
confidence in this assessment.
THE CASE FOR ALTERNATIVE A
Both core and headline inflation have run below 2 percent for several years, and
renewed declines in oil and other commodity prices, along with further downward
pressure on non-commodity import prices stemming from the additional appreciation of
Alternatives
the dollar, suggest that headline inflation will linger at very low levels well into 2016.
Some policymakers may see substantial risk that longer-term inflation expectations will
slide lower and that actual inflation will not rise to 2 percent over the medium term.
They might note that the staff and FOMC participants have consistently overpredicted
inflation in recent years. Policymakers may judge that it is more likely that real GDP
growth will fall short of potential growth this year in light of the disappointing spending
data for the fourth quarter, the appreciation of the dollar, and a weaker foreign outlook.
Accordingly, they may judge that the neutral rate of interest has declined. Moreover,
they may view the likelihood that turmoil in China exerts a substantial drag on U.S.
economic activity as having risen sharply over the intermeeting period.
These policymakers might also note that the Michigan Survey measure of longerterm inflation expectations remains near the lower end of its range in recent years, and
that market-based measures of inflation compensation have been at low levels for so long
that it is hard to believe that these declines are entirely due to liquidity and risk
premiums. They might point to the global disinflationary pressures that seem prevalent at
the moment as well as wage gains that remain subdued, and view the relationship
between inflation and aggregate demand as too weak to generate much upward pressure
on inflation without a substantial period of very high resource utilization. These
observations may lead some participants to conclude that there is little reason to be
confident that inflation will return to 2 percent if the Committee raises interest rates in the
near future. Moreover, these policymakers might argue that the chronic failure to get
inflation moving up has put at risk the credibility of the FOMC’s commitment to
achieving 2 percent inflation. They might therefore prefer Alternative A, which
maintains the current target range for the federal funds rate, signals that an increase in
Page 30 of 50
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
this range is unlikely at the March FOMC meeting and possibly for some time thereafter,
and indicates that the risks to the labor market and inflation are tilted to the downside.
Participants might favor including language that indicates that the risks are tilted
to the downside in light of recent global financial market turmoil and deteriorating
confidence among market participants in the ability of Chinese authorities to ensure a
smooth transition to slower and more sustainable growth there. Accordingly, they may
see the alternative scenarios “China-Driven EME Crisis” or “Stronger Dollar and Low
Oil Prices” in the “Risks and Uncertainty” section of Tealbook A as increasingly likely.
If either scenario plays out, policymakers may judge that the Federal Reserve will need to
provide greater policy accommodation in order to offset the likely adverse effects on the
associated asymmetric risks to U.S. activity and inflation, they may prefer to signal a
delay in the removal of policy accommodation based on risk management considerations.
Although some respondents in the Desk’s latest survey expected the statement to
reflect greater downside risks to the economic outlook, a statement like that in
Alternative A would likely surprise many financial market participants. Investors might
push further into the future the expected date of the next rate increase and a flattening of
the expected path for the federal fund rate is also possible. Longer-term yields would
decline, inflation compensation and equity prices would rise, and the dollar would
depreciate. However, if investors read the statement as reflecting a downbeat assessment
of global economic conditions, equity prices and inflation compensation could possibly
fall.
THE CASE FOR ALTERNATIVE C
Policymakers may judge that the economy is at or near maximum sustainable
employment and that the breadth of improvement in the labor market in recent months
confirms that the economy is strong and likely to be resilient. Although spending
indicators suggest that GDP growth slowed in the fourth quarter, policymakers may
conclude that the slowdown largely reflects temporary factors related to inventories and
the effects of unseasonably warm weather on the consumption of energy services. More
broadly, they may judge that conditions remain favorable for solid consumption growth,
as household balance sheets have improved, gains in disposable income have been
healthy, gasoline prices are low, consumer confidence is high, and job prospects are
Page 31 of 50
Alternatives
domestic economy. Moreover, given the proximity of the effective lower bound and the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
good. Moreover, these strong fundamentals should help limit any negative spillover
effects from weaker activity abroad.
