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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 01/08/2021. Authorized for Public Release Class I FOMC – Restricted Controlled (FR) Report to the FOMC on Economic Conditions and Monetary Policy Book B Monetary Policy: Strategies and Alternatives March 12, 2015 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.) Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 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, and they incorporate the staff’s lower estimate of the longer-run equilibrium real federal funds rate.2 (Medium-term prescriptions derived from dynamic simulations of the rules are discussed below.) As in January, all of the simple rules prescribe an increase in the federal funds rate by the third quarter. The Taylor (1993) and the Taylor (1999) rules call for sizable increases in the federal funds rate to values of 1½ percent or higher over the near term. The inertial Taylor (1999) rule and the first-difference rule prescribe less-sizable interest-rate increases—to near ½ percent and just over ¼ percent in the third quarter of 2015, respectively—because both rules place a considerable weight on keeping the federal funds rate close to its lagged value. In general, the current prescriptions from the simple rules using the current staff forecast imply slightly lower policy rates than those using the previous Tealbook forecast. This difference reflects the downward revisions in the staff’s projection for the output gap and core PCE inflation. As explained in Tealbook, Book A, and as shown in the lower panel of the exhibit, the staff now projects that the trajectory of the output gap will run, on average, about ½ percentage point lower than in the previous Tealbook through 2017, with the output gap closing in the third quarter of 2016, two quarters later than in the January Tealbook. The staff’s projection for core PCE inflation is a bit lower in 2015 but mostly unchanged thereafter. The top panel of the first exhibit also reports the Tealbook-consistent estimate of the equilibrium real federal funds rate, r*, generated using the FRB/US model. This measure is an estimate of the real federal funds rate that would, if maintained, return output to potential in 12 quarters. Reflecting the staff’s updated assessment of slack in the economy, the current estimate of r*, at 0.82 percent, 1 The appendix to this section provides details on each of the four rules. As detailed in the box, “Changes to Interest Rates in the Longer Run,” in Tealbook, Book A, the staff has revised its estimate of the longer-run value of the real federal funds rate down from 1¾ to 1½ percent. To facilitate comparisons, new values of the intercepts of rules, where applicable, have been used to construct both the “Current Tealbook” and “Previous Tealbook outlook” numbers tabulated in the exhibit. 2 Page 1 of 48 Strategies Monetary Policy Strategies Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Strategies Policy Rules and the Staff Projection Near-Term Prescriptions of Selected Policy Rules 2015Q2 2015Q3 Taylor (1993) rule Previous Tealbook 1.85 2.02 1.95 2.20 Taylor (1999) rule Previous Tealbook 1.49 1.69 1.67 2.00 Inertial Taylor (1999) rule Previous Tealbook outlook 0.33 0.36 0.53 0.61 First-difference rule Previous Tealbook outlook 0.22 0.38 0.29 0.66 Memo: Equilibrium and Actual Real Federal Funds Rates Tealbook-consistent FRB/US r* estimate Actual real federal funds rate Current Tealbook Previous Tealbook -0.82 -1.27 -0.56 -1.28 Note: The lines denoted "Previous Tealbook outlook" report rule prescriptions based on the previous Tealbook’s staff outlook using the current rule specifications, which have intercept terms that have been adjusted, where applicable, to reflect the staff’s downward revision to the longer-run real federal funds rate. Rules that have the lagged policy rate as a right-hand-side variable jump off from the average value of the policy rate thus far in the current quarter. Key Elements of the Staff Projection GDP Gap PCE Prices Excluding Food and Energy Percent Current Tealbook Previous Tealbook 2 3.0 2.5 2.0 2.0 1.5 1.5 1.0 1.0 -3 0.5 0.5 -4 0.0 0 0 -1 -1 -2 -2 -3 2015 2016 2017 3.0 2.5 1 2014 Percent 2 1 -4 Four-quarter average 2018 2019 2020 Page 2 of 48 2014 2015 2016 2017 2018 2019 2020 0.0 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 is 26 basis points lower than the corresponding value derived from the staff’s outlook in points below the current estimate of r*. The second exhibit, “Policy Rule Simulations,” reports dynamic simulations of the FRB/US model under each of the policy rules. 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, under the assumption that the federal funds rate is subject to an effective lower bound of 12½ basis points. 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 the private sector fully understands the policy that will be pursued as well as its implications for real activity and inflation. The exhibit also displays the implications of following the baseline monetary policy assumptions adopted in the current staff forecast.3 As in January, the staff has assumed in its current forecast that the first increase in the federal funds rate will occur at the June FOMC meeting. After departing from its effective lower bound, the federal funds rate is assumed to rise at a pace prescribed by the inertial Taylor (1999) rule. The prescribed path for the federal funds rate initially increases a little more than ¼ percentage point per quarter and reaches 3 percent in the first half of 2018; the pace of tightening subsequently slows, and the federal funds rate begins to level off near its longer-run value of 3½ percent. All of the policy rules in these dynamic simulations call for tightening to begin immediately.4 The Taylor (1993) and the Taylor (1999) rules produce paths for the real federal funds rate that lie significantly above the Tealbook baseline over the next few years, leading to somewhat higher unemployment rates but similar trajectories for inflation. Under the inertial Taylor (1999) rule, the real federal funds rate initially rises 3 The dynamic simulations discussed here and below incorporate the assumptions about underlying economic conditions used in the staff’s baseline forecast, including the macroeconomic effects of the Committee’s asset holdings from the large-scale asset purchase programs, and the staff’s downward revision to the longer-run real federal funds rate. 4 Unlike the Tealbook baseline, the simulations employing the four policy rules make no attempt to account for the Committee’s forward guidance regarding the start of policy firming. However, as shown in the December Tealbook, policy rule simulations that take account of this guidance by imposing an unemployment rate threshold only delay the departure from the effective lower bound by at most one quarter, with negligible implications for unemployment and inflation. Page 3 of 48 Strategies January. The actual real federal funds rate, at about -1¼ percent, is almost 50 basis Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Strategies Policy Rule Simulations Effective Nominal Federal Funds Rate Unemployment Rate Percent 6 Taylor (1993) rule Taylor (1999) rule Inertial Taylor (1999) rule First-difference rule Tealbook baseline 5 6 7.0 Staff’s estimate of the natural rate 5 6.5 6.5 6.0 6.0 5.5 5.5 2020 5.0 5.0 Percent 4.5 4.5 4 4 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 Real Federal Funds Rate 3 3 2 2 1 1 0 0 -1 -1 -2 Percent 7.0 2014 2015 2016 2017 2018 2019 2020 4.0 2014 2015 2016 2017 2018 2019 2020 4.0 PCE Inflation 3.0 Four-quarter average Percent 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -2 Real 10-year Treasury Yield Percent 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 2020 -0.5 2014 2015 2016 2017 2018 2019 2020 Note: The policy rule simulations in this exhibit are based on rules that respond to core inflation. This choice of rule specification was made in light of the tendency for current and near-term core inflation rates to outperform headline inflation rates as predictors of the medium-term behavior of headline inflation. Page 4 of 48 -0.5 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 above its baseline path because the federal funds rate departs from its effective lower the difference is too small to have a material effect on the real longer-term interest rates that influence economic activity in the FRB/US model, so macroeconomic outcomes are essentially the same in this case as those under the Tealbook baseline. The first-difference rule calls for a slightly higher real federal funds rate over the coming year than in the Tealbook baseline. However, because the first-difference rule responds to the expected change in the output gap rather than its level, declines in the output gap later in the decade—expected to occur after the initial overshooting of output relative to its potential level—generate a federal funds rate path that is below baseline after the middle of 2017. This lower path, combined with expectations of higher price and wage inflation in the future, leads to higher levels of resource utilization and more inflation in the short run. Overall, this rule generates outcomes late in the decade that are farther than the other policy rules from both the staff’s estimate of the natural rate of unemployment and the Committee’s 2 percent longer-run inflation objective. The third exhibit, “Optimal Control Policy under Commitment,” compares optimal control simulations for this Tealbook’s baseline forecast with those reported in January. 