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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 03/31/2011. CLASS I FOMC - RESTRICTED CONTROLLED (FR) OCTOBER 27, 2005 MONETARY POLICY ALTERNATIVES PREPARED FOR THE FEDERAL OPEN MARKET COMMITTEE BY THE STAFF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Class I FOMC - Restricted Controlled (FR) October 27, 2005 MONETARY POLICY ALTERNATIVES Recent Developments (1) With investors putting only small odds on a pause in the tightening cycle following Hurricane Katrina, there was little market reaction to the FOMC’s decision at the September meeting to raise the target federal funds rate 25 basis points to 3¾ percent, to maintain its assessment that the risks to price stability and sustainable growth were balanced, and to retain the “measured pace” language. 1 The expected path for monetary policy shifted up in subsequent weeks though, as incoming data indicated that output had been expanding briskly prior to the hurricane and that the disruptions to economic activity from Hurricane Katrina and Rita were likely to be less severe than initially feared. This upward pressure on interest rates may have been amplified by comments from a number of Federal Reserve officials that were read as stressing inflation concerns. By the time of the release of the FOMC minutes, investors had reportedly anticipated their somewhat hawkish tone, and the market response to their publication was minimal. Current readings on futures contracts indicate that the federal funds rate expected after the December meeting has increased about 25 basis points over the intermeeting period to nearly 4¼ percent, consistent with investors placing high odds on a quarter-point rate hike at each of the next two meetings (Chart 1).2 The level of the funds rate expected to prevail by June 2006 rose Over the intermeeting period, the effective federal funds rate was close to the target. The Desk purchased $4.2 billion of Treasury coupon securities and $2.7 billion of Treasury bills, $1.5 billion of which were from foreign customers. The volume of outstanding long-term RPs decreased $7 billion, to $11 billion. 2 Today is the first day of the maintenance period that includes the upcoming FOMC meeting. Judging from the October federal funds futures contract, market participants expect the funds rate to average about 17 basis points above the target, on average, over the 1 Class I FOMC - Restricted Controlled (FR) Page 2 of 36 Chart 1 Interest Rate Developments Expected Federal Funds Rates* Probability of a 25 b.p. Tightening at Upcoming FOMC Meetings* Percent Percent 5.0 120 September 19, 2005 (black) October 27, 2005 (red) October 27, 2005 September 19, 2005 100 4.5 80 60 4.0 40 3.5 20 0 3.0 Oct. Jan. 2005 Apr. July 2006 Oct. Jan. Apr. 2007 Nov. Implied Volatilities Percent 12 190 FOMC Ten-Year Treasury (left scale) Six-Month Eurodollar (right scale) 10 Jan. Mar. Nominal Treasury Yields* Basis points Daily Dec. *Estimated from federal funds futures. *Estimates from federal funds and eurodollar futures, with an allowance for term premia and other adjustments. Percent 7 Daily 170 FOMC Ten-Year Two-Year 150 5 130 8 6 4 110 3 90 6 2 70 1 50 4 0 30 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. *Par yields from a smoothed nominal off-the-run Treasury yield curve. Energy Prices Dollars per barrel 75 70 65 60 55 50 45 40 35 30 25 20 Inflation Compensation* Dollars per gallon FOMC Daily 4.0 FOMC Daily Five-to-Ten Years Ahead Next Five Years 3.5 Spot WTI (left scale) Spot Unleaded Gasoline* (right scale) Percent 4.0 3.5 3.0 2.5 3.0 2.0 2.5 1.5 2.0 1.0 1.5 0.5 Jan. Apr. July 2004 Oct. *Spot wholesale price of gasoline Jan. Apr. July 2005 Oct. Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. *Based on a comparison of a smoothed TIPS yield curve to a smoothed nominal off-the-run Treasury yield curve. Note: Vertical lines indicate September 19, 2005. Last daily observations are for October 27, 2005. Class I FOMC - Restricted Controlled (FR) Page 3 of 36 50 basis points, to a peak just above 4½ percent. Respondents to the Desk’s latest dealer survey have similarly come to expect more policy tightening, with the majority now anticipating rate increases at the November, December, and January meetings. Most of the respondents expect little change in the measured pace and accommodative language, and six of twenty-two respondents indicated that recent statements by Federal Reserve officials had influenced their interest rate forecasts. Uncertainty about the expected path for policy over the coming six months, as measured by implied volatility read from eurodollar options, has decreased some since the September meeting, although it remains above its pre-Katrina levels. (2) Nominal Treasury yields rose 25 to 50 basis points on net, with most of the advance accounted for by increases in near-term forward rates.3, 4 In addition to stronger-than-expected economic data, declines in some energy prices likely contributed to a more positive economic outlook, helping to push yields higher. Increases at the longer end of the term structure, especially late in the period, may have been due in part to increased mortgage hedging flows, as suggested by anecdotal reports. Despite a higher-than-expected reading on the overall consumer price index for September, TIPS-based measures of inflation compensation were about unchanged over the intermeeting period, although they remain 15 to 20 basis points above the levels seen prior to Hurricane Katrina. (3) Partly in response to the rise in interest rates, major stock price indexes fell 3 to 4¼ percent over the period (Chart 2). Although reported earnings for the third quarter appear to have largely met or exceeded expectations, investors may also have remaining days prior to the meeting. Federal funds futures contracts for December and January are currently pricing in minimal year-end pressures in the federal funds market. 3 President Bush’s announcement on October 24 that he was nominating Ben S. Bernanke to succeed Chairman Greenspan was accompanied by an increase of a few basis points in Treasury yields and a modest rally in equity markets. 4 Open interest in the September ten-year Treasury futures contract remained elevated through its final days of trading. Nonetheless, all the deliveries were met using the August 2012 note, which was the cheapest-to-deliver security. Class I FOMC - Restricted Controlled (FR) Stock Prices S&P 500 Earnings Expectations Revisions Index Index(12/31/03=100) Daily Page 4 of 36 Chart 2 Asset Market Developments Percent 130 FOMC Wilshire Nasdaq Monthly 4 S&P 500 S&P 500 excluding energy 120 3 2 1 110 0 MidOct. 100 -1 -2 90 -3 -4 80 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 2002 Oct. Implied Volatilities 2004 2005 Note. Index is a weighted average of the percent change in the consensus forecasts of current-year and following-year EPS for constant sample. Equity Valuation Percent 40 Daily 2003 Percent 12 Monthly FOMC S&P 500 Nasdaq 10 30 8 12-Month Forward Trend E/P Ratio 20 + 6 4 10 + 2 Real Long-Term Treasury Yield* 0 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 0 1988 Oct. 2000 2004 Expected Defaults of Nonfinancial Companies and Bond Default Rate Basis points Basis points Percent of Liabilities Percent of Outstandings 8 Daily Ten-Year BBB (left scale) Five-Year High-Yield (right scale) 160 1996 *Perpetuity Treasury yield minus Philadelphia Fed 10-year expected inflation. Note. + Denotes the latest observation using daily interest rates and stock prices and latest earnings data from I/B/E/S. Corporate Bond Spreads* 200 1992 FOMC 1150 2.0 Monthly 7 Expected Defaults* (left scale) Bond Default Rate** (right scale) 950 120 6 1.5 5 750 4 1.0 80 3 550 40 350 0 Sep 0.5 1 150 0.0 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. *Measured relative to an estimated off-the-run Treasury yield curve. 