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Meeting of the Federal Open Market Committee
January 30-31, 2007 Presentation Materials -- Text Version

Presentation Materials (PDF)

Pages 216 to 255 of the Transcript

Appendix 1: Materials used by Mr. Dudley

Class II FOMC - Restricted FR

Page 1

Top panel
(1)

Title: 2007 Fed Fund Futures Curves
Series: Fed fund futures curves, including the monthly fed fund futures contracts from January 2007 through July 2007
Horizon: Three curves shown for the dates of 10/25/2006, 12/12/2006, and 1/26/2007
Description: The more recent curve from 1/26/2007 shows that U.S. monetary policy expectations have come back up to levels similar to the 10/25/2006 curve.

Middle panel
(2)

Title: Eurodollar Futures March 2008 - March 2007 Calendar Spread
Series: Eurodollar futures March 2008 - March 2007 calendar spread
Horizon: October 1, 2006 to January 26, 2007
Description: The calendar spread declined gradually throughout the first half of the period shown, then it has risen continually since the December 12, 2006 FOMC meeting. The FOMC meetings on October 25, 2006 and December 12, 2006 are shown with tripwires.

Bottom panel
(3)

Title: Treasury Yield Curves
Series: Treasury yield curves, including the 2-year, 5-year, 10-year, and 30-year securities.
Horizon: Three curves shown for the dates of 10/25/2006, 12/12/2006, and 1/26/2007
Description: The more recent yield curve from 1/26/2007 shows that yields have significantly come back up since 12/12/2006, even surpassing levels seen on the 10/25/2006 yield curve.

Page 2

Top panel
(4)

Title: U.S. Breakeven Inflation Rates
Series: 5-year, 10-year, and 5-year 5-year forward breakeven inflation rates
Horizon: January 2, 2006 to January 26, 2007
Description: All three breakeven inflation rates have fluctuated over the period shown. However, on net, all three breakeven inflation rates have risen, primarily occurring since early January 2007. The FOMC meetings on October 25, 2006 and December 12, 2006 are shown with tripwires.

Source: Barclays

Middle panel
(5)

Title: Corporate Cash Index Spreads, Investment Grade and High Yield
Series: Merrill Lynch High Yield Index and Merrill Lynch Investment Grade Index
Horizon: January 3, 2005 to January 26, 2007
Description: Both spreads have tightened significantly since late September 2006.

Bottom panel
(6)

Title: Implied Volatility on the S&P 100 and Treasury Yield Implied Volatility
Series: VIX Index and Merrill Lynch Move Index
Horizon: January 2, 1995 to January 26, 2007
Description: Although both indexes began to pick up in December 2006, they have been declining significantly since mid 2002 and are at historical low levels dating back to 1995.

Page 3

Top panel
(7)

Title: Foreign Exchange Implied Volatility
Series: 1-month euro-dollar* and dollar-yen option implied volatility
Horizon: January 2, 1995 to January 26, 2007
Description: Although implied volatility began to pick up in December 2006, it has since declined as it has been since 2004, and it is at historical low levels dating back to 1995.

* Euro: 1990-1999 = USD/DM, 2000-present = USD/Euro  Return to text

Source: Goldman Sachs (1995-1996), Bloomberg (1997-present).

Bottom panel
(8)

Title: Composition of First-Lien Mortgage Originations 2001-2006*
Series: Conforming Mortgages, Jumbo, Subprime, Alt-A, and Subprime as % of Total
Horizon: 2001 to 2006, full-year 2006 volumes are estimated as of Q3 2006.
Description: While total first-lien mortgage originations have been flat since 2004 at around $2.5 trillion per year, subprime mortgages have grown from just 9 percent of total originations in 2003 to about 24 percent in 2006.

* Conforming mortgages include FHA/VA.  Return to text

Source: Inside Mortgage Finance

Page 4

Top panel
(9)

Title: Delinquency and Charge-off Rates for Subprime MBS
Series: 60+ days delinquencies and charge-off rate
Horizon: January 1996 to September 2006
Description: Although the charge-off rate among securitized subprime mortgages has declined in the last couple years, delinquencies have risen and may portend higher future losses on subprime mortgages.

Source: Moody's

Middle panel
(10)

Title: 60+ Days Delinquencies by Vintage (Subprime ARMs)
Series: Level of 60+ day delinquencies on subprime mortgages backing MBS pools. Shows delinquency levels according to year in which subprime MBS was issued.
Horizon: 2002 to 2006
Description: Delinquency rates for mortgages originated during 2006 are increasing much faster than those of recent years. Delinquency data may indicate that credit problems may be particularly severe among recently originated mortgages.

Source: JPMorgan

Bottom panel
(11)

Title: Subprime MBS Tranche Spreads, Weekly
Series: AA, A, and BBB subprime MBS tranche spreads
Horizon: January 5, 1998 to January 22, 2007
Description: Spread widening in the cash subprime MBS market has been mostly confined to tranches rated triple-B and worse. Nonetheless, spreads on triple-B rated securities remain below the widest levels reached near the end of last year and during 2004. Moreover, spreads on double-A and single-A rated subprime MBS tranches remain near historically tight levels, implying that credit deterioration may be relatively contained.