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 decisions that policymakers make today are assumed to constrain future policy choices.5 Compared with the January Tealbook, optimal control policy entails a lower path of the federal funds rate, reflecting the weaker aggregate demand embedded in the current forecast.6 Despite the more accommodative policy, the unemployment rate undershoots the staff’s estimate of the natural rate by less than in January, consistent with the staff’s assessment of a slightly higher trajectory for the unemployment rate. The optimal control 5 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. 6 As noted above, the current Tealbook baseline reflects the staff’s reduction in its estimate of the longer-run real federal funds rate, and this change also contributes to the lower optimal control path for the federal funds rate. Page 5 of 48 Strategies bound immediately, almost one quarter earlier than in the Tealbook baseline. However, Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Strategies Optimal Control Policy under Commitment Effective Nominal Federal Funds Rate Unemployment Rate Percent 6 Current Tealbook Previous Tealbook Tealbook baseline 5 6 7.0 Staff’s estimate of the natural rate 5 6.5 6.5 6.0 6.0 5.5 5.5 2020 5.0 5.0 Percent 4.5 4.5 4 4 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 Real Federal Funds Rate 3 3 2 2 1 1 0 0 -1 -1 -2 Percent 7.0 2014 2015 2016 2017 2018 2019 2020 4.0 2014 2015 2016 2017 2018 2019 2020 4.0 PCE Inflation 3.0 Four-quarter average Percent 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -2 Real 10-year Treasury Yield Percent 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 2020 -0.5 Page 6 of 48 2014 2015 2016 2017 2018 2019 2020 -0.5 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 path for headline inflation is nearly identical to the baseline path, with differences relative baseline projection associated with upward revisions to energy prices in the near term. Under the optimal control policy, the federal funds rate departs from the effective lower bound almost one quarter earlier than in the Tealbook baseline and then increases at about the same pace as in the baseline through 2017; on average, the federal funds rate path prescribed by optimal control is about ½ percentage point higher than the baseline path over the next few years. Compared with the Tealbook baseline, the tighter stance of the optimal control policy—evident from the somewhat higher path of real longer-term rates—generates less undershooting of unemployment below the staff’s estimate of the natural rate, while inflation converges to the Committee’s objective at about the same pace. OPTIMAL CONTROL WITH A NONLINEAR WAGE PHILLIPS CURVE The optimal control simulations discussed above assume that the response of inflation to labor market slack or tightness is modest in magnitude and linear in the degree of resource utilization. An Alternative View box in the January Tealbook, Book A, considered implications of a nonlinear wage Phillips curve for the staff’s inflation projection. The special exhibit, “Optimal Control with a Nonlinear Wage Phillips Curve,” examines the policy implications of a related specification in which wage inflation is more sensitive to the unemployment rate gap when the labor market is tight than when there is economic slack. As in the January box, a nonlinear wage Phillips curve could be motivated, for instance, by the presence of downward nominal wage rigidities, which could make wages and prices relatively unresponsive to slack during and after economic downturns. Once the labor market reaches full employment, the sensitivity of wages and prices to slack could surge back. Consistent with such an asymmetric response, FRB/US estimates of the immediate response of wage inflation to the unemployment rate gap are about twice as large using a 1985-2007 sample rather than the 1985-2012 sample currently in use. To capture such a nonlinearity, we replace the standard, linear wage Phillips curve in the FRB/US model with one in which the sensitivity of wage inflation to labor market slack is the same as in the FRB/US model when the unemployment rate is above the staff’s estimate of its natural rate but is four times as responsive when the unemployment rate is below the natural rate. While the calibration is meant to be illustrative, it is within Page 7 of 48 Strategies to the trajectory shown in the January Tealbook mostly reflecting revisions to the staff’s Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Strategies Optimal Control with a Nonlinear Wage Phillips Curve Effective Nominal Federal Funds Rate Unemployment Rate Percent 6 Linear wage Phillips curve Nonlinear wage Phillips curve Tealbook baseline 5 6 7.0 Staff’s estimate of the natural rate 5 6.5 6.5 6.0 6.0 5.5 5.5 2020 5.0 5.0 Percent 4.5 4.5 4 4 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 Real Federal Funds Rate 3 3 2 2 1 1 0 0 -1 -1 -2 Percent 7.0 2014 2015 2016 2017 2018 2019 2020 4.0 2014 2015 2016 2017 2018 2019 2020 4.0 PCE Inflation 3.0 Four-quarter average Percent 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -2 Real 10-year Treasury Yield Percent 3 3 2 2 1 1 0 0 2014 2015 2016 2017 2018 2019 2020 -0.5 2014 2015 2016 2017 2018 2019 2020 Note: The nonlinear wage Phillips curve assumes that wage inflation is four times as responsive to the unemployment rate gap when the unemployment rate is below the staff’s estimate of the natural rate than when it is above. Page 8 of 48 -0.5 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 the range of conventional estimates.7 In the simulation, it is assumed that both the private understand its implications for inflation and real activity.8 In addition, as in the previous exhibit, policymakers are assumed to commit to the prescribed policy and this prescription is regarded as credible by the public. Because inflation is initially below the Committee’s 2 percent target, the higher sensitivity of wage inflation to labor market slack in the simulation with a nonlinear wage Phillips curve makes the tradeoff between pushing inflation up toward target and reducing the unemployment rate below the natural rate more meaningful. Accordingly, policy is more accommodative than in the standard optimal control simulation: Real long-term rates rise a bit more gradually and the unemployment rate undershoots the natural rate more in the simulation with the nonlinear wage Phillips curve. Given the tighter labor market and wage inflation’s greater sensitivity to real activity in this specification, inflation rises faster and then slightly overshoots the Committee’s 2 percent objective. Overall, the trajectory for inflation is about 0.1 percentage point higher than in the standard optimal control simulation. The result that monetary policy is more accommodative and leads to a more pronounced undershooting of unemployment reflects the fact that inflation starts from well below the Committee’s objective. If inflation were closer to the longer-run target, policy would instead be tighter under optimal control with the nonlinear wage Phillips curve than under standard optimal control, as concerns about unemployment falling below its natural rate would weigh more heavily in policymakers’ objective function. Two assumptions noted above point to caveats worth emphasizing. First, these simulations assume that policymakers fully understand the wage and price dynamics of the economy. However, our understanding of these dynamics is imperfect, limiting the 7 The calibration implies that, all else equal, a one percentage point positive unemployment gap, leads to an immediate reduction in annualized nominal wage inflation of 0.015 percentage point, while a one percentage point negative unemployment gap leads to an immediate increase in annualized nominal wage inflation of 0.060 percentage point. The latter response is within two standard deviations of the FRB/US model estimate informed by the 1985-2007 subsample. Using a different specification, Kumar and Orrenius (2014) also report a significantly larger response of wage inflation to a fall in the unemployment rate when the unemployment rate is low. Finally, the qualitative results of the simulation hold under even larger asymmetries. 