2 0 1999 2000 2001 2002 2003 2004 2005 *Firm-level estimates of year-ahead defaults from KMV corporation, weighted by firm liabilities as a percent of total liabilities, excluding defaulted firms. **Six-month moving average, from Moody’s Investors Service Note: Vertical lines indicate September 19, 2005. Last daily observations are for October 27, 2005. Class I FOMC - Restricted Controlled (FR) Page 5 of 36 been concerned about the cautious tone to corporate guidance about future earnings growth. Implied volatilities from equity options remained low but edged up a bit over the period in response to several announcements of corporate distress, including the sudden collapse of Refco, the bankruptcy filings by Delphi, Delta Airlines, and Northwest Airlines, and the announcement of an SEC investigation into the pension practices of General Motors (more details about the bankruptcies are provided in the box “Credit Market Developments”). The timing of some of the bankruptcy filings may have been related to the implementation of new bankruptcy rules in October. As a result of the problems at these firms, the number of downgrades of corporate bonds increased, as did the aggregate bond default rate. However, corporate quality outside of the automobile and airline sectors remained solid. Broad indexes of investmentand speculative-grade corporate bond yields moved largely in line with Treasury yields over the period, leaving spreads little changed. (4) The dollar’s foreign exchange value against major currencies rose about ¾ percent on balance over the intermeeting period (Chart 3).5 Somewhat strongerthan-expected U.S. economic data and the expressed resolve of U.S. officials to combat inflationary pressures reportedly supported the dollar. A number of foreign central bankers conveyed similar determination, heightening expectations of monetary policy tightening abroad. In Canada, the Bank of Canada raised its policy rate another 25 basis points in mid-October, citing inflation concerns. In most major industrial economies, yields on foreign long-term government securities rose a bit less than in the United States. The dollar was little changed against the Canadian dollar and the euro, but gained 1¼ percent against sterling and almost 3¼ percent against the yen. Although recent Japanese data have been somewhat softer than during the first half of the year, that economy apparently advanced further. Bank of Japan officials have 5 Class I FOMC - Restricted Controlled (FR) Page 6 of 36 Credit Market Developments Four high-profile companies—Refco, Delphi, and Delta and Northwest Airlines— filed for Chapter 11 bankruptcy protection in the last six weeks; corporate bonds with par value totaling slightly more than $8 billion were affected by these filings. Refco, a large derivatives broker, collapsed when clients deserted the firm following the revelation of accounting irregularities just two months after its initial public offering. Delphi, the largest U.S. automobile parts manufacturer, cited its inability to reach cost-cutting agreements with unions and with General Motors—from which it spun off in 1999—as reasons for its filing. Competition from low-cost carriers and soaring fuel prices were instrumental in the airlines’ defaults. Some of these firms may have filed for bankruptcy more quickly than they otherwise would have in order to avoid the corporate provisions of the new bankruptcy law, which took effect on October 17. Delphi’s bankruptcy filing rekindled investors’ concerns about credit quality in the automobile sector—where spreads on several firms, including Ford and General Motors, initially rose sharply and have since remained volatile. The airlines’ defaults, however, elicited little reaction, as they were largely expected. Refco’s collapse had no discernible effect on financial market functioning, as its wind-down was orderly and its accounting troubles were seen as isolated. Overall, the impact of the bankruptcies on the broad credit market appears to have been limited. In a sign that investors expect little spillover from the recent defaults, a measure of the likelihood that future defaults in the investment-grade sector will be clustered—the so-called implied default correlation obtained from CDS index tranches—has remained extremely low. The equivalent measure for the speculative-grade sector has picked up, but that increase reflects in part the considerable presence of automobile-sector firms in the high-yield CDS index. Even with the recent increase, investors apparently still judge the likelihood of correlated defaults among speculative-grade firms to be lower than it was last spring. Class I FOMC - Restricted Controlled (FR) Page 7 of 36 Chart 3 International Financial Indicators Nominal Trade-Weighted Dollar Indexes Ten-Year Government Bond Yields Index(12/31/03=100) Daily 112 6.0 FOMC Broad Major Currencies Other Important Trading Partners Percent Daily UK (left scale) Germany (left scale) Japan (right scale) 110 5.5 2.5 108 106 5.0 2.0 104 102 3.0 FOMC 4.5 1.5 100 4.0 98 96 1.0 3.5 94 0.5 3.0 92 90 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. 2.5 0.0 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. EMBI+ Index Stock Price Indexes Index(12/31/03=100) Daily 145 FOMC Basis Points Daily 140 FOMC Overall Brazil 1000 900 135 800 130 UK (FTSE-350) Euro Area (DJ Euro) Japan (Topix) 125 700 120 600 115 500 110 105 400 100 300 95 90 Jan. Apr. July 2004 Oct. Jan. Apr. July 2005 Oct. 200 Jan. Apr. July 2004 Oct. Note: Vertical lines indicate September 20, 2005. Last daily observations are for October 27, 2005. Jan. Apr. July 2005 Oct. Class I FOMC - Restricted Controlled (FR) Page 8 of 36 continued to hint that, given their economic outlook, the quantitative easing regime will likely end during the first half of next year. Share prices in Japan made solid gains during the intermeeting period, led by banking and other financial-sector stocks that reacted positively to passage of the postal reform bill. Stock prices in other foreign industrial countries recorded declines of 2 to 7 percent, broadly similar to those in U.S. markets. (5) The dollar recorded a small gain against an index of currencies of our other important trading partners over the intermeeting period. The dollar moved up ¾ percent against the peso, as the Bank of Mexico eased its overnight lending rate 25 basis points for the second time in recent months. The dollar continued on its downward trend against the Brazilian real, and the Brazilian central bank surprised markets with a 50 basis point easing of its policy rate to counter weakening domestic demand. Equity prices in many emerging market countries dropped fairly sharply, as investor demand for riskier assets appeared to abate with increases in U.S. interest rates. (6) Domestic nonfinancial debt is estimated to have advanced briskly in the third quarter, rising 8¼ percent on net (Chart 4). Growth in household debt appears to have edged down in the third quarter owing to a slowing in mortgage debt growth, although the forecast of the latter remains at an elevated level. Household bankruptcies surged in the weeks immediately before bankruptcy reforms went into effect on October 17. The debt of nonfinancial businesses appears to have risen in the third quarter at a rate comparable to increases seen in the first half of the year. In October, bond issuance has slowed as higher yields may have discouraged new longerterm issues. Commercial paper, which ran off at quarter-end, bounced back in early October. Bank loans to businesses continued to advance briskly, and the results of the most recent Senior Loan Officer Opinion Survey show some further easing of lending terms and standards for such loans. Class I FOMC - Restricted Controlled (FR) Page 9 of 36 Chart 4 Debt and Money Growth of Household Debt Growth of Nonfinancial Debt Percent Percent, s.a.a.r. Total _____ 8.1 7.6 Q1 Q2 Q3 Q4 9.3 7.2 8.5 8.1 2005 8.6 6.8 9.0 8.4 Q1 Q2 Q3 9.7 7.3 8.2 18 Nonfederal __________ 8.7 9.0 8.9 2003 2004 21 Quarterly, s.a.a.r. p Consumer Credit 15 12 Q3p 9 6 Home Mortgage Q3p 3 0 -3 p Projected. 