Although headline inflation is low, participants may point out that some measures
of the underlying trend in inflation, such as the 12-month trimmed mean PCE inflation
rate calculated by the Dallas Fed, are running not that far below 2 percent. They might
judge that downward pressures on inflation from the appreciation of the dollar and the
decline in non-oil import prices are restraining core as well as headline inflation, and that
this restraint is likely to fade in the near term. Participants may also be less concerned by
the recent declines in longer-term inflation compensation because they judge that these
declines reflect movements in liquidity and risk premiums unrelated to inflation
Alternatives
expectations. Moreover, they may attribute the softening over 2015 in the median
Michigan Survey respondent’s expectation of average inflation over the coming five or
ten years to the transitory effects of the declines in energy prices rather than a reduction
in expected inflation over the longer run. Participants may also expect headline inflation
to move back to the Committee’s 2 percent objective over the medium term as energy
prices bottom out.
For these reasons, policymakers may judge that it is appropriate to announce a
25 basis point increase in the target range for the federal funds rate to ½ to ¾ percent, as
in Alternative C. Policymakers may note that, even with this increase, the real federal
funds rate would still lie well below the Tealbook-consistent estimate of the equilibrium
real federal funds rate reported in the “Monetary Policy Strategies” section of Tealbook
B. A rate increase would also be consistent with the level of the federal funds rate
prescribed by the optimal control policy reported there.
These policymakers might further argue that leaving rates unchanged in the face
of rapid job growth and when the unemployment rate is already at a level consistent with
maximum employment would likely foster expectations of a prolonged, unconditionally
shallow path for the federal funds rate, creating incipient excess demand. Leaving the
stance of monetary policy unchanged thus runs the risk that inflation will persistently
overshoot 2 percent, eliciting an upward drift in inflation expectations, possibly along the
lines of the alternative scenario “Faster Growth with Higher Inflation” in the “Risks and
Uncertainty” section of Tealbook A. In addition, such an expected path could induce
further “reaching for yield,” and excessive risk-taking behavior in financial markets.
Some policymakers might also be concerned that a statement like Alternative B risks
Page 32 of 50
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January 21, 2016
sending the signal that the Committee is reacting to financial volatility rather than to its
medium-term outlook for the labor market and inflation.
According to the Desk’s latest survey, the perceived probability of a tightening at
this meeting is negligible, and a decision to increase the target range at this meeting
would be very surprising. Accordingly, it is difficult to predict how markets might react.
If market participants infer that “gradualism” implies that the Committee intends to
tighten at each successive meeting this year and thus pursue a much less accommodative
stance of policy going forward than had been expected, then medium- and longer-term
real interest rates would rise, equity prices and inflation compensation would likely
decline, and the dollar would appreciate. However, if investors see a statement like
equity prices and inflation compensation might fall less than otherwise, or even rise.
Page 33 of 50
Alternatives
Alternative C as reflecting an upbeat assessment for global economic conditions, then
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Class I FOMC - Restricted Controlled (FR)
January 21, 2016
IMPLEMENTATION NOTE
Drafts of the implementation note that would be issued for the drafts of the
alternative statements follows. If the Committee decides to maintain the current target
range for the federal funds rate, as in Alternative A or Alternative B, an implementation
note that indicates no change in the Federal Reserve’s administered rates—the interest
rates on required and excess reserves, the ON RRP offered rate, and the discount rate—
would be issued. If the Committee instead decides to raise the target range for the federal
funds rate, as in Alternative C, an implementation note that communicates the changes
the Federal Reserve decided to make to these three policy tools would be issued.
Alternatives
Regardless of which policy alternative the Committee adopts, the implementation
note issued in January will contain two minor changes relative to the note that was issued
in December. First, the footnote stating that the new directive “supersedes the resolution
on overnight reverse repurchase agreement (ON RRP) test operations approved by the
Committee at its December 16–7, 2014 meeting” will be dropped because this
information was relevant only at the commencement of policy firming in December,
when the testing phase of ON RRP operations ceased. Second, the reference in the
directive to “the resolution on term RRP operations approved by the Committee at its
March 17–18, 2015, meeting” will be dropped because that resolution has expired.1 The
Committee may discuss its plans for conducting future term RRP operations at the
January meeting; text could be added to the directive in March regarding the conduct of
future term RRP operations, such as if the Committee decides to offer them at March
quarter-end.2
On the following pages, struck-out text indicates language deleted from the
December directive and implementation note; bold red underlined text indicates added
language; blue underlined text indicates text that links to websites. Accordingly, the
December directive and implementation note can be inferred from each of the drafts that
follow.