8 In particular, if the unemployment rate fluctuates over time around the natural rate, monetary policy would need to keep the unemployment rate above the natural rate on average over time to prevent an upward acceleration of inflation. Page 9 of 48 Strategies sector and policymakers know that the wage Phillips curve is nonlinear and fully Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 ability of policymakers to achieve inflation outcomes near their longer-run objective in Strategies the presence of this nonlinearity. Second, as with the earlier optimal control simulations, this simulation embeds the critical assumption that policy is perfectly credible and that inflation expectations remain well anchored. If the private sector doubted policymakers’ commitment to their goals and plans, the increase in inflation could be larger and more persistent than shown in the simulations. The final two exhibits, “Outcomes under Alternative Policies” and “Outcomes under Alternative Policies, Quarterly,” tabulate the simulation results for key variables under the above-described policies. Page 10 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Outcomes under Alternative Policies 2015 Measure and policy H1 2016 2017 2018 2019 H2 Real GDP Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 2.2 2.2 2.2 2.2 2.2 2.2 2.3 1.9 1.9 2.3 2.5 2.2 2.3 2.0 2.0 2.3 2.5 2.2 2.0 2.1 2.0 2.1 2.3 2.1 1.6 1.8 1.8 1.6 1.9 1.7 1.5 1.7 1.7 1.5 1.7 1.6 Unemployment rate2 Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 5.3 5.3 5.3 5.3 5.3 5.3 5.2 5.3 5.3 5.2 5.1 5.2 5.1 5.3 5.3 5.1 4.9 5.1 5.0 5.3 5.3 5.0 4.8 5.1 5.0 5.2 5.2 5.0 4.7 5.1 5.2 5.2 5.2 5.2 4.8 5.1 Total PCE prices Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control -0.3 -0.3 -0.3 -0.3 -0.3 -0.3 1.6 1.5 1.5 1.6 1.7 1.6 1.7 1.6 1.6 1.6 1.8 1.7 1.9 1.8 1.8 1.9 2.1 1.9 1.9 1.9 1.9 1.9 2.1 2.0 2.0 1.9 1.9 2.0 2.2 2.0 Core PCE prices Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 1.1 1.1 1.1 1.1 1.1 1.1 1.5 1.4 1.4 1.5 1.6 1.5 1.6 1.5 1.5 1.6 1.7 1.6 1.8 1.8 1.8 1.8 2.0 1.9 1.9 1.9 1.9 1.9 2.1 2.0 2.0 1.9 2.0 2.0 2.2 2.0 Effective nominal federal funds rate2 Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 0.2 2.0 1.6 0.4 0.3 0.4 0.7 2.2 1.9 0.8 0.8 1.0 1.8 2.8 2.7 1.8 2.0 2.2 2.7 3.3 3.4 2.7 2.7 3.0 3.3 3.5 3.5 3.2 2.7 3.4 3.4 3.5 3.5 3.4 2.7 3.5 1. In the Tealbook baseline, the federal funds rate first departs from an effective lower bound of 12½ basis points in the second quarter of 2015. Thereafter, the federal funds rate follows the prescriptions of the inertial Taylor (1999) rule. 2. Percent, average for the final quarter of the period. Page 11 of 48 Strategies (Percent change, annual rate, from end of preceding period except as noted) Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Outcomes under Alternative Policies, Quarterly Strategies (Four-quarter percentage change, except as noted) 2015 Measure and policy Q1 Q2 2016 Q3 Q4 Q1 Q2 Q3 Q4 Real GDP Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 3.5 3.5 3.5 3.5 3.5 3.7 3.0 3.0 3.0 3.0 3.0 3.2 2.5 2.3 2.3 2.5 2.5 2.6 2.7 2.4 2.5 2.7 2.7 2.7 2.8 2.4 2.5 2.8 2.8 2.6 2.7 2.3 2.3 2.7 2.8 2.6 2.7 2.4 2.4 2.7 2.8 2.6 2.6 2.3 2.3 2.6 2.7 2.6 Unemployment rate2 Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 5.5 5.5 5.5 5.5 5.5 5.4 5.4 5.4 5.4 5.4 5.4 5.3 5.3 5.4 5.4 5.3 5.3 5.3 5.2 5.4 5.3 5.2 5.2 5.2 5.1 5.3 5.3 5.1 5.1 5.1 5.1 5.3 5.3 5.1 5.1 5.1 5.0 5.3 5.3 5.0 5.0 5.1 5.0 5.2 5.2 5.0 5.0 5.0 Total PCE prices Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 0.3 0.3 0.3 0.3 0.3 0.1 0.1 0.1 0.1 0.1 0.1 -0.1 0.2 0.2 0.2 0.2 0.2 0.0 0.7 0.7 0.7 0.8 0.8 0.6 1.6 1.6 1.6 1.7 1.8 1.8 1.7 1.7 1.7 1.7 1.9 1.9 1.7 1.7 1.7 1.8 1.9 1.9 1.7 1.7 1.7 1.8 1.9 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 1.4 1.2 1.2 1.2 1.2 1.2 1.3 1.2 1.2 1.2 1.2 1.3 1.3 1.4 1.3 1.3 1.4 1.5 1.5 1.6 1.5 1.5 1.6 1.7 1.6 1.6 1.6 1.6 1.6 1.8 1.7 1.6 1.6 1.6 1.7 1.8 1.7 1.6 1.6 1.6 1.7 1.8 1.8 Effective nominal federal funds rate2 Extended Tealbook baseline1 Taylor (1993) Taylor (1999) Inertial Taylor (1999) First-difference Optimal control 0.1 0.1 0.1 0.1 0.1 0.4 0.2 2.2 1.7 0.4 0.5 0.8 0.5 2.3 1.9 0.6 0.9 1.1 0.9 2.6 2.3 0.9 1.3 1.4 1.2 2.9 2.7 1.3 1.6 1.8 1.6 3.0 2.9 1.6 2.0 2.1 1.9 3.1 3.0 1.9 2.4 2.4 2.2 3.2 3.2 2.2 2.7 2.8 1. In the Tealbook baseline, the federal funds rate first departs from an effective lower bound of 12½ basis points in the second quarter of 2015. Thereafter, the federal funds rate follows the prescriptions of the inertial Taylor (1999) rule. 2. Percent, average for the quarter. Page 12 of 48 Authorized for Public Release Class I FOMC - Restricted Controlled (FR) March 12, 2015 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 effective 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 (nt and ^t+3|t), the output gap estimate for the current period (gapt), and the forecast of the three-quarter-ahead annual change in the output gap (A4gap),-3,). The value of policymakers' longer-run inflation objective, denoted nLR, is 2 percent. Taylor (1993) rule Rt = rLR +nt + 0.5 (nt — nLR) + 0.5gapt Taylor (1999) rule Rt = rRR +nt + 0.5 (nt — nLR) + gapt Inertial Taylor (1999) rule Rt = 0.85Rt_1 + 0.15(rLR + nt + 0.5(nt — n;LR) + gapt) First-difference rule Rt — Rt-i + 0.5(^t+3|t nLR) + 0.5&4gapt+3it The first two of the selected rules were studied by Taylor (1993, 1999), while the inertial Taylor (1999) rule has been featured prominently in recent analysis by Board staff.1 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 interest rate, denoted rLR, of 1/ percent, a value used in the FRB/US model.2 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 denoted “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 See Erceg and others (2012). For the March 2015 Tealbook, the staff revised the longer-run value of the real interest rate from 1% percent to 1/ percent. 1 2 Page 13 of 48 Strategies Appendix Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Strategies 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. References Erceg, Christopher, Jon Faust, Michael Kiley, Jean-Philippe Laforte, David López-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 of Monetary Economics, Vol. 50 (July), pp. 9831022. Taylor, John B. (1993). “Discretion versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy, Vol. 39 (December), pp. 195214. Taylor, John B. (1999). “A Historical Analysis of Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy Rules. University of Chicago Press, pp. 319341. ESTIMATES OF THE EQUILIBRIUM AND ACTUAL REAL FEDERAL FUNDS RATES An estimate of the equilibrium real federal funds rate appears as a memo item in the first exhibit, “Policy Rules and the Staff Projection.” The concept of the short-run equilibrium real rate underlying the estimate corresponds to the level of the real federal funds rate that is consistent with output reaching potential in 12 quarters using an output projection from FRB/US, the staff’s large-scale econometric model of the U.S. economy. This estimate depends on a very broad array of economic factors, some of which take the form of projected values of the model’s exogenous variables. The memo item in the exhibit reports the “Tealbook-consistent” estimate of r*, which is generated after the paths of exogenous variables in the FRB/US model are adjusted so that they match those in the extended Tealbook forecast. Model simulations then determine the value of the real federal funds rate that closes the output gap conditional on the exogenous variables in the extended baseline forecast. The estimated actual real federal funds rate reported in the exhibit is constructed as the difference between the federal funds rate and the trailing four-quarter change in the core PCE price index. The federal funds rate is specified as the midpoint of the target range for the federal funds rate on the Tealbook, Book B, publication date. 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. For the optimal control simulations, the dotted line labeled “Previous Tealbook” is derived from the Page 14 of 48 March 12, 2015 previous Tealbook projection. 