1991 1993 1995 1997 1999 2001 2003 2005 p Projected. Household Bankruptcies Thousands of filings Weekly, n.s.a. Changes in Selected Components of Nonfinancial Business Debt 600 Monthly rate 550 500 450 $Billions C&I Loans Commercial Paper Bonds Sum 50 40 400 350 300 30 e 20 250 200 150 100 2003 2004 2005 10 0 50 0 Oct.24 60 -10 -20 2003 2006 2004 Q1 Q2 Q3 Oct 2005 Note. Commercial paper and C&I loans are seasonally adjusted, bonds are not. *Source. Visa Bankruptcy Notification Service. e Estimated. M2 Velocity and Opportunity Cost Growth of M2 Percent s.a.a.r. 10 8.00 Percent Velocity 2.3 Quarterly 8 Opportunity Cost* (left axis) 4.00 2.2 6 4 Q3 2.00 2.1 2.0 2 0 1.00 Velocity (right axis) Q3p 1.9 0.50 -2 1.8 0.25 -4 2003 2004 Q1 Q2 2005 Q3 1993 1995 1997 *Two-quarter moving average. p Projected. 1999 2001 2003 2005 Class I FOMC - Restricted Controlled (FR) (7) Page 10 of 36 M2 expanded at an annual rate of 6 percent in September, bringing third- quarter growth to 4 percent. The increase in September was in part attributable to a surge in retail money market funds and to a boost to currency and liquid deposits resulting from Hurricane Katrina.6 Growth in nominal output in the third quarter likely exceeded that of M2, implying a further rise in velocity. Through September, the Federal Emergency Management Agency had paid out about $2 billion in the Gulf region, and insurance transfers are estimated to have been about $1 billion, a portion of which will likely rest in liquid deposits for a time. The staff assumes that by year-end, FEMA will have paid out about $6.5 billion and insurance companies will have delivered nearly $9.5 billion as a result of the hurricanes. 6 Class I FOMC - Restricted Controlled (FR) Page 11 of 36 Economic Outlook (8) The staff has revised down slightly its projection for real GDP growth since the September Greenbook, as the rise in longer-term yields, drop in equity values, and appreciation of the exchange value of the dollar over the intermeeting period established a launching-off point for the forecast consistent with more financial restraint than in the previous projection. The outlook is predicated on the same cumulative amount of policy tightening, which brings the federal funds rate to 4¼ percent, but is now based on an assumption that the process of firming will be completed this year, rather than in the middle of next year. At the time of the September meeting, market participants had foreseen a little less tightening than the staff; now they foresee somewhat more. As a result, bond yields are forecast to decline slightly as investors’ expectations for policy gradually come into line with the lower path in the staff outlook. As in previous forecasts, the stock market generates risk-adjusted returns similar to those on fixed-income investments, while the foreign exchange value of the dollar depreciates modestly. In the context of these financial conditions and the impetus to spending from a burst of rebuilding in the Gulf region, GDP grows a little faster than the 3 percent expansion of potential output next year and a little slower than that pace in 2007. The unemployment rate in 2007 edges slightly above the estimated NAIRU of 5 percent and the output gap widens a bit to almost ½ percent. Core PCE inflation picks up to 2¼ percent next year, in light of some pass-through to inflation expectations of recently elevated headline inflation. However, falling energy prices help bring overall PCE inflation down from 3¼ percent this year to 2 percent in 2006 and 1¾ percent in 2007 and, along with a little economic slack, pull core inflation below 2 percent in 2007. Class I FOMC - Restricted Controlled (FR) Page 12 of 36 Policy Alternatives (9) This Bluebook presents three policy alternatives for the Committee’s consideration, summarized by the draft statements in Table 1. Under Alternative A, the Committee would leave its target for the federal funds rate unchanged at 3¾ percent at this meeting; the statement emphasizes uncertainties surrounding the economic dislocations of the hurricanes and associated effects on consumer and business confidence, but still signals that remaining monetary policy accommodation could likely be removed at a measured pace. Under Alternatives B and C, the Committee would raise the target federal funds rate 25 basis points. Alternative B retains much of the statement the Committee issued after its September meeting, including the characterization that policy remains accommodative. Alternative C takes a somewhat more aggressive tone and eliminates the balance-of-risks, accommodative, and measured pace language.7 (10) Although core inflation readings have been favorable in recent months, Committee members may be concerned that, in light of some signs of sharply higher near-term inflation expectations and reports of greater pricing power, elevated energy and other costs threaten to pass through significantly to core price inflation. If the Committee believes that a continued measured pace of policy firming will prove sufficient to contain these inflationary pressures, it might be inclined to raise the target funds rate another 25 basis points at this meeting and choose language as in Alternative B. As seen in Chart 5, a 25 basis point increase in the target funds rate would move the real funds rate into the range of rates estimated by the staff to be broadly consistent with closing the output gap over the next few years. However, the The box “Other Language Alternatives” at the end of this section considers other possible modifications to the language. Given the wholesale changes proposed in the third row of Table 1, we have not followed the usual practice of striking out deletions and bolding insertions relative to the prior statement. 