1
That resolution authorized the Desk to conduct term RRPs between December 17 and 30, 2015,
to mature no later than January 8, 2016.
2
If the Committee were to decide to reduce the aggregate capacity of the ON RRP facility at the
January meeting, the draft implementation notes that follow would need to be revised to convey that
decision. See the memo sent to the Committee on January 20, 2015 entitled "Reducing the Aggregate
Capacity of the ON RRP Facility" by Deborah Leonard, Josh Frost, Jane Ihrig, and Gretchen Weinbach.
Page 34 of 50
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Implementation Note for January 2016 Alternatives A and B
Release Date: December 16, 2015 January 27, 2016
Decisions Regarding Monetary Policy Implementation
The Board of Governors of the Federal Reserve System voted unanimously to
raise the interest rate paid on required and excess reserve balances to 0.50 percent,
effective December 17, 2015 left unchanged the interest rate paid on required
and excess reserve balances at 0.50 percent.
As part of its policy decision, the Federal Open Market Committee voted to
authorize and direct the Open Market Desk at the Federal Reserve Bank of New
York, until instructed otherwise, to execute transactions in the System Open
Market Account in accordance with the following domestic policy directive:1
"Effective December 17, 2015 January 28, 2016, the Federal Open Market
Committee directs the Desk to undertake open market operations as necessary to
maintain the federal funds rate in a target range of 1/4 to 1/2 percent, including:
(1) overnight reverse repurchase operations (and reverse repurchase operations
with maturities of more than one day when necessary to accommodate weekend,
holiday, or similar trading conventions) at an offering rate of 0.25 percent, in
amounts limited only by the value of Treasury securities held outright in the
System Open Market Account that are available for such operations and by a percounterparty limit of $30 billion per day; and (2) term reverse repurchase
operations to the extent approved in the resolution on term RRP operations
approved by the Committee at its March 17–18, 2015, meeting.
The Committee directs the Desk to continue rolling over maturing Treasury
securities at auction and to continue reinvesting principal payments on all agency
debt and agency mortgage-backed securities in agency mortgage-backed
securities. The Committee also directs the Desk to engage in dollar roll and
coupon swap transactions as necessary to facilitate settlement of the Federal
Reserve's agency mortgage-backed securities transactions."
More information regarding open market operations may be found on the Federal
Reserve Bank of New York's website.
In a related action, the Board of Governors of the Federal Reserve System voted
unanimously to approve a 1/4 percentage point increase in the discount rate (the
primary credit rate) to 1.00 percent, effective December 17, 2015. In taking this
action, the Board approved requests submitted by the Boards of Directors of the
Federal Reserve Banks of Boston, Philadelphia, Cleveland, Richmond, Atlanta,
Chicago, St. Louis, Kansas City, Dallas, and San Francisco. The Board of
1
This directive supersedes the resolution on the overnight reverse repurchase agreement (ON
RRP) test operations approved by the Committee at its December 16–17, 2014 meeting.
Page 35 of 50
Alternatives
The Federal Reserve has made the following decisions to implement the monetary policy
stance announced by the Federal Open Market Committee in its statement on December
16, 2015 January 27, 2016:
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Governors of the Federal Reserve System took no action to change the
discount rate (the primary credit rate), which remains at 1.00 percent.
Alternatives
This information will be updated as appropriate to reflect decisions of the Federal Open
Market Committee or the Board of Governors regarding details of the Federal Reserve's
operational tools and approach used to implement monetary policy.
Page 36 of 50
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Implementation Note for January 2016 Alternative C
Release Date: December 16, 2015 January 27, 2016
Decisions Regarding Monetary Policy Implementation
The Board of Governors of the Federal Reserve System voted [ unanimously ] to
raise the interest rate paid on required and excess reserve balances to 0.50 0.75
percent, effective December 17, 2015 January 28, 2016.
As part of its policy decision, the Federal Open Market Committee voted to
authorize and direct the Open Market Desk at the Federal Reserve Bank of New
York, until instructed otherwise, to execute transactions in the System Open
Market Account in accordance with the following domestic policy directive: 1
"Effective December 17, 2015 January 28, 2016, the Federal Open Market
Committee directs the Desk to undertake open market operations as necessary to
maintain the federal funds rate in a target range of 1/4 to 1/2 to 3/4 percent,
including: (1) overnight reverse repurchase operations (and reverse repurchase
operations with maturities of more than one day when necessary to accommodate
weekend, holiday, or similar trading conventions) at an offering rate of 0.25 0.50
percent, in amounts limited only by the value of Treasury securities held outright
in the System Open Market Account that are available for such operations and by
a per-counterparty limit of $30 billion per day; and (2) term reverse repurchase
operations to the extent approved in the resolution on term RRP operations
approved by the Committee at its March 17–18, 2015, meeting.
