Monetary Policy Report, February 23, 2018

Board of Governors of the Federal Reserve System

Monetary Policy rePort

February 23, 2018

For use at 11:00 a.m., EST

February 23, 2018

Letter of transmittaL

B  G  

F R S

Washington, D.C., February 23, 2018

T P   S

T S   H  R

The Board of Governors is pleased to submit its Monetary Policy Report pursuant to

section 2B of the Federal Reserve Act.

Sincerely,

Jerome H. Powell, Chairman

Adopted effective January24, 2012; as amended effective January30, 2018

The Federal Open Market Committee (FOMC) is rmly committed to fullling its statutory

mandate from the Congress of promoting maximum employment, stable prices, and moderate

long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public

as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and

businesses, reduces economic and nancial uncertainty, increases the eectiveness of monetary

policy, and enhances transparency and accountability, which are essential in a democratic society.

Ination, employment, and long-term interest rates uctuate over time in response to economic and

nancial disturbances. Moreover, monetary policy actions tend to inuence economic activity and

prices with a lag. Therefore, the Committee’s policy decisions reect its longer-run goals, its medium-

term outlook, and its assessments of the balance of risks, including risks to the nancial system that

could impede the attainment of the Committee’s goals.

The ination rate over the longer run is primarily determined by monetary policy, and hence the

Committee has the ability to specify a longer-run goal for ination. The Committee rearms its

judgment that ination at the rate of 2percent, as measured by the annual change in the price

index for personal consumption expenditures, is most consistent over the longer run with the

Federal Reserve’s statutory mandate. The Committee would be concerned if ination were running

persistently above or below this objective. Communicating this symmetric ination goal clearly to the

public helps keep longer-term ination expectations rmly anchored, thereby fostering price stability

and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum

employment in the face of signicant economic disturbances. The maximum level of employment

is largely determined by nonmonetary factors that aect the structure and dynamics of the labor

market. These factors may change over time and may not be directly measurable. Consequently,

it would not be appropriate to specify a xed goal for employment; rather, the Committee’s policy

decisions must be informed by assessments of the maximum level of employment, recognizing that

such assessments are necessarily uncertain and subject to revision. The Committee considers a

wide range of indicators in making these assessments. Information about Committee participants’

estimates of the longer-run normal rates of output growth and unemployment is published four

times per year in the FOMC’s Summary of Economic Projections. For example, in the most

recent projections, the median of FOMC participants’ estimates of the longer-run normal rate of

unemployment was 4.6percent.

In setting monetary policy, the Committee seeks to mitigate deviations of ination from its

longer-run goal and deviations of employment from the Committee’s assessments of its maximum

level. These objectives are generally complementary. However, under circumstances in which the

Committee judges that the objectives are not complementary, it follows a balanced approach in

promoting them, taking into account the magnitude of the deviations and the potentially dierent

time horizons over which employment and ination are projected to return to levels judged

consistent with its mandate.

The Committee intends to rearm these principles and to make adjustments as appropriate at its

annual organizational meeting each January.

statement on Longer-run goaLs and monetary PoLicy strategy

Note: This report reects information that was publicly available as of noon EST on February 22, 2018.

Unless otherwise stated, the time series in the gures extend through, for daily data, February21, 2018; for monthly

data, January2018; and, for quarterly data, 2017:Q4. In bar charts, except as noted, the change for a given period is

measured to its nal quarter from the nal quarter of the preceding period.

For gures 15 and 33, note that the S&P 500 Index and the Dow Jones Bank Index are products of S&P Dow Jones Indices LLC and/or its afliates and

Redistribution, reproduction, and/or photocopying in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more

information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor’s Financial

Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark

Holdings LLC, their afliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to

accurately represent the asset class or market sector that it purports to represent, and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings

LLC, their afliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

contents

Summary ..................................................1

Economic and Financial Developments ......................................... 1

Monetary Policy ........................................................... 2

Special Topics ............................................................. 2

Part 1: Recent Economic and Financial Developments ................ 5

Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Financial Developments .................................................... 21

International Developments ................................................. 27

Part 2: Monetary Policy ....................................... 31

Part 3: Summary of Economic Projections ......................... 39

The Outlook for Economic Activity ............................................ 40

The Outlook for Ination ................................................... 45

Appropriate Monetary Policy ................................................ 45

Uncertainty and Risks ...................................................... 45

Abbreviations ..............................................55

List of Boxes

How Tight Is the Labor Market? ................................................ 8

Low Ination in the Advanced Economies ...................................... 14

Developments Related to Financial Stability ..................................... 24

Monetary Policy Rules and Their Role in the Federal Reserve’s Policy Process ............ 35

Forecast Uncertainty ....................................................... 54

summary

Economic activity increased at a solid pace

over the second half of 2017, and the labor

market continued to strengthen. Measured

on a 12-month basis, ination has remained

below the Federal Open Market Committee’s

(FOMC) longer-run objective of 2percent.

The FOMC raised the target range for the

federal funds rate twice in the rst half of

2017, resulting in a range of 1 to 1¼percent

by the end of its June meeting. With the

federal funds rate rising toward more normal

levels, at its September meeting, the FOMC

decided to initiate a program of gradually

and predictably reducing the size of its

balance sheet. At its meeting in December,

the Committee judged that current and

prospective economic conditions called for

a further increase in the target range for the

federal funds rate, to 1¼ to 1½percent.

Economic and Financial

Developments

The labor market. The labor market has

continued to strengthen since the middle of

last year. Payroll employment has posted solid

gains, averaging 182,000 per month in the

seven months starting in July2017, about the

same as the average pace in the rst half of

2017. Although net job creation last year was

slightly slower than in 2016, it has remained

considerably faster than what is needed,

on average, to absorb new entrants into the

labor force. The unemployment rate declined

from 4.3percent in June to 4.1percent in

January—somewhat below the median of

FOMC participants’ estimates of its longer-

run normal level. Other measures of labor

utilization also suggest that the labor market

has tightened since last summer. Nonetheless,

wage growth has been moderate, likely held

down in part by the weak pace of productivity

growth in recent years.

Ination. Consumer price ination has

remained below the FOMC’s longer-run

objective of 2percent. The price index for

personal consumption expenditures increased

1.7percent over the 12 months ending in

December2017, about the same as in 2016.

The 12-month measure of ination that

excludes food and energy items (so-called

core ination), which historically has been

a better indicator of where overall ination

will be in the future than the headline gure,

was 1.5percent in December—0.4percentage

point lower than it had been one year earlier.

However, monthly readings on core ination

were somewhat higher during the last few

months of 2017 than earlier in the year.

Measures of longer-run ination expectations

have, on balance, been generally stable,

although some measures remain low by

historical standards.

Economic growth. Real gross domestic product

(GDP) is reported to have increased at an

annual rate of nearly 3percent in the second

half of 2017 after rising slightly more than

2percent in the rst half. Consumer spending

expanded at a solid rate in the second half,

supported by job gains, rising household

wealth, and favorable consumer sentiment.

Business investment growth was robust, and

indicators of business sentiment have been

strong. The housing market has continued

to improve slowly. Foreign activity remained

solid and the dollar depreciated further in the

second half, but net exports subtracted from

real U.S. GDP growth as imports of consumer

and capital goods surged late in the year.

Financial conditions. Financial conditions

for businesses and households have

eased on balance since the middle of

2017 amid an improving global growth

outlook. Notwithstanding nancial market

developments in recent weeks, broad measures

of equity prices are higher, and spreads of

yields on corporate bonds over those of

comparable-maturity Treasury securities have

narrowed. Most types of consumer loans

2 SUMMARY

remained widely available, though credit

was still dicult to access in credit card and

mortgage markets for borrowers with low

credit scores or harder-to-document incomes.

Longer-term nominal Treasury yields and

mortgage rates have moved up on net. The

dollar depreciated, on average, against the

currencies of our trading partners. In foreign

nancial markets, equity prices generally

increased in the second half of 2017, and most

of those indexes remain higher, on net, despite

recent declines. Most longer-term yields rose

noticeably.

Financial stability. Vulnerabilities in the U.S.

nancial system are judged to be moderate on

balance. Valuation pressures continue to be

elevated across a range of asset classes even

after taking into account the current level

of Treasury yields and the expectation that

the reduction in corporate tax rates should

generate an increase in after-tax earnings.

Leverage in the nonnancial business sector

has remained high, and net issuance of risky

debt has climbed in recent months. In contrast,

leverage in the household sector has remained

at a relatively low level, and household debt

in recent years has expanded only about in

line with nominal income. Moreover, U.S.

banks are well capitalized and have signicant

liquidity buers.

Monetary Policy

Interest rate policy. The FOMC continued

to gradually increase the target range for the

federal funds rate. After having raised it twice

in the rst half of 2017, the Committee raised

the target range for the federal funds rate

again in December, bringing it to the current

range of 1¼ to 1½percent. The decision

to increase the target range for the federal

funds rate reected the solid performance of

the economy. Even with this rate increase,

the stance of monetary policy remains

accommodative, thereby supporting strong

labor market conditions and a sustained return

to 2percent ination.

The FOMC expects that, with further gradual

adjustments in the stance of monetary policy,

economic activity will expand at a moderate

pace and labor market conditions will remain

strong. Ination on a 12-month basis is

expected to move up this year and to stabilize

around the Committee’s 2percent objective

over the next few years. The federal funds

rate is likely to remain, for some time, below

levels that are expected to prevail in the longer

run. Consistent with this outlook, in the most

recent Summary of Economic Projections

(SEP), which was compiled at the time of the

December FOMC meeting, the median of

participants’ assessments for the appropriate

level of the federal funds rate through the end

of 2019 remains below the median projection

for its longer-run level. (The December SEP is

presented in Part 3 of this report.) However,

as the Committee has continued to emphasize,

the actual path of the federal funds rate will

depend on the economic outlook as informed

by incoming data. In particular, with ination

having persistently run below the 2percent

longer-run objective, the Committee will

carefully monitor actual and expected ination

developments relative to its symmetric

ination goal.

Balance sheet policy. In the second half of

2017, the Committee initiated the balance

sheet normalization program that is described

in the Addendum to the Policy Normalization

Principles and Plans the Committee issued in

June.

Specically, since October, the Federal

Reserve has been gradually reducing its

holdings of Treasury and agency securities

by decreasing the reinvestment of principal

payments it receives from these securities.

Special Topics

How tight is the labor market? Although

there is no way to know with precision, the

1. The June addendum is available on the Board’s

website at https://www.federalreserve.gov/monetarypolicy/

files/FOMC_PolicyNormalization.20170613.pdf.

MONETARY POLICY REPORT: FEBRUARY 2018 3

labor market appears to be near or a little

beyond full employment at present. The

unemployment rate is somewhat below most

estimates of its longer-run normal rate, and

the labor force participation rate is relatively

close to many estimates of its trend. Although

employers report having more diculties

nding qualied workers, hiring continues

apace, and serious labor shortages would likely

have brought about larger wage increases than

have been evident to date. (See the box “How

Tight Is the Labor Market?” in Part1.)

Low global ination. Ination has generally

come in below central banks’ targets in the

advanced economies for several years now.

Resource slack and commodity prices—as

well as, for the United States, movements in

the U.S. dollar—appear to explain ination’s

behavior fairly well. But our understanding is

imperfect, and other, possibly more persistent,

factors may be at work. Resource slack at

home and abroad might be greater than it

appears to be, or ination expectations could

be lower than suggested by the available

indicators. Moreover, some observers have

pointed to increased competition from online

retailers or international developments—

such as global economic slack or the

integration of emerging economies into the

world economy—as contributing to lower

ination. Policymakers remain attentive

to the possibility of such forces leading to

continued low ination; they also are watchful

regarding the opposite risk of ination moving

undesirably high. (See the box “Low Inflation

in the Advanced Economies” in Part 1.)

Monetary policy rules. Monetary policymakers

consider a wide range of information on

current economic conditions and the outlook

before deciding on a policy stance they deem

most likely to foster the FOMC’s statutory

mandate of maximum employment and stable

prices. They also routinely consult monetary

policy rules that connect prescriptions for the

policy interest rate with variables associated

with the dual mandate. The use of such rules

requires careful judgments about the choice

and measurement of the inputs into these

rules as well as the implications of the many

considerations these rules do not take into

account. (See the box “Monetary Policy Rules

and Their Role in the Federal Reserve’s Policy

Process” in Part 2.)

Domestic Developments

The labor market strengthened further

during the second half of 2017 and early

this year

Payroll employment has continued to post

solid gains, averaging 182,000 per month

in the seven months starting in July2017,

about the same pace as in the rst half of

2017.

Although net job creation last year was

slightly slower than in 2016, it has remained

considerably faster than what is needed, on

average, to absorb new entrants to the labor

force and is therefore consistent with the

view that the labor market has strengthened

further (gure1). The strength of the labor

market is also evident in the decline in the

unemployment rate to 4.1percent in January,

¼percentage point below its level in June2017

and about ½percentage point below the

median of Federal Open Market Committee

(FOMC) participants’ estimates of its longer-

run normal level (gure2).

Other indicators also suggest that labor

market conditions have continued to tighten.

The labor force participation rate (LFPR)—

that is, the share of adults either working or

actively looking for work—was 62.7percent

in January. The LFPR is little changed, on

net, since early 2014 (gure3). However, the

average age of the population is continuing

to increase. In particular, the members of the

baby-boom cohort increasingly are moving

into their retirement years, a time when labor

force participation typically is low. That

development implies that a sustained period

in which the demand for and supply of labor

were in balance would be associated with a

downward trend in the overall participation

rate. Accordingly, the at prole of the LFPR

2. The hurricanes that struck the United States during

the second half of last year caused substantial variation

in the month-to-month pattern of job gains, but the

average performance over the period as a whole was

probably substantially unaected.

during the past few years is consistent with

an overall picture of improving labor market

conditions. In line with this perspective, the

LFPR for individuals aged 25 to 54—which is

much less sensitive to population aging—has

been rising since 2015. The employment-

to-population ratio for individuals 16 and

older—that is, the share of people who are

working—was 60.1percent in January and has

been increasing since 2011; this gain primarily

reects the decline in the unemployment rate.

(The box “How Tight Is the Labor Market?”

describes the available measures of labor

market slack in more detail.)

Other indicators are also consistent with

continuing strong labor demand. The

number of people ling initial claims for

unemployment insurance has remained near

its lowest level in decades.

As reported in the

Job Openings and Labor Turnover Survey, the

rate of job openings remained elevated in the

second half of 2017, while the rate of layos

remained low. In addition, the rate of quits

stayed high, an indication that workers are able

to obtain a new job when they seek one.

3. Initial claims jumped in the fall of 2017 as a

consequence of disruptions from the hurricanes and then

returned to a low level.

Total nonfarm

800

600

400

200

400

Thousands of jobs

2018201720162015201420132012201120102009

1. Net change in payroll employment

3-month moving averages

Private

OURCE

: Bureau of Labor Statistics via Haver Analytics.

Part 1

recent economic and financiaL deveLoPments

6 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

Employment-to-population ratio

Prime-age labor force participation rate

Percent

20182014201020062002

3. Labor force participation rates and

employment-to-population ratio

Percent

Labor force participation rate

NOTE

: The data are monthly. The prime-age labor force participation

rate

is a percentage of the population aged 25 to 54. The labor force

participation

rate and the employment-to-population ratio are percentages of the

population

aged 16 and over.

OURCE

: Bureau of Labor Statistics via Haver Analytics.

Unemployment rates have declined across

demographic groups, but unemployment

remains high for some groups

Unemployment rates have trended downward

across racial and ethnic groups (gure4). The

decline in the unemployment rate for blacks or

African Americans over the past few years has

been particularly notable. This broad pattern

is typical: The unemployment rates for blacks

and Hispanics tend to rise considerably more

than the rates for whites and Asians during

recessions, and then they decline more rapidly

during expansions. Yet even with the recent

narrowing, the disparities in unemployment

rates across demographic groups remain

substantial and largely the same as before the

recession. The unemployment rate for whites

has averaged 3.7percent since the middle of

2017 and the rate for Asians has been about

3.3percent, while the unemployment rates for

Hispanics or Latinos (5.0percent) and blacks

(7.3percent) have been substantially higher.