7 Class I FOMC - Restricted Controlled (FR) Page 13 of 36 Table 1: Alternative Language for the November FOMC Announcement September FOMC Policy Decision Rationale Alternative A Alternative B Alternative C 1. The Federal Open Market Committee decided The Federal Open Market Committee decided today to leave its target for the federal funds rate unchanged. Elevated energy prices and hurricane-related disruptions in economic activity seem to have slowed the growth of spending, set back employment, and weakened consumer and business confidence. The persistence of such effects is uncertain, but robust underlying growth of productivity and monetary policy accommodation are providing support to economic activity. The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4 percent. Elevated energy prices and hurricane-related disruptions in economic activity seem to have temporarily slowed the growth of spending and set back employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Spending will also be boosted by rebuilding efforts in hurricaneaffected areas. The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4 percent. The disruptive effects of recent hurricanes seem likely to be temporary, especially in light of increased spending associated with rebuilding efforts. Economic growth continues to be supported by robust underlying growth in productivity. High energy and other costs have added to inflation pressures. However, core inflation has been relatively low in recent months, and longer-term inflation expectations remain contained. The cumulative rise in energy and other costs has added to inflation pressures. However, core inflation has been relatively low in recent months, and longer-term inflation expectations remain contained. Core inflation and longer-term inflation expectations remain contained. However, high energy and other costs have boosted near-term inflation expectations and price pressures, likely making further policy firming necessary. today to raise its target for the federal funds rate by 25 basis points to 3¾ percent. 2. Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility. While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. 3. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months, and longer-term inflation expectations remain contained. 4. The Committee perceives that, with Assessment of Risk appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. 5. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability. [no change] With underlying inflation expected to be contained, the Committee believes that remaining policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability. [no change] [none] [no change] [none] Class I FOMC - Restricted Controlled (FR) Page 14 of 36 Chart 5 Equilibrium Real Federal Funds Rate Short-Run Estimates with Confidence Bands Percent 8 Actual real federal funds rate Range of model-based estimates 70 percent confidence band 90 percent confidence band Greenbook-consistent measure 7 6 5 4 3 50 b.p. Tightening 25 b.p. Tightening Current Rate 2 1 0 -1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Notes: The actual real federal funds rate is constructed as the difference between the quarterly average of the observed nominal funds rate and the log difference of the core PCE price index over the previous four quarters. For the current quarter, the nominal funds rate used is the target federal funds rate as of the Bluebook publication date. Short-Run and Medium-Run Measures Current Estimate Previous Bluebook 1.9 2.4 2.3 1.9 2.3 1.9 Short-Run Measures Single-equation model Small structural model Large model (FRB/US) Confidence intervals for three model-based estimates 70 percent confidence interval 90 percent confidence interval Greenbook-consistent measure (0.7 - 3.6( -0.2 - 4.5( 2.0 1.9 2.1 2.4 2.2 2.3 Medium-Run Measures Single-equation model Small structural model Confidence intervals for two model-based estimates 70 percent confidence interval 90 percent confidence interval TIPS-based factor model (1.4 - 3.2( (0.7 - 3.7( 2.1 2.0 1.85 1.59 Memo Actual real federal funds rate Notes: Confidence intervals and bands reflect uncertainties about model specification, coefficients, and the level of potential output. The final column indicates the values for the current quarter based on the estimation for the previous Bluebook, except that the TIPS-consistent measure and the actual real funds rate are the values published in the previous Bluebook. -2 Class I FOMC - Restricted Controlled (FR) Page 15 of 36 Equilibrium Real Rate Chart: Explanatory Notes The equilibrium real rate is the real federal funds rate that, if maintained, would be projected to return output to its potential level over time. For the first three measures listed below, the short-run equilibrium rate is defined as the rate that would close the output gap in twelve quarters given the corresponding model’s projection of the economy. For the first two measures, the medium-run concept is the value of the real funds rate projected to keep output at potential in seven years under the assumption that monetary policy acts to bring actual and potential output into line in the short run and then keep them equal thereafter. The TIPS-based factor model measure provides an estimate of market expectations for the real federal funds rate seven years ahead. The actual real federal funds rate shown in the chart employs the log difference of the core PCE price index over the previous four quarters as a proxy for expected inflation, with the staff projection used for the current quarter. Measure Description Single-Equation Model The measure of the equilibrium real rate in the single-equation model is based on an estimated aggregate-demand relationship between the current value of the output gap and its lagged values as well as the lagged values of the real federal funds rate. In light of this model’s simple structure, the short-run measure of the equilibrium real rate depends only on the recent position of output relative to potential, and the medium-run measure is virtually constant. Small Structural The small-scale model of the economy consists of equations for five variables: the output gap, the equity premium, the federal budget surplus, the trend growth rate of output, and Model the real bond yield. Unlike the estimates from the single-equation model, values of the equilibrium real rate also depend directly on conditions associated with output growth, fiscal policy, and capital markets. Large Model (FRB/US) Estimates of the equilibrium real rate using FRB/US—the staff’s large-scale econometric model of the U.S. economy—depend on a very broad array of economic factors, some of which take the form of projected values of the model’s exogenous variables. These projections make use of several simple forecasting rules which are appropriate for the three-year horizon relevant for the short-run concept but are less sensible over longer horizons. Thus, we report only the short-run measure for the FRB/US model. Greenbookconsistent Measures of the equilibrium real rate cannot be directly obtained from the Greenbook forecast, because the Greenbook is not based on a formal model. Rather, we use the FRB/US model in conjunction with an extended version of the Greenbook forecast to derive a Greenbook-consistent measure. FRB/US is first add-factored so that its simulation matches the extended Greenbook forecast, and then a second simulation is run off this baseline to determine the value of the real federal funds rate that closes the output gap. The medium-run concept of the equilibrium real rate is not computed because it requires a relatively long extension of the Greenbook forecast. TIPS-based Factor Model Yields on TIPS (Treasury Inflation-Protected Securities) reflect investors’ expectations of the future path of real interest rates, but also include term and liquidity premiums. The TIPS-based measure of the equilibrium real rate is constructed using the seven-year-ahead instantaneous real forward rate derived from TIPS yields as of the Bluebook publication date. This forward rate is adjusted to remove estimates of the term and liquidity premiums based on a three-factor arbitrage-free term-structure model applied to TIPS yields, nominal yields, and inflation. Because TIPS indexation is based on the total CPI, this measure is also adjusted for the medium-term difference—projected at 40 basis points—between total CPI inflation and core PCE inflation. Class I FOMC - Restricted Controlled (FR) Page 16 of 36 Committee may believe that higher real interest rates and a bit more resource slack will be required to