Page 5

Top panel
(12)

Title: Copper 3-Month Forward Price and LME Warehouse Stock
Series: London Metal Exchange stock and 3-month forward contract price
Horizon: June 2004 to January 2007
Description: The consistent rise in LME copper inventories since October 2006 is indicative of an improvement in the supply and demand fundamentals for copper and coincides with a decline in the 3-month forward contract price.

Source: London Metal Exchange

Middle panel
(13)

Title: Annual Global Corn Inventory vs. Weekly Front-Month Futures Price
Series: World stock, U.S. stock, and front-month corn futures price
Horizon: 2000 to 2006
Description: The decline in the world stock of corn has been led by a decline in U.S. stocks of corn. The broader use of corn as a bio-fuel likely contributed to decline in U.S. stocks and coincides with the sharp rise in the front-month corn futures price.

Source: USDA, Bloomberg

Bottom panel
(14)

Title: Crude Oil Inventory vs. Front-Month Futures Price
Series: June 2006 - January 2007 U.S. inventory, 5-year historical average U.S. inventory, and front-month WTI price
Horizon: June 2006 to January 2007
Description: U.S. crude oil inventory levels are above the 5-year historical average and unseasonably warm weather this winter further contributed to a decline in the front-month WTI crude oil futures price.

Source: Department of Energy, Bloomberg

Page 6

Top panel
(15)

Title: WTI Crude Oil Futures Curves
Series: WTI crude oil futures curves, including the monthly rolling contracts from spot to 24 months
Horizon: Three curves shown for the dates of 6/30/2006, 12/12/2006, and 1/26/2007
Description: The WTI crude oil futures curves have progressively shifted lower since June 2006 given an improvement in supply and demand fundamentals and a reduction in risks to supply.

Source: NYMEX, Bloomberg

Middle panel
(16)

Title: OPEC Spare Production Capacity
Series: OPEC spare production capacity in millions of barrels per day, 2007 forecast excludes potential production capacity increases
Horizon: 2000 - 2006, plus forecast for 2007
Description: OPEC spare capacity has been rising since mid- 2006 and is forecast to continue rising through 2007 even if potential production capacity increases (as a result of investment) are not included.

Source: International Energy Agency

Appendix 2: Materials used by Mr. Slifman, Mr. Wascher, and Mr. Gagnon

Material for Staff Presentation on the Economic Outlook
January 30, 2007

STRICTLY CONFIDENTIAL (FR) CLASS I-FOMC*
*Downgraded to Class II upon release of the February 2007 Monetary Policy Report.

Exhibit 1
Recent Indicators

Top panel
Real GDP

* Private domestic final purchases is the sum of PCE, business fixed investment, and residential investment.  Return to table

p - staff projection.  Return to table

Middle-left panel
Private Payroll Employment

Middle-right panel
Real Personal Consumption Expenditures

* Quarterly figures are averages. Figures for 2006:Q4 and 2007:Q1 are staff estimates.  Return to table

p - staff projection.  Return to table

Bottom-left panel
Single-Family Housing Starts

* Adjusted for non-permit-issuing localities.  Return to table

Bottom-right panel
Orders and Shipments of Nondefense Capital Goods*

* Excluding aircraft.  Return to text

Exhibit 2
A Closer Look at Recent Developments

Top-left panel
Production of Light Motor Vehicles

Note: Based on data from the Industrial Production system.

* Annual bars are Q4/Q4: Half-year bar is Q2/Q4.  Return to table

Top-right panel
Residential Investment

* Annual bars are Q4/Q4: Half-year bar is Q2/Q4.  Return to table

p Projection.  Return to table

Middle-left panel
Upstream Effects

• The drop in motor vehicle output affects IP directly through its impact on light motor vehicle manufacturing and indirectly through its influence on production in upstream industries.
• In the case of construction, all of the IP effect comes through the influence of construction declines on upstream industries.

Middle-right panel
Industrial Production

Bottom panels
Changes in Payroll Employment - Highly and Moderately Cyclical Industries

Note: Shading indicates NBER periods of cyclical contraction (November 1973 to March 1975, January 1980 to July 1980, July 1981 to November 1982, July 1990 to March 1991, and March 2001 to November 2001).

ND No data  Return to table

Exhibit 3
Forecast Summary

Top panel
GDP Projection

* 2008 is Q4/Q4; half years are either Q4/Q2 or Q2/Q4.  Return to table

** Private domestic final purchases is the sum of PCE, business fixed investment, and residential investment.  Return to table

Middle panel
Major Forces Shaping the Outlook

• Restraint from housing diminishes this year, and the contribution from housing turns slightly positive next year.
• Recent declines in oil prices boost real income; the lagged effects support consumption growth this year and into next year.
• Fiscal policy remains somewhat stimulative, although the impetus ebbs over the projection period.
• Monetary policy: Given our conditioning assumptions, the assumed path of the nominal federal funds rate is consistent with a real funds rate that closes the output gap over time.