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. Page 15 of 48 Strategies Authorized for Public Release Class I FOMC – Restricted Controlled (FR) Authorized for Public Release Strategies Class I FOMC – Restricted Controlled (FR) (This page is intentionally blank.) Page 16 of 48 March 12, 2015 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Monetary Policy Alternatives This Tealbook presents three alternative draft FOMC statements—labeled A, B, and C—for the Committee’s consideration. In addition to providing different possibilities for characterizing incoming information and the outlook, these alternatives offer a variety of options for forward guidance regarding the federal funds rate. The Committee’s March meeting is taking place against a backdrop in which continued improvement in the labor market is juxtaposed with a significant shortfall in inflation from the Committee’s 2 percent objective. While many participants may be soon, they may be less confident about the trajectory for inflation. The key judgment to be made at this meeting is whether the Committee can replace the “patient” language that is now associated with a two-meeting delay before liftoff with more flexible, data-dependent forward guidance that would put decisionmaking about the first increase in the target federal funds rate in play at the June meeting or later. Under Alternative B, the Committee would modify its forward guidance in a manner that signals that an increase in the target range is possible as early as June provided that the Committee has seen further improvement in the labor market and is reasonably confident that inflation will move back to 2 percent over the medium term. Under Alternative A, the statement would indicate that policymakers want to see clear evidence that inflation is turning up before they would increase the federal funds rate. In contrast, under Alternative C, policymakers would communicate that an increase in the target range for the federal funds rate will likely be appropriate at the June meeting. With regard to forward guidance, Alternative B replaces the Committee’s previous assessment that “it can be patient in beginning to normalize the stance of monetary policy.” The new guidance states that, consistent with the Committee’s previous postmeeting statement, an increase in the federal funds rate “remains unlikely at the April FOMC meeting” and notes the Committee’s anticipation that the first increase in the federal funds rate will be appropriate when the Committee “has seen further improvement in the labor market” and is “reasonably confident” that inflation will move back to 2 percent “over the medium term.” Alternative B further adds that this “change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.” The Committee would presumably drop the Page 17 of 48 Alternatives confident that conditions consistent with maximum employment may be reached fairly Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 reference to the April decision from future statements, but may want to retain some indication that the timing of the initial increase has not been decided. The draft statement for Alternative A extends the notion of being patient by adding the condition that the federal funds rate will remain at its current level “until inflation is clearly moving up toward 2 percent.” In addition, the Committee would assert the intention to “use its tools as necessary to return inflation to 2 percent in two to three years.” In contrast, the statement under Alternative C indicates that the Committee judges that economic conditions “will likely warrant an increase in the target range for the federal funds rate in a couple of meetings.” Under this alternative, the Committee would also retain the qualification that “slower” progress toward the Committee’s dual Alternatives objectives would likely cause the initial increase in the target range to occur later than currently expected; the converse stipulation that faster progress would result in an earlier tightening would be dropped in light of the indication that a tightening will soon occur under that alternative. Under Alternatives A and B, the Committee would retain the language stating that, in determining “how long to maintain” the current target range, it will assess progress toward its dual objectives. Under Alternative C, however, the Committee would state that it will assess progress toward its objectives to determine “future adjustments of the target range,” meaning both the initial and subsequent adjustments. With respect to the Committee’s characterization of its approach to removing policy accommodation, under Alternatives A and B the Committee would reaffirm its intention to take a “balanced approach.” Under Alternative C, the “balanced approach” phrase would be dropped in favor of language emphasizing the data dependence of the Committee’s policy decisions. The new language would state that “in response to unanticipated economic and financial developments, the Committee will adjust the target federal funds rate to best promote the attainment of its objectives of maximum employment and 2 percent inflation.” The text of all three alternatives would reiterate that economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. With regard to balance sheet policy, under all three alternatives, the Committee would maintain its existing reinvestment policy. Page 18 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Concerning the characterization of current economic conditions, Alternative B would incorporate three key changes relative to the January statement: It would use “moderate” instead of “solid” to describe the expansion in economic activity; note that export growth had weakened; and acknowledge that measures of inflation compensation have reversed part of their previous decline but remain low. Relative to Alternative B, the corresponding language under Alternatives C and A reflect brighter and more downbeat tones, respectively, than that for Alternative B in their characterizations of economic activity, labor market conditions, household spending, business fixed investment, export growth, and market-based measures of inflation compensation. Data to be received between the publication of this Tealbook and the second day of the March FOMC meeting could lead to revisions in the first paragraph of each of the draft Regarding the Committee’s outlook for inflation, with energy price declines now expected to stay in the rear-view mirror, all of the alternative statements would describe near-term inflation as anticipated to “remain near its recent low level” (instead of decline further). In contrast with Alternative B, under Alternative C the Committee would say it expects inflation to rise gradually “to” (not toward) 2 percent over the medium term, while Alternative A would say the rise toward 2 percent is expected to be “very” gradual. Finally, Alternative A would add that the Committee is concerned that inflation could run substantially below 2 percent for a protracted period. Subsequent pages present: the January FOMC statement; the draft statements for March under Alternatives A, B, and C; supporting arguments for the three alternatives; and a draft directive. Page 19 of 48 Alternatives statements. Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 JANUARY 2015 FOMC STATEMENT Alternatives 1. Information received since the Federal Open Market Committee met in December suggests that economic activity has been expanding at a solid pace. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation have declined substantially in recent months; survey-based measures of longer-term inflation expectations have remained stable. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate. The Committee continues to monitor inflation developments closely. 3. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress—both realized and expected—toward 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. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated. 4. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgagebacked securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. 5. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Page 20 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 1. Information received since the Federal Open Market Committee met in December January suggests indicates that growth in economic activity has been expanding at a solid pace moderated. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish, but wage increases remain subdued. Household spending is rising moderately; recent earlier declines in energy prices have boosted household purchasing power. Business fixed investment is advancing modestly, export growth has weakened, while and the recovery in the housing sector remains slow. Inflation has declined further below the Committee’s longer-run objective, largely partly reflecting earlier declines in energy prices. Market-based measures of inflation compensation have declined substantially in recent months remain well below levels observed last summer; survey-based measures of longer-term inflation expectations have remained stable. 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further remain near its recent low level in the near term. , but The Committee expects inflation to rise very gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower earlier energy prices price declines and other factors dissipate. However, the Committee is concerned that inflation could run substantially below the 2 percent objective for a protracted period and continues to monitor inflation developments closely. 3. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress—both realized and expected— toward 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. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy until inflation is clearly moving up toward 2 percent. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated. The Committee is prepared to use its tools as necessary to return inflation to 2 percent in two to three years. Page 21 of 48 Alternatives FOMC STATEMENT—MARCH 2015 ALTERNATIVE A Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 4. 