In addition, the labor force participation

rates for blacks, Hispanics, and Asians have

generally been lower than those for whites

of the same age group. As the labor market

U-5

U-4

U-6

Percent

2018201620142012201020082006

2. Measures of labor underutilization

Monthly

Unemployment rate

OTE: Unemployment rate measures total unemployed as a percentage of the labor force. U-4 measures total unemployed plus discouraged workers, as a

percentage of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work

because they believe no jobs are available for them. U-5 measures total unemployed plus all marginally attached to the labor force, as a percentage of the labor

force plus persons marginally attached to the labor force. Marginally attached workers are not in the labor force, want and are

available for work, and have looked

for a job in the past 12 months. U-6 measures total unemployed plus all marginally attached workers plus total employed part time for economic reasons, as a

percentage of the labor force plus all marginally attached workers. The shaded bar indicates a period of business recession as defined by the National Bureau of

Economic Research.

OURCE

: Bureau of Labor Statistics via Haver Analytics.

MONETARY POLICY REPORT: FEBRUARY 2018 7

has strengthened over the past few years, the

participation rates for prime-age individuals in

each of these groups have risen.

Growth of labor compensation has been

moderate . . .

Despite the strong labor market, the available

indicators generally suggest that the growth

of hourly compensation has been moderate.

Growth of compensation per hour in the

business sector—a broad-based measure

of wages, salaries, and benets that is quite

volatile—was 2¼percent over the four

quarters ending in 2017:Q4 (gure5), well

above the low reading in 2016 but about in

line with the average annual increase from

2010 to 2015.

The employment cost index—

which also measures both wages and the cost

to employers of providing benets—was up

about 2½percent in the fourth quarter of

2017 relative to its year-ago level, roughly

4. The compensation per hour measure of wages and

salaries declined at the end of 2016, possibly reecting

the shifting of bonuses or other types of income into

2017 in anticipation of a possible cut in personal income

tax rates.

Black or African American

Asian

Hispanic or Latino

Percent

2018201620142012201020082006

4. Unemployment rate by race and ethnicity

Monthly

White

OTE: Unemployment rate measures total unemployed as a percentage of the labor force. Persons whose ethnicity is identified as Hispanic or Latino may be of

any race. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research.

OURCE

: Bureau of Labor Statistics via Haver Analytics.

Employment cost index

Atlanta Fed's Wage Growth Tracker

Average hourly earnings

Percent change from year earlier

20182016201420122010

5. Measures of change in hourly compensation

Compensation per hour,

business sector

OTE: Business-sector compensation is on a four-quarter

percentage

change basis. For the employment cost index, change is over the 12

months

ending in the last month of each quarter; for average hourly earnings,

change

is from 12 months earlier; for the Atlanta Fed's Wage Growth Tracker,

the

data are shown as a 3-month moving average of the 12-month

percent

change.

OURCE

: Bureau of Labor Statistics via Haver Analytics; Federal

Reserve

Bank of Atlanta, Wage Growth Tracker.

8 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

The fact that the LFPR for prime-age men remains

below its pre-recession levels might suggest that slack

remains along this dimension; however, the lower

level of the LFPR for prime-age men primarily seems

to reect the continuation of a decades-long secular

decline rather than a cyclical shortfall in their LFPR. In

addition, the U-6 measure of labor utilization—which

includes the unemployed, those marginally attached

to the labor force, and those employed part time who

would like full-time work—rose even more steeply

than the unemployment rate during and immediately

after the recession and has since recovered to near

its pre-recession level. Although there is substantial

uncertainty about the trends in each of the components

of U-6, its current level can be cautiously interpreted

as consistent with a labor market close to full

employment.

One can also look at less-direct indicators of labor

market tightness. For example, the share of small

businesses with at least one job opening that they view

as hard to ll is now close to its record levels in the late

1990s (as seen in the black line in gure B), consistent

with the notion that as the labor market tightens,

businesses nd it increasingly difcult to hire additional

workers. Similarly, survey measures of households’

Any assessment of labor market tightness is

inherently uncertain, as it involves comparing current

labor market conditions with an estimate of conditions

that would prevail under full employment, where the

latter circumstance cannot be directly observed or

measured and can change over time. Many economists

would describe the labor market as being at full

employment when the unemployment rate has reached

an “equilibrium” level, sometimes called the natural

rate of unemployment or the longer-run normal rate of

unemployment. In judging the level of full employment,

one may also consider additional margins of labor

utilization—including the labor force participation rate

(LFPR), the share of workers employed part time who

would like to be working full time, and individuals

who are classied as marginally attached to the labor

force—as compared with trends in these measures.

While the uncertainty around the “normal” trends in

all of these variables is substantial, the labor market

in early 2018 appears to be near or a little beyond full

employment.

The unemployment rate is now somewhat below

most estimates of its natural rate. Specically, the

unemployment rate in January, at 4.1percent, is

½percentage point below the median of Federal Open

Market Committee (FOMC) participants’ estimates of

the longer-run normal rate of unemployment, which

was reported to have been 4.6percent as of the

December2017 FOMC meeting. The unemployment

rate is also about ½percentage point below the

Congressional Budget Ofce’s (CBO) current estimate

of the natural rate; by this measure, the labor market is

about as tight as it was in the late 1980s but less tight

than in the late 1990s (gure A). That said, the median

of FOMC participants’ estimates of the longer-run

normal rate of unemployment and the CBO’s estimate

of the natural rate of unemployment have both been

revised down by about 1percentage point over the past

few years, one indication of the substantial uncertainty

surrounding estimates of the “full employment” rate of

unemployment.

As discussed in the main text, the LFPR has been

roughly unchanged, on net, over the past four years,

representing an important cyclical improvement

relative to its declining trend. While estimates of the

trend LFPR are subject to substantial uncertainty and

differ among analysts, the current level of the LFPR

is relatively close to many estimates of its trend.

How Tight Is the Labor Market?

1. As another indication of this uncertainty, the range of

FOMC participants’ estimates of the longer-run normal rate of

unemployment was 4.3 to 5.0percent in December2017.

2. For a variety of approaches to assessing the level

of trend LFPR and the associated range of estimates, see

Stephanie Aaronson, Tomaz Cajner, Bruce Fallick, Felix

Percent of labor force

2017201320092005200119971993198919851981

A. Unemployment rate gap

Quarterly

NOTE

: The unemployment rate gap is the unemployment rate minus

the

Congressional

Budget Office's estimate of the natural rate of

unemployment.

The

shaded bars indicate periods of business recession as defined by

the

National Bureau of Economic Research.

SOURCE: For unemployment rate, Bureau of Labor Statistics; for

natural

rate of unemployment, Congressional Budget Office; all via Haver Analytics.

Galbis-Reig,Christopher Smith, and William Wascher (2014),

“Labor Force Participation: Recent Developments and

Future Prospects,” Brookings Papers on Economic Activity,

Fall, pp. 197–275, https://www.brookings.edu/wp-content/

uploads/2016/07/Fall2014BPEA_Aaronson_et_al.pdf.

Estimates of trend LFPR are also provided by the CBO in their

recurring publication The Budget and Economic Outlook and

its updates.

MONETARY POLICY REPORT: FEBRUARY 2018 9

taken longer for businesses to nd workers in recent

years, yet wage growth has remained steady or slowed.

Finally, while the aggregate labor market appears

to be modestly tight at the moment, not all individuals

have beneted equally from these developments. As

discussed in the main text, noticeable differences

in labor market outcomes remain present across

racial and ethnic groups. Moreover, the labor market

improvement in recent years has not been sufcient

to make important progress in narrowing income

inequality. Finally, regional disparities are also striking,

and in certain aspects these disparities have widened

in recent years; for example, the employment-

to-population ratio for prime-age individuals has

recovered less for those outside of metro areas than for

those in metro areas (gure C).

perceptions about job availability are currently at high

levels, as shown by the blue line in gure B.

However, despite reports that employers are now

having more difculties nding qualied workers,

hiring has continued apace. Although payroll

employment gains have gradually slowed over time

from about 250,000 per month, on average, in 2014

to about 180,000 per month, on average, in 2017, job

growth remains consistent with further strengthening

in the labor market.

Finally, the pace of wage gains

has been moderate; while wage gains have likely been

held down by the sluggish pace of productivity growth

in recent years, serious labor shortages would probably

bring about larger increases than have been observed

thus far.

It is possible that labor shortages have arisen in

certain pockets of the economy, which could be an

early indication of bottlenecks that are not yet readily

apparent in the aggregate labor market. However, even

at the industry level it is difcult to see much evidence of

emerging supply constraints.

In some industries, such as

trade and transportation as well as leisure and hospitality,

employment growth has slowed markedly and it has

Job availability

100

120

140

160

Index

2018201420102006200219981994199019861982

B. Job availability and hard-to-fill positions

Percent

Hard-to-fill

OTE: Job availability is the proportion of households believing jobs

are

plentiful

minus the proportion believing jobs are hard to get, plus

100.

Hard-to-fill

is the three-month moving average of the percent of

small

businesses

surveyed with at least one hard-to-fill job opening, and it

seasonally adjusted by Federal Reserve Board staff. Monthly hard-to-fill data

from

the National Federation of Independent Business start in January

1986.

The

shaded bars indicate periods of business recession as defined by

the

National Bureau of Economic Research. Data are monthly.

SOURCE

: For job availability, Conference Board; for hard-to-fill,

National

Federation of Independent Business.

3. Payroll gains in the range of about 90,000 to 120,000

per month are estimated to be consistent with a constant

unemployment rate and a decline in the labor force

participation rate in line with its demographically driven trend.

4. The analysis behind this statement considered six

broad industries—construction, manufacturing, trade and

Non-metro

Smaller MSAs

Percent

201820162014201220102008200620042002200019981996

C. Prime-age employment-to-population ratio by

metropolitan status

Monthly

Larger MSAs

OTE: The data are 12-month centered moving averages.

Larger

metropolitan statistical areas (MSAs) consist of 500,000 people or more,

and

smaller MSAs consist of 100,000 to 500,000 people. The shaded bars

indicate

periods of business recession as defined by the National Bureau of Economic

Research.

OURCE

: Alison Weingarden (2017), “Labor Market Outcomes

Metropolitan and Non-metropolitan Areas: Signs of Growing

Disparities,”

FEDS Notes (Washington: Board of Governors of the Federal

Reserve

System, September 25),

www.federalreserve.gov/econres/notes/feds-notes/

labor-market-outcomes-in-metropolitan-and-non-metropolitan-areas-signs-of

-growing-disparities-20170925.htm. Calculations use data from the

U.S.

Census Bureau, Current Population Survey; note that the Bureau of

Labor

Statistics is involved in the survey process for the Current Population Survey.

transportation, health and education, leisure and hospitality,

and professional and business services.

5. See Alison Weingarden (2017), “Labor Market Outcomes

in Metropolitan and Non-metropolitan Areas: Signs of

Growing Disparities,” FEDS Notes (Washington: Board of

Governors of the Federal Reserve System, September25),

https://www.federalreserve.gov/econres/notes/feds-notes/labor-

market-outcomes-in-metropolitan-and-non-metropolitan-

areas-signs-of-growing-disparities-20170925.htm.

10 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

½percentage point faster than its gain a year

earlier. Among measures that do not take

account of benets, average hourly earnings

rose slightly less than 3percent through

January of this year, a gain that was somewhat

faster than the average increase in the

preceding few years. Similarly, the measure

of wage growth computed by the Federal

Reserve Bank of Atlanta that tracks median

12-month wage growth of individuals

reporting to the Current Population Survey

showed an increase of about 3percent in

January, similar to its readings from the past

three years and above the average increase in

the preceding few years.

. . . and likely was restrained by slow

growth of labor productivity

These moderate rates of compensation gain

likely reect the osetting inuences of a

tightening labor market and persistently

weak productivity growth. Since 2008, labor

productivity has increased only a little more

than 1percent per year, on average, well

below the average pace from 1996 through

2007 and also below the gains in the 1974–95

period (gure6). Considerable debate remains

about the reasons for the general slowdown in

productivity growth and whether it will persist.

The slowdown may be partly attributable

to the sharp pullback in capital investment

during the most recent recession and the

relatively long period of modest growth

in investment that followed, but a reduced

pace of capital deepening can explain only

a portion of the step-down. Beyond that,

some economists think that more recent

technological advances, such as information

technology, have been less revolutionary than

earlier general-purpose technologies, such as

electricity and internal combustion. Others

have pointed to a slowdown in the speed at

which capital and labor are reallocated toward

their most productive uses, which is reected

in fewer business start-ups and a reduced

5. The Atlanta Fed’s measure diers from others in

that it measures the wage growth only of workers who

were employed both in the current survey month and

12months earlier.

Percent, annual rate

6. Change in business-sector output per hour

1948–

1974–

1996–

2000

2001–

2008–

present

NOTE

: Changes are measured from Q4 of the year immediately

preceding

the period through Q4 of the final year of the period. The final period

measured from 2007:Q4 through 2017:Q4.

OURCE

: Bureau of Labor Statistics via Haver Analytics.

MONETARY POLICY REPORT: FEBRUARY 2018 11

pace of hiring and investment by the most

innovative rms. Still others argue that there

have been important innovations in many

elds in recent years, from energy to medicine,

often underpinned by ongoing advances in

information technology, which augurs well for

productivity growth going forward. However,

those economists note that such productivity

gains may appear only slowly as new rms

emerge to exploit the new technologies and

as incumbent rms invest in new vintages of

capital and restructure their businesses.

Price ination remains below 2percent,

but the monthly readings picked up

toward the end of 2017

Consumer price ination, as measured by

the 12-month change in the price index for

personal consumption expenditures (PCE),

remained below the FOMC’s longer-run

objective of 2percent during most of 2017.

The PCE price index increased 1.7percent

over the 12 months ending in December2017,

about the same as in 2016 (gure7). Core

ination, which typically provides a better

indication than the headline measure of

where overall ination will be in the future,

was 1.5percent over the 12months ending in

December2017—0.4percentage point lower

than it had been one year earlier.

Both measures of ination reected some

weak readings in the spring and summer

of 2017. A portion of those weak readings

seemed attributable to idiosyncratic events,

such as a steep 1-month decline in the price

index for wireless telephone services. However,

the monthly readings on core ination were

somewhat higher during the last few months

of 2017, in contrast to the more typical pattern

that has prevailed in recent years in which

readings around the end of the year have

tended to be slightly below average. Moreover,

the 12-month change in the trimmed mean

PCE price index—an alternative indicator of

underlying ination produced by the Federal

Reserve Bank of Dallas that may be less

sensitive to idiosyncratic price movements—

was 1.7percent in December2017 and has

slowed by less than core PCE price ination

Excluding food

and energy

Trimmed mean

1.0

1.5

2.0

2.5

3.0

12-month percent change

2017201620152014201320122011

7. Change in the price index for personal consumption

expenditures

Monthly

Total

NOTE

: The data extend through December 2017; changes are from one year

earlier.

SOURCE: For trimmed mean, Federal Reserve Bank of Dallas; for all else,

Bureau of Economic Analysis; all via Haver Analytics.

12 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

over the past 12 months.

(For more discussion

of ination both in the United States and

abroad, see the box “Low Ination in the

Advanced Economies.”)

Oil and metals prices increased notably

Headline ination was a little higher than

core ination last year, which reected a rise

in consumer energy prices. The price of crude

oil rose from $48 per barrel at the end of June

to a peak of about $70 per barrel early in the

year and, even after recent declines, remains

more than 30percent above its mid-2017 level

(gure8). The upswing in oil prices appears to

have been driven primarily by strengthening

global demand as well as OPEC’s decision to

further extend its November2016 production

cuts through the end of 2018. The higher oil

prices fed through to moderate increases in the

cost of gasoline and heating oil.