contain inflation, making it appropriate to issue a statement suggesting that more tightening is likely in store. Such a policy course might also be favored if the Committee viewed the current rate of core inflation to be at or above the upper limit of a range consistent with price stability. With most measures of labor compensation posting moderate gains and some reversal of the runup in energy prices in prospect, members may believe that remaining firming can be done gradually, consistent with the measured pace language of Alternative B. While a policy hike at this meeting would place the funds rate at the high end of the prescriptions of several policy rules that are based on a 1½ percent objective for core PCE inflation, that is only a matter of timing because those rules indicate a need for an even higher funds rate by mid-2006 (Chart 6). (11) The Committee may wish to begin the rationale portion of the statement for Alternative B by reaffirming the view that adverse effects of the hurricanes will probably slow the pace of the expansion only temporarily. Robust underlying growth in productivity may still be seen as a support for economic activity. The statement could also note the boost to aggregate demand from increased private and public spending associated with rebuilding efforts in hurricane-affected areas. While a 25 basis point move would place the funds rate at about the midpoint of the staff's range of estimated equilibrium rates, the Committee may still prefer to characterize policy as accommodative in light of the underlying strength of demand and upward pressures on inflation. As for inflation, the Committee could cite indications, evident in some producer prices and in surveys of near-term inflation expectations, that “The cumulative rise in energy and other costs has added to inflation pressures,” while still noting that “core inflation has been relatively low in recent months.” The observation that “longer-term inflation expectations remain contained” may be seen as appropriate to convey a balanced view of the inflation outlook. Class I FOMC - Restricted Controlled (FR) Page 17 of 36 Chart 6 Actual and Assumed Federal Funds Rate and Range of Values from Policy Rules and Futures Markets Percent 10 10 Actual federal funds rate and Greenbook assumption Market expectations estimated from futures quotes Shaded region is the range of values from rules 1a, 2a, 4, 5, and 6 below 8 8 6 6 4 4 2 2 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Values of the Federal Funds Rate from Policy Rules and Futures Markets 2005 2006 Q3 Q4 Q1 Q2 Q3 4.22 3.97 4.07 3.82 3.48 3.23 3.88 3.63 3.63 3.38 4.08 3.83 3.99 3.74 3.85 3.60 4.59 4.09 4.30 4.05 4.23 3.98 4.92 4.17 4.62 4.37 4.53 4.28 5.10 4.10 3.43 3.38 2.79 3.29 3.65 3.78 3.24 3.92 3.79 3.91 3.68 4.02 3.92 3.61 4.25 3.85 3.54 3.46 3.97 3.95 4.35 4.25 4.55 4.25 4.58 4.25 Rules with Imposed Coefficients 1. Baseline Taylor Rule: a) π*=1.5 1. Baseline Taylor Rule: b) π*=2 2. Aggressive Taylor Rule: a) π*=1.5 3. First-difference Rule: b) π*=2 3. First-difference Rule: a) π*=1.5 3. First-difference Rule: b) π*=2 Rules with Estimated Coefficients 4. Outcome-based Rule 5. Greenbook Forecast-based Rule 6. FOMC Forecast-based Rule 7. TIPS-based Rule Memo Expected federal funds rate derived from futures Actual federal funds rate and Greenbook assumption Note: Rule prescriptions for 2005Q4 through 2006Q3 are calculated using current Greenbook projections for inflation and the output gap (or unemployment gap). For rules that contain the lagged funds rate, the rule’s previous prescription for the funds rate is used to compute prescriptions for 2006Q1 through 2006Q3. It is assumed that there is no feedback from the rule prescriptions to the Greenbook projections through 2006Q3. The TIPS-based rule is computed using average TIPS and nominal Treasury yields to date. 0 Class I FOMC - Restricted Controlled (FR) Page 18 of 36 Policy Rules Chart: Explanatory Notes In all of the rules below, it denotes the federal funds rate, πt the staff estimate at date t of trailing fourquarter core PCE inflation, (yt – yt*) the staff estimate (at date t) of the output gap, π* policymakers’ long-run objective for inflation, it-1 the lagged federal funds rate, gt-1 the residual from the rule’s prescription the previous quarter, (yt+3|t – yt+3|t*) the staff’s three-quarter-ahead forecast of the output gap, (Δ yt+3|t – Δyt+3|t*) the staff’s forecast of output growth less potential output growth three quarters ahead, πt+3|t a three-quarter-ahead forecast of inflation, and (ut+3|t – ut+3|t*) a three-quarter-ahead forecast of the unemployment gap. Data are quarterly averages taken from the Greenbook and staff memoranda closest to the middle of each quarter, unless otherwise noted. Rule Specification Root-meansquare error 1988:12005:3 2001:12005:3 Rules with Imposed Coefficients 1. Baseline Taylor Rule it = 2 + πt + 0.5(yt – yt*) + 0.5(πt – π*) .96a 1.04a 2. Aggressive Taylor Rule it = 2 + πt + (yt – yt*) + 0.5(πt – π*) .67a .62a 3. First-difference Rule it = it-1 + 0.5(Δ yt+3|t – Δ yt+3|t*) .96a .40a .23 .25 .25 .27 .47 .64 .40b .41 + 0.5(πt+3|t – π*) Rules with Estimated Coefficients 4. Estimated Outcome-based Rule Rule includes both lagged interest rate and serial correlation in residual. it = .51it-1 + 0.49 [1.29 + 0.95(yt – yt*) 5. Estimated Greenbook Forecast-based Rule Rule includes both lagged interest rate and serial correlation in residual. it = .71it-1 + 0.29 [0.75 6. Estimated FOMC Forecast-based Rule Unemployment and inflation forecasts are from semiannual “central tendency” of FOMC forecasts, interpolated if necessary to yield 3qtr-ahead values; ut* forecast is from staff memoranda. Inflation forecasts are adjusted to core PCE deflator basis. Rule is estimated at semiannual frequency, and projected forward using Greenbook forecasts. + 1.45πt]+ 0.53gt-1 + 1.03(yt+3|t – yt+3|t*) + 1.59πt+3|t] + 0.38gt-1 it = 0.48it-2 + 0.52 [0.43 – 2.09(ut+3|t – ut+3|t*) + 1.56πt+3|t] 7. Estimated TIPS-based Rule πcomp5|t denotes the time-t difference between 5-yr nominal Treasury yields and TIPS. it = 0.97it-1+ [–1.27 + 0.70πcomp5|t] Sample begins in 1999 due to TIPS volatility in 1997-8. a RMSE for rules with imposed coefficients is calculated setting π* = 1.5. b RMSE for TIPS-based rule is calculated for 1999:1-2005:3. Class I FOMC - Restricted Controlled (FR) (12) Page 19 of 36 Futures market quotes suggest that investors are virtually certain of a 25 basis point firming of policy at this meeting, and surveys reveal that primary dealers expect little change in the nature of the statement. Therefore, market prices would likely be essentially unaffected by a 25 basis point increase in the funds rate and the statement language as under Alternative B. (13) If the Committee wished to convey greater concern about upside risks to inflation, it might prefer to combine a 25 basis point increase in the target funds rate with the language included under Alternative C. The Committee may especially favor this alternative if increases in energy and other costs were viewed as beginning to unmoor inflation expectations, potentially starting an upward shift in inflation dynamics that would be hard to reverse later. Even if inflation expectations remain well anchored for a time, a sharper rebound in spending growth as rebuilding in the hurricane-affected areas picks up steam may put excessive strains on resources. The proposed statement drops the characterization of policy as accommodative, but it indicates in the comments on inflation (row 3) that further policy firming likely is necessary on the