Part 2: Monetary Policy
Monetary Policy Report submitted to the Congress on February 14, 2017, pursuant to section 2B of the Federal Reserve Act
In December, the Federal Open Market Committee (FOMC) raised the target for the federal funds rate by ¼ percentage point to a range of 1/2 to 3/4 percent. The FOMC’s decision reflected realized and expected labor market conditions and inflation. Moreover, the decision to raise the target range was consistent with the Committee’s expectation that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace, labor market conditions would strengthen somewhat further, and inflation would rise to the FOMC’s 2 percent objective over the medium term. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. In addition, the Committee anticipates reinvesting principal payments of its securities holdings until normalization of the level of the federal funds rate is well under way.
The FOMC raised the federal funds rate target range in December
About a year ago, in December 2015, the FOMC raised the target range for the federal funds rate after holding the range at near zero since late 2008 to support economic activity and stem disinflationary pressures in the wake of the Great Recession. At that time, the Committee judged that it had seen sufficient improvement in the labor market and was reasonably confident that inflation would move back to its 2 percent objective, which would warrant an initial increase in the federal funds rate. Through most of 2016, the Committee maintained the target range of 1/4 to 1/2 percent, pending further evidence of continued progress toward its objectives. In December, in view of realized and expected labor market conditions and inflation, the FOMC raised the target range for the federal funds rate another 1/4 percentage point, to a range of 1/2 to 3/4 percent (figure 43).3 The Committee kept that same target range at its most recent meeting, which concluded on February 1.
Monetary policy continues to support the economic expansion
The Committee has continued to see the federal funds rate as likely to remain, for some time, below the levels that are expected to prevail in the longer run. With gradual adjustments in the stance of monetary policy, the FOMC expects that economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will rise to 2 percent over the medium term.
Consistent with this outlook, in the most recent Summary of Economic Projections (included as Part 3 of this report), which was compiled at the time of the December 2016 meeting, most participants projected that the appropriate level of the federal funds rate would be below its longer-run level through 2018.
Future changes in the federal funds rate will depend on the economic outlook as informed by incoming data
Although the Committee has expected that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate, the Committee has continued to emphasize that the actual path of monetary policy will depend on the evolution of the economic outlook. In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee has indicated that it will carefully monitor actual and expected progress toward its inflation goal.
The size of the Federal Reserve’s balance sheet has remained stable
To help maintain accommodative financial conditions, the Committee has continued its existing policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Federal Reserve’s total assets have held steady at around $4.5 trillion, with holdings of U.S. Treasury securities at $2.5 trillion and holdings of agency debt and agency mortgage-backed securities at approximately $1.8 trillion (figure 44). The Committee has for some time stated that it anticipates maintaining this policy until normalization of the level of the federal funds rate is well under way.
Interest income on the System Open Market Account, or SOMA, portfolio has continued to support substantial remittances to the U.S. Treasury. Preliminary results indicate that the Reserve Banks provided for payments of $92 billion of their estimated 2016 net income to the Treasury. The Federal Reserve’s remittances to the Treasury have averaged about $80 billion a year since 2008, compared with about $25 billion a year over the decade prior to 2008.4
The Federal Reserve’s implementation of monetary policy has continued smoothly
As in December 2015, the Federal Reserve successfully raised the effective federal funds rate in December 2016 using the interest rate paid on reserve balances, together with an overnight reverse repurchase agreement (ON RRP) facility.5 Specifically, the Federal Reserve raised the interest rate paid on required and excess reserve balances to 3/4 percent and the ON RRP offering rate to ½ percent. In addition, the Board of Governors approved an increase in the discount rate (the primary credit rate) to 1.25 percent. The effective federal funds rate rose into the new range amid orderly trading conditions in money markets. Increases in interest rates in other money markets were similar to the rise in the federal funds rate following the December meeting.
The total take-up at the ON RRP facility increased modestly in the second half of 2016 as a result of higher demand by government money market mutual funds in the wake of money fund reform that took effect in mid-October.
Although the implementation of monetary policy has been smooth, 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 2016; seven-day deposits were offered at both operations with a floating rate of 1 basis point over the interest rate on excess reserves. In addition, the Open Market Desk conducted several small-value exercises solely for the purpose of maintaining operational readiness.
3. See Board of Governors of the Federal Reserve System (2016), “Federal Reserve Issues FOMC Statement,” press release, December 14, https://www.federalreserve.gov/newsevents/press/monetary/20161214a.htm. Return to text
4. Total remittances include a one-time transfer of $19.3 billion in December 2015 to reduce the aggregate Reserve Bank capital surplus to $10 billion, as required by the Fixing America’s Surface Transportation Act. See Board of Governors of the Federal Reserve System (2016), “Federal Reserve System Publishes Annual Financial Statements,” press release, March 18, https://www.federalreserve.gov/newsevents/press/other/20160317a.htm. Return to text
5. See Board of Governors of the Federal Reserve System (2014), “Federal Reserve Issues FOMC Statement on Policy Normalization Principles and Plans,” press release, September 17, https://www.federalreserve.gov/newsevents/press/monetary/20140917c.htm. Return to text