Bottom-left panel
Crude Oil Prices

Bottom-right panel
Fiscal Impetus

Exhibit 4
Private Domestic Final Demand

Top panel
Single-Family Starts and New Home Sales

Note: Shading indicates periods of cyclical contraction in single-family starts (1972:Q3 to 1975:Q1, 1977:Q4 to 1981:Q4, 1990:Q1 to 1991:Q1, 1993:Q4 to 1995:Q2, and 2005:Q3 to 2007:Q1).

Middle-left panel
Real PCE and DPI

Note: 2006:Q4 is a projection.

* Excluding December 2004 Microsoft dividend.  Return to table

Middle-right panel
Saving Rate and Wealth-to-Income Ratio

Note: Excluding December 2004 Microsoft dividend.

Bottom-left panel
E&S Spending excluding Transportation

Note: 2006:Q4 is a projection.

Bottom-right panel
Nonresidential Structures*

Note: 2006:Q4 is a projection.

* Excluding mining exploration, shafts, and wells.  Return to text

Exhibit 5
Potential Output

Top panel
Staff Assumptions

Note: Components may not add to totals due to rounding.

Middle-left panel
Outside Estimates of Potential Output Growth

Middle-right panel
Labor Force Participation Rate

Note: Shading indicates periods when the unemployment rate was below the NAIRU (1988:Q1 to 1990:Q2, 1997:Q1 to 2001:Q3, and 2005:Q3 to 2008:Q4).

Bottom-left panel
Flows from Nonparticipation to Employment*

Note: Shading indicates periods when the unemployment rate was below the NAIRU (1988:Q1 to 1990:Q2, 1997:Q1 to 2001:Q3, and 2005:Q3 to 2006:Q4). The series has a statistical break in January 1994.

* As a percent of persons not in labor force last month.  Return to text

Bottom-right panel
Labor Force Participation Rates

Exhibit 6
Okun's Law and Productivity

Top-left panel
Okun's Law*

* Dynamic simulation beginning in 1990:Q3.  Return to text

Top-right panel
GDP and GDI

Middle-left panel
Labor Productivity: Nonfarm Business Sector

Middle-right panel
Evolution of Structural Productivity Estimates

Bottom-left panel
Productivity: Nonfinancial Corporate Sector

Bottom-right panel
Productivity: Nonfarm Business Excluding Residential Construction

Exhibit 7
Labor Market and Measures of Slack

Top-left panel
Payroll Employment

Top-right panel
Unemployment Rate

Middle-left panel
Job Openings Rate*

* Number of job openings as a percent of the sum of private employment and job openings.  Return to text

Middle-right panel
Beveridge Curve

Note: The data cover 2001:Q1 to 2006:Q4. A vertical line at an unemployment rate of approximately 5.00 percent intersects the fitted curve at a job openings rate of approximately 2.78 percent.

* The openings rate for 2006:Q4 is the average of October and November.  Return to table

Bottom-left panel
Persons Working Part-Time for Economic Reasons

Note: As shown in the chart, a horizontal line marks the average for 1996:H2, approximately 3.24 percent.

Bottom-right panel
Manufacturing Capacity Utilization

Note: As shown in the chart, a horizontal line marks the average from 1972 to 2006, approximately 79.55 percent.

Exhibit 8
Inflation Outlook

Top-left panel
Recent Price Data

Note: Quarterly figures are at annual rates.

e - staff estimate.  Return to table

Top-right panel
PCE Energy Prices

Middle-left panel
Core Nonfuel Import Prices

Middle-right panel
PCE Price Projection

Alternative Simulation

Bottom-left panel
Unemployment Rate

Bottom-center panel
Core PCE Prices

Bottom-right panel
Federal Funds Rate

Exhibit 9
Recent Market Developments

Exhibit 9 is a two-by-two array of panels, including graphs on the primary commodity prices, the real trade-weighted dollar, equity prices of industrial countries, and equity prices of emerging markets.

Top-left panel
Primary Commodity Prices

Primary Commodity Prices on a monthly basis for oil and the IMF nonfuel index for 2005 through early 2007 (actual) and for early 2007 through 2008 (forecast). The range of the right y-axis, which measures the IMF nonfuel index, January 2005 = 100, is [90, 160]. The range of the left y-axis, which measures the oil price in dollars per barrel, is [45, 80]. The oil price is the West Texas Intermediate spot price. The oil price starts at about $47 per barrel, rises to nearly $75 per barrel by mid-2006, and falls to about $54 dollars per barrel by early 2007; over the forecast horizon, the oil price rises to about $62 by the end of the period. The IMF nonfuel index starts at 100, rises to about 149 by end-2006, and then declines slightly to about 147 by early 2007; over the forecast horizon, the index rises to about 150 by mid-2007, and then eases to about 148 by the end of the forecast period.