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. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. Alternatives 5. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Page 22 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 FOMC STATEMENT—MARCH 2015 ALTERNATIVE B 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower earlier energy prices price declines and other factors dissipate. The Committee continues to monitor inflation developments closely. 3. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress—both realized and expected— toward 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. Based on its current assessment Consistent with its previous statement, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves Page 23 of 48 Alternatives 1. Information received since the Federal Open Market Committee met in December January suggests that economic activity has been is expanding at a solid moderate pace. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. On balance, A range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; recent earlier declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow and export growth has weakened. Inflation has declined further below the Committee’s longer-run objective, largely reflecting earlier declines in energy prices. Market-based measures of inflation compensation have declined substantially in recent months have reversed part of their previous decline but remain low; survey-based measures of longer-term inflation expectations have remained stable. Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 slower than expected, then increases in the target range are likely to occur later than currently anticipated. 4. 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. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. Alternatives 5. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Page 24 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 FOMC STATEMENT—MARCH 2015 ALTERNATIVE C 2. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward to 2 percent over the medium term as the labor market improves further and the transitory effects of lower earlier energy prices price declines and other factors dissipate. The Committee continues to monitor inflation developments closely. 3. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this future adjustments of the target range for the federal funds rate, the Committee will assess progress—both realized and expected—toward 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. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy economic conditions will likely warrant an increase in the target range for the federal funds rate in a couple of meetings. However, if incoming information indicates faster slower progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are the initial increase is likely to occur later than currently anticipated. 4. 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 Page 25 of 48 Alternatives 1. Information received since the Federal Open Market Committee met in December January suggests indicates that economic activity has been expanding at a solid pace on average in recent quarters. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. On balance, A wide range of labor market indicators suggests that underutilization of labor resources continues to diminish the labor market is approaching conditions consistent with maximum employment. Household spending is rising moderately solidly; recent earlier declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has declined further below the Committee’s longer-run objective, largely reflecting earlier declines in energy prices. Market-based measures of inflation compensation have declined substantially in recent months increased; survey-based measures of longer-term inflation expectations have remained stable. Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. Alternatives 5. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. Based on its economic outlook, the Committee currently anticipates that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. In response to unanticipated economic and financial developments, the Committee will adjust the target federal funds rate to best promote the attainment of its objectives of maximum employment and 2 percent inflation. Page 26 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 THE CASE FOR ALTERNATIVE B The Committee may view the information received during the intermeeting period as consistent with an assessment that the current target range of the federal funds rate remains appropriate for at least another meeting. However, policymakers may want to drop “patient” from the postmeeting statement because they may judge that an increase in the target range may be warranted at the June meeting. The Committee may therefore choose to maintain the current target range for the federal funds rate while updating its forward guidance, as in Alternative B. In light of the latest readings on the labor market, showing strong job gains and a consider it appropriate to again indicate in the Committee’s postmeeting statement that the underutilization of labor resources “continues to diminish.” Policymakers might also continue to judge that resource slack remains. They may point to the persistent absence of price and wage pressures despite large declines in the unemployment rate. More broadly, policymakers may judge that a range of other labor-market indicators continues to indicate that resource utilization is lower than suggested by the unemployment rate alone; they might for example point to the below-trend labor force participation rate, the still-elevated share of those who are working part time but would prefer a full-time job, and the still-high share of unemployed workers who have been out of work for six months or more. Some policymakers might be inclined to signal that the target range for the federal funds rate is likely to be raised sooner than what would be suggested by the language of Alternative B. In light of the further improvement in labor market conditions in January and February, they may judge that levels of resource slack are low and are poised to be eliminated altogether in the near future. They may be concerned that prolonging a policy of near-zero short-term interest rates, and maintaining below-normal policy rates for some time once the economy returns to full employment, would risk pushing the unemployment rate well below levels consistent with maximum sustainable employment and fuel an undesirably large rise in inflation over the medium run. Nonetheless, they may remain cautious in their judgment about the momentum in economic activity in light of the recent downward revision to real GDP growth in the fourth quarter as well as weaker incoming data on spending and international trade in the current quarter. Furthermore, they might note that inflation remains well below the Committee’s objective, and judge that inflation expectations remain well anchored and that there are as Page 27 of 48 Alternatives further decline in the unemployment rate over the intermeeting period, members may Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 yet no signs of increasing wage and price pressures. They might also note that the higher foreign exchange value of the dollar implies less accommodative financial conditions, all else equal. Moreover, participants might see the experience of other countries exiting from periods of long-standing high levels of policy accommodation—most notably Sweden and Japan, countries for which the departure from the effective lower bound proved premature and subsequently was reversed—as suggesting that it may be better to err on the side of commencing policy firming later, rather than earlier.1 They may therefore conclude that the costs of waiting another couple of meetings before increasing the target range for the federal funds rate are likely outweighed by the risks of removing accommodation too early. Alternatives Some policymakers may be concerned that the extended period of near-zero interest rates is increasing incentives for risk-taking in the financial sector, with potential for undermining financial stability in the future. However, they may note that signs of excessive risk-taking are not widespread, and use of short-term financing instruments and indicators of leverage have remained at moderate levels to date. Moreover, a premature tightening of policy might itself pose risks to financial stability—namely by undermining the economic recovery, increasing loan losses, and thereby impairing the balance sheets of financial institutions. Policymakers may accordingly conclude that the statement language provided under Alternative B—by signaling that the first increase in the federal funds rate may, but need not, take place as early as June—gives the Committee ample flexibility to take financial stability concerns into account while supporting its employment and inflation objectives. Conversely, some participants may be concerned that the updated