The Committee directs the Desk to continue rolling over maturing Treasury
securities at auction and to continue reinvesting principal payments on all agency
debt and agency mortgage-backed securities in agency mortgage-backed
securities. The Committee also directs the Desk to engage in dollar roll and
coupon swap transactions as necessary to facilitate settlement of the Federal
Reserve's agency mortgage-backed securities transactions."
More information regarding open market operations may be found on the Federal
Reserve Bank of New York's website.
In a related action, the Board of Governors of the Federal Reserve System voted [
unanimously ] to approve a 1/4 percentage point increase in the discount rate (the
primary credit rate) to 1.00 1.25 percent, effective December 17, 2015 January
28, 2016. In taking this action, the Board approved requests submitted by the
Boards of Directors of the Federal Reserve Banks of Boston, Philadelphia,
1
This directive supersedes the resolution on the overnight reverse repurchase agreement (ON
RRP) test operations approved by the Committee at its December 16–17, 2014 meeting.
Page 37 of 50
Alternatives
The Federal Reserve has made the following decisions to implement the monetary policy
stance announced by the Federal Open Market Committee in its statement on December
16, 2015 January 27, 2016:
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Cleveland, Richmond, Atlanta, Chicago, St. Louis, Kansas City, Dallas, and San
Francisco ….
Alternatives
This information will be updated as appropriate to reflect decisions of the Federal Open
Market Committee or the Board of Governors regarding details of the Federal Reserve's
operational tools and approach used to implement monetary policy.
Page 38 of 50
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Projections
BALANCE SHEET AND INCOME
The staff has developed a projection of the Federal Reserve’s balance sheet and
income statement that is consistent with the monetary policy assumptions incorporated in
the staff’s forecast presented in Tealbook A. We assume that reinvestments of maturing
Treasury securities and agency debt as well as principal received on agency MBS will
cease at the end of 2016, about two quarters later than posited in the December Tealbook,
and when the federal funds rate is projected to reach about 1½ percent in the staff
forecast. Once reinvestments cease, the SOMA portfolio shrinks through redemptions of
maturing Treasury and agency debt securities as well as paydowns of principal from
agency MBS. Regarding the Federal Reserve’s use of its policy normalization tools, we
assume that the level of overnight reverse repurchase agreements (ON RRPs) runs at
$100 billion through the end of 2018 and then declines, reaching zero by the end of 2019,
and that term deposits and term RRPs are not used during the normalization period.1,2
The bullets below highlight some key features of the projections for the Federal
Reserve’s balance sheet and income statement under these assumptions.
Balance sheet. As shown in the exhibit “Total Assets and Selected Balance Sheet
fourth quarter of 2021, about a quarter later than projected in the December
Tealbook, reflecting the later cessation of reinvestment assumed in this
projection.3 Once reserve balances reach their steady-state level, total assets stand
1
Use of term RRPs or term deposits would result in a shift in the composition of Federal Reserve
liabilities—a decline in reserve balances and an equal increase in term RRPs or term deposits—but would
not produce a change in the overall size of the balance sheet.
2
We also assume that RRPs associated with foreign official and international accounts remain
around their December 31, 2015 level of $238 billion throughout the projection period.