Top-right panel
Real Trade-Weighted Dollar

Real Trade-Weighted Dollar on a quarterly basis for the major currencies index, the broad dollar index, and the index for other important trading partners for 2005 through early 2007 (actual) and for early 2007 through 2008 (forecast). The range of the y-axis is [90, 110]; index, Q1 2005 = 100. All three series begin at 100. The major currencies index rises to about 107 by late 2005, falls to about 102½ by late 2006, rises to about 103½ by early 2007, and falls to about 102 by the end of the period. The broad dollar index rises to about 103 by late 2005, falls to about 98½ by late 2006, and falls further to about 97½ by the end of the period. The index for other important trading partners falls to about 94 by early 2007, and declines further to about 93 by the end of the period.

Bottom-left panel
Equity Prices: Industrial Countries

Equity Prices: Industrial Countries on a daily basis for the United States (Wilshire 5000), the United Kingdom (FTSE 350), Japan (TOPIX), and the euro area (DJ Euro Stoxx) for 2005 through early 2007. The range of the y-axis is [50, 120], ratio scale; index, March 2000 = 100. All the series are somewhat volatile. The United States' Wilshire 5000 index starts at about 85 and rises to about 102 by the end of the period. The United Kingdom's FTSE 350 index starts at about 77 and rises to about 103 by the end of the period. Japan's TOPIX index starts at about 68 and rises to about 104 by the end of the period. The euro-area's DJ Euro Stoxx index starts at about 59 and rises to about 89 by the end of the period.

Bottom-right panel
Equity Prices: Emerging Markets

Equity Prices: Emerging Markets on a daily basis for Mexico, Brazil, Thailand, and Korea for 2005 through early 2007. The range of the y-axis is [90, 340], ratio scale; index, March 2000 = 100. All the series are somewhat volatile. The index for Mexico starts at about 163 and rises to about 340 by the end of the period. The index for Brazil starts at about 138 and rises to about 240 by the end of the period. The index for Thailand starts at about 175 and declines to about 168 by the end of the period. The index for Korea starts at about 105 and rises to about 159 by the end of the period.

Exhibit 10
Emerging-Market Debt and Capital Flows

Exhibit 10 is comprised of four panels, including graphs on gross external debt, yield spreads over U.S. Treasuries, official capital outflows and current account balances, and emerging-market official flows and industrial country interest rates.

Top-left panel
Gross External Debt

Gross External Debt on a yearly basis for Latin America and Asia for 1990-2006. The range of the y-axis is [15, 55]; unit is percent of GDP. The source of the data is the IMF World Economic Outlook database. The gross external debt of Latin America starts at about 41 percent of GDP, falls to about 34 percent of GDP by 1997, rises to about 46 percent of GDP by 2002, and falls to about 27 percent of GDP by the end of the period. The gross external debt of Asia starts at about 30 percent of GDP, rises to about 35 percent of GDP by 1998, and falls to about 20 percent of GDP by the end of the period.

Top-right panel
Yield Spreads over U.S. Treasuries

Yield Spreads over U.S. Treasuries on a monthly basis for Latin America and Asia for 1992-2006. The range of the y-axis is [0, 1800]; unit is basis points. The source of the data is Merrill Lynch. Both series show considerable volatility. The spread for Latin America starts at about 600 basis points, rises to about 1600 basis points by early 1995, falls to about 300 basis points by late 1997, rises to about 1450 basis points by mid-1998, and falls to about 150 basis points by the end of the period. The spread for Asia starts at about 900 basis points, falls to about 100 basis points by early 1997, rises to about 800 basis points by mid-1998, and falls to about 150 basis points by the end of the period.

Middle panel
Official Capital Outflows and Current Account Balances

Official Capital Outflows and Current Account Balances for emerging Asia, Africa and the Middle East, Eastern Europe, and Latin America as a bar chart for 2005-2006e. The range of the y-axis is [0, 400]; unit is billions of dollars. Net official capital outflows are defined as changes in foreign exchange reserves, external public debt, and assets of government-run investment funds. The source of the data is the IMF World Economic Outlook database. Approximate values for the two periods are as follows:

Bottom panel
Emerging-Market Official Flows and Industrial Country Interest Rates