thought that the Committee might soon envision moving the real funds rate past its neutral level—that is, to impose policy restraint. The sentence on the balance of risks is also eliminated; the Committee might see that formula as redundant or possibly misleading about the extent of upside inflation risks at present. The final paragraph on the measured pace language is also dropped, allowing greater flexibility for possible future adjustments of policy. The Committee may see this more forceful tone as warranted in light of the backup in market interest rates, increase in inflation compensation, and depreciation of the dollar in recent days, which might be viewed as signs of the emergence of inflation jitters in financial markets. Indeed, the Committee may prefer to raise the target funds rate 50 basis points at this meeting in association with language similar to that under Alternative C to underscore its determination to resist an increase in inflation. Class I FOMC - Restricted Controlled (FR) (14) Page 20 of 36 Market participants would be surprised by the removal of the measured pace and policy accommodation language and, perhaps, by the explicit indication that additional firming was likely to be necessary. With a 25 basis point move and the language proposed under Alternative C, short-term interest rates and the exchange value of the dollar would likely rise, while stock prices would fall. If markets revised down their outlook for longer-term inflation as a result of the statement, however, longer-term interest rates might increase only a little. With a 50 basis point firming, market participants would likely raise their sense of inflation risks and the near-term path of expected monetary policy substantially; short- and intermediate-term market interest rates would jump, the dollar would rally, and the stock market could sell off sharply. (15) Committee members may wish to consider Alternative A if they think that the recent moderate rates of core inflation are likely to continue and if they see the outlook for the economy as especially uncertain because of the effects of the hurricanes and elevated energy prices. Particularly if the Committee, like the staff, views the real federal funds rate as in the vicinity of its equilibrium level, a pause in policy firming might be seen as desirable, partly to await further readings on consumer and business sentiment and spending. Such a pause may also be chosen if members believe that the real estate market is in the process of softening, which heretofore has been an important spur to household spending. Under this alternative, the Committee might refer to “remaining” policy accommodation in the final risk assessment paragraph. Markets would be surprised at the decision to leave the target funds rate unchanged. Short-term interest rates would probably decline considerably as markets lowered the probability of near-term tightening moves. Longer-term interest rates might be little changed or even back up if investors saw the FOMC as more tolerant than they expected of an increase in inflation. The foreign exchange value of the dollar would likely fall, especially if inflation expectations deteriorated. Class I FOMC - Restricted Controlled (FR) Page 21 of 36 Other Language Alternatives Committee members have recognized for some time that certain features of its policy statement would not prove durable, not the least being its characterization of policy as accommodative and its prediction that this accommodation can be removed at a pace that is likely to be measured. The assessment that policy is accommodative becomes increasingly problematic as the real federal funds rate enters the range of plausible estimates of its equilibrium level. Moreover, the Committee may feel it necessary to move the real funds rate beyond its neutral level to unwind inflationary pressures or to roll back some of the rise in inflation over the past couple of years. In doing so, the Committee might be reluctant to switch its characterization of policy from accommodative to contractionary. Two alternatives might be considered. For one, if it is important to convey the sense that policy action will remain gradual, the statement could replace the description of the stance of policy with words describing the direction of its likely future action. In particular, the key portion of row 5 could read: ". . . the Committee believes that policy firming can continue at a pace that is likely to be measured." (16) For another, the Committee could drop rows 4 and 5 in favor of a formula for its risk assessment. One such formula, for example, was proposed in a box in the September Bluebook. In that structure, the Committee would provide separate assessments of the risks to its two goals under the explicit assumption that the stance of policy remains unchanged for the next few quarters. Money and Debt Forecasts (17) Under the staff forecast, M2 is expected to expand 3¾ percent this year, almost 2½ percentage points slower than nominal GDP, owing to rising opportunity costs (Table 2). With short-term market rates assumed to be unchanged in 2006 and 2007, deposit rates should gradually catch up, partially unwinding the recent sharp increases in the opportunity cost of money holding. As a consequence, M2 is projected to accelerate to a 4½ percent pace next year and 5 percent in 2007, a little below and above the growth rates of nominal GDP, respectively. Domestic Class I FOMC - Restricted Controlled (FR) Page 22 of 36 Table 2 Alternative Growth Rates for M2 (percent, annual rate) No Change Monthly Growth Rates Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 2005 Q1 2005 Q2 2005 Q3 2005 Q4 2006 Q1 2005 2006 M2 25 bp Increase 50 bp Increase M2 Greenbook Path 6.1 6.9 3.2 4.0 4.9 6.1 6.0 4.0 1.7 3.9 5.4 4.9 3.8 5.3 6.1 6.9 3.0 3.4 4.1 5.3 5.4 4.0 1.7 3.9 5.3 4.3 3.8 4.9 6.1 6.9 2.8 2.8 3.3 4.5 4.8 4.0 1.7 3.9 5.2 3.6 3.7 4.5 6.1 6.9 3.0 3.2 3.5 4.5 4.7 4.0 1.7 3.9 5.3 3.7 3.8 4.5 Growth From 2004 Q4 2004 Q4 To Sep-05 Oct-05 3.5 3.8 3.5 3.8 3.5 3.8 3.5 3.8 Dec-04 Oct-05 Oct-05 Mar-06 3.6 4.9 3.6 4.3 3.6 3.7 3.6 3.8 * This forecast is consistent with nominal GDP and interest rates in the Greenbook forecast. Class I FOMC - Restricted Controlled (FR) Page 23 of 36 nonfinancial sector debt is expected to grow around 8¼ percent this year and then decelerate to a 6½ percent pace in 2007. Less rapid home price appreciation tempers mortgage borrowing by households, and business debt growth slows with the deceleration of economic activity. Class I FOMC - Restricted Controlled (FR) Page 24 of 36 Directive and Balance-of-Risks Statement (18) Draft language for the directive and draft risk assessments identical to those presented in Table 1 are provided below. Directive Wording The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with MAINTAINING/increasing/REDUCING the federal funds rate AT/to an average of around ____________ 3¾ percent. Risk Assessments A. The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that remaining policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability. B. The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to Class I FOMC - Restricted Controlled (FR) changes in economic prospects as needed to fulfill its obligation to maintain price stability. C. None. Page 25 of 36 Class I FOMC - Restricted Controlled (FR) Page 26 of 36 Appendix Chart 1 Treasury Yield Curve Spread Between Ten−year Treasury Yield and Federal Funds Rate Percentage Points 4 Quarterly 2 + 0 −2 −4 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 + Denotes most recent weekly value. Note. Blue