Ination momentum was also supported by

nonfuel import prices, which rose throughout

2017 in part because of dollar depreciation

(gure9). That development marked a turn

from the past several years, during which

nonfuel import prices declined or held at.

In addition to the decline in the dollar,

nonfuel import prices were driven higher by a

substantial increase in the price of industrial

metals. Despite recent volatility, metals prices

remain higher, on net, boosted primarily by

improved prospects for global demand and

also by government policies that restrained

production in China.

In contrast, headline ination has been

held down by consumer food prices, which

increased only about ½percent in 2017 after

having declined in 2016. Food prices have

6. The trimmed mean index excludes whatever prices

showed the largest increases or decreases in a given

month; for example, the sharp decline in prices for

wireless telephone services in March2017 was excluded

from this index.

Spot price

100

110

120

130

Dollars per barrel

2014 2015 2016 2017 2018

8. Brent spot and futures prices

Weekly

24-month-ahead

futures contracts

OTE

: The data are weekly averages of daily data and extend

through

February 21, 2018.

OURCE: ICE Brent Futures via Bloomberg.

Nonfuel import prices

100

102

104

January 2014 = 100

100

110

120

20182017201620152014

9. Nonfuel import prices and industrial metals indexes

January 2014 = 100

Industrial metals

OTE

: The data for nonfuel import prices are monthly. The data for

industrial

metals are a monthly average of daily data and extend through

February 21, 2018.

OURCE

: For nonfuel import prices, Bureau of Labor Statistics; for

industrial

metals, S&P GSCI Industrial Metals Spot Index via Haver

Analytics.

MONETARY POLICY REPORT: FEBRUARY 2018 13

been restrained by softness in the prices of

farm commodities, which in turn has reected

robust supply in the United States and abroad.

Although the harvests for many crops in the

United States declined in 2017, they were

larger than had been expected earlier in

the year.

Survey-based measures of ination

expectations have been generally stable. . .

Expectations of ination likely inuence actual

ination by aecting wage- and price-setting

decisions. Survey-based measures of ination

expectations at medium- and longer-term

horizons have remained generally stable. In the

Survey of Professional Forecasters conducted

by the Federal Reserve Bank of Philadelphia,

the median expectation for the annual rate of

increase in the PCE price index over the next

10years has been around 2percent for the past

several years (gure10). In the University of

Michigan Surveys of Consumers, the median

value for ination expectations over the next

5 to 10years—which had drifted downward

starting in 2014—has held about at since the

end of 2016 at a level that is a few tenths lower

than had prevailed through 2014.

. . . and market-based measures of

ination compensation have increased in

recent months but remain relatively low

Ination expectations can also be gauged

by market-based measures of ination

compensation, though the inference is not

straightforward because market-based

measures can be importantly aected

by changes in premiums that provide

compensation for bearing ination and

liquidity risks. Measures of longer-term

ination compensation—derived either from

dierences between yields on nominal Treasury

securities and those on comparable Treasury

Ination-Protected Securities (TIPS) or from

ination swaps—have increased since June,

returning to levels seen in early 2017, but

Michigan survey expectations

for next 5 to 10 years

Percent

2018201620142012201020082006

SPF expectations

for next 10 years

10. Median inflation expectations

NOTE

: The Michigan survey data are monthly and extend

through

February; the February data are preliminary. The SPF data for

inflation

expectations for personal consumption expenditures are quarterly and

extend

from 2007:Q1 through 2018:Q1.

SOURCE: University of Michigan Surveys of Consumers; Federal

Reserve

Bank of Philadelphia, Survey of Professional Forecasters (SPF).

14 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

But our understanding of the forces that drive

ination is imperfect, and the fact that many advanced

economies are experiencing low ination at the same

time suggests that other, possibly more persistent,

factors may be at work. As one possibility, the natural

rate of unemployment—the rate at which labor markets

exert neither upward nor downward pressure on

ination—is highly uncertain, and it could be lower

in many economies than most economists estimate.

Alternatively, ination expectations could be lower

than suggested by the available indicators.

More-fundamental changes in the global economy

could also be contributing to the recent stretch of

lower ination. First, anecdotal reports suggest that

technological changes could be reducing pricing

power in many industries, holding down ination as

that occurs.

For example, the increased prevalence of

Internet shopping allows consumers to compare prices

more easily across sellers, possibly implying greater

competition that could be putting downward pressure

on consumer prices (gure C). While this hypothesis is

certainly plausible, it does not easily square with the

observation that, at least within the United States, prot

margins have been high (gure D).

Ination has been persistently low in recent years

across many advanced economies. In the United States,

both overall ination and core (excluding food and

energy prices) ination, as measured by the price index

for personal consumption expenditures, have run below

2percent for most of the period since 2008 (gureA).

In other advanced economies, measures of core

ination have run even lower in some cases, with core

ination in the euro area currently at around 1percent

and in Japan at close to zero (gure B).

What explains this period of low ination? Across

the advanced economies, the main factors holding

ination down likely include the extended period of

economic slack following the Great Recession and

the falling prices of oil and other commodities from

around mid-2014 to early 2016. In the United States,

ination also has been held down by the rise in the

foreign exchange value of the dollar from mid-2014

through 2016. The low core U.S. ination in 2017 has

been more of a puzzle (albeit modest in magnitude)

and harder to associate with an identiable cause.

As is discussed in the December2017 Summary of

Economic Projections (Part 3 of this report), most

Federal Reserve policymakers view these recent low

ination readings as likely to prove transitory and

project U.S. ination this year to move closer to their

2percent objective. Many private forecasters appear to

share this view.

Low Ination in the Advanced Economies

Excluding food

and energy

12-month percent change

201720152013201120092007

A. Change in the price index for personal consumption

expenditures

Monthly

Total

NOTE

: The data extend through December 2017; changes are from one year

earlier.

OURCE: Bureau of Economic Analysis via Haver Analytics.

1. For additional discussion of the reasons for low ination

in the United States, see Janet Yellen (2017), “Ination,

Uncertainty, and Monetary Policy,” speech delivered at

“Prospects for Growth: Reassessing the Fundamentals,” 59th

Annual Meeting of the National Association for Business

Economics, Cleveland, Ohio, September26, https://www.

federalreserve.gov/newsevents/speech/yellen20170926a.htm.

United Kingdom

Canada

Euro area

12-month percent change

201820162014201220102008

B. Inflation excluding food and energy in selected

advanced foreign economies

Monthly

Japan

OTE:

The data for the euro area incorporate the flash estimate for January

2018. The data for Canada and Japan extend through December 2017.

SOURCE:

For the United Kingdom, Office for National Statistics; for Japan,

Ministry

of International Affairs and Communications; for the euro

area,

Statistical

Office of the European Communities; for Canada,

Statistics

Canada; all via Haver Analytics.

2. Goldman Sachs (2017), “The Amazon Effect in

Perspective,” U.S. Economics Analyst (New York: Goldman

Sachs, September30).

3. See Council of Economic Advisers (2016), “Benets

of Competition and Indicators of Market Power,” Council

of Economic Advisers Issue Brief (Washington: CEA, April),

https://obamawhitehouse.archives.gov/sites/default/les/page/

les/20160414_cea_competition_issue_brief.pdf.

MONETARY POLICY REPORT: FEBRUARY 2018 15

than other consumers.

Others have pointed to a

slowdown in medical services price increases across

countries, possibly associated with either health-care

reform or scal austerity.

This slowdown has had a

material effect on U.S. ination, though the extent to

which these declines will persist is uncertain.

In summary, while standard economic models

appear to explain much of the post–Great Recession

period of low ination, they do not preclude other

explanations. Even as most policymakers expect

ination in their economies to move back to their

targets over time, they remain attentive to the possibility

that factors not included in those models, such as those

described here, may keep ination low. At the same

time, they are attentive to the opposite risk of ination

moving undesirably high, should tightening demand

conditions lead to faster rises in wages and prices than

currently anticipated.

Second, some observers have pointed to global

developments as helping to explain persistent low

ination across countries. These developments

include economic slack abroad or the integration of

emerging economies into the world economy, leading

to increased competition or downward pressures on

wages.

But the evidence that global slack can help

explain ination in a given country, beyond its effect

on commodity and import prices, is mixed at best.

Moreover, measures of integration, such as global

trade as a fraction of gross domestic product or the

participation in global value chains, appear to have

leveled off in recent years.

A number of other explanations for low global

ination have been advanced as well. These

explanations include some tentative evidence

suggesting that the aging of the population could be

exerting downward pressure on trend ination, perhaps

because retirees may tend to be more price conscious

Percent

2017201420112008200520021999

C. E-commerce sales as a share of retail sales

Quarterly

NOTE: E-commerce sales are sales of goods and services where an order

placed

by the buyer or where the price and terms of sale are negotiated

over

an online system. Payment may or may not be made online.

OURCE: Retail Indicators Branch, U.S. Census Bureau.

Percent

20172012200720021997199219871982

Quarterly

D. Corporate profits as a share of gross national product

NOTE: The data extend through 2017:Q3. Corporate profits

include

inventory valuation and capital consumption adjustments.

OURCE: Bureau of Economic Analysis via Haver Analytics.

4. See Claudio Borio and Andrew Filardo (2007),

“Globalisation and Ination: New Cross-Country Evidence

on the Global Determinants of Domestic Ination,” BIS

Working Papers 227 (Basel, Switzerland: Bank for International

Settlements, May), www.bis.org/publ/work227.pdf; and

Raphael Auer, Claudio Borio, and Andrew Filardo (2017), “The

Globalisation of Ination: The Growing Importance of Global

Value Chains,” BIS Working Papers 602 (Basel, Switzerland:

Bank for International Settlements, January), www.bis.org/

publ/work602.pdf.

5. See Jane Ihrig, Steven B. Kamin, Deborah Lindner,

and Jaime Marquez (2010), “Some Simple Tests of the

Globalization and Ination Hypothesis,” International Finance,

vol. 13 (Winter), pp. 343–75; and European Central Bank

(2017), “Domestic and Global Drivers of Ination in the Euro

Area,” ECB Economic Bulletin, no. 4 (June), pp. 72–96, https://

www.ecb.europa.eu/pub/pdf/other/ebart201704_01.en.pdf.

6. See Jong-Won Yoon, Jinill Kim, and Jungjin Lee (2014),

“Impact of Demographic Changes on Ination and the

Macroeconomy,” IMF Working Paper WP/14/210 (Washington:

International Monetary Fund, November), https://www.imf.

org/external/pubs/ft/wp/2014/wp14210.pdf. However, other

evidence suggests increased inationary pressure from an

aging population; see Mikael Juselius and Előd Takáts (2015),

“Can Demography Affect Ination and Monetary Policy?” BIS

Working Papers 485 (Basel, Switzerland: Bank for International

Settlements, February), https://www.bis.org/publ/work485.pdf.

7. See Tim Mahedy and Adam Shapiro (2017), “What’s

Down with Ination?” FRBSF Economic Letter 2017-35 (San

Francisco: Federal Reserve Bank of San Francisco, November),

https://www.frbsf.org/economic-research/publications/

economic-letter/2017/november/contribution-to-low-pce-

ination-from-healthcare); and Goldman Sachs (2017), “What

Can We Learn from Lower Ination Abroad?” U.S. Economics

Analyst (New York: Goldman Sachs, November12)

16 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

nevertheless remain relatively low (gure11).

The TIPS-based measure of 5-to-10-year-

forward ination compensation and the

analogous measure of ination swaps are now

slightly lower than 2¼percent and 2½percent,

respectively, with both measures below the

ranges that persisted for most of the 10years

before the start of the notable declines

in mid-2014.

Real gross domestic product growth

picked up in the second half of 2017

Real gross domestic product (GDP) is

reported to have risen at an annual rate of

nearly 3percent in the second half of 2017

after increasing slightly more than 2percent

in the rst half of 2017 (gure12). Much of

that faster growth reects the stabilization

of inventory investment, which had slowed

considerably in the rst half of last year.

Private domestic nal purchases—that is,

nal purchases by U.S. households and

businesses, which tend to provide a better

indication of future GDP growth than most

other components of overall spending—rose

at a solid annual rate of about 3½percent in

the second half of the year, similar to the rst-

half pace.

The economic expansion continues to

be supported by steady job gains, rising

household wealth, favorable consumer

sentiment, strong economic growth abroad,

and accommodative nancial conditions,

including the still low cost of borrowing and

easy access to credit for many households and

businesses. In addition to these factors, very

7. Ination compensation implied by the TIPS

breakeven ination rate is based on the dierence, at

comparable maturities, between yields on nominal

Treasury securities and yields on TIPS, which are indexed

to the headline consumer price index (CPI). Ination

swaps are contracts in which one party makes payments

of certain xed nominal amounts in exchange for cash

ows that are indexed to cumulative CPI ination over

some horizon. Focusing on ination compensation 5 to

10years ahead is useful, particularly for monetary policy,

because such forward measures encompass market

participants’ views about where ination will settle in the

long term after developments inuencing ination in the

short term have run their course.

Percent, annual rate

2017201620152014201320122011

12. Change in real gross domestic product and gross

domestic income

H2*

*Gross domestic income is not yet available for 2017:H2.

SOURCE: Bureau of Economic Analysis via Haver Analytics.

Gross domestic product

Gross domestic income

Inflation swaps

1.0

1.5

2.0

2.5

3.0

3.5

Percent

20182016201420122010

11. 5-to-10-year-forward inflation compensation

Weekly

TIPS breakeven rates

OTE

:The data are weekly averages of daily data and extend

through

February 16, 2018. TIPS is Treasury Inflation-Protected Securities.

SOURCE: Federal Reserve Bank of New York; Barclays; Federal

Reserve

Board staff estimates.

MONETARY POLICY REPORT: FEBRUARY 2018 17

upbeat business sentiment appears to have

supported solid growth over the past year.

Ongoing improvement in the labor

market and gains in wealth continue to

support consumer spending . . .

Supported by ongoing improvement in the

labor market, real consumer spending rose at

a solid annual rate of 3percent in the second

half of 2017, a somewhat faster pace than

in the rst half. Real disposable personal

income—that is, income after taxes and

adjusted for price changes—increased at a

modest average rate of 1percent in 2016 and

2017, as real wages changed little over this

period (gure13). With spending growth

estimated to have outpaced income growth, the

personal saving rate has declined considerably

since the end of 2015 (gure14).

Consumer spending has also been supported

by further increases in household net wealth.

Broad measures of U.S. equity prices rose

robustly last year, though markets have been

volatile in recent weeks; house prices have also

continued to climb, strengthening the wealth

of homeowners (gure15). As a result of the

increases in home and equity prices, aggregate

household net worth rose appreciably in 2017.

In fact, at the end of the third quarter of 2017,

household net worth was 6.7 times the value of

disposable income, the highest-ever reading for

that ratio, which dates back to 1947 (gure16).

. . . borrowing conditions for consumers

remain generally favorable . . .

Consumer credit expanded in 2017 at about

the same pace as in 2016 (gure17). Financing

conditions for most types of consumer loans

are generally favorable. However, banks have

continued to tighten standards on credit card

and auto loans for borrowers with low credit

scores, possibly in response to some upward

drift in delinquency rates for those borrowers.

Mortgage credit has remained readily available

for households with solid credit proles, but

it was still dicult to access for households

with low credit scores or harder-to-document

incomes.

Percent, annual rate

2017201620152014201320122011

13. Change in real personal consumption expenditures

and disposable personal income

SOURCE

: Bureau of Economic Analysis via Haver Analytics.

Personal consumption expenditures

Disposable personal income

PercentMonthly

201720152013201120092007

14. Personal saving rate

NOTE: Data are through December 2017.