forward guidance in Alternative B—in particular the signal that the process of policy normalization may begin as early as June—might be premature. They may be concerned that persistently low market-based measures of inflation compensation might be an indication that the credibility of the Committee’s commitment to its 2 percent inflation objective is in question. However, as survey-based measures of longer-term inflation expectations have so far remained stable and as market-based measures of inflation compensation have, over the intermeeting period, reversed some of their earlier declines, these participants may now be less concerned that changes in market-based measures of 1 For an account of the relevant foreign experience, see the memo, “Foreign Experience with Liftoff from the Effective Lower Bound,” by Andrea De Michelis, Michiel De Pooter, and Paul Wood, sent to the Committee on January 16, 2015. Page 28 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 inflation compensation in recent quarters reflect a fundamental shift in inflation expectations rather than movements in risk or liquidity premiums.2 Alternatively, they may see risks that weakness in economic activity abroad might have significant repercussions for the U.S. economy—especially if that weakness intensified, along the lines of the “Greek Exit with Severe Spillovers” scenario in the “Risks and Uncertainty” section of Tealbook, Book A. However, weighing these risks against the assessment that there has so far been only a modest spillover of weakness abroad to U.S. growth, these policymakers may recognize that under Alternative B, the Committee would retain the latitude to adjust the stance of monetary policy as necessary in response to softer-thanexpected data. Consequently, before signaling the potential provision of greater policy accommodation, policymakers may prefer to wait for further information about inflation and thus choose statement language as proposed in Alternative B. On average, respondents to both the Desk’s Survey of Primary Dealers and to the Desk’s Survey of Market Participants place odds of about 30 percent on the first increase in the target range for the federal funds rate occurring in June, but consider an increase in September almost as likely. In addition, the majority of respondents to both surveys expects a modification in forward guidance at this meeting that removes the “patient” language. Accordingly, overall, the new language in Alternative B is not likely to surprise many market participants. THE CASE FOR ALTERNATIVE C Some policymakers may be more confident that the expansion has gained sufficient momentum such that economic slack—if any should still remain—will likely be absorbed fairly quickly, and they may see inflation as likely to move back toward 2 percent in short order. In support of this view, policymakers might highlight the strong expansion in payroll employment as well as the decline in the unemployment rate over the past year. In particular, these policymakers might note that the unemployment rate, at 5.5 percent in February, has reached the upper end of the central tendency of participants’ longer-run projections for the unemployment rate given in the December SEP, raising the 2 Five-to-ten-year-ahead inflation forecasts from the Michigan survey in February, as well as forecasts from the first-quarter SPF for CPI inflation five and ten years ahead, and PCE inflation five years ahead ticked down by just about one tenth—well with their historical ranges—and the ten-year-ahead SPF forecast for PCE prices remained unchanged. Short-term forecasts from those surveys varied mostly in line with observed changes in gasoline prices. Page 29 of 48 Alternatives expectations and the economic situation abroad and its implications for the U.S. outlook, Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 possibility that the unemployment gap may already have closed. Policymakers might also point to the fact that oil prices recently appear to have leveled off, and that oil futures prices suggest that energy prices will no longer be reducing headline inflation relative to core inflation. These policymakers might also see increased momentum in U.S. economic activity in the period ahead, and point for example to the elevated consumer confidence and the solid growth in real consumption expenditures shown in the revised data for the fourth quarter. Accordingly, these policymakers may regard it as appropriate to indicate that a first increase in the target range for the federal funds rate at the June meeting is more likely than suggested by Alternative B; consequently, they may prefer Alternative Alternatives C. Policymakers may also be concerned that the path for the federal funds rate currently expected by market participants could imply an overly accommodative policy. They may judge that the current low levels of inflation largely reflect transitory effects of earlier declines in energy prices and thus may expect headline inflation to rise toward 2 percent before long. Participants may point to increases in market-based measures of inflation compensation that came in the wake of the recent upturn in energy prices, and they may regard earlier declines in these measures observed since summer as predominantly reflecting changes in risk or liquidity premiums rather than a decline in longer-run inflation expectations. Thus, they may view the balance of the evidence, including information from survey measures, as suggesting that longer-run expected inflation has not declined. In contrast, they may already see a significant risk that the unemployment rate could substantially undershoot its natural rate, a development that might generate higher actual wage and price inflation in the future, and in turn boost expected inflation above 2 percent as the labor market tightens. These policymakers might cite the scenario “Faster Growth with Higher Inflation” in the “Risks and Uncertainty” section of Tealbook, Book A, as encapsulating some of the risks they have in mind. They also might emphasize that all of the simple monetary policy rule prescriptions and the optimal control simulations presented in the “Monetary Policy Strategies” section of Tealbook, Book B, call for an immediate policy tightening. Based on these judgments, some participants may want to signal that an initial increase in rates by June is quite likely. A decision to issue a statement along the lines of Alternative C would likely surprise market participants to some extent. Although respondents to the Survey of Page 30 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Primary Dealers and the Survey of Market Participants place, on average, the highest odds on the first target-range increase to occur in June, at 30 percent, these odds are not very high, and respondents consider it, on average, twice as likely that the first increase will occur only after the June meeting. In addition, the views expressed in the surveys are disperse, and quite a few respondents view dates later than June as the most likely. Many market participants might thus be surprised by the high likelihood placed by Alternative C on an increase in the target range for the federal rate at the June meeting. If so, in response to a statement like that in Alternative C, medium- and longer-term real interest rates would likely rise, inflation compensation would likely fall, equity prices would probably decline, and the dollar appreciate. However, to the extent that investors interpreted the statement as reflecting a more positive outlook for economic activity and would not fall as much or could even rise. THE CASE FOR ALTERNATIVE A In light of the information received over the intermeeting period on inflation, economic developments abroad, and the restraining effects of the appreciation of the dollar, some policymakers may be concerned that the durability of the current expansion is at risk, or that inflation is likely to remain well below 2 percent for the foreseeable future. Accordingly, these policymakers may regard it as appropriate that the Committee more clearly specify these concerns as a reason to be patient in beginning to normalize the stance of monetary policy, as in the statement under Alternative A. While acknowledging that job gains in January and February were “solid,” and that the unemployment rate fell further, these policymakers might judge that subdued nominal wage growth and other indicators of labor market utilization suggest that appreciable slack remains in the labor market. Some policymakers may note that, over the last few years, inflation has persistently fallen short of the Committee’s 2 percent objective without much sign of moving back up again; they may be concerned that “inflation could run substantially below the 2 percent objective for a protracted period.” They may take little comfort from the stability of survey-based measures of longer-term inflation expectations, pointing, for example, to the behavior of survey expectations in Japan that failed to reflect a