Emerging-Market Official Flows and Industrial Country Interest Rates. On a yearly basis, the panel plots the real interest rate and GDP growth rate for industrial countries as a line chart and plots emerging-market net official flows as a bar chart for 1985-2006. The range of the y-axis is [-4, 6]; unit is percent. Emerging-market net official flows are defined as the net official capital flows of emerging markets as a share of aggregate industrial-country GDP. The GDP growth rate and the real interest rate for industrial countries are defined as the real GDP growth rate and three-month interest rate minus CPI inflation rate for the G-10 countries (including the United States) plus Australia and Spain, weighted by GDP. The sources for the data are the IMF World Economic Outlook database and the IFS database. 2006 data are estimates. The real GDP growth rate for industrial countries starts at nearly 4 percent, rises to about 4¾ percent by 1988, falls to about ¾ percent by 1993, rises to about 3½ percent by 2000, falls to about 1 percent by 2001, and rises to about 3 percent by 2006. The real interest rate for industrial countries starts at about 4¾ percent, rises to about 5 percent by 1990, falls to about 3¼ percent by 2000, falls more sharply to about -¼ percent in 2003-2004, and then rises to about 1½ percent by 2006. Emerging-market net official flows start at about ¼ percent, fluctuate between about ¼ percent and -1 percent through 2002, and then decline from about -1½ percent in 2003 to about -2½ percent by 2006; approximate values for emerging-market net official flows for the twenty-two periods are as follows:

Exhibit 11
Bond Markets, Inflation Compensation, and Monetary Policy

Exhibit 11 is a three-by-four array of panels. The four top panels plot "Indexed Bond Yields, 10-Year" for the United States and France, the United Kingdom, Japan, and Canada. The four middle panels plot "Inflation Compensation, 10-Year" for the United States and the euro area, the United Kingdom, Japan, and Canada. The four bottom panels plot "Policy Interest Rates" for the United States and the euro area, the United Kingdom, Japan, and Canada. Data are monthly. Unit is percent.

Top panels
Indexed Bond Yields, 10-Year

Indexed Bond Yields, 10-Year for the United States and France for 2003 through early 2007. The range of the y-axis is [0, 3½]. The yields for the United States start at about 2 percent, and, with considerable volatility, fall to about 1½ percent by late 2005, rise to about 2½ percent by mid-2006, decline to about 2¼ percent by early 2007, and then rise back to nearly 2½ percent by the end of the period. The yields for France start at about 2-1/3 percent, and, with considerable volatility, fall to about 7/8 percent by late 2005, rise to about 1¾ percent by mid-2006, fall to about 1½ percent by early 2007, and then rise to about 1-7/8 percent by the end of the period.

Indexed Bond Yields, 10-Year for the United Kingdom for 2003 through early 2007. The range of the y-axis is [0, 3½]. The yields for the United Kingdom start at just above 2 percent, and, with considerable volatility, fall to about 1-1/3 percent by late 2005, rise to about 1¾ percent by mid-2006, decline to about 1½ percent by early 2007, and then rise back to about 1¾ percent by the end of the period.

Indexed Bond Yields, 10-Year for Japan. Although the dates on the chart are set for 2003 through early 2007, the data actually begin in early 2004, because Japan first issued an inflation-linked bond in March 2004. The range of the y-axis is [0, 3½]. The yields for Japan start at just above 1 percent, and, with some volatility, fall to about 1/3 percent by mid-2005, and then rise to about 1¼ percent by the end of the period.

Indexed Bond Yields, 10-Year for Canada** for 2003 through early 2007. The range of the y-axis is [0, 3½]. The yields for Canada start at about 3¼ percent, and, with some volatility, fall to about 1½ percent by late 2005, rise to about 1¾ percent by mid-2006, decline to about 1-2/3 percent by early 2007, and then rise back to about 1¾ percent by the end of the period.

** Bond maturing in 2021.  Return to text

Middle panels
Inflation Compensation, 10-Year

Inflation Compensation, 10-Year for the United States and the euro area for 2003 through early 2007. The range of the y-axis is [0, 3½]. Inflation compensation for the United States starts at about 2 percent, and, with some volatility, rises to about 2¾ percent by mid-2006, declines to about 2-1/3 percent by early 2007, and then rises to about 2½ percent by the end of the period. Inflation compensation for the euro area starts at about 1-7/8 percent, and, with some volatility, rises to about 2-2/3 percent by mid-2004, falls to about 2 percent by mid-2005, and then rises to about 2¼ percent by the end of the period.

Inflation Compensation, 10-Year for the United Kingdom for 2003 through early 2007. The range of the y-axis is [0, 3½]. Inflation compensation for the United Kingdom starts at about 2-1/3 percent, and, with some volatility, rises to about 3 percent by mid-2004, declines to about 2½ percent by early 2005, and then rises to nearly 3 percent by the end of the period.

Inflation Compensation, 10-Year for Japan. Although the dates on the chart are set for 2003 through early 2007, the data actually begin in early 2004, because Japan first issued an inflation-linked bond in March 2004. The range of the y-axis is [0, 3½]. Inflation compensation for Japan starts at about 1/3 percent, and, with some volatility, rises immediately to about 7/8 percent, stays at about that rate through early 2005, falls to about ½ percent by mid-2005, rises to about 1 percent by early 2006, and falls to about ½ percent by the end of the period.