SOURCE

: Bureau of Economic Analysis via Haver Analytics.

CoreLogic

price index

S&P/Case-Shiller

national index

Percent change from year earlier

201720152013201120092007

15. Prices of existing single-family houses

Monthly

Zillow index

OTE

: The data for the S&P/Case-Shiller index extend through November

2017.

The data for the Zillow index and the CoreLogic index extend through

December 2017.

SOURCE

: CoreLogic Home Price Index; Zillow; S&P/Case-Shiller U.S.

National Home Price Index. The S&P/Case-Shiller Index is a product of S&P

Dow

Jones Indices LLC and/or its affiliates. (For Dow Jones Indices

licensing information, see the note on the Contents page.)

18 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

Although household borrowing continued to

increase last year, the household debt service

burden—the ratio of required principal and

interest payments on outstanding household

debt to disposable income, measured for the

household sector as a whole—remained low by

historical standards.

. . . and consumer condence is strong

Consumers have remained optimistic about

their economic situation. As measured by the

Michigan survey, consumer sentiment was

solid throughout 2017, likely reecting rising

income, job gains, and low ination (gure18).

Furthermore, the share of households

expecting real income to rise over the next year

or two has continued to strengthen and now

exceeds its pre-recession level.

Activity in the housing sector has

improved modestly

Real residential investment spending increased

around 2percent in 2017, about the same

modest gain that was seen in 2016. Housing

activity was soft in the spring and summer,

possibly reecting the rise in mortgage interest

rates early in the year, and then picked up

toward the end of the year. For the year as a

whole, sales of new and existing homes gained,

and single-family housing starts increased

(gures 19 and 20). In contrast, multifamily

housing starts continued to edge down from

the solid pace seen in 2016. Going forward,

lean inventories are likely to support further

gains in homebuilding activity, as the months’

supply of homes for sale has remained near

low levels.

Business investment has continued to

rebound . . .

Real outlays for business investment—that

is, private nonresidential xed investment—

rose at an annual rate of about 6percent

in the second half of 2017, a bit below the

gain in the rst half but still notably faster

than the unusually weak pace recorded

in 2016 (gure21). Business spending on

equipment and intangibles (such as research

Consumer sentiment

100

110

Index

2018201620142012201020082006

Diffusion index

18. Indexes of consumer sentiment and income expectations

Real income expectations

OTE

: The data extend through February 2018; the February data are

preliminary. The consumer sentiment data are monthly and are indexed to

100 in 1966. The real income expectations data are calculated as the net

percentage of survey respondents expecting family income to go up more

than prices during the next year or two plus 100 and are shown as a

three-month moving average.

OURCE

: University of Michigan Surveys of Consumers.

200

400

600

800

1,000

Billions of dollars, annual rate

201720152013201120092007

17. Changes in household debt

Sum

NOTE

: The values for 2017 are the averages of the seasonally

adjusted

annualized quarterly flows through 2017:Q3.

OURCE: Federal Reserve Board, Statistical Release Z.1,

“Financial

Accounts of the United States.”

Mortgages

Consumer credit

5.0

5.5

6.0

6.5

7.0

Ratio

20172014201120082005200219991996

16. Wealth-to-income ratio

Quarterly

NOTE

: The data extend through 2017:Q3. The series is the ratio of

household net worth to disposable personal income.

SOURCE: For net worth, Federal Reserve Board, Statistical Release Z.1,

“Financial

Accounts of the United States”; for income, Bureau of Economic

Analysis via Haver Analytics.

MONETARY POLICY REPORT: FEBRUARY 2018 19

and development) advanced at a solid pace

in the second half of the year, and forward-

looking indicators of business spending are

generally favorable: Orders and shipments of

capital goods have posted net gains in recent

months, and indicators of business sentiment

and activity remain very upbeat. That said,

business outlays on structures turned down in

the second half of 2017, as investment growth

in drilling and mining structures retreated

from a very rapid pace in the rst half and

investment in other nonresidential structures

declined.

. . . while corporate nancing conditions

have remained accommodative

Aggregate ows of credit to large nonnancial

rms remained solid through the third

quarter, supported in part by continued low

interest rates (gure22). The gross issuance

of corporate bonds stayed robust during

the second half of 2017, and yields on both

investment-grade and high-yield corporate

bonds remained low by historical standards

(gure23).

Despite solid growth in business investment,

outstanding commercial and industrial (C&I)

loans on banks’ books continued to rise

only modestly in the third quarter of 2017.

Respondents to the Senior Loan Ocer

Opinion Survey on Bank Lending Practices,

or SLOOS, reported that demand for C&I

loans declined in the third quarter and was

little changed in the fourth quarter even as

lending standards and terms on such loans

eased.

Respondents attributed this decline in

demand in part to rms drawing on internally

generated funds or using alternative sources

of nancing. Financing conditions for small

businesses appear to have remained favorable,

and although credit growth has remained

sluggish, survey data suggest this sluggishness

is largely due to continued weak demand for

credit by small businesses.

8. The SLOOS is available on the Board’s website at

https://www.federalreserve.gov/data/sloos/sloos.htm.

Existing home sales

1.0

1.2

1.4

1.6

Millions, annual rate

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

2018201620142012201020082006

19. New and existing home sales

Millions, annual rate

New home sales

OTE

: Data are monthly. New home sales extend through December

2017

and include only single-family sales. Existing home sales

includes

single-family, condo, townhome, and co-op sales.

OURCE

: For new home sales, U.S. Census Bureau; for existing

home

sales, National Association of Realtors; all via Haver Analytics.

Percent, annual rate

20172016201520142013201220112010

21. Change in real private nonresidential fixed investment

SOURCE

: Bureau of Economic Analysis via Haver Analytics.

Structures

Equipment and intangible capital

Multifamily starts

Single-family permits

1.2

1.6

2.0

Millions of units, annual rate

2018201620142012201020082006

20. Private housing starts and permits

Monthly

Single-family starts

SOURCE: U.S. Census Bureau via Haver Analytics.

20 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

Net exports subtracted from GDP

growth in the fourth quarter after

providing a modest addition during the

rest of the year

U.S. real exports expanded at a moderate

pace in the second half of last year after

having increased more rapidly in the rst half,

supported by solid foreign growth (gure24).

At the same time, real imports surged in the

fourth quarter following a slight contraction in

the third quarter. As a result, real net exports

moved from modestly lifting U.S. real GDP

growth during the rst three quarters of 2017

to subtracting more than 1percentage point in

the fourth quarter. Although the nominal trade

and current account decits narrowed in the

third quarter of 2017, the trade decit widened

in the fourth quarter (gure25).

Federal scal policy actions had a

roughly neutral effect on economic

growth in 2017 . . .

Federal government purchases rose 1percent

in 2017, and policy actions had little eect on

federal taxes or transfers (gure26). Under

currently enacted legislation, which includes

the Tax Cuts and Jobs Act (TCJA) and the

Bipartisan Budget Act, federal scal policy

will likely provide a moderate boost to GDP

growth this year.

The federal unied decit continued to widen

in scal year 2017, reaching 3½percent of

nominal GDP. Although expenditures as a

share of GDP were relatively stable at a little

under 21percent, receipts moved lower in 2017

to roughly 17percent of GDP (gure27).

The ratio of federal debt held by the public

to nominal GDP was 75¼percent at the end

of scal year 2017 and remains quite elevated

relative to historical norms (gure28).

9. The Joint Committee on Taxation estimates that the

TCJA will reduce average annual tax revenue by a little

more than 1percent of GDP over the next few years.

This revenue estimate does not account for the potential

macroeconomic eects of the legislation.

Percent, annual rate

2017201620152014

24. Change in real imports and exports of goods

and services

OURCE

: Bureau of Economic Analysis via Haver Analytics.

Imports

Exports

Double-A

High-yield

Percentage points

2000 2003 2006 2009 2012 2015 2018

23. Corporate bond yields, by securities rating

Daily

Triple-B

OTE: The yields shown are yields on 10-year bonds.

OURCE

: ICE Bank of America Merrill Lynch Indices, used

with

permission.

Billions of dollars, monthly rate

201720152013201120092007

22. Selected components of net debt financing for

nonfinancial businesses

Sum

OURCE

: Federal Reserve Board, Statistical Release Z.1,

“Financial

Accounts of the United States.”

Commercial paper

Bonds

Bank loans

MONETARY POLICY REPORT: FEBRUARY 2018 21

. . . and the scal position of most state

and local governments is stable

The scal position of most state and local

governments is stable, although there is a

range of experiences across these governments.

Many state governments are experiencing

lackluster revenue growth, as income tax

collections have only edged up, on average,

in recent quarters. In contrast, house price

gains have continued to push up property tax

revenues at the local level. Employment in the

state and local government sector only inched

up in 2017, while outlays for construction by

these governments continued to decline on net

(gure29).

Financial Developments

The expected path of the federal funds

rate has moved up

The path of the expected federal funds rate

implied by market quotes on interest rate

derivatives has moved up on net since the

middle of last year amid an improving global

growth outlook (gure30). Part of the upward

shift occurred around FOMC communications

in the fall that were interpreted as implying a

somewhat quicker pace of policy rate increases

than had been previously anticipated. The

expected policy path also moved higher around

the time when the U.S. tax legislation was

nalized.

Survey-based measures of the expected path

of the policy rate have been generally little

changed on net, suggesting that part of the

rise in the market-implied path reected higher

term premiums. In the Federal Reserve Bank

of New York’s Survey of Primary Dealers and

Survey of Market Participants, which were

conducted just before the January2018 FOMC

meeting, the median respondents expected

three 25 basis point increases in the FOMC’s

target range for the federal funds rate as the

most likely outcome for this year, unchanged

from what they had expected in surveys

conducted before the June FOMC meeting.

Market-based measures of uncertainty about

Expenditures

Percent of nominal GDPPercent of nominal GDP

201720132009200520011997

Annual

27. Federal receipts and expenditures

Receipts

OTE

: The receipts and expenditures data are on a unified-budget basis

and

are

for fiscal years (October through September); gross domestic

product

(GDP) data are for the four quarters ending in Q4.

OURCE

: Office of Management and Budget via Haver Analytics.

Percent, annual rate

201720162015201420132012201120102009

26. Change in real government expenditures on

consumption and investment

SOURCE: Bureau of Economic Analysis via Haver Analytics.

Federal

State and local

Current account

Percent of nominal GDP

201720152013201120092007200520032001

25. U.S. trade and current account balances

Quarterly

Trade

OTE: GDP is gross domestic product. Current account data

extend

through 2017:Q3.

SOURCE: Bureau of Economic Analysis via Haver Analytics.

22 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

the policy rate approximately one to two years

ahead have, on balance, edged up from their

levels in the middle of 2017.

The nominal Treasury yield curve has

shifted up

The nominal Treasury yield curve has shifted

up on net since the middle of 2017, owing

to greater optimism about the global growth

outlook and investors’ perceptions of higher

odds for the removal of monetary policy

accommodation (gure31). Yields on shorter-

term nominal Treasury securities increased

relatively more than those on longer-term

nominal Treasury securities, thus resulting in

some attening of the yield curve. According

to market participants, among the factors

contributing to this outcome has been the

Treasury Department’s stated intention to

increase its reliance on issuance of short-dated

securities, as discussed in the two most recent

releases of the Treasury’s quarterly nancing

statement.

Consistent with the changes in Treasury yields,

yields on 30-year agency mortgage-backed

securities (MBS)—an important determinant

of mortgage interest rates—increased but

remain quite low by historical standards

(gure32).

Broad equity price indexes have

increased further . . .

Broad U.S. equity indexes, despite some

declines seen in recent weeks, have, on balance,

increased further since June2017, with most

of the net gains occurring during the nal

quarter of last year (gure33). Equity prices

were reportedly supported in part by an

increase in investors’ condence that changes

to the federal tax law will boost corporate

earnings. Stock prices generally increased

across industries outside utilities and real

estate, two sectors for which the increases in

interest rates described earlier are likely to have

weighed more heavily on stock prices; stock

prices of banks rose more than the broader

market. Implied volatility for the S&P500

index, as calculated from options prices,

Percent of nominal GDP

Quarterly

28. Federal government debt held by the public

1967 1977 1987 1997 2007 2017

OTE: The data extend through 2017:Q3. The data for gross

domestic

product (GDP) are at an annual rate. Federal debt held by the public

equals

federal debt less Treasury securities held in federal employee defined

benefit

retirement accounts, evaluated at the end of the quarter.

SOURCE: For GDP, Bureau of Economic Analysis via Haver Analytics;

for

federal debt, Federal Reserve Board, Statistical Release Z.1,

“Financial

Accounts of the United States.”

Employment

19.0

19.2

19.4

19.6

19.8

Millions of employees

200

220

240

260

280

300

20182016201420122010

29. State and local employment and structures investment

Billions of chained (2009) dollars, annual rate

Real structures

OTE

:The employment data are monthly, and the structures data

are

quarterly.

SOURCE: For employment data, Bureau of Labor Statistics; for

structures

data, Bureau of Economic Analysis; all via Haver Analytics.

Feb. 21, 2018

1.0

1.5

2.0

2.5

Percent

2020201920182017

30. Market-implied federal funds rate

Quarterly

June 30, 2017

OTE

: The federal funds rate path is implied by quotes on overnight

index

swaps—a

derivative contract tied to the effective federal funds rate.

The

implied

path as of February 21, 2018, is compared with that as of June

30,

2017.

The path is estimated with a spline approach, assuming a term

premium

of 0 basis points. The paths extend through 2020:Q4.

OURCE

: Bloomberg; Federal Reserve Board staff estimates.

MONETARY POLICY REPORT: FEBRUARY 2018 23

increased notably in early February, ending

the period close to the median of its historical

distribution.

. . . while risk spreads on corporate bonds

have continued to decrease

Spreads on both high-yield and investment-

grade corporate bond yields over comparable-

maturity Treasury yields have decreased

further since the middle of last year, with

spreads for high-yield bonds moving closer

to the bottom of their historical ranges. The

narrowing of the spreads since the middle of

2017 appears to reect both an anticipation

that the losses from defaults on these bonds

will be smaller and a lower compensation

being charged for bearing the risk of such

losses. (For a discussion of nancial stability

issues, see the box “Developments Related to

Financial Stability.”)

Markets for Treasury securities, mortgage-

backed securities, municipal bonds, and

short-term funding have functioned well

Available indicators of Treasury market

functioning have generally remained stable

over the second half of 2017 and early 2018,

with a variety of liquidity metrics—including

bid-ask spreads, bid sizes, and estimates of

transaction costs—mostly unchanged over

the period. Liquidity conditions in the agency

MBS market have also been generally stable.

In recent months, the functioning of Treasury

and agency MBS markets has not been notably

aected by the implementation of the Federal

Reserve’s balance sheet normalization program

and the resulting reduction in reinvestment of

principal payments from the Federal Reserve’s

securities holdings. In early February, amid

nancial market volatility, liquidity conditions

in the Treasury market deteriorated but have

recovered somewhat since. Credit conditions

in municipal bond markets have also remained

generally stable since June2017. Over that

period, yield spreads on 20-year general

obligation municipal bonds over comparable-

maturity Treasury securities have narrowed

on balance. Nevertheless, signicant nancial

strains were still evident for some issuers.

S&P 500 index

100

125

150

175

200

December 31, 1999 = 100

2018201620142012201020082006200420022000

33. Equity prices

Daily

Dow Jones bank index

OURCE

: Standard & Poor's Dow Jones Indices via Bloomberg. (For

Dow

Jones Indices licensing information, see the note on the Contents page.)

Yield

100

150

200

250

300

Basis points

2018201620142012201020082006200420022000

32. Yield and spread on agency mortgage-backed securities

Percent

Spread

OTE: The data are daily. Yield shown is for the Fannie Mae 30-year

current coupon, the coupon rate at which new mortgage-backed securities

would be priced at par, or face, value. Spread shown is to the average of the

5- and 10-year nominal Treasury yields. The data extend through February

16, 2018.