3
The size of the balance sheet is assumed to be normalized when the securities portfolio reverts to
the level consistent with its longer-run trend, which is determined largely by currency in circulation and a
projected steady-state level of reserve balances. The projected timing of the normalization of the size of the
balance sheet depends importantly on the level of reserve balances deemed necessary to conduct monetary
policy; currently, we assume that level of reserve balances to be $100 billion. However, ongoing regulatory
and structural changes could lead to a higher demand for reserve balances in the new steady state. In turn,
a higher steady-state level for reserve balances would, all else equal, imply an earlier normalization of the
size of the balance sheet. For instance, with a $500 billion steady-state level of reserve balances, the
balance sheet would likely normalize at the end of 2020. Alternatively, a lower assumed steady-state level
Page 39 of 50
Projections
Items” and in the table that follows, the size of the portfolio is normalized in the
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Total Assets and Selected Balance Sheet Items
January Tealbook
Total Assets
December Tealbook
Reserve Balances
Billions of dollars
Monthly
Billions of dollars
5500
Monthly
3500
5000
3000
4500
4000
2500
3500
2000
3000
2500
1500
2000
1000
1500
1000
500
500
0
SOMA Treasury Holdings
2024
2022
2020
2018
2016
2014
SOMA Agency MBS Holdings
Billions of dollars
Monthly
3000
Billions of dollars
Monthly
2400
2200
2000
2500
1800
1600
2000
1400
1200
1500
1000
800
1000
600
400
500
200
0
Page 40 of 50
2024
2022
2020
2018
2016
2014
2012
2010
2024
2022
2020
2018
2016
2014
2012
0
2010
Projections
2012
2010
2024
2022
2020
2018
2016
2014
2012
2010
0
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Federal Reserve Balance Sheet
End-of-Year Projections -- January Tealbook
(Billions of dollars)
Dec 31, 2015
Total assets
4,485
2017
2019
2021
2023
2025
4,094 2,989 2,378 2,536 2,712
Selected assets
Loans and other credit extensions*
Securities held outright
U.S. Treasury securities
3
0
0
0
0
4,242
3,897 2,823 2,234 2,404 2,588
2,462
2,270 1,486 1,131 1,469 1,789
Agency debt securities
Agency mortgage-backed securities
0
33
1,747
4
2
2
2
2
1,623 1,335 1,100
932
797
Unamortized premiums
189
154
120
96
83
74
Unamortized discounts
-17
-13
-10
-8
-7
-6
47
49
49
49
49
49
Total other assets
Total liabilities
4,445
4,052 2,943 2,328 2,482 2,653
1,380
1,551 1,701 1,831 1,985 2,156
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits with Federal Reserve Banks
Reserve balances held by depository institutions
U.S. Treasury, General Account
712
238
238
238
238
2,347
2,159 1,000
255
255
255
1,977
2,004
845
100
100
100
333
150
150
150
150
150
36
5
5
5
5
5
39
42
45
49
54
59
Other deposits
Total capital**
338
Source: Federal Reserve H.4.1 statistical releases and staff calculations.
Note: Components may not sum to totals due to rounding.
*Loans and other credit extensions includes primary, secondary, and seasonal credit; central bank liquidity swaps; and net portfolio holdings of Maiden Lane LLC.
**Total capital includes capital paid-in and capital surplus accounts.
Page 41 of 50
Projections
Selected liabilities
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Income Projections
January Tealbook
Interest Income
Interest Expense
60
60
40
40
20
20
0
0
Billions of dollars
140
Annual
140
120
40
20
20
0
0
−20
−20
Memo: Unrealized Gains/Losses
Billions of dollars
Page 42 of 50
2024
2022
2020
2018
End of year
2016
120
110
100
90
80
70
60
50
40
30
20
10
0
2024
2022
2020
2018
2016
End of year
2012
Billions of dollars
2014
Deferred Asset
2024
40
2022
60
2020
60
2018
80
2016
80
2014
100
2012
100
2024
2022
2020
2018
2016
120
2014
2024
80
2022
80
2020
100
2018
100
2016
120
2012
Annual
2014
140
Earnings Remittances to Treasury
Billions of dollars
2012
Annual
120
Realized Capital Gains
2012
Billions of dollars
140
2024
2022
2020
2018
2016
2014
2012
Annual
2014
Billions of dollars
Projections
December Tealbook
400
300
200
100
0
−100
−200
−300
−400
−500
−600
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
at $2.4 trillion, with about $2.2 trillion in total SOMA securities holdings. Total
assets and SOMA holdings increase thereafter, keeping pace with the growth in
both Federal Reserve notes in circulation and Federal Reserve Bank capital.4
Federal Reserve earnings remittances. The exhibit “Income Projections” shows
the implications of the balance sheet projection and interest rate assumptions for
Federal Reserve income.5 After record remittances in 2015, including estimated
payments of $98 billion in net income and $19 billion in a transfer of surplus,
remittances to the Treasury are projected to be about $80 billion this year.6
Subsequently, annual remittances diminish to a trough of roughly $33 billion in
2019, with no recorded deferred asset.7 The Federal Reserve’s cumulative
remittances from 2009 through 2025 are about $1.1 trillion.