Inflation Compensation, 10-Year for Canada** for 2003 through early 2007. The range of the y-axis is [0, 3½]. Inflation compensation for Canada starts at about 2¼ percent, and, with some volatility, rises to nearly 3 percent by mid-2006, and then falls to about 2½ percent by the end of the period.

** Bond maturing in 2021.  Return to text

Bottom panels
Policy Interest Rates

Policy Interest Rates for the euro-area refinancing rate and the U.S. federal funds rate for 2005-2006 (actual) and for 2007-early 2009 (forecast). The range of the y-axis is [0, 6]. The euro-area refinance rate starts at 2 percent, stays at that rate through 2005, rises to about 3¾ percent by late 2006, rises in early 2007 to 4 percent, and remains there through the end of the period. The U.S. federal funds rate starts at 2¼ percent, rises to 5¼ percent by mid-2006, and remains there through the end of the period.

Policy Interest Rates for the U.K. bank rate for 2005-2006 (actual) and for 2007-early 2009 (forecast). The range of the y-axis is [0, 6]. The U.K. bank rate starts at 4¾ percent, stays at that rate through mid-2005, declines to 4½ percent in mid-2005, stays there through mid-2006, then rises to 5¼ percent by late 2006, rises in early 2007 to 5½ percent, stays there through early 2008, declines to 5¼ percent in early 2008, and remains there through the end of the period.

Policy Interest Rates for the Japanese call rate target for 2005-2006 (actual) and for 2007-early 2009 (forecast). The range of the y-axis is [0, 6]. The Japanese call rate target starts in early 2006 at 0 percent, rises to ¼ percent in mid-2006, stays at that rate until early 2007, rises in early 2007 to ½ percent, and then, in several small steps, rises to 1¼ percent by the end of the period.

Policy Interest Rates for the Canadian overnight rate target for 2005-2006 (actual) and for 2007-early 2009 (forecast). The range of the y-axis is [0, 6]. The Canadian overnight rate target starts at 2½ percent, stays at that rate until late 2005, rises to 4¼ percent by mid-2006, and remains there through the end of the period.

Exhibit 12
Housing Sectors

Exhibit 12 is comprised of four panels, including graphs on real house prices, Australia, and the United Kingdom, and a table on real GDP.

Top panel
Real House Prices

Real House Prices on a quarterly basis for the Netherlands, France, Canada, and Japan for 1992-2006. The range of the y-axis is [-10, 20]; unit is four-quarter percent change. Real house prices are defined as the house price index deflated by CPI. The house price index for France begins in 1996. The series for Japan is semi-annual. Real house prices for the Netherlands start at about 6 percent, rise to about 17 percent by 2000, decline to about 5 percent by mid-2001, and then slow to about 2 percent by the end of the period. Real house prices for France start at about -3 percent, rise to about 13 percent by early 2004, remain there until early 2006, and then decline to about 10 percent by the end of the period. Real house prices for Canada start at about -2 percent, rise to about 0 percent by early 1993, remain there until late 1994, fall to about -4 percent by early 1995, rise to about 0 percent by late 1997, fluctuate around 0 percent through mid-2001, rise to about 2 percent by mid-2005, rise sharply to about 12 percent by mid-2006, and decline to about 8 percent by the end of the period. Real house prices for Japan start at about -5 percent, fall to about -7 percent by mid-1992, rise to about -1 percent by early 1995, decline to about -7 percent by early 2004, and then rise to about -3 percent by the end of the period.

Middle-left panel
Australia

A line chart plots real house prices and residential investment for Australia on a quarterly basis for 1992-2006. The range of the right y-axis, which measures residential investment as percent of GDP, is [0, 10]. The range of the left y-axis, which measures real house prices as an index, 1992Q1=100, is [50, 250], ratio scale. Real house prices are defined as the house price index deflated by CPI. Real house prices start at 100, remain around 100 through 1996, then rise to about 180 by late 2003 and remain at about that level through the end of the period. Residential investment starts at about 5 percent, rises to about 7 percent by early 2004, and then declines to just above 6 percent by the end of the period.

Middle-right panel
United Kingdom

A line chart plots real house prices and residential investment for the United Kingdom on a quarterly basis for 1992-2006. The range of the right y-axis, which measures residential investment as percent of GDP, is [0, 10]. The range of the left y-axis, which measures real house prices as an index, 1992Q1=100, is [50, 250], ratio scale. Real house prices are defined as the house price index deflated by CPI. Real house prices start at 100, fall to about 90 by mid-1995, rise to about 210 by mid-2004, stay at about that level through late 2005, and then rise to about 230 by the end of the period. Residential investment starts at about 2¾ percent, fluctuates around 2¾ percent through 2001, and then rises to about 4 percent by the end of the period.

Bottom panel
Real GDP*

* GDP aggregates weighted by shares of U.S. exports.  Return to text

** Years are Q4/Q4; half years are Q2/Q4 or Q4/Q2.  Return to table

Exhibit 13
U.S. External Sector

Exhibit 13 is comprised of three panels, including a graph on import prices, a table on U.S. real goods exports, and a graph on contributions to U.S. GDP growth by imports, exports, and net exports.

