Part 2: Monetary Policy
Monetary Policy Report submitted to the Congress on February 7, 2020, pursuant to section 2B of the Federal Reserve Act
The Federal Open Market Committee reduced the federal funds rate to support sustained economic expansion and foster a return of inflation to the Committee's 2 percent objective
After having gradually increased its target range for the federal funds rate from late 2015 through the end of 2018, the Committee maintained its target range for the federal funds rate at 2-1/4 to 2-1/2 percent during the first half of 2019. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Federal Open Market Committee (FOMC) lowered the target range for the federal funds rate at its July, September, and October meetings by 25 basis points each, bringing it to 1-1/2 to 1-3/4 percent (figure 47).11 At its December and January meetings, the Committee judged that the prevailing stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to its symmetric 2 percent objective.
Future changes in the federal funds rate will depend on the economic outlook and risks to the outlook as informed by incoming data
The FOMC has continued to emphasize that the actual path of monetary policy will depend on the evolution of the economic outlook and risks to the outlook as informed by incoming data. Specifically, in deciding on 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 symmetric 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 addition to evaluating a wide range of economic and financial data and information gathered from business contacts and other informed parties around the country, policymakers routinely consult prescriptions for the policy interest rate from various monetary policy rules, which can provide useful guidance to the FOMC. Although many practical considerations make it undesirable for the FOMC to mechanically follow the prescriptions of any specific rule, the FOMC's framework for conducting systematic monetary policy respects key principles of good monetary policy embodied by these rules, while at the same time, providing flexibility to address many of the limitations of these policy rules (see the box "Monetary Policy Rules and Uncertainty in Monetary Policy Settings").
Monetary Policy Rules and Uncertainty in Monetary Policy Settings
Monetary policy rules are mathematical formulas that relate a policy interest rate, such as the federal funds rate, to a small number of other economic variables—typically including the deviation of inflation from its target value and a measure of resource slack in the economy. The prescriptions for the policy interest rate from these rules can provide helpful guidance for the Federal Open Market Committee (FOMC).1
This discussion examines prescriptions from selected policy rules and considers how these prescriptions often depend on judgments and assumptions about economic variables that are inherently uncertain and may change over time. Notably, many policy rules depend on estimates of resource slack and of the longer-run neutral real interest rate, both of which are not directly observable and are estimated with a high degree of uncertainty. As a result, the policy stance that these rules prescribe—and whether that stance is appropriate in light of underlying economic conditions—is also uncertain. Such a situation cautions against mechanically following the prescriptions of any specific rule.
Policy Rules: Some Key Design Principles and Historical Prescriptions
In many models of the economy, good economic performance can be achieved by following a monetary policy rule that fosters public understanding and that incorporates key principles of good monetary policy.2 One such principle is that monetary policy should respond in a predictable way to changes in economic conditions. A second principle is that monetary policy should be accommodative when inflation is below policymakers' longer-run inflation objective and employment is below its maximum sustainable level; conversely, monetary policy should be restrictive when the opposite holds. A third principle is that, to stabilize inflation, the policy rate should be adjusted over time by more than one-for-one in response to persistent increases or decreases in inflation.
Economists have analyzed many monetary policy rules, including the well-known Taylor (1993) rule, the "balanced approach" rule, the "adjusted Taylor (1993)" rule, the "price level" rule, and the "first difference" rule (figure A).3 These policy rules embody the three key principles of good monetary policy and take into account estimates of how far the economy is from the Federal Reserve's dual-mandate goals of maximum employment and price stability. The Taylor (1993), balanced-approach, adjusted Taylor (1993), and price-level rules provide prescriptions for the level of the federal funds rate; all require an estimate of the neutral real interest rate in the longer run (r t LR)—that is, the level of the real federal funds rate that is expected to be consistent, in the longer run, with maximum employment and stable inflation.4 The rules feature the