Unrealized gains or losses. The staff estimates that the portfolio was in an
unrealized gain position of about $106 billion as of the end of December.8 The
unrealized gain or loss position of the SOMA portfolio going forward will depend
importantly on the path of interest rates. Because of the assumed rise in longerterm interest rates over the next several years, the position is projected to shift to
an unrealized loss within the next 6 months, and then to record a peak unrealized
of reserve balances, such as $10 billion, would induce a delay in the projected normalization of the balance
sheet until the first quarter of 2022.
4
We now assume that capital paid-in will grow at an annual rate of 5½ percent, whereas in the
December Tealbook our assumption was for a 12½ percent growth rate. Our revised assumption is more in
line with the average pace of increase in recent years.
5
We assume that the interest rate paid on excess reserve balances will average about 15 basis
points above the effective federal funds rate and the ON RRP rate will average about 10 basis points below
the effective federal funds rate.
6
The Fixing America’s Surface Transportation Act signed on December 4, 2015, permanently
reduces the Federal Reserve’s capital surplus account from its previous level of $29 billion to a maximum
of $10 billion. In addition, it adjusts the dividends paid by the Federal Reserve to large member depository
institutions on their capital paid-in from a 6 percent rate to the smaller of 6 percent and the rate on the most
recently auctioned 10-year Treasury security. For reference, large depository institutions are defined as
those with total assets above $10 billion, and account for about $27 billion of the overall $29 billion of total
capital paid-in.
7
In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to cover
its operating costs and pay dividends, a deferred asset for interest on Federal Reserve notes would be
recorded.
8
The Federal Reserve reports the level and the change in the quarter-end net unrealized gain/loss
position of the SOMA portfolio to the public in the “Federal Reserve Banks Combined Quarterly Financial
Reports,” available on the Board’s website at
http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm#quarterly.
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Projections
loss of about $254 billion in mid-2019, about $10 billion larger than the peak in
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Projections for the 10-Year Treasury Term Premium Effect
(Basis Points)
Date
January
Tealbook
December
Tealbook
Quarterly Averages
-111
-106
-102
-97
-105
-100
-95
-91
2017:Q4
2018:Q4
2019:Q4
2020:Q4
2021:Q4
2022:Q4
2023:Q4
2024:Q4
2025:Q4
-81
-67
-56
-47
-39
-33
-27
-21
-15
-75
-62
-52
-43
-37
-31
-25
-20
-14
Projections
2016:Q1
Q2
Q3
Q4
Page 44 of 50
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
the December Tealbook. At that time, almost $105 billion of the unrealized
losses will be attributable to the portfolio of Treasury securities and $149 billion
to the portfolio of agency MBS. The unrealized loss position then narrows
through 2025, as the value of securities acquired under the large-scale asset
purchase programs returns to par when these securities approach maturity and
then mature, and new securities are added to the portfolio at prevailing market
yields.
Term premium effects. As shown in the table “Projections for the 10-Year
Treasury Term Premium Effect,” the Federal Reserve’s elevated stock of longerterm securities is estimated to hold down the term premium embedded in the
10-year Treasury yield by 111 basis points in the current quarter. Over the next
couple of years, the estimated term premium effect diminishes at a pace of about
4 basis points per quarter, reflecting in part the projected shrinking of the
portfolio. The path for the term premium effects in this projection is slightly
more negative than in the December Tealbook. The shift reflects our assumption
that reinvestment will end two quarters later, which implies that SOMA securities
holdings will remain elevated for a bit longer.
SOMA Characteristics. The exhibit “Projections for the Characteristics of
SOMA Holdings” shows that under the staff baseline balance sheet assumptions,
2016 and 2020, with the amounts maturing varying considerably from month to
month. While projected MBS paydowns are considerably smoother than Treasury
maturities, realized MBS paydowns will reflect the evolution of interest rates and
other factors over time and thus could be significantly more volatile than the
projected MBS paydowns.9 In 2016, the $216 billion of maturing Treasury
securities in the SOMA portfolio are assumed to be reinvested in notes and
bonds.10 By the end of 2016, the weighted-average duration of SOMA Treasury
9
The Board’s balance sheet and income projections now use a staff MBS prepayment model
instead of the BlackRock prepayment model used in the December and earlier Tealbooks. For reference,
the staff MBS prepayment model was already used in the context of the “Confidence Interval Projections of
the Balance Sheet” boxes in the September and December Tealbooks. With this model, the stock of agency
MBS is now projected to be higher, as prepayments towards the end of the forecast period are expected to
be slower than previously predicted.