SOURCE: Department of the Treasury; Barclays.

5-year

30-year

Percent

2018201620142012201020082006200420022000

31. Yields on nominal Treasury securities

Daily

10-year

OTE: The Treasury ceased publication of the 30-year constant

maturity

series on February 18, 2002, and resumed that series on February 9, 2006.

OURCE

: Department of the Treasury.

24 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

1. An overview of the framework for assessing nancial

stability in the United States is provided in Stanley Fischer

(2017), “An Assessment of Financial Stability in the United

States,” speech delivered at the IMF Workshop on Financial

Surveillance and Communication: Best Practices from

Latin America, the Caribbean, and Advanced Economies,

Washington, June27, www.federalreserve.gov/newsevents/

speech/scher20170627a.htm.

Overall vulnerabilities in the U.S. nancial system

remain moderate on balance.

Valuation pressures

continue to be elevated across a range of asset

classes, including equities and commercial real estate.

Vulnerabilities from leverage in the nancial sector

appear low, reecting in part capital and liquidity

ratios of banks that have continued to improve from

already strong positions. However, there are signs

that nonbank nancial leverage has been increasing

in some areas—for example, in the provision of

margin credit to equity investors such as hedge funds.

Vulnerabilities from nonnancial leverage are judged

to be moderate. While household debt balances have

been increasing modestly, the leverage of the business

sector is elevated, particularly among speculative-grade

rms. Vulnerabilities related to maturity and liquidity

transformation remain low on net.

Over the second half of 2017, valuation pressures

edged up from already elevated levels. In general,

valuations are higher than would be expected based

solely on the current level of longer-term Treasury

yields. In part reecting growing anticipation of the

boost to future (after-tax) earnings from a corporate

tax rate cut, price-to-earnings ratios for U.S. stocks

rose through January and were close to their highest

levels outside of the late 1990s (gure A); ratios

dropped back somewhat in early February. In a sign of

increasing valuation pressures in commercial real estate

markets, net operating income relative to property

values (referred to as capitalization rates) have been

declining relative to Treasury yields of comparable

maturity for multifamily and industrial properties.

While these spreads narrowed further from already

low levels, they are wider than in 2007. Even though

the aggregate residential house price-to-rent ratio has

been increasing faster than its long-run trend, it is

only slightly elevated at present. In corporate credit

markets, spreads of corporate bond yields over those

of Treasury securities with comparable maturities fell,

and the high-yield spread is now near the bottom of its

historical distribution. Spreads on leveraged loans and

collateralized loan obligations—which are a signicant

Developments Related to Financial Stability

funding source for the corporate sector—stayed

compressed. In addition, nonprice terms eased on these

types of loans, indicating weaker investor protection

than at the peak of the previous credit cycle in 2007.

Consistent with elevated risk appetite, virtual currencies

experienced sharp price increases in 2017.

Vulnerabilities related to nancial-sector leverage

appear low. Leverage at insurance companies and at

broker-dealers is on the low end of its historical range,

and most indicators of leverage at other nonbank

nancial rms are stable. However, there is some

evidence that dealers have eased price terms to hedge

funds and real estate investment trusts, and that hedge

funds have gradually increased their use of leverage,

in particular margin credit for equity trades. Although

such easing of price terms has taken place against the

backdrop of building valuation pressures, the strong

capital position of bank holding companies reduces

the risk that sudden drops in asset prices could

signicantly affect bank-afliated dealers. Risk-based

regulatory capital ratios for most of the largest bank

holding companies continued to increase from already

high levels.

If interest rates were to increase unexpectedly,

banks’ strong capital position should help absorb the

consequent losses on securities. About one-third of

the losses that could be experienced by banks would

affect held-to-maturity securities. While these losses

Ratio

201820142010200620021998199419901986

A. Forward price-to-earnings ratio of S&P 500 firms

Monthly

Historical median

OTE: The February 2018 value is based on a mid-month estimate.

The

data

depict the aggregate forward price-to-earnings ratio of S&P 500

firms.

The

historical median is based on data from 1985 to the present. Shaded

bars

indicate

periods of recession as defined by the National Bureau of

Economic

Research. Data are based on 12-month-ahead expected earnings per share.

OURCE

: Staff estimates based on Thomson Reuters, IBES.

MONETARY POLICY REPORT: FEBRUARY 2018 25

would not reduce regulatory capital, they could still

have a variety of negative consequences—for example,

by worsening banks’ funding terms. The large share of

deposits in bank liabilities is also likely to soften the

effect of an unexpected rise in interest rates on banks,

because deposit rates tend to adjust with a delay and

bank protability would improve in the meantime.

Overall vulnerabilities arising from leverage in

the nonnancial sector continue to be moderate.

Continuing its pattern in recent years, household debt

has expanded about in line with nominal income,

and the household credit-to-GDP gap remains sizable

and negative (gure B). Leverage in the nonnancial

business sector remains high, with net issuance of risky

debt climbing in recent months. However, the share of

the lowest-quality debt in total issuance declined, and

relatively low interest expenses mitigated some of the

vulnerabilities associated with elevated leverage.

In part attributable to regulations introduced

since the nancial crisis, vulnerabilities associated

with liquidity and maturity transformation—that is,

the nancing of illiquid or long-maturity assets with

short-maturity debt—continue to be low. The reliance

of global systemically important banks (G-SIBs) on

short-term wholesale funding has risen only slightly

from post-crisis lows, while their holdings of high-

quality liquid assets stand at high levels and exceed

those required by the Liquidity Coverage Ratio. The

share of core deposits in total liabilities at G-SIBs

also remains at historically high levels. More than

one year after the money market fund reform, which

reduced run risk as investors shifted from prime to

government funds, the growth in alternative short-

term investment vehicles has been limited. Regarding

securitized products, although the issuance of asset-

backed securities (ABS) was strong, overall issuance

has remained well below pre-crisis levels for most asset

classes, and securitizations appear to involve limited

maturity or liquidity transformation. Nonetheless, ABS

issuance was boosted by the securitization of assets

that were rarely securitized in the past, such as aircraft

leases and mobile phone contracts. In addition, certain

nontraditional liabilities of life insurers, including

funding-agreement-backed securities, have grown

notably recently, although levels remain low relative to

the broader market for securitizations.

Financial vulnerabilities in foreign economies are

moderate overall. Advanced foreign economies, many

of which have strong nancial and real linkages to

the United States, continue to struggle with elevated

valuations, the disposal of legacy assets, and, in some

cases, worrisome rises in mortgage debt. Some major

emerging market economies harbor more pronounced

vulnerabilities, reecting one or more of the following:

substantial corporate leverage, scal concerns, or

excessive reliance on foreign funding.

The countercyclical capital buffer (CCyB) is a

macroprudential tool the Federal Reserve Board can

use to increase the resilience of the nancial system

by raising capital requirements on internationally

active banking organizations. The CCyB is activated

when there is an elevated risk of above-normal future

losses and when the banking organizations for which

capital requirements would be raised by the buffer

are exposed to or are contributing to this elevated

risk—either directly or indirectly. The nancial stability

developments, assessments, and framework described

and used here bear importantly on the Board’s setting

of the CCyB.

In December2017, the Board voted to

afrm the CCyB at its level of 0percent.

2. See Board of Governors of the Federal Reserve System

(2016), “Regulatory Capital Rules: The Federal Reserve Board’s

Framework for Implementing the U.S. Basel III Countercyclical

Capital Buffer,” nal policy statement (Docket No. R-1529),

Federal Register, vol. 81 (September16), pp. 63682–88.

Corporate business

Noncorporate business

Percentage point difference from trend

2017201320092005200119971993198919851981

Quarterly

B. Private nonfinancial sector credit-to-GDP gap

NOTE: The data extend through 2017:Q3 and are smoothed using

Hodrick-Prescott

filter. The shaded bars indicate periods of

business

recession

as defined by the National Bureau of Economic Research.

Gaps

have

been weighted by their share of overall credit. GDP is gross

domestic

product.

SOURCE

: Federal Reserve Board, Statistical Release Z.1,

“Financial

Accounts

of the United States”; Bureau of Economic Analysis via

Haver

Analytics,

national income and product accounts, Table 1.1.5:

Gross

Domestic Product; Board staff calculations.

Household

(continued on next page)

26 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

Over the second half of 2017, the Federal Reserve

Board has taken some key steps to reduce regulatory

burden while promoting the nancial stability of the

United States. The Federal Reserve Board, Ofce of

the Comptroller of the Currency, and Federal Deposit

Insurance Corporation jointly proposed amendments

to the banking agencies’ commercial real estate

appraisal regulations that raised the threshold price

for mandating appraisals from $250,000 to $400,000,

thereby reducing the number of required appraisals.

In addition, the federal banking agencies issued a

proposal to simplify aspects of community banking

organizations’ regulatory capital rules, with the goal

of reducing regulatory burden on smaller institutions

while maintaining the safety and soundness of the

banking system.

The Board requested comment on a corporate

governance proposal to enhance the effectiveness

of nancial rms’ boards of directors. The proposal

refocuses the Federal Reserve’s supervisory expectations

for the largest rms’ boards of directors on their core

responsibilities and would also reduce unnecessary

burden for the boards of smaller institutions.

The Board

3. See Ofce of the Comptroller of the Currency, Board

of Governors of the Federal Reserve System, and the

Federal Deposit Insurance Corporation (2017), “Real Estate

Appraisals,” notice of proposed rulemaking and request for

comment (Docket No. R-1568), Federal Register, vol. 82

(July31), pp. 35478–93.

4. See Ofce of the Comptroller of the Currency, Board

of Governors of the Federal Reserve System, and the Federal

Deposit Insurance Corporation (2017), “Simplications to the

Capital Rule Pursuant to the Economic Growth and Regulatory

Paperwork Reduction Act of 1996,” notice of proposed

rulemaking (Docket No. R-1576), Federal Register, vol. 82

(October27), pp. 49984–50044.

5. See Board of Governors of the Federal Reserve System

(2017), “Federal Reserve Board Invites Public Comment on

also adopted a nal rule to improve the resolvability

and resilience of G-SIBs and their subsidiaries to

restrictions regarding the terms of their noncleared

qualied nancial contracts.

In addition, the Board

proposed changes to its supervisory rating system

for large nancial institutions to better align with the

post-crisis supervisory program for these rms; smaller

institutions, including community banks, would

continue to use the current rating system.

Finally, the

Board requested comment on a package of proposals

that would increase the transparency of its stress-testing

program. In particular, the proposals would provide

more information about the models used to estimate

hypothetical losses in the stress tests while maintaining

the Board’s ability to test the resilience of the nation’s

largest and most complex banks.

Two Proposals; Corporate Governance and Rating System

for Large Financial Institutions,” press release, August3,

https://www.federalreserve.gov/newsevents/pressreleases/

bcreg20170803a.htm.

6. See Board of Governors of the Federal Reserve System

(2017), “Restrictions on Qualied Financial Contracts of

Systemically Important U.S. Banking Organizations and the

U.S. Operations of Systemically Important Foreign Banking

Organizations; Revisions to the Denition of Qualifying

Master Netting Agreement and Related Denitions,” nal rule

(Docket No. R-1538), Federal Register, vol. 82 (September12),

pp. 42882–926.

7. See Board of Governors, “Federal Reserve Board Invites

Public Comment on Two Proposals,” in note 5.

8. See Board of Governors of the Federal Reserve System

(2017), “Federal Reserve Board Requests Comment on

Package of Proposals That Would Increase the Transparency

of Its Stress Testing Program,” press release, December7,

www.federalreserve.gov/newsevents/pressreleases/

bcreg20171207a.htm.

Developments Related to Financial Stability (continued)

MONETARY POLICY REPORT: FEBRUARY 2018 27

In particular, prices for Puerto Rico general

obligation bonds fell notably after Hurricane

Maria hit the island and its economic outlook

deteriorated even further. However, these

developments left little imprint in broader

municipal bond markets. Conditions in

domestic short-term funding markets have

remained stable since the middle of last year.

Bank credit continued to expand and

bank protability remained stable

Aggregate credit provided by commercial

banks continued to expand in the second

half of 2017 at a pace similar to the one seen

earlier in the year but more slowly than in

2016. Its pace was also slower than that of

nominal GDP, thus leaving the ratio of total

commercial bank credit to current-dollar GDP

slightly lower than earlier in 2017 (gure34).

Measures of bank protability were little

changed at levels below their historical

averages (gure35).

International Developments

Economic activity in most foreign

economies continued at a healthy pace in

the second half of 2017

Foreign real GDP appears to have expanded

notably in the second half of 2017, extending

the period since mid-2016 when the pace of

economic growth picked up broadly around

the world.

Growth in advanced foreign economies

was solid, and unemployment fell to

multidecade lows . . .

In the advanced foreign economies (AFEs),

the economic recovery has continued to rm.

Real GDP in the euro area and the United

Kingdom expanded at a solid pace in the

second half of the year (gure36). Economic

activity also continued to expand in Japan,

though real GDP growth slowed sharply in

the fourth quarter. In Canada, data through

November indicate that economic growth

moderated somewhat in the second half

following a very rapid expansion earlier in

the year. Unemployment declined further as

Percent, annual rate

2017201620152014

36. Real gross domestic product growth in selected

advanced foreign economies

OTE:The data for the United Kingdom and the euro area

incorporate

flash estimates for 2017:Q4. The data for Japan incorporate the

preliminary

estimate for 2017:Q4. The data for Canada extend through 2017:Q3.

OURCE

For the United Kingdom, Office for National Statistics; for Japan,

Cabinet Office, Government of Japan; for the euro area, Eurostat; for

Canada,

Statistics Canada; all via Haver Analytics.

United Kingdom

Japan

Euro area

Canada

Return on assets

Percent, annual rate

2.0

1.5

1.0

1.5

2.0

201720152013201120092007200520032001

35. Profitability of bank holding companies

Percent, annual rate

Return on equity

OTE: The data are quarterly and are seasonally adjusted. The data

extend

through 2017:Q3.

SOURCE: Federal Reserve Board, Form FR Y-9C, Consolidated

Financial

Statements for Bank Holding Companies.

Percent

201720152013201120092007200520032001

34. Ratio of total commercial bank credit to nominal gross

domestic product

Quarterly

SOURCE

: Federal Reserve Board, Statistical Release H.8, “Assets

and

Liabilities

of Commercial Banks in the United States”; Bureau of

Economic

Analysis via Haver Analytics.

28 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

well, reaching 40-year lows in Canada and

the United Kingdom, while growth in labor

compensation ticked up only modestly.

. . . but ination remained subdued . . .

Consumer price ination rose somewhat in

most AFEs, boosted by the rise in commodity

prices (gure37). However, headline and

especially core ination remained below the

central banks’ targets in the euro area and

Japan. In contrast, U.K. ination rose further

above the Bank of England’s (BOE) 2percent

target as the substantial sterling depreciation

observed since the June2016 Brexit

referendum continued to provide some uplift

to import prices. (For more discussion

of ination both in the United States and

abroad, see the box “Low Ination in the

Advanced Economies” in the Domestic

Developments section.)

. . . leading AFE central banks to maintain

accommodative monetary policies

The Bank of Japan kept its policy rates at

historically low levels, with the target for

10-year government bond yields around

zero. In October, the European Central Bank

extended its asset purchase program until

September2018, albeit at a reduced pace. The

Bank of Canada and the BOE both raised

their policy rates but also indicated that they

intend to proceed gradually with further

removal of policy accommodation.

In emerging Asia, growth remained solid. . .

Economic growth in China remained relatively

strong in the second half of 2017 even as the

authorities enacted policies to limit production

in heavily polluting industries, tighten nancial

regulations, and curb house price growth

(gure38). Most other emerging Asian

economies registered very strong growth in the

third quarter of 2017, fueled by solid external

demand, but slowed in the fourth quarter.