decadelong experience of very low, even negative, inflation rates. These participants may judge that market-based measures of inflation compensation provide a more useful gauge of longer-term inflation expectations. While these market-based measures have increased, Page 31 of 48 Alternatives inflation, and accepted that outlook as correct, equity prices and inflation compensation Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 on balance, over the intermeeting period, policymakers might point to their still-low levels and interpret these as suggesting that inflation expectations may have begun to drift down—possibly along the lines of the scenario “Lower Long-Term Inflation Expectations” that is considered in the “Risks and Uncertainty” section of Tealbook, Book A—or that the potential costs of low inflation outcomes have increased. In addition, they might be concerned about the possible implications for prices and personal incomes of low growth in labor compensation. Containing such risks might be a particular concern for policymakers because the effective lower bound on policy rates and the Federal Reserve’s already-large balance sheet could limit the Committee’s flexibility in responding to downside outcomes. In response, some participants may want to signal the Committee’s readiness to use its tools as necessary to move inflation back Alternatives up again. Some policymakers may read the incoming data since the January meeting as suggesting that real GDP growth is likely to be no more than moderate in coming quarters. While they might judge that the recent decline in energy prices has raised household purchasing power, they might see this effect as likely to be transitory, and they might note the relatively weak retail sales data for January and February. They could also point to weakness in business investment and residential construction, in the face of a highly accommodative stance of monetary policy, as signs that the underlying trend in private domestic demand remains unsatisfactory. These participants may also be concerned that the prospects for continued moderate growth over coming quarters have been damaged by weakness in key European economies and the strong appreciation of the dollar. They may regard the weakness in energy prices over recent months as an indicator that global growth is on a lower path than before, with adverse implications for U.S. net exports. Based on these judgments, some participants may want to lay out more stringent conditions than in Alternative B (or the current statement), for beginning to normalize the stance of monetary policy. An announcement like that in Alternative A would likely surprise market participants. The third paragraph of the alternative not only retains the Committee’s existing “patient” language, but also adds the requirement that inflation should clearly move up toward 2 percent before beginning to normalize the stance of monetary policy, and hints at the possible provision of additional policy accommodation. In response to such a statement, investors would likely push further into the future their expectation of the date of the first increase in the target range for the federal funds rate. Medium- and longer-term real interest rates would likely decline, inflation compensation and equity Page 32 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 prices might rise, and the dollar could depreciate. However, insofar as investors interpreted the statement as reflecting a more downbeat assessment of the outlook for economic growth and inflation, equity prices would not rise as much or could even Alternatives decline, and inflation compensation could fall. Page 33 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 DIRECTIVE The directive that was issued after the January meeting appears on the next page. It is followed by a draft of the March directive for Alternatives A, B, and C. This draft directive is the same for all three alternative statements; it is also identical to the January directive. Regarding balance sheet policies, the draft directive continues to instruct the Desk to maintain the current policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed Alternatives securities and of rolling over maturing Treasury securities into new issues. Page 34 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 January 2015 Directive Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to undertake open market operations as necessary to maintain such conditions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of 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 will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability. Page 35 of 48 Alternatives securities transactions. The System Open Market Account manager and the secretary Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Directive for March 2015 Alternatives A, B, and C Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to ¼ percent. The Committee directs the Desk to undertake open market operations as necessary to maintain such conditions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of 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 Alternatives securities transactions. The System Open Market Account manager and the secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability. Page 36 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Projections BALANCE SHEET, INCOME, AND MONETARY BASE The staff has developed a projection of the Federal Reserve’s balance sheet and income statement that is broadly consistent with the monetary policy assumptions incorporated in the staff’s forecast presented in Tealbook, Book A. In particular, the projection is based on the assumptions that the first increase in the target range for the federal funds rate will occur in the second quarter of 2015, and that rollovers of maturing Treasury securities and the reinvestment of principal received on agency securities will cease in the fourth quarter of 2015. From that point forward, the SOMA portfolio shrinks through redemptions of maturing Treasury securities 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 falls to 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 second quarter of 2021, at which point total assets stand at $2.2 trillion, with about $2 trillion in total SOMA securities holdings.3 Total assets and securities holdings increase thereafter, keeping pace with growth in currency in circulation and Federal Reserve Bank capital. 1 Use of RRPs or term deposits results in a shift in the composition of Federal Reserve liabilities— a decline in reserve balances and an equal increase in RRPs or term deposits—but does not produce an overall change in the size of the balance sheet. 2 RRPs associated with foreign official and international accounts remain around $135 billion throughout the projection period. 3 The size of the balance sheet is considered normalized when reserve balances revert to an assumed $100 billion steady state level. At this time, the size of the securities portfolio is primarily determined by the level of currency in circulation plus Federal Reserve capital and the projected steadystate level of reserve balances. Page 37 of 48 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) March 12, 2015 Total Assets and Selected Balance Sheet Items March Tealbook Total Assets January Tealbook Reserve Balances Billions of dollars Monthly Billions of dollars 5500 Monthly 5000 4000 3500 4500 3000 4000 3500 2500 3000 2000 2500 1500 2000 1500 1000 1000 500 500 2024 2022 2020 2018 2016 2014 2012 2010 SOMA Treasury Holdings SOMA Agency MBS Holdings Billions of dollars Monthly 3000 Billions of dollars Monthly 2200 2000 2500 1800 1600 2000 1400 1200 1500 1000 800 1000 600 400 500 200 0 Page 38 of 48 2024 2022 2020 2018 2016 2014 2012 2010 2024 2022 2020 2018 2016 2014 2012 0 2010 Projections 0 2024 2022 2020 2018 2016 2014 2012 2010 0 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Federal Reserve Balance Sheet End-of-Year Projections -- March Tealbook (Billions of dollars) Feb 28, 2015 Total assets 4,488 2015 2017 2019 2021 2023 2025 4,458 3,658 2,664 2,262 2,463 2,689 Selected assets Loans and other credit extensions* Securities held outright U.S. Treasury securities 2 0 0 0 0 0 4,237 4,232 3,471 2,508 2,128 2,340 2,575 2,460 2,463 2,056 1,357 1,191 1,580 1,964 Agency debt securities Agency mortgage-backed securities 0 37 1,740 33 4 2 2 2 2 1,737 1,412 1,149 935 757 608 Unamortized premiums 204 191 148 115 91 79 69 Unamortized discounts -18 -17 -13 -11 -8 -7 -6 42 44 44 44 44 44 44 Total other assets Total liabilities 4,430 4,398 3,586 2,573 2,147 2,318 2,505 1,307 1,375 1,550 1,678 1,827 1,997 2,185 Federal Reserve notes in circulation Reverse repurchase agreements Deposits with Federal Reserve Banks Reserve balances held by depository institutions 340 235 135 135 135 135 2,776 2,783 1,796 756 180 180 180 2,513 2,703 1,716 675 100 100 100 U.S. Treasury, General Account Other deposits 235 35 75 75 75 75 75 75 228 5 5 5 5 5 5 2 0 0 0 0 0 0 58 60 72 91 115 145 184 