shaded regions denote NBER−dated recessions. Treasury Yield Curve* Percent 6.0 October 27, 2005 September 19, 2005 5.5 5.0 4.5 4.0 3.5 3.0 1 3 5 7 10 20 Maturity in Years *Smoothed yield curve estimated from off−the−run Treasury coupon securities. Yields shown are those on notional par Treasury securities with semi−annual coupons. Class I FOMC - Restricted Controlled (FR) Page 27 of 36 Appendix Chart 2 Dollar Exchange Rate Indexes Nominal Ratio Scale March 1973=100 150 Monthly 140 130 120 Major Currencies 110 100 90 + 80 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 + Denotes most recent weekly value. Ratio Scale March 1973=100 Real 140 Monthly 130 120 Other Important 110 100 Broad 90 Major Currencies 80 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 Note. The major currencies index is the trade−weighted average of currencies of the Euro area, Canada, Japan, the U.K., Switzerland, Australia, and Sweden. The other important trading partners index is the trade−weighted average of currencies of 19 other important trading partners. The Broad index is the trade−weighted average of currencies of all important trading partners. Real indexes have been adjusted for relative changes in U.S. and foreign consumer prices. Blue shaded regions denote NBER−dated recessions. Class I FOMC - Restricted Controlled (FR) Page 28 of 36 Appendix Chart 3 Stock Indexes Nominal Ratio Scale 1941−43=10 Ratio 45 2000 Monthly 1500 40 + S&P 500 1000 35 30 500 25 P/E Ratio* 20 + 15 10 5 0 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 * Based on trailing four−quarter earnings. + Denotes most recent weekly value. Real Ratio Scale 1941−43=10 160 140 Monthly 120 + 100 80 60 S&P 500* 40 20 1960 1963 1966 1969 1972 1975 1978 1981 * Deflated by the CPI. + Denotes most recent weekly value. Note. Blue shaded regions denote NBER−dated recessions. 1984 1987 1990 1993 1996 1999 2002 2005 Class I FOMC - Restricted Controlled (FR) Page 29 of 36 Appendix Chart 4 One−Year Real Interest Rates One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Michigan Survey)* Percent 8 Monthly 4 0 + −4 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 * Mean value of respondents. One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Philadelphia Fed)* Percent 8 Monthly GDP Deflator 4 + CPI 0 −4 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 * ASA/NBER quarterly survey until 1990:Q1; Philadelphia Federal Reserve Bank Survey of Professional Forecasters thereafter. Median value of respondents. One−Year Treasury Constant Maturity Yield Less Change in the Core CPI from Three Months Prior Percent 8 Monthly 4 + 0 −4 1985 1987 1989 1991 1993 1995 1997 1999 2001 + Denotes most recent weekly Treasury constant maturity yield less most recent inflation expectation. Note. Blue shaded regions denote NBER−dated recessions. 2003 2005 Class I FOMC - Restricted Controlled (FR) Page 30 of 36 Appendix Chart 5 Long−Term Real Interest Rates* Real Ten−Year Treasury Yields Percent 10 Monthly 8 Real rate using Philadelphia Fed Survey 6 Ten−year TIPS yield 4 + Real rate using Michigan Survey 2 + 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Nominal and Real Corporate Bond Rates Percent 14 Monthly 12 Nominal rate on Moody’s A−rated corporate bonds 10 8 Real rate using Philadelphia Fed Survey + 6 4 Real rate using Michigan Survey + + 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 * For real rates, measures using the Philadelphia Fed Survey employ the ten−year inflation expectations from the Blue Chip Survey until April 1991 and the Philadelphia Federal Reserve Bank Survey of Professional Forecasters thereafter (median value of respondents). Measures using the Michigan Survey employ the five− to ten−year inflation expectations from that survey (mean value of respondents). + For TIPS and nominal corporate rate, denotes the most recent weekly value. For other real rate series, denotes the most recent weekly nominal yield less the most recent inflation expectation. Note. Blue shaded regions denote NBER−dated recessions. 2 Class I FOMC - Restricted Controlled (FR) Page 31 of 36 Appendix Chart 6 Commodity Price Measures Journal of Commerce Index Ratio scale, index (1980=100) 140 130 120 Weekly 110 Metals 100 Total 90 80 70 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 CRB Spot Industrials Ratio scale, index (1967=100) 380 360 340 320 Weekly 300 280 260 240 220 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 CRB Futures Ratio scale, index (1967=100) 350 Weekly 300 250 200 1985 1987 1989 1991 1993 1995 Note. Blue shaded regions denote NBER−dated recessions. 1997 1999 2001 2003 2005 Class I FOMC - Restricted Controlled (FR) Page 32 of 36 Appendix Chart 7 Growth of Real M2 and M3 M2 Percent 10 Quarterly 5 0 −5 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 M3 Percent 15 Quarterly 10 5 0 −5 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Note. Four−quarter moving average deflated by the CPI. Blue shaded regions denote NBER−dated recessions. Gray areas denote projection period. Class I FOMC - Restricted Controlled (FR) Page 33 of 36 Appendix Chart 8 Inflation Indicator Based on M2 Price Level Ratio Scale 140 Quarterly 120 100 Implicit GDP price deflator (P) 80 Long-run equilibrium price level (P*) 60 40 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 Inflation 1 2004 Percent 12 Quarterly 10 8 6 4 2 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 1. Change in the implicit GDP price deflator over the previous four quarters. Note: P* is defined to equal M2 times V* divided by potential GDP. V*, or long-run velocity, is estimated using average velocity over the 1959:Q1-to-1989:Q4 period and then, after a break, over the interval from 1993:Q1 to the present. For the forecast period, P* is based on the staff M2 forecast and P is simulated using a short-run dynamic model relating P to P*. Blue areas indicate periods in which P* is notably less than P. Gray areas denote the projection period. Appendix Table 1 Class I FOMC - Restricted Controlled (FR) Page 34 of 36 Selected Interest Rates (Percent) Short-term Treasury bills secondary market Federal funds Long-term CDs secondary market Comm. paper Off-the-run Treasury yields Indexed yields Moody’s Baa Municipal Bond Buyer Conventional home mortgages primary market 4-week 1 3-month 6-month 3-month 1-month 2-year 5-year 10-year 20-year 5-year 10-year Fixed-rate ARM 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 04 -- High -- Low 2.34 0.92 2.08 0.73 2.28 0.87 2.63 0.96 2.51 1.04 2.29 0.97 3.13 1.49 4.10 2.65 5.03 3.84 5.64 4.68 1.57 0.40 2.28 1.38 6.90 6.00 5.45 4.73 6.34 5.38 4.27 3.36 05 -- High -- Low Monthly Oct 04 Nov 04 Dec 04 3.93 2.19 3.71 1.86 3.93 2.31 4.21 2.63 4.20 2.50 3.98 2.24 4.43 3.11 4.48 3.58 4.73 3.97 5.04 4.28 1.85 0.98 2.05 1.50 6.44 5.64 5.13 4.72 6.15 5.53 4.91 4.10 1.76 1.93 2.16 1.62 1.91 1.95 1.79 2.11 2.23 2.05 2.33 2.50 2.04 2.26 2.45 1.79 2.01 2.22 2.57 2.86 3.02 3.35 3.52 3.59 4.24 4.32 4.34 4.92 4.95 4.94 1.00 0.93 0.97 1.76 1.68 1.65 6.21 6.20 6.15 4.99 5.06 5.03 5.72 5.73 5.75 4.02 4.15 4.18 Jan Feb Mar Apr May Jun Jul Aug Sep Weekly Aug Sep Sep Sep Sep Sep Oct Oct Oct Oct Daily Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct 2.28 2.50 2.63 2.79 3.00 3.04 3.26 3.50 3.62 2.02 2.36 2.64 2.63 2.62 2.82 3.09 3.33 3.21 2.38 2.59 2.80 2.84 2.90 3.03 3.29 3.52 3.50 2.68 2.85 3.09 3.14 3.17 3.22 3.53 3.78 3.80 2.61 2.77 2.97 3.09 3.22 3.38 3.57 3.77 3.87 2.33 2.49 2.67 2.84 2.97 3.11 3.27 3.47 3.64 3.23 3.39 3.74 3.67 3.65 3.65 3.90 4.06 3.96 3.70 3.76 4.15 3.99 3.84 3.76 3.98 4.12 4.01 4.32 4.25 4.59 4.42 4.22 4.07 4.25 4.34 