United Kingdom

Canada

Euro area

12-month percent change

2014 2015 2016 2017 2018

37. Consumer price inflation in selected advanced foreign

economies

Monthly

Japan

OTE

The data for the euro area incorporate the flash estimate for January

2018. The data for Canada and Japan extend through December 2017.

SOURCE:

For the United Kingdom, Office for National Statistics; for Japan,

Ministry of International Affairs and Communications; for the euro

area,

Statistical Office of the European Communities; for Canada,

Statistics

Canada; all via Haver Analytics.

Percent, annual rate

2017201620152014

38. Real gross domestic product growth in selected

emerging market economies

OTE: The data for China are seasonally adjusted by Board staff. The

data

for

Korea, Mexico, and Brazil are seasonally adjusted by their

respective

government

agencies. The data for Mexico incorporate the flash estimate

for

2017:Q4. The data for Brazil extend through 2017:Q3.

SOURCE: For China, China National Bureau of Statistics; for Korea,

Bank

Korea; for Mexico, Instituto Nacional de Estadistica y Geografia;

for

Brazil, Instituto Brasileiro de Geografia e Estatistica; all via Haver Analytics.

China

Korea

Mexico

Brazil

MONETARY POLICY REPORT: FEBRUARY 2018 29

. . . while the largest Latin American

economies continued to struggle

In Mexico, real GDP declined in the third

quarter as two major earthquakes and a

hurricane signicantly disrupted economic

activity, but rebounded in the fourth quarter.

Following a prolonged period of contraction,

the Brazilian economy continues to recover,

but only at a weak pace. Private investment has

remained sluggish amid corporate deleveraging

and continued uncertainty about government

policies, although it turned positive in the third

quarter for the rst time in nearly four years.

Foreign equity prices rose further on net. . .

Solid macroeconomic data and robust

corporate earnings helped broad AFE and

emerging market economies (EMEs) equity

indexes extend their 2016 gains through the

start of this year (gure39). Declines since

the end of January have erased some of these

gains, and volatility in foreign stock markets

increased. On balance, most AFE stock

prices are higher, and EME equity markets

signicantly outperformed those of AFEs.

Capital ows into emerging market mutual

funds generally remained robust as higher

commodity prices added to optimism about

the economic outlook (gure40).

. . . and government bond yields

increased

Longer-term government bond yields in most

AFEs were noticeably higher than their mid-

2017 levels, reecting strengthening growth

and mounting prospects for the normalization

of monetary policies (gure41). In Canada,

where the central bank has raised its policy

interest rate 75 basis points since June, the rise

in longer-term yields was particularly notable.

On balance, spreads of dollar-denominated

emerging market sovereign bonds over U.S.

Treasury securities were stable around the

levels observed in mid-2017 (as shown in

gure40).

EMBI+ (left axis)

Billions of dollars

250

300

350

400

450

500

2014 2015 2016 2017 2018

40. Emerging market mutual fund flows and spreads

Basis points

Jan.

Feb.

OTE

: The bond and equity fund flow data are quarterly sums of

weekly

data from January 1, 2014, to December 31, 2017, and monthly sums

weekly data from January 1, 2018, to February 14, 2018. The fund flows data

exclude funds located in China. The J.P. Morgan Emerging Markets

Bond

Index Plus (EMBI+) data are weekly averages of daily data and

extend

through February 20, 2018.

OURCE

: For bond and equity fund flows, EPFR Global; for EMBI+,

J.P.

Morgan Emerging Markets Bond Index Plus via Bloomberg.

Bond fund flows (right axis)

Equity fund flows (right axis)

United Kingdom

Emerging market economies

Euro area

100

105

110

115

120

125

130

135

140

145

150

Week ending January 8, 2014 = 100

2014 2015 2016 2017 2018

39. Equity indexes for selected foreign economies

Weekly

Japan

OTE

: The data are weekly averages of daily data and extend

through

February 21, 2018.

OURCE: For euro area, DJ Euro Stoxx Index; for Japan, TOPIX

Stock

Index; for United Kingdom, FTSE 100 Stock Index; for emerging

market

economies, MSCI Emerging Markets Local Currency Index; all

via

Bloomberg.

30 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

The dollar depreciated on net

The broad dollar index––a measure of the

trade-weighted value of the dollar against

foreign currencies––fell roughly 5percent in

the rst half of 2017. Notwithstanding some

appreciation in early February, the currency

has depreciated further since the end of June,

partially reversing substantial appreciation

realized over the period from 2014 to 2016

(gure42). The weakness in the dollar mostly

reects a broad-based improvement in the

outlook for foreign economic growth. Brexit-

related headlines weighed on the British pound

at times during the second half of 2017, but

progress regarding the terms of the U.K.

separation from the European Union boosted

the currency later in the year. In contrast,

the dollar appreciated against the Mexican

peso, on net, amid uncertainty around North

American Free Trade Agreement negotiations.

Canada

United States

Germany

1.0

1.5

2.0

2.5

3.0

Percent

2014 2015 2016 2017 2018

41. Nominal 10-year government bond yields in

selected advanced economies

Weekly

United Kingdom

OTE

: The data are weekly averages of daily benchmark yields and

extend

through February 21, 2018.

OURCE

:Bloomberg.

Mexican peso

British pound

Euro

100

110

120

130

140

150

160

170

Week ending January 8, 2014 = 100

2014 2015 2016 2017 2018

42. U.S. dollar exchange rate indexes

Weekly

Broad dollar

Dollar appreciation

OTE: The data, which are in foreign currency units per dollar, are

weekly

averages of daily data and extend through February 21, 2018. As indicated by

the

arrow, increases in the data represent U.S. dollar appreciation,

and

decreases represent U.S. dollar depreciation.

SOURCE: Federal Reserve Board, Statistical Release H.10,

“Foreign

Exchange Rates.”

The Federal Open Market Committee

raised the federal funds rate target range

in December

For more than two years, the Federal Open

Market Committee (FOMC) has been

gradually increasing its target range for

the federal funds rate as the labor market

strengthened and headwinds in the aftermath

of the recession continued to abate. After

having raised the target range for the federal

funds rate twice in the rst half of 2017,

the Committee raised it again in December,

bringing the target range to 1¼ to 1½percent

(gure43).

As on previous occasions, the

decision to increase the federal funds rate in

December reected realized and expected labor

market conditions and ination relative to the

FOMC’s objectives. Information available at

that time indicated that economic activity had

been rising at a solid rate and the labor market

had continued to strengthen. In addition,

although ination had continued to run below

the FOMC’s 2percent longer-run objective,

10. See Board of Governors of the Federal Reserve

System (2017), “Federal Reserve Issues FOMC

Statement,” press release, December13, https://

www.federalreserve.gov/newsevents/pressreleases/

monetary20171213a.htm.

the Committee expected that it would stabilize

around that target over the medium term. At

its most recent meeting, which concluded on

January31, the Committee kept the target

range for the federal funds rate unchanged.

Monetary policy continues to support

economic growth

Even with the gradual increases in the federal

funds rate to date, the Committee judges

that the stance of monetary policy remains

accommodative, thereby supporting strong

labor market conditions and a sustained return

to 2percent ination. The federal funds rate

remains somewhat below most estimates of its

neutral rate—that is, the level of the federal

funds rate that is neither expansionary nor

contractionary.

In evaluating the stance of monetary policy,

policymakers routinely consult prescriptions

from a variety of policy rules, which can

serve as useful benchmarks. However, the

11. See Board of Governors of the Federal

Reserve System (2018), “Federal Reserve Issues

FOMC Statement,” press release, January31, https://

www.federalreserve.gov/newsevents/pressreleases/

monetary20180131a.htm.

Target range for the federal funds rate

2-year Treasury rate

Percent

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

43. Selected interest rates

Daily

10-year Treasury rate

OTE

: The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities.

OURCE

: Department of the Treasury; Federal Reserve Board.

Part 2

monetary PoLicy

32 PART 2: MONETARY POLICY

use and interpretation of such prescriptions

require careful judgments about the choice

and measurement of the inputs to these

rules as well as the implications of the many

considerations these rules do not take into

account (see the box “Monetary Policy Rules

and Their Role in the Federal Reserve’s Policy

Process”).

Future changes in the federal funds rate

will depend on the economic outlook as

informed by incoming data

The Committee has continued to emphasize

that, in determining the timing and size of

future adjustments to the target range for

the federal funds rate, it will assess realized

and expected economic conditions relative to

its objectives of maximum employment and

2percent ination. This assessment will take

into account a wide range of information,

including measures of labor market

conditions, indicators of ination pressures

and ination expectations, and readings on

nancial and international developments.

The FOMC has emphasized that it will

carefully monitor actual and expected ination

developments relative to its symmetric ination

goal, as ination has been running persistently

below the 2percent longer-run objective.

The Committee expects that the ongoing

strength in the economy will warrant further

gradual increases in the federal funds rate,

and that the federal funds rate will likely

remain, for some time, below the levels that

the Committee expects to prevail in the

longer run. Consistent with this outlook,

in the most recent Summary of Economic

Projections, which was compiled at the time of

the December FOMC meeting, the median of

participants’ assessments for the appropriate

level of the midpoint of the target range

for the federal funds rate at year-end rises

gradually over the period from 2018 to 2020,

remaining below the median projection for its

longer-run level through the end of 2019.

12. See the December Summary of Economic

Projections, which appeared as an addendum to the

The size of the Federal Reserve’s balance

sheet has begun to decrease

The Committee had communicated for some

time that it intended to reduce the size of

the Federal Reserve’s balance sheet once

normalization of the level of the federal funds

rate was well under way. At its meeting in

September, the FOMC decided to initiate the

balance sheet normalization program described

in the June2017 Addendum to the Policy

Normalization Principles and Plans. This

program is gradually and predictably reducing

the Federal Reserve’s securities holdings by

decreasing the reinvestment of the principal

payments it receives from securities held in the

System Open Market Account (SOMA). Since

October, such payments have been reinvested

only to the extent that they exceeded gradually

rising caps (gure44).

In the fourth quarter, the Open Market Desk

at the Federal Reserve Bank of New York, as

directed by the Committee, reinvested principal

payments from the Federal Reserve’s holdings

of Treasury securities maturing during each

calendar month in excess of $6billion. The

Desk also reinvested in agency mortgage-

backed securities (MBS) the amount of

principal payments from the Federal Reserve’s

holdings of agency debt and agency MBS

received during each calendar month in excess

of $4billion. Since January, payments of

principal from maturing Treasury securities

and from the Federal Reserve’s holdings

of agency debt and agency MBS have been

reinvested to the extent that they have exceeded

$12billion and $8billion, respectively. The

Committee has indicated that the cap for

Treasury securities will continue to increase

in steps of $6billion at three-month intervals

until it reaches $30billion per month, and

that the cap for agency debt and agency MBS

will continue to increase in steps of $4billion

at three-month intervals until it reaches

$20billion per month. These caps will remain

in place until the Committee judges that the

Federal Reserve is holding no more securities

minutes of the December12–13, 2017, meeting of the

FOMC and is presented in Part 3 of this report.

MONETARY POLICY REPORT: FEBRUARY 2018 33

than necessary to implement monetary policy

eciently and eectively.

The initiation of the balance sheet

normalization program was widely anticipated

and therefore did not elicit a notable reaction

in nancial markets. Subsequently, the

implementation of the program has proceeded

smoothly without materially aecting Treasury

and MBS markets. With the caps having

been set thus far at relatively low levels, the

reduction in SOMA securities has represented

a small fraction of the SOMA securities

holdings. Consequently, the Federal Reserve’s

total assets have declined somewhat to about

$4.4 trillion, with holdings of Treasury

securities at approximately $2.4 trillion and

holdings of agency debt and agency MBS at

approximately $1.8 trillion (gure45).

Interest income on the SOMA portfolio has

continued to support substantial remittances

to the U.S. Treasury. Preliminary nancial

statement results indicate that the Federal

Billions of dollars

Treasury securities

Monthly Billions of dollars

Agency debt and mortgage-backed securities

Monthly

: Reinvestment and redemption amounts of agency mortgage-backed securities are projections starting in January 2018. The

data extend through December 2019.

S: Federal Reserve Bank of New York; Federal Reserve Board sta calculations.

44. Principal payments on SOMA securities

201920182017

Monthly cap

Redemptions

Reinvestments

201920182017

Monthly cap

Redemptions

Reinvestments

Trillions of dollars

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

45. Federal Reserve assets and liabilities

Weekly

Assets

Liabilities and capital

Other assets

Credit and liquidity

facilities

Agency debt and mortgage-backed securities holdings

Treasury securities held outright

Federal Reserve notes in circulation

Deposits of depository institutions

Capital and other liabilities

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

OTE

: “Credit and liquidity facilities” consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for

Maiden

Lane, Bear Stearns, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money

Market

Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. “Other assets” includes

unamortized

premiums and discounts on securities held outright. “Capital and other liabilities” includes reverse repurchase agreements, the U.S. Treasury

General Account, and the U.S. Treasury Supplementary Financing Account. The data extend through February 14, 2018.

OURCE

: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.”

34 PART 2: MONETARY POLICY

Reserve remitted about $80.2 billion of its

estimated 2017 net income to the Treasury.

The Federal Reserve’s implementation of

monetary policy has continued smoothly

In December2017, the Federal Reserve raised

the eective federal funds rate by increasing

the interest rate paid on reserve balances along

with the interest rate oered on overnight

reverse repurchase agreements (ON RRPs).

Specically, the Federal Reserve increased

the interest rate paid on required and excess

reserve balances to 1½percent and the ON

RRP oering rate to 1¼percent. In addition,

the Board of Governors approved an increase

in the discount rate (the so-called primary

credit rate) to 2percent. Yields on a broad set

of money market instruments moved higher

in response to the FOMC’s policy action in

December. The eective federal funds rate rose

in line with the increase in the FOMC’s target

range and generally traded near the middle

of the new target range amid orderly trading

conditions in money markets. Usage of the

ON RRP facility has declined on net since the

middle of 2017, reecting relatively attractive

yields on alternative investments.

Although the normalization of the monetary

policy stance has proceeded smoothly, the

Federal Reserve has continued to test the

operational readiness of other policy tools as

part of prudent planning. Two operations of

the Term Deposit Facility were conducted in

the second half of 2017; seven-day deposits

were oered at both operations with a oating

rate of 1 basis point over the interest rate

on excess reserves. In addition, the Desk

conducted several small-value exercises solely

for the purpose of maintaining operational

readiness.

MONETARY POLICY REPORT: FEBRUARY 2018 35

the three key principles of good monetary policy

noted earlier. Each rule takes into account estimates

of how far away the economy is from achieving the

Federal Reserve’s dual-mandate goals of maximum

employment and price stability. Specically, most of

the rules include the difference between the rate of

unemployment that is sustainable in the longer run (u

)

and the current unemployment rate (the unemployment

gap); the rst-difference rule includes the change in the

unemployment gap rather than its level.

In addition,

most of the rules include the difference between

ination and its longer-run objective (2percent as

measured by the annual change in the price index

for personal consumption expenditures (PCE), in the

case of the Federal Reserve), while the price-level rule

includes the gap between the level of prices today

and the level of prices that would be observed if

ination had been constant at 2percent from a

specied starting year.

The Taylor (1993), balanced-approach, adjusted

Taylor (1993), and price-level rules provide

prescriptions for the level of the federal funds rate and

require an estimate of the neutral real interest rate in

the longer run (r

)—that is, the level of the real federal

What are monetary policy rules?

Monetary policy rules are formulas that prescribe

the setting of a policy rate, such as the federal funds

rate, that should prevail in relation to the values of a

small number of other variables—typically including

the gap between actual and target ination along with

an estimate of resource slack in the economy. Policy

rules can provide helpful guidance for policymakers.