Interest on Federal Reserve Notes due to U.S. Treasury Total capital Source: Federal Reserve H.4.1 statistical releases and staff calculations. Note: Components may not sum to totals due to rounding. *Loans and other credit extensions includes primary, secondary, and seasonal credit; central bank liquidity swaps; and net portfolio holdings of Maiden Lane LLC. Page 39 of 48 Projections Selected liabilities Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Federal Reserve remittances. The next exhibit, “Income Projections,” shows the implications of the balance sheet projection and interest rate assumptions for Federal Reserve income.4 Remittances to the Treasury are projected to be about $90 billion this year (down a bit from their $100 billion peak in 2014) and then to decline further over the next three years. Annual remittances reach their trough at about $25 billion in 2018; no deferred asset is recorded.5 The Federal Reserve’s cumulative remittances from 2009 through 2025 are about $1 trillion, approximately $200 billion above the staff estimate of the amount that would have been observed had there been no asset purchase programs.6 Unrealized gains or losses. The unrealized gain or loss position of the SOMA portfolio is influenced importantly by the level of interest rates. The staff estimates that the portfolio was in an unrealized gain position of about $210 billion as of the end of February.7 Reflecting the assumed rise in long-term interest rates over the next several years, the position is projected to shift to an unrealized loss by the end of this year, with projected year-end unrealized losses peaking at $260 billion in 2017. At this date, roughly $120 billion of the unrealized losses can be attributed to the portfolio of U.S. Treasury securities and $140 billion to the portfolio of MBS. The unrealized loss position then narrows through 2025, as securities acquired under the large-scale asset purchase Projections programs mature or pay down and new securities are added to the portfolio at then-current market rates. Term premium effects. As shown in the table, “Projections for the 10-Year Treasury Term Premium Effect,” the effect of the Federal Reserve’s elevated stock of longer-term securities on the term premium embedded in the 10-year 4 We assume the interest rate paid on reserve balances remains 25 basis points as long as the federal funds rate remains at its effective lower bound. In addition, we assume that, once firming of the policy rate begins, the spread between the interest rate paid on reserve balances and the ON RRP rate is 25 basis points. Moreover, we assume that the effective federal funds rate will average about 15 basis points below the rate paid on reserve balances and about 10 basis points above the ON RRP rate. 5 In the event that a Federal Reserve Bank’s earnings fall short of the amount necessary to cover its operating costs, pay dividends, and equate surplus to capital paid-in, a deferred asset would be recorded. 6 The staff estimate is obtained by linear interpolation from 2006 to 2025 of actual 2006 income and projected 2025 income. 7 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. Page 40 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Income Projections March Tealbook Interest Income Interest Expense Annual 60 40 40 20 20 0 0 Billions of dollars Annual 140 120 40 40 20 20 0 0 −20 −20 Memo: Unrealized Gains/Losses Billions of dollars End of year Page 41 of 48 400 300 200 100 0 −100 −200 −300 2024 2022 2020 2018 −400 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 60 2022 60 2020 80 2018 80 2016 100 2012 100 2024 2022 2020 2018 2016 120 −500 Projections 140 2014 Annual 2014 2024 60 2022 80 2020 80 2018 100 2016 100 2012 120 Remittances to Treasury Billions of dollars 2014 140 120 Realized Capital Gains 2012 Billions of dollars 140 2024 2022 2020 2018 2016 2014 2012 Annual 2014 Billions of dollars 2012 January Tealbook Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Projections for the 10-Year Treasury Term Premium Effect (Basis Points) Date March Tealbook January Tealbook Quarterly Averages -113 -108 -103 -98 -94 -89 -85 -81 -112 -107 -102 -97 -92 -88 -83 -79 2017:Q4 2018:Q4 2019:Q4 2020:Q4 2021:Q4 2022:Q4 2023:Q4 2024:Q4 2025:Q4 -66 -54 -45 -38 -32 -28 -23 -18 -13 -64 -53 -44 -36 -31 -26 -21 -17 -12 Projections 2015:Q1 Q2 Q3 Q4 2016:Q1 Q2 Q3 Q4 Page 42 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Treasury yield in the first quarter of 2015 is estimated to be negative 113 basis points. Over the next couple of years, the term premium effect diminishes at a pace of about 5 basis points per quarter, reflecting the projected normalization of the portfolio. Monetary base. As shown in the final table, “Projections for the Monetary Base,” once the normalization process begins in the second quarter of 2015, the monetary base first grows less rapidly and then shrinks through the second quarter of 2021, primarily because redemptions of securities generate corresponding reductions in reserve balances. Starting around mid-2021, after reserve balances are assumed to have stabilized at $100 billion, the monetary base begins to expand in line with Projections the increase in currency in circulation.8 8 The projection for the monetary base depends critically on the FOMC’s choice of tools during normalization. In this projection, a steady $100 billion take-up in an ON RRP facility is assumed and, therefore, the level of the monetary base is lower than it would otherwise be until 2019 (when the facility is phased out). The projected growth rate of the monetary base, however, is generally unaffected. If the FOMC employs additional reserve-draining tools during normalization, however, the projected level of reserve balances and the monetary base could decline quite markedly. Page 43 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Projections for the Monetary Base (Percent change, annual rate; not seasonally adjusted) March Tealbook January Tealbook Quarterly 2015:Q1 Q2 Q3 Q4 2016:Q1 Q2 Q3 Q4 1.7 13.3 0.2 0.4 -4.3 -13.9 -11.0 -9.1 36.3 4.2 0.7 1.1 -3.7 -13.1 -10.8 -9.0 Annual 2017 2018 2019 2020 2021 2022 2023 2024 2025 -10.3 -15.6 -14.4 -14.9 -5.5 4.2 4.3 4.3 4.3 -9.7 -14.5 -13.2 -13.4 -5.6 3.8 3.9 3.9 3.9 Projections Date Note: For years, Q4 to Q4; for quarters, calculated from corresponding average levels. Page 44 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 MONEY M2 is expected to increase modestly faster than nominal GDP, on average, in the first half of 2015. Thereafter, M2 is projected to contract slightly through early 2016 and then to grow slowly over the remainder of the forecast horizon as the projected increase in the target range for the federal funds rate and the associated rise in the opportunity cost of holding money restrains money demand.9 The increase in the opportunity cost is expected to slow M2 growth to a pace below that of nominal GDP in 2016 and, to a lesser extent, in 2017. In previous forecasts, staff had assumed that M2 growth will be additionally restrained by businesses and households reallocating a portion of the M2 balances accumulated during and after the financial crisis to other investments. However, in light of the continued strong growth in M2, staff is no longer assuming such a Projections reallocation. 9 The three-month Treasury bill rate is assumed to begin rising in 2015:Q1—one quarter earlier than the time at which the staff projects the target range for the federal funds rate to be raised above its effective lower bound. Subsequently, the Treasury bill rate is assumed to continue rising through the end of the forecast period, implying an increasing opportunity cost of holding M2 balances. Page 45 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 M2 Monetary Aggregate Projections (Percent change, annual rate; seasonally adjusted)* Quarterly 2015: 2016: 2017: Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 8.0 2.9 -3.6 -2.8 -1.4 0.0 0.6 0.9 1.5 1.9 2.1 2.2 2015 2016 2017 1.1 0.0 2.0 Projections Annual Note: This forecast is consistent with nominal GDP and interest rates in the Tealbook forecast. Actual data through March 2, 2015; projections thereafter. * Quarterly growth rates are computed from quarter averages. Annual growth rates are calculated using the change from fourth quarter of previous year to fourth quarter of year indicated. Page 46 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 Abbreviations ABS asset-backed securities BEA Bureau of Economic Analysis, Department of Commerce BHC bank holding company CDS credit default swaps 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 ECB European Central Bank 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 LIBOR London interbank offered rate MBS mortgage-backed securities 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 Page 47 of 48 Authorized for Public Release Class I FOMC – Restricted Controlled (FR) March 12, 2015 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 48 of 48
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