10
The Desk replaces maturing securities holdings with newly issued debt at Treasury
auctions. Consistent with longstanding practice, these rollovers are carried out at Treasury auctions by
Page 45 of 50
Projections
approximately $1.4 trillion in SOMA Treasury holdings will mature between
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
Projections for the Characteristics of SOMA Holdings
Projected Receipts of Principal on SOMA Securities
Billions of Dollars
Projected MBS paydowns
Treasury maturities
80
60
40
20
0
2016
2017
2018
2019
2020
SOMA Weighted−Average Treasury Duration
Monthly
Years
Reinvestment Ends
Projections
Dec. TB
Jan. TB
10
Normalization Achieved
Dec. TB
Jan. TB
9
8
7
6
5
4
3
2
2008
2010
2012
2014
2016
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2018
2020
2022
2024
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
holdings decreases by about four months from its current level of 6½ years.11
Thereafter, reflecting the end of reinvestment as well as the aging of the portfolio,
the weighted-average duration declines through 2017, and then it rebounds until
2021, when the size of the balance sheet is normalized. Afterwards, the duration
of the SOMA portfolio of Treasury securities is projected to resume its decline as
the Desk starts purchasing securities to keep pace with currency growth. This
projection is based on the key assumption that the Federal Reserve will buy only
bills until those holdings are equal to approximately 30 percent of the Treasury
portfolio, similar to the pre-crisis composition of the portfolio (currently there are
no Treasury bill holdings). Thereafter, purchases are assumed to be spread across
Projections
the Treasury maturity spectrum.
placing bids for the SOMA in a par amount equal to the value of holdings maturing on the issue date of a
newly issued security. Moreover, across the various maturities, these bids are placed proportionately to the
issue amounts of the new securities. The Desk’s bids at Treasury auctions are placed as noncompetitive
tenders and are treated as add-ons to announced auction sizes.
11
The July 2015 Tealbook B box “History and Projections for the Characteristics of SOMA
Treasury Holdings” provides more information on the duration of the SOMA Treasury portfolio.
Page 47 of 50
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Projections
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January 21, 2016
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Abbreviations
ABS
asset-backed securities
BEA
Bureau of Economic Analysis, Department of Commerce
BHC
bank holding company
CDS
credit default swaps
CFTC
Commodity Futures Trading Commission
C&I
commercial and industrial
CLO
collateralized loan obligation
CMBS
commercial mortgage-backed securities
CPI
consumer price index
CRE
commercial real estate
Desk
Open Market Desk
DSGE
dynamic stochastic general equilibrium
ECB
European Central Bank
EDO
Estimated, dynamic, optimization-based model
EME
emerging market economy
FDIC
Federal Deposit Insurance Corporation
FOMC
Federal Open Market Committee; also, the Committee
GCF
general collateral finance
GDI
gross domestic income
GDP
gross domestic product
GSIBs
globally systemically important banking organizations
HQLA
high-quality liquid assets
ISM
Institute for Supply Management
LIBOR
London interbank offered rate
MBS
mortgage-backed securities
MMFs
money market funds
NBER
National Bureau of Economic Research
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January 21, 2016
Authorized for Public Release
Class I FOMC - Restricted Controlled (FR)
January 21, 2016
NIPA
national income and product accounts
OIS
overnight index swap
ON RRP
overnight reverse repurchase agreement
PCE
personal consumption expenditures
repo
repurchase agreement
RMBS
residential mortgage-backed securities
RRP
reverse repurchase agreement
SCOOS
Senior Credit Officer Opinion Survey on Dealer Financing Terms
SEP
Summary of Economic Projections
SFA
Supplemental Financing Account
SLOOS
Senior Loan Officer Opinion Survey on Bank Lending Practices
SOMA
System Open Market Account
TBA
to be announced (for example, TBA market)
TGA
U.S. Treasury’s General Account
TIPS
Treasury inflation-protected securities
TPE
Term premium effects
Page 50 of 50
@FedFRASER