Indeed, since 2004, prescriptions from policy rules

have been part of the information regularly reported

to the Federal Open Market Committee (FOMC)

ahead of its meetings.

However, interpretation of the

prescriptions of policy rules requires careful judgment

about the measurement of the inputs to the rules and

the implications of the many considerations the rules

do not take into account.

Policy rules can incorporate key principles of good

monetary policy. One key principle is that monetary

policy should respond in a predictable way to changes

in economic conditions. A second key principle is

that monetary policy should be accommodative when

ination is below the desired level and employment

is below its maximum sustainable level; conversely,

monetary policy should be restrictive when the

opposite holds. A third key principle is that, to stabilize

ination, the policy rate should be adjusted by more

than one-for-one in response to persistent increases or

decreases in ination.

Economists have analyzed many monetary policy

rules, including the well-known Taylor (1993) rule

as well as other rules that will be discussed later: the

“balanced approach” rule, the “adjusted Taylor (1993)”

rule, the “price level” rule, and the “rst difference”

rule (gure A).

These policy rules generally embody

Monetary Policy Rules and Their Role in the Federal Reserve’s

Policy Process

1. Prescriptions from monetary policy rules are included

in the Board staff’s Tealbook (previously the Bluebook); the

precise set of rules presented has changed from time to time.

The transcripts and brieng materials for FOMC meetings

through 2012 are available on the Board’s website at https://

www.federalreserve.gov/monetarypolicy/fomc_historical.

htm. In the materials from 2012, the policy rule prescriptions

are contained in the Monetary Policy Strategies section of

Tealbook B. The brieng materials that FOMC policymakers

review regularly also include the Board staff’s baseline

forecast for the economy and model simulations of a variety of

alternative scenarios intended to provide a sense of the effects

of other plausible developments that were not included in the

staff’s baseline forecast.

2. The Taylor (1993) rule was rst suggested in John B.

Taylor (1993), “Discretion versus Policy Rules in Practice,”

Carnegie-Rochester Conference Series on Public Policy, vol.39

(December), pp. 195–214. The balanced-approach rule was

analyzed in John B. Taylor (1999), “A Historical Analysis of

Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy

Rules (Chicago: University of Chicago Press), pp.319–41. The

adjusted Taylor (1993) rule was studied in David Reifschneider

and John C. Williams (2000), “Three Lessons for Monetary

Policy in a Low-Ination Era,” Journal of Money, Credit, and

Banking, vol. 32 (November), pp. 936–66. A price-level rule

was discussed in Robert E. Hall (1984), “Monetary Strategy

with an Elastic Price Standard,” in Price Stability and Public

Policy, proceedings of a symposium sponsored by the Federal

Reserve Bank of Kansas City, held in Jackson Hole, Wyo.,

August2–3 (Kansas City: Federal Reserve Bank of Kansas

City), pp. 137–59, https://www.kansascityfed.org/publicat/

sympos/1984/s84.pdf. Finally, the rst-difference rule was

introduced by Athanasios Orphanides (2003), “Historical

Monetary Policy Analysis and the Taylor Rule,” Journal

of Monetary Economics, vol. 50 (July), pp. 983–1022. A

comprehensive review of policy rules is in John B. Taylor

and John C. Williams (2011), “Simple and Robust Rules for

Monetary Policy,” in Benjamin M. Friedman and Michael

Woodford, eds., Handbook of Monetary Economics, vol.3B

(Amsterdam: North-Holland), pp. 829–59. The same volume

of the Handbook of Monetary Economics also discusses

approaches other than policy rules for deriving policy rate

prescriptions.

3. The Taylor (1993) rule represented slack in resource

utilization using an output gap (the difference between the

current level of real gross domestic product (GDP) and what

GDP would be if the economy was operating at maximum

employment). The rules in gure A represent slack in resource

utilization using the unemployment gap instead, because that

gap better captures the FOMC’s statutory goal to promote

maximum employment. Movements in these alternative

(continued on next page)

36 PART 2: MONETARY POLICY

In four of the rules, the interest rate responds to

deviations of ination from its longer-run value of

2percent; in the price-level rule, however, the interest

rate responds to the price-level gap (PLgap

). This

gap measures how far the price level is from where it

would have been had it been increasing at 2percent

each year.

The price-level rule thereby takes account

of deviations of ination from the longer-run objective

in earlier periods as well in the current period. Thus,

if ination has been running persistently above the

central bank’s objective, the price-level rule would

prescribe a higher policy interest rate than rules that use

the current ination gap. Likewise, if ination has been

running persistently below the central bank’s objective,

a price-level rule would prescribe setting the policy

rate lower than rules that use the current ination gap.

The purpose of this dependence on previous ination

funds rate that is expected to be consistent in the longer

run with sustained maximum employment and stable

ination.

In contrast, the rst-difference rule prescribes

how the level of the federal funds rate at a given time

should be altered from its previous level—that is, it

indicates how the existing rate should be increased or

decreased in a particular period.

The adjusted Taylor (1993) rule recognizes that

the federal funds rate cannot be reduced materially

below zero, and that following the prescriptions of

the Taylor (1993) rule after a period when interest

rates have been constrained may not provide enough

policy accommodation. To make up for the cumulative

shortfall in accommodation (Z

), the adjusted rule

prescribes only a gradual return of the policy rate to

the (positive) levels prescribed by the unadjusted Taylor

(1993) rule as the economy recovers.

measures of resource utilization are highly correlated. For

more information, see the note below gure A.

4. Taylor-type rules—including John Taylor’s original

rule—have often been estimated assuming that the value of

the neutral real interest rate in the longer run, r

, is equal to

2percent, which roughly corresponds to the average historical

value of the real federal funds rate before the nancial crisis.

5. Estimation of the price-level rule requires selecting a

starting year for the price level from which to cumulate the

2percent annual ination. For the U.S. economy, 1998 is used

as the starting year; around that time, the underlying trend

of ination and longer-term ination expectations stabilized

at a level consistent with PCE price ination being close to

2percent.

NOTE:

Taylor (1993) rule

= + + 0.5

(

−

)

− )

= + + 0.5

(

−

)

+2(

− )

Taylor (1993) rule, adjusted

= {

− ,0}

= { + +

(

−

)

+0.5

( )

,0}

−1

+ 0.5

(

−

)

(

−

)

−(

−4

−

−4

)

A. Monetary policy rules

Balanced-approach rule

Price-level rule

First-difference rule

, ,

, , and represent the values of the nominal federal funds rate prescribed by

the Taylor (1993), balanced-approach, adjusted Taylor (1993), price-level, and rst

-dierence rules, respectively.

denotes the actual nominal federal funds rate for quarter t, is four-quarter price ination for quarter t,

is the unemployment rate in quarter t,and is the level of the neutral real federal funds rate in the longer

run that, on average, is expected to be consistent with sustaining maximum employment and ination at its

ercent longer-run objective,

. In addition, is the rate of unemployment in the longer run. is the

cumulative su

m of past deviations of the federal funds rate from the prescriptions of the Taylor (1993) rule when

that rule prescribes setting the federal funds rate below zero.

is the percent deviation of the actual level

of prices from a price level that rises 2 percent per year from its level in a specied starting period

The Taylor (1993) rule and other policy rules are generally written in terms of the deviation of real output

from its full capacity level. In these equations, the output gap has been replaced with the gap between the rate of

unemployment

in the longer run and its actual level (using a relationship known as Okun’s law) in order to

represent the rules in terms of the FOMC’s statutory goals. Historically, movements in the output and

unemployment gaps have been highly correlated. Footnote 2 provides references for the policy rules.

Monetary Policy Rules and Their Role (continued)

MONETARY POLICY REPORT: FEBRUARY 2018 37

in the economy by lowering short-term interest rates.

This asymmetric risk has, in recent years, provided a

sound rationale for following a more gradual path of

rate increases than that prescribed by policy rules.

these circumstances, increasing the policy rate quickly

in order to have room to cut rates during an economic

downturn could be counterproductive because it would

make the downturn more likely to happen.

Estimates of the neutral real interest rate in the

longer run (such as those in gure B), taken together

with the FOMC’s ination objective of 2percent,

suggest that the neutral level of the federal funds rate

that can be expected to prevail in the longer run is

currently around 3percent, well below the average

federal funds rate of 6percent from 1960 to 2007.

With the neutral federal funds rate so low, there is

a likelihood that the policy interest rate will hit its

lower limit of zero more frequently than in the past.

Historically, the FOMC has cut the federal funds rate

by 5percentage points, on average, during downturns

in the economy—cutting the policy rate by this much

starting from a neutral level of 3percent would not be

feasible. Under these circumstances, the prescriptions

from many policy rules would lead to poor economic

performance, with ination averaging below the

behavior is to bring the price level back into line with

where it would be if it had been running at a constant

2percent per year. Like the adjusted Taylor (1993)

rule, the price-level rule recognizes that the federal

funds rate cannot be reduced materially below zero.

If ination runs below the 2percent objective during

periods when the rule prescribes setting the federal

funds rate well below zero, the price-level rule will

make up for past ination shortfalls as the economy

recovers.

The adjusted Taylor (1993) and price-level rules

may prescribe more appropriate policy settings than

the other rules following a period when the policy rate

falls below zero. However, all of the rules shown are

highly simplied and do not capture the substantial

complexity of the U.S. economy. Furthermore, both

the level of the neutral real interest rate in the longer

run and the level of the unemployment rate that is

sustainable in the longer run are difcult to estimate

precisely, and estimates made in real time may differ

substantially from estimates made later on, after

the relevant economic data have been revised and

additional data have become available.

For example,

since 2000, respondents to the Blue Chip survey have

markedly reduced their projections of the longer-run

level of the real short-term interest rate (gureB).

Survey respondents have also made considerable

changes over time to their estimates of the rate of

unemployment in the longer run, with consequences

for the unemployment gap. Revisions of this magnitude

to the neutral real interest rate and the rate of

unemployment in the longer run can have important

implications for the federal funds rate prescribed by

monetary policy rules. Policy rules must be adjusted to

take into account these changes in the projected values

of longer-run rates as they occur over time.

Accounting for risks to the economic

outlook

Monetary policy rules do not take account of

broader risk considerations. In the years following the

nancial crisis, with the federal funds rate still close

to zero, the FOMC has recognized that it would have

limited scope to respond to an unexpected weakening

Estimated unemployment

rate in the longer run

4.6

4.8

5.0

5.2

5.4

5.6

5.8

6.0

Percent

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

201720152013201120092007200520032001

B. Real-time estimates of the neutral real interest

rate and the unemployment rate in the longer run

Percent

Estimated neutral real interest

rate in the longer run

OTE

: The data are biannual and have been interpolated to yield

quarterly

values. The estimated neutral real interest rate in the longer run equals

the

three-month Treasury bill rate projected in the long run deflated by

the

long-run projected annual change in the price index for gross

domestic

product.

OURCE

: Wolters Kluwer, Blue Chip Economic Indicators.

6. The rst-difference rule shown in gure A reduces the

need for good estimates of longer-run rates because it does

not require an estimate of the neutral real interest rate in the

longer run. However, this rule has its own shortcomings. For

example, research suggests that this sort of rule will result in

greater volatility in employment and ination relative to what

would be obtained under the Taylor (1993) and balanced-

approach rules unless the estimates of the neutral real federal

funds rate in the longer run and the rate of unemployment in

the longer run are sufciently far from their true values.

7. Asymmetric risk need not always provide a rationale

for a more gradual path; if the risks were strongly tilted

toward substantial and persistent overheating and too-high

ination, the asymmetric risk could argue for higher rates than

prescribed by simple rules.

(continued on next page)

38 PART 2: MONETARY POLICY

Committee’s 2percent objective.

Rules that try to offset

the cumulative shortfall of accommodation posed by

the zero bound on interest rates, such as the adjusted

Taylor (1993) rule, or make up the cumulative shortfall

in the level of prices, such as the price-level rule, are

intended to help achieve average ination at or near

2percent over time.

Different monetary policy rules often offer quite

different prescriptions for the federal funds rate, and

there is no unambiguous metric for favoring one rule

over another. While monetary policy rules often agree

about the direction (up or down) in which policymakers

should move the federal funds rate, they frequently

disagree about the appropriate level of that rate.

Historical prescriptions from policy rules differ from

one another and also differ from the Committee’s target

for the federal funds rate, as shown in gure C. (These

prescriptions are calculated using both the actual data

and the estimates of the neutral real interest rate in

the longer run and of the rate of unemployment in the

longer run—data and estimates that were available to

FOMC policymakers at the time.) Moreover, the rules

sometimes prescribe setting short-term interest rates

well below zero—a setting that is not feasible. With

the exception of the adjusted Taylor (1993) and price-

level rules, which impose a lower limit of zero, all of

the rules shown in gureC called for the federal funds

rate to turn negative in 2009 and to stay below zero

for several years thereafter. Thus, these rules indicated

that the Federal Reserve should provide more monetary

stimulus than could be achieved by setting the federal

funds rate at zero. Almost all of the policy rules have

called for rising values of the federal funds rate in

recent years, but the pace of tightening that the rules

prescribe has varied widely. Prescriptions from these

rules for the level of the federal funds rate in the fourth

quarter of 2017 ranged from 0 basis points (price-level

rule) to 3.0percent (balanced-approach rule).

First-difference rule

Price-level ruleTarget federal funds rate

Balanced-approach rule

Taylor (1993) rule, adjusted

Percent

201720152013201120092007200520032001

C. Historical federal funds rate prescriptions from simple policy rules

Quarterly

Taylor (1993) rule

OTE: The rules use real-time historical values of inflation, the federal funds rate, and the unemployment rate. Inflation is measur

ed as the four-quarter percent

change

in the price index for personal consumption expenditures excluding food and energy. Quarterly projections of long-run values for the federal funds

rate

and

the unemployment rate are derived through interpolations of biannual projections from Blue Chip Economic Indicators. The long-run value for inflation

taken

as 2 percent. The target value of the price level is the average level of the price index for personal consumption expenditures excluding food and energy

1998, extrapolated at 2 percent per year.

SOURCE

: Federal Reserve Bank of Philadelphia; Wolters Kluwer, Blue Chip Economic Indicators; Federal Reserve Board staff estimates.

8. For further discussion of these issues, see Michael T.

Kiley and John M. Roberts (2017), “Monetary Policy in a Low

Interest Rate World,” Brookings Papers on Economic Activity,

Spring, pp. 317–72, https://www.brookings.edu/wp-content/

uploads/2017/08/kileytextsp17bpea.pdf.

9. Economists have found that a “makeup” policy can

be the best response in theory when the policy interest

rate is constrained at zero. See Ben S. Bernanke (2017),

“Monetary Policy in a New Era,” paper presented at

“Rethinking Macroeconomic Policy,” a conference held at the

Peterson Institute for International Economics, Washington,

October12–13, https://www.brookings.edu/wp-content/

uploads/2017/10/bernanke_rethinking_macro_nal.pdf;

and Michael Woodford (1999), “Commentary: How Should

Monetary Policy Be Conducted in an Era of Price Stability?”

Monetary Policy Rules and Their Role (continued)

in New Challenges for Monetary Policy, proceedings of a

symposium sponsored by the Federal Reserve Bank of Kansas

City, held in Jackson Hole, Wyo., August26–28 (Kansas

City: Federal Reserve Bank of Kansas City), pp.277–316,

https://www.kansascityfed.org/publications/research/escp/

symposiums/escp-1999.

10. As noted earlier, the price-level rule makes up for the

cumulative shortfall in the price level when ination runs

below 2percent. Because ination has been below 2percent

in recent years, the price-level rule calls for the federal funds

rate to remain at zero.

Part 3

summary of economic Projections

The following material appeared as an addendum to the minutes of the December12–13, 2017,

meeting of the Federal Open Market Committee.