4.28 4.82 4.65 4.92 4.78 4.59 4.38 4.50 4.56 4.55 1.15 1.10 1.27 1.21 1.25 1.37 1.64 1.69 1.40 1.72 1.63 1.77 1.69 1.65 1.67 1.88 1.89 1.70 6.02 5.82 6.06 6.05 6.01 5.86 5.95 5.96 6.03 4.92 4.87 5.01 4.93 4.83 4.77 4.85 4.90 4.94 5.71 5.63 5.93 5.86 5.72 5.58 5.70 5.82 5.77 4.12 4.16 4.23 4.25 4.23 4.24 4.40 4.55 4.51 05 05 05 05 05 05 05 05 05 26 2 9 16 23 30 7 14 21 28 05 05 05 05 05 05 05 05 05 05 3.52 3.55 3.50 3.54 3.68 3.80 3.82 3.68 3.76 -- 3.33 3.39 3.33 3.26 3.10 3.12 3.30 3.45 3.50 3.64 3.54 3.51 3.50 3.48 3.52 3.52 3.61 3.74 3.86 3.91 3.81 3.72 3.72 3.78 3.84 3.89 4.01 4.09 4.16 4.21 3.81 3.81 3.77 3.84 3.91 3.99 4.05 4.10 4.14 4.19 3.52 3.54 3.55 3.61 3.70 3.72 3.74 3.79 3.84 3.93 4.04 3.89 3.87 3.92 3.98 4.13 4.24 4.28 4.30 4.38 4.06 3.93 3.92 3.99 4.04 4.15 4.24 4.32 4.34 4.42 4.28 4.16 4.20 4.27 4.31 4.39 4.46 4.54 4.56 4.64 4.50 4.40 4.48 4.55 4.58 4.62 4.67 4.75 4.78 4.84 1.63 1.42 1.38 1.38 1.39 1.47 1.60 1.68 1.66 1.79 1.82 1.68 1.68 1.70 1.71 1.75 1.86 1.96 1.92 2.01 5.91 5.84 5.96 6.03 6.06 6.12 6.19 6.29 6.31 -- 4.87 4.83 4.87 4.96 4.98 5.04 5.06 5.11 5.13 -- 5.77 5.71 5.71 5.74 5.80 5.91 5.98 6.03 6.10 6.15 4.56 4.48 4.45 4.46 4.48 4.68 4.77 4.85 4.89 4.91 11 12 13 14 17 18 19 20 21 24 25 26 27 05 05 05 05 05 05 05 05 05 05 05 05 05 3.72 3.36 3.75 3.77 3.82 3.71 3.71 3.77 3.76 3.76 3.74 3.75 3.81 p 3.36 3.49 3.49 3.47 3.49 3.57 3.56 3.44 3.44 3.45 3.71 3.70 3.71 3.74 3.70 3.75 3.77 3.87 3.86 3.86 3.85 3.86 3.93 3.93 3.90 3.88 4.10 4.10 4.09 4.08 4.17 4.15 4.15 4.16 4.16 4.20 4.21 4.21 4.20 4.08 4.09 4.11 4.11 4.13 4.13 4.15 4.15 4.16 4.17 4.18 4.19 4.20 3.83 3.74 3.77 3.82 3.82 3.83 3.82 3.88 3.85 3.90 3.92 3.98 -- 4.26 4.28 4.29 4.30 4.32 4.30 4.29 4.30 4.26 4.30 4.38 4.43 4.41 4.27 4.31 4.33 4.35 4.37 4.36 4.33 4.34 4.28 4.33 4.42 4.48 4.45 4.48 4.53 4.57 4.58 4.59 4.58 4.56 4.56 4.48 4.55 4.63 4.70 4.67 4.68 4.74 4.79 4.79 4.80 4.80 4.79 4.78 4.71 4.76 4.83 4.90 4.87 1.65 1.70 1.70 1.69 1.66 1.65 1.66 1.68 1.66 1.72 1.79 1.84 1.81 1.92 1.98 1.96 1.97 1.94 1.92 1.92 1.92 1.90 1.95 2.01 2.05 2.02 6.19 6.28 6.34 6.35 6.34 6.33 6.33 6.32 6.24 6.30 6.35 6.44 -- -------------- -------------- -------------- NOTE: Weekly data for columns 1 through 13 are week-ending averages. Columns 2 through 4 are on a coupon equivalent basis. Data in column 6 are interpolated from data on certain commercial paper trades settled by the Depository Trust Company. Column 14 is the Bond Buyer revenue index, which is a 1-day quote for Thursday. Column 15 is the average contract rate on new commitments for fixed-rate mortgages (FRMs) with 80 percent loan-to-value ratios at major institutional lenders. Column 16 is the average initial contract rate on new commitments for 1-year, adjustable-rate mortgages (ARMs) at major institutional lenders offering both FRMs and ARMs with the same number of discount points. MFMA p - preliminary data Class I FOMC - Restricted Controlled (FR) Page 35 of 36 Appendix Table 2 Money Aggregates Seasonally Adjusted M1 M2 1 Period 2 nontransactions components in M2 in M3 only 3 4 M3 5 Annual growth rates (%): Annually (Q4 to Q4) 2002 2003 2004 3.2 7.4 5.4 6.7 5.5 5.2 7.7 5.0 5.2 6.0 3.4 7.0 6.5 4.8 5.8 Quarterly (average) 2004-Q4 2005-Q1 Q2 Q3 5.7 0.5 -0.6 -2.0 5.8 4.0 1.7 3.9 5.8 4.9 2.3 5.4 0.4 8.8 14.7 17.3 4.0 5.5 5.9 8.3 Monthly 2004-Oct. Nov. Dec. 1.0 13.8 -2.0 5.3 7.0 4.5 6.5 5.2 6.3 -6.7 -2.4 10.0 1.4 4.0 6.3 -8.0 6.4 6.0 -15.2 10.9 0.8 -17.5 14.8 -6.7 -2.0 3.4 2.8 3.7 -0.6 0.2 6.1 1.7 5.4 6.1 6.9 6.6 1.8 3.1 3.4 -2.6 7.5 6.9 2.9 9.5 9.3 13.5 8.3 3.8 21.3 15.6 19.8 7.1 26.9 23.2 14.2 6.7 4.6 3.8 6.5 5.3 10.6 3.5 12.5 11.9 9.4 1373.4 1374.3 1354.3 1371.0 1363.4 6482.8 6515.6 6525.1 6554.4 6587.9 5109.4 5141.3 5170.8 5183.4 5224.5 3180.0 3232.5 3251.6 3324.4 3388.8 9662.8 9748.2 9776.7 9878.7 9976.7 5 12 19 26 1364.7 1340.0 1358.3 1373.7 6569.2 6564.0 6599.8 6598.5 5204.5 5224.1 5241.5 5224.8 3383.9 3386.7 3372.6 3395.1 9953.1 9950.8 9972.4 9993.6 3 10p 17p 1396.8 1356.7 1347.6 6622.3 6610.8 6635.5 5225.5 5254.2 5287.8 3412.4 3416.5 3432.4 10034.7 10027.3 10067.9 2005-Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. e Levels ($billions): Monthly 2005-May June July Aug. Sep. Weekly 2005-Sep. Oct. p e preliminar y estimated Class I FOMC - Restricted Controlled (FR) Page 36 of 36 Appendix Table 3 Changes in System Holdings of Securities 1 (Millions of dollars, not seasonally adjusted) October 27, 2005 Treasury Bills Treasury Coupons Federal Net Purchases 3 Net Redemptions Net Purchases 2 (-) Change <1 1-5 5-10 Redemptions (-) Over 10 total Redemptions (-) Net Change outright holdings 4 Net RPs 5 Net change Agency ShortTerm 6 LongTerm 7 Net Change 2002 2003 21,421 18,150 ----- 21,421 18,150 12,720 6,565 12,748 7,814 5,074 4,107 2,280 220 ----- 32,822 18,706 --10 54,242 36,846 -5,366 2,223 517 1,036 -4,850 3,259 2004 18,138 --- 18,138 7,994 17,249 5,763 1,364 --- 32,370 --- 50,507 -2,522 -331 -2,853 2004 QIII 4,508 --- 4,508 1,898 4,406 1,507 434 --- 8,244 --- 12,753 -1,787 782 -1,005 QIV 4,167 --- 4,167 3,092 7,453 2,018 571 --- 13,134 --- 17,301 -5,956 1,728 -4,227 2005 QI 35 --- 35 --- --- --- --- 544 -544 --- -509 1,653 -3,454 -1,801 QII QIII 2,010 4,743 ----- 2,010 4,743 --1,298 3,495 5,025 1,708 1,118 1,015 90 1,305 757 4,914 6,774 ----- 6,923 11,517 1,082 964 1,361 1,538 2,443 2,502 2005 Feb Mar 35 --- ----- 35 --- ----- ----- ----- ----- 333 211 -333 -211 ----- -298 -211 2,163 1,746 -2,187 896 -24 2,642 Apr May --1,760 ----- --1,760 ----- 1,200 2,295 470 898 230 --- ----- 1,900 3,193 ----- 1,900 4,953 385 -2,453 1,499 340 1,884 -2,113 Jun Jul 250 --- ----- 250 --- ----- ----- 340 --- 785 --- 1,305 --- -180 --- ----- 70 --- 1,371 671 -606 2,413 764 3,084 Aug Sep 2,751 1,992 ----- 2,751 1,992 1,298 --- 1,390 3,635 988 130 --90 757 --- 2,919 3,855 ----- 5,670 5,847 136 283 -581 -599 -445 -316 2005 Aug 3 Aug 10 ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- 8,355 -7,150 -1,000 2,000 7,355 -5,150 Aug 17 Aug 24 1,244 1,249 ----- 1,244 1,249 ----- 1,390 --- --988 ----- ----- 1,390 988 ----- 2,634 2,237 -3,366 1,583 2,000 -2,000 -1,366 -417 Aug 31 Sep 7 258 14 ----- 258 14 1,298 --- ----- ----- ----- 757 --- 541 --- ----- 799 14 3,673 -1,709 -1,000 3,000 2,673 1,291 Sep 14 Sep 21 47 96 ----- 47 96 ----- 2,531 --- 130 --- 90 --- ----- 2,751 --- ----- 2,798 96 -3,235 4,279 1,000 -4,000 -2,235 279 Sep 28 Oct 5 1,565 291 ----- 1,565 291 ----- 1,104 1,193 ----- ----- ----- 1,104 1,193 ----- 2,669 1,484 1,009 -2,432 -4,000 --- -2,991 -2,432 Oct 12 Oct 19 54 317 ----- 54 317 ----- ----- ----- ----- ----- ----- ----- 54 317 -1,615 -874 ----- -1,615 -874 Oct 26 500 --- 500 120 880 --- --- --- 1,000 --- 1,500 1,685 -2,000 -315 2005 Oct 27 1 --- 1 --- --- --- 902 --- 902 --- 903 1,693 -1,000 693 2,728 --- 2,728 120 3,177 --- 902 --- 4,199 --- 6,927 2,367 -7,000 -4,633 270.6 128.5 210.6 52.6 469.8 --- 740.4 -12.2 11.0 -1.2 Intermeeting Period Sep 20-Oct 27 Memo: LEVEL (bil. $) Oct 27 1. Change from end-of-period to end-of-period. Excludes changes in compensation for the effects of inflation on the principal of inflation-indexed securities. 2. Outright purchases less outright sales (in market and with foreign accounts). 3. Outright purchases less outright sales (in market and with foreign accounts). Includes short-term notes acquired in exchange for maturing bills. Excludes maturity shifts and rollovers of maturing issues, except the rollover of inflation compensation. 78.1 4. 5. 6. 7. Includes redemptions (-) of Treasury and agency securities. RPs outstanding less reverse RPs. Original maturity of 13 days or less. Original maturity of 14 to 90 days. MRA:BEW
@FedFRASER