Top-left panel
Import Prices

Import Prices on a quarterly basis for core goods and for core goods and services for 2005-2006 (actual), and for 2007-2008 (forecast). The range of the y-axis is [-15, 15]; unit is percent change, annual rate. The import price of core goods and services starts at about 2½ percent, rises to about 11 percent by mid-2005, falls to about -1 percent by early 2006, rises to about 10 percent by mid-2006, falls to about -8 percent by late 2006, rises to about 2 percent by mid-2007, remains there through early 2008, and then eases to about 1 percent by the end of the period. The import price of core goods starts at about 5 percent, falls to about 0 percent by mid-2005, rises to nearly 4 percent by mid-2006, declines to about 2 percent by late 2006, and then declines further to about 1½ percent by the end of the period.

Top-right panel
U.S. Real Goods Exports*

* Census data.  Return to text

** January-November at annual rate.  Return to table

Middle panel
Contributions to U.S. GDP Growth

Contributions to U.S. GDP Growth of net exports as a line chart, and of exports and imports as a bar chart, for 2005:H1 through 2006:H2 (actual), and 2007:H1 through 2008:H2 (forecast). The range of the y-axis is [-1.5, 1.5]; unit is percentage points, annual rate. Approximate values for the eight periods are as follows:

* Half years are Q2/Q4 or Q4/Q2.  Return to table

Exhibit 14 - Last Exhibit

Top panel
ECONOMIC PROJECTIONS FOR 2007

Central tendencies calculated by dropping high and low three from ranges.

Bottom panel
ECONOMIC PROJECTIONS FOR 2008

Appendix 3: Materials used by Mr. Reinhart

Material for FOMC Briefing on Monetary Policy Alternatives
Vincent Reinhart
January 31, 2007

Class I FOMC - Restricted Controlled FR

Exhibit 1

Exhibit 1 includes charts and tables that provide information on policy expectations and interest rate developments over the intermeeting period.

Top-left panel
Estimated Expected Federal Funds Rate

A line chart displays the expected path of the federal funds rate derived from interest rate futures quotes as of the most recent date (January 30, 2007) and the date of the last FOMC meeting (December 11, 2006). The chart indicates that the expected path of policy has rotated up significantly over the intermeeting period. Currently, futures market participants anticipate only one quarter-point easing this year and a second easing sometime next year. Much of the change in the expected policy path over the intermeeting period occurred immediately following various economic releases.

Note. Estimates from federal funds and eurodollar futures, with an allowance for term premia and other adjustments.

Top-right panel
FRBNY Survey of Primary Dealers

• Dealers are unanimous in anticipating no change in policy rate at this meeting
• Nearly all dealers anticipate the funds rate at 5-1/4 percent through the May meeting
• Some anticipate a more upbeat assessment of the economic outlook
• Nearly unanimous in expecting no change in the assessment of risks

Bottom-left panel
Nominal and Inflation-Indexed Yields

A line chart displays the changes in the nominal and inflation-indexed Treasury yield curves over the intermeeting period. The nominal yield curve shifted up 20 to 30 basis points in roughly parallel fashion across maturities. The inflation-indexed yield curve shifted up as well, but not by quite as much as the nominal curve. As a consequence, inflation compensation--measured as the vertical difference between nominal yields and inflation-indexed yield curves--edged up a few basis points over the period.

Middle-right panel
Decomposition of Change in Ten-Year Yield

A bar chart parses the change in ten-year nominal yields over the intermeeting period into portions attributable to economic data releases, the December FOMC statement, the release of the December FOMC minutes, speeches by Federal Reserve officials, and a residual "other" category. This decomposition was produced by cumulating the changes in the ten-year yield over short time intervals following each type of event; unit is basis points. The results show that about half of the change in ten-year yields over the intermeeting period occurred immediately following economic data releases. Various FOMC communications including the December FOMC statement and minutes as well as speeches by Federal Reserve officials had only a small net effect on yields over the period. All other changes in yields not directly attributable to economic releases or FOMC communications were grouped in the "other" category. This category accounted for about half of the net change in the ten-year yield over the period.

Bottom-right panel
Primary Dealer Expectations, 2007

Exhibit 2
Optimal Policy Under Alternative Inflation Goals

Exhibit 2 includes six charts that summarize the results of optimal monetary policy simulations using the FRB/US model with an assumption that policymakers wish to minimize an objective function that includes squared deviations of output from potential, squared deviations of inflation from an inflation target, and squared values of changes in the target funds rate from one period to the next. This objective function is broadly consistent with the Federal Reserve's statutory objectives to pursue maximum sustainable employment and stable prices.