In conjunction with the Federal Open

Market Committee (FOMC) meeting held on

December12–13, 2017, meeting participants

submitted their projections of the most likely

outcomes for real gross domestic product

(GDP) growth, the unemployment rate, and

ination for each year from 2017 to 2020

and over the longer run.

Each participant’s

projection was based on information available

at the time of the meeting, together with his

or her assessment of appropriate monetary

policy—including a path for the federal

funds rate and its longer-run value—and

assumptions about other factors likely to

aect economic outcomes. The longer-run

projections represent each participant’s

assessment of the value to which each variable

would be expected to converge, over time,

under appropriate monetary policy and in the

absence of further shocks to the economy.

“Appropriate monetary policy” is dened as

the future path of policy that each participant

deems most likely to foster outcomes for

economic activity and ination that best

satisfy his or her individual interpretation of

the statutory mandate to promote maximum

employment and price stability.

All participants who submitted longer-run

projections expected that, under appropriate

13. Four members of the Board of Governors were

in oce at the time of the December2017 meeting, the

same number as in September2017. However, since

the September meeting, one member, Stanley Fischer,

resigned from the Board and another, Randal K. Quarles,

joined. The incoming president of the Federal Reserve

Bank of Richmond is scheduled to assume oce on

January1, 2018; First Vice President Mark L. Mullinix

submitted economic projections at this meeting as he did

in September.

14. One participant did not submit longer-run

projections for real output growth, the unemployment

rate, or the federal funds rate.

monetary policy, growth in real GDP in

2018 would be somewhat stronger than their

individual estimates of its longer-run rate.

All participants projected that real GDP

growth would moderate in 2019, and nearly

all predicted that it would ease further in

2020; a solid majority of participants thought

that growth in real GDP would be at or

close to their individual estimates of the

economy’s longer-run growth rate by 2020.

All participants who submitted longer-run

projections expected that the unemployment

rate would run below their estimates of

its longer-run normal level through 2020.

Participants generally projected that ination,

as measured by the four-quarter percentage

change in the price index for personal

consumption expenditures (PCE), would

step up toward the Committee’s 2percent

objective in 2018 and be at or close to that

objective by 2019. Most participants indicated

that prospective changes in federal tax policy

were a factor that led them to boost their

projections of real GDP growth over the next

couple of years; some participants, however,

noted that they had already incorporated at

least some eects of future tax cuts in their

September projections. Several also noted the

possibility that changes to tax policy could

raise the level of potential GDP in the longer

run.

Table1 and gure1 provide summary

statistics for the projections.

As shown in gure2, participants generally

expected that the evolution of the economy

relative to their objectives of maximum

employment and 2percent ination would

15. Participants completed their submissions for

the Summary of Economic Projections before the

reconciliation of the House and Senate tax bills in the

Congress.

40 PART 3: SUMMARY OF ECONOMIC PROJECTIONS

likely warrant further gradual increases in

the federal funds rate. Compared with the

projections they submitted in September,

some participants raised their federal funds

rate projections for 2018 and 2019, while

several others lowered their projections, leaving

the median projection for the federal funds

rate in those years unchanged; the median

projection for 2020 was slightly higher, and the

median projection for the longer-run normal

level of the federal funds rate was unchanged.

Nearly all participants saw it as likely to be

appropriate for the federal funds rate to rise

above their estimates of its longer-run normal

level at some point during the forecast period.

Participants generally noted several sources

of uncertainty about the future course of

the federal funds rate, including the details

of potential changes in tax policy, how those

changes would aect the economy, and the

range of factors inuencing ination over the

medium term.

In general, participants viewed the uncertainty

attached to their economic projections

as broadly similar to the average of the

past 20years, and all participants saw the

uncertainty associated with their projections

for real GDP growth, the unemployment rate,

and ination as essentially unchanged from

September. As in September, most participants

judged the risks around their projections for

economic growth, the unemployment rate, and

ination as broadly balanced.

The Outlook for Economic Activity

The median of participants’ projections for the

growth rate of real GDP for 2018, conditional

on their individual assessments of appropriate

monetary policy, was 2.5percent, the same

as for 2017. The median projections for GDP

growth in 2019 and 2020 were slightly lower,

at 2.1 and 2.0percent, respectively. Compared

with the Summary of Economic Projections

(SEP) from September, the median of the

projections for real GDP growth for 2018

was notably higher, while the medians for real

GDP growth for 2019 and 2020 were modestly

higher. The median of projections for the

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their

individual assessments of projected appropriate monetary policy, December2017

Percent

Variable

Median

Central tendency

Range

2017 2018 2019 2020

Longer

run

2017 2018 2019 2020

Longer

run

2017 2018 2019 2020

Longer

run

Change in real GDP ..... 2.5 2.5 2.1 2.0 1.8 2.4–2.5 2.2–2.6 1.9–2.3 1.7–2.0 1.8–1.9 2.4–2.6 2.2–2.8 1.7–2.4 1.1–2.2 1.7–2.2

September projection .. 2.4 2.1 2.0 1.8 1.8 2.2–2.5 2.0–2.3 1.7–2.1 1.6–2.0 1.8–2.0 2.2–2.7 1.7–2.6 1.4 –2.3 1.4 –2.0 1.5–2.2

Unemployment rate. . . . . . 4.1 3.9 3.9 4.0 4.6 4.1 3.7–4.0 3.6–4.0 3.6–4.2 4.4–4.7 4.1 3.6–4.0 3.5–4.2 3.5–4.5 4.3–5.0

September projection .. 4.3 4.1 4.1 4.2 4.6 4.2–4.3 4.0–4.2 3.9–4.4 4.0–4.5 4.5–4.8 4.2–4.5 3.9–4.5 3.8–4.5 3.8–4.8 4.4–5.0

PCE ination ............ 1.7 1.9 2.0 2.0 2.0 1.6 –1.7 1.7–1.9 2.0 2.0–2.1 2.0 1.5–1.7 1.7–2.1 1.8–2.3 1.9–2.2 2.0

September projection .. 1.6 1.9 2.0 2.0 2.0 1.5–1.6 1.8–2.0 2.0 2.0–2.1 2.0 1.5–1.7 1.7–2.0 1.8–2.2 1.9–2.2 2.0

Core PCE ination

...... 1.5 1.9 2.0 2.0 1.5 1.7–1.9 2.0 2.0–2.1 1.4 –1.5 1.7–2.0 1.8–2.3 1.9–2.3

September projection .. 1.5 1.9 2.0 2.0 1.5–1.6 1.8–2.0 2.0 2.0–2.1 1.4–1.7 1.7–2.0 1.8–2.2 1.9–2.2

Memo: Projected

appropriate policy path

Federal funds rate ....... 1.4 2.1 2.7 3.1 2.8 1.4 1.9–2.4 2.4–3.1 2.6 –3.1 2.8–3.0 1.1–1.4 1.1–2.6 1.4 –3.6 1.4–4.1 2.3–3.0

September projection .. 1.4 2.1 2.7 2.9 2.8 1.1–1.4 1.9–2.4 2.4–3.1 2.5–3.5 2.5–3.0 1.1–1.6 1.1–2.6 1.1–3.4 1.1–3.9 2.3–3.5

N: Projections of change in real gross domestic product (GDP) and projections for both measures of ination are percent changes from the fourth quarter of the previous year to

the fourth quarter of the year indicated. PCE ination and core PCE ination are the percentage rates of change in, respectively, the price index for personal consumption expenditures

(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year

indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate

to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds

rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the

specied calendar year or over the longer run. The September projections were made in conjunction with the meeting of the Federal Open Market Committee on September19–20,

2017. One participant did not submit longer-run projections for the change in real GDP, the unemployment rate, or the federal funds rate in conjunction with the September19–20,

2017, meeting, and one participant did not submit such projections in conjunction with the December12–13, 2017, meeting.

1. For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average

of the two middle projections.

2. The central tendency excludes the three highest and three lowest projections for each variable in each year.

3. The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.

4. Longer-run projections for core PCE ination are not collected.

MONETARY POLICY REPORT: FEBRUARY 2018 41

Change in real GDP

Percent

2012 2013 2014 2015 2016 2017 2018 2019 2020

Longer

run

Median of projections

Central tendency of projections

Range of projections

Actual

Unemployment rate

Percent

2012 2013 2014 2015 2016 2017 2018 2019 2020

PCE ination

Percent

2012 2013 2014 2015 2016 2017 2018 2019 2020

Core PCE ination

Percent

2012 2013 2014 2015 2016 2017 2018 2019 2020

Figure 1. Medians, central tendencies, and ranges of economic projections, 2017–20 and over the longer run

: Denitions of variables and other explanations are in the notes to table 1. The data for the actual values of the variables

are annual.

Longer

run

Longer

run

Longer

run

42 PART 3: SUMMARY OF ECONOMIC PROJECTIONS

longer-run normal rate of real GDP growth

remained at 1.8percent. Most participants

pointed to changes in tax policy as likely

to provide some boost to real GDP growth

over the forecast period; in September, fewer

than half of the participants incorporated

prospective tax policy changes in their

projections. Several participants indicated

that they had marked up their estimates of

the magnitude of tax cuts, relative to their

assumptions in September.

The medians of projections for the

unemployment rate in the fourth quarter

of both 2018 and 2019 were 3.9percent,

0.2percentage point below the medians from

September and about ¾percentage point

below the median assessment of its longer-

run normal level. The median projection for

the unemployment rate ticked up slightly to

4.0percent in 2020.

Figures 3.A and 3.B show the distributions of

participants’ projections for real GDP growth

and the unemployment rate from 2017 to 2020

and in the longer run. The distribution of

individual projections for real GDP growth

for 2018 shifted up, with more than half of

the participants now expecting real GDP

growth of 2.5percent or more and none

seeing it below 2.2percent. The distribution

of projected real GDP growth in 2019 and

2020 also shifted up, albeit only slightly. The

distribution for the longer-run normal rate

of GDP growth was little changed from

September. The distributions of individual

projections for the unemployment rate in

2018 and 2019 shifted down relative to those

Percent

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2017 2018 2019 2020 Longer run

Figure 2. FOMC participants’ assessments of appropriate monetary policy: Midpoint of target range or target level

for the federal funds rate

N:

Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual participant’s

judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal

funds rate at the end of the specied calendar year or over the longer run. One participant did not submit longer-run projections

for the federal funds rate.

MONETARY POLICY REPORT: FEBRUARY 2018 43

2017

2018

2019

2020

Longer run

Percent range

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2017–20 and over the longer run

N: Denitions of variables and other explanations are in the notes to table 1.

Number of participants

1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 –

1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 –

1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 –

1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 –

1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

1.0 – 1.2 – 1.4 – 1.6 – 1.8 – 2.0 – 2.2 – 2.4 – 2.6 – 2.8 –

1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

December projections

September projections

44 PART 3: SUMMARY OF ECONOMIC PROJECTIONS

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2017–20 and over the longer run

N: Denitions of variables and other explanations are in the notes to table 1.

Number of participants

Percent range

2017

December projections

September projections

2018

2019

2020

Longer run

3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 –

3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1

3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 –

3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1

3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 –

3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1

3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 –

3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1

3.2 – 3.4 – 3.6 – 3.8 – 4.0 – 4.2 – 4.4 – 4.6 – 4.8 – 5.0 –

3.3 3.5 3.7 3.9 4.1 4.3 4.5 4.7 4.9 5.1

MONETARY POLICY REPORT: FEBRUARY 2018 45

in September, broadly consistent with the

changes in the distributions for real

GDP growth.

The Outlook for Ination

The median of projections for headline

PCE price ination was 1.9percent in 2018

and 2percent in 2019 and 2020, the same

as in the September SEP. Most participants

anticipated that ination would continue to

run a bit below 2percent in 2018, and only

one participant expected ination above

2percent that year. A majority of participants

projected that ination would be equal to

the Committee’s objective in 2019 and 2020.

Several participants projected that ination

would slightly exceed 2percent in 2019 or

2020. The medians of projections for core PCE

price ination over the 2018–20 period were

the same as those for headline ination.

Figures 3.C and 3.D provide information on

the distributions of participants’ views about

the outlook for ination. On the whole, the

distributions of projections for headline

PCE price ination and core PCE price

ination beyond 2017 were little changed

from September.

Appropriate Monetary Policy

Figure 3.E provides the distribution of

participants’ judgments regarding the

appropriate target—or midpoint of the target

range—for the federal funds rate at the end

of each year from 2017 to 2020 and in the

longer run. Overall, the distributions diered

in only small ways from those reported in

the September SEP. There was a moderate

reduction in the dispersion of the distribution

for 2020 and for the longer run; some of the

lower-end projections for those horizons from

the September SEP were revised up in the

current projections.

The median projection of the year-end federal

funds rate continued to rise gradually over the

2018–20 period. The median projection for the

end of 2018 was 2.13percent; the medians of

the projections were 2.69percent at the end

of 2019 and 3.07percent at the end of 2020.

Nearly all participants projected that it would

likely be appropriate for the federal funds

rate to rise above their individual estimates

of the longer-run normal rate at some point

over the forecast period. Compared with their

projections prepared for the September SEP,

a few participants raised their projections for

the federal funds rate in the longer run and

one lowered it; the median was unchanged at

2.75percent.

In discussing their projections, many

participants once again expressed the view

that the appropriate trajectory of the federal

funds rate over the next few years would

likely involve gradual increases. This view

was predicated on several factors, including a

judgment that the neutral real interest rate

was currently low and would move up only

slowly, as well as the balancing of risks

associated with, among other things, the

possibility that ination pressures could build

if the economy expands well beyond its long-

run sustainable level, and the possibility that

the forces depressing ination could prove to

be more persistent than currently anticipated.

As always, the actual path of the federal

funds rate will depend on evolving economic

conditions and their implications for the

economic outlook.

Uncertainty and Risks

In assessing the path for the federal funds rate

that, in their view, is likely to be appropriate,

FOMC participants take account of the

range of possible economic outcomes,

the likelihood of those outcomes, and the

potential benets and costs should they

occur. As a reference, table2 provides a

measure of forecast uncertainty, based on

the forecast errors of various private and

government forecasts over the past 20years,

for real GDP growth, the unemployment

rate, and total consumer price ination. That

measure is incorporated graphically in the

top panels of gures 4.A, 4.B, and 4.C, which

display “fan charts” plotting the median SEP

46 PART 3: SUMMARY OF ECONOMIC PROJECTIONS

Figure 3.C. Distribution of participants’ projections for PCE ination, 2017–20 and over the longer run

N: Denitions of variables and other explanations are in the notes to table 1.

Number of participants

Percent range

2017

December projections

September projections

2018

2019

2020

Longer run

1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.6 1.8 2.0 2.2

2.4

1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.6 1.8 2.0 2.2

2.4

1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.6 1.8 2.0 2.2

2.4

1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.6 1.8 2.0 2.2

2.4

1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.6 1.8 2.0 2.2

2.4

MONETARY POLICY REPORT: FEBRUARY 2018 47

2017

December projections

September projections

2018

2019

2020

Figure 3.D. Distribution of participants’ projections for core PCE ination, 2017–20

Percent range

N: Denitions of variables and other explanations are in the notes to table 1.

Number of participants

1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.4 1.6 1.8 2.0 2.2 2.4

1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.4 1.6 1.8 2.0 2.2 2.4

1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.4 1.6 1.8 2.0 2.2 2.4

1.3 – 1.5 – 1.7 – 1.9 – 2.1 – 2.3 –

1.4 1.6 1.8 2.0 2.2 2.4

48 PART 3: SUMMARY OF ECONOMIC PROJECTIONS

2017

2018

2019

2020

Longer run

Number of participants

December projections

September projections

1.13 – 1.38 – 1.63 – 1.88 – 2.13 – 2.38 – 2.63 – 2.88 – 3.13 – 3.38 – 3.63 – 3.88 – 4.13 –

1.37 1.62 1.87 2.12 2.37 2.62 2.87 3.12 3.37 3.62 3.87 4.12 4.37