1½ Percent Inflation Goal

The left column of the exhibit displays three line charts showing simulation results for the federal funds rate, civilian unemployment rate, and core PCE inflation over the period from 2007 to 2012. These simulations assume that policymakers operate with a 1½ percent inflation goal. Each of these charts also displays the optimal policy simulations as of the time of the October and December FOMC meetings. In general, the evolution of these optimal policy simulations suggests the FOMC currently faces a more favorable policy outlook than at the last two meetings. Relative to the October and December simulations, the results suggest that the FOMC can run a somewhat firmer monetary policy that will be associated with both lower inflation and lower unemployment over much of the forecast period.

Top-left panel
Federal funds rate

The chart shows that the optimal funds rate policy in this case would involve a tightening of monetary policy over the next year that would push the federal funds rate a little above 6 percent. Thereafter, the funds rate would gradually decline to about 3½ percent by the end of 2012.

Middle-left panel
Civilian unemployment rate

The chart shows that this funds rate path would be associated with a gradual rise in the unemployment rate from about 4½ percent currently to almost 5½ percent by early 2009. After 2009, the unemployment rate gradually edges lower to about 5¼ percent by 2012.

Bottom-left panel
Core PCE inflation

The chart shows that the path for core PCE inflation falls from about 2¼ percent currently to around 1¾ percent by the end of 2012.

2 Percent Inflation Goal

The right column of the exhibit displays the same basic set of charts shown in the left column but assuming that policymakers operate with a 2 percent inflation goal. The general contour of the paths for all these variables are similar to those estimated at the time of the October and December FOMC meetings. However, the simulation results for the current meeting suggest that the FOMC can achieve both lower unemployment and lower inflation over much of the projection period than in the earlier simulation results.

Top-right panel
Federal funds rate

The chart shows that in these simulations, the optimal path for the funds rate stays close to its current level of 5¼ percent through this year and into early 2008. Thereafter, the funds rate gradually falls to about 4 percent by the end of 2012.

Middle-right panel
Civilian unemployment rate

The chart shows that the unemployment rate drifts up to about 5 percent by the end of 2008 and remains close to that level through the end of the projection period.

Bottom-right panel
Core PCE inflation

The chart shows that core PCE inflation edges down to about 2 percent by mid-2009 and remains close to that level until the end of the projection period.

Exhibit 3
Policy Alternatives

Exhibit 3 contains charts and bullet points that describe factors that the Committee might wish to consider in choosing between Alternative B (no change in the funds rate) and Alternative C (a quarter point tightening in the funds rate).

Top-left panel
Alternative C

• 1.5 percent inflation goal.
• Concerned about cost pressures.
• Inflation expectations unchanged despite incoming data on prices.

Top-right panel
Alternative B

• 2 percent inflation goal.
• Still concerned about housing and possible spillovers.
• Lower NAIRU.

Middle panels
Federal Funds Rate, Unemployment Rate, and Core PCE Prices

Each of three line charts displays simulations from the FRB/US model: baseline; using a lower NAIRU; and "buoyant PCE", assuming that personal consumption expenditures are stronger than the staff anticipates.

Using a lower NAIRU, the fund rate can edge lower over the next two years with unemployment remaining below 5 percent and inflation gradually drifting lower toward 1½ percent. Even if the Committee was wary about inflation pressures, it might view financial markets as well positioned to provide restraint. Longer-term yields would likely backup appreciably on adverse news about inflation, providing necessary restraint and lessening the possibility that the FOMC would fall "behind the curve" in countering inflation.

If PCE is buoyant, these charts show that the FOMC would need to push the funds rate up to nearly 7 percent over the next two years to contain incipient inflation.

Bottom-left panel
Inflation Compensation*

A line chart displays evidence of the third bullet point under Alternative C. Inflation compensation measures derived from the Treasury market, plotted as the solid line for the next five years** and the dashed red line for the five-year, five-year-forward rate, each varied within a fairly wide range of nearly 40 basis points over recent months and rose a touch on net over the intermeeting period, perhaps undercutting some of the claim that longer-term inflation expectations are well anchored.

* Estimates based on smoothed nominal and inflation-indexed Treasury yield curves.   Return to text

** Adjusted for the indexation-lag (carry) effect.   Return to text

Bottom-right panel
Uncertainty Around Expected Policy Path

A line chart displays curves and confidence intervals. Actual and Greenbook assumptions begin in 2007:Q1 at about 5.25%, and remain at about that level through 2008:Q3. Expectations from forward contracts begin in 2007:Q1 at about 5.25%, decline to about 4.7% by 2008:Q4, then decline more gradually to about 4.5% by 2012:Q4. Market-based confidence intervals surrounding investors' expectations, derived from interest-rate caps and shown by a blue fan chart, are narrow in the near term but then widen markedly. By 2012:Q4, the 70 percent confidence interval widens to about 3.2% to 5.8%, and the 90 percent confidence interval widens to about 2.6% to 7.0%, consistent with the notion that market participants can envision a wide range of policy outcomes.

Table 1:
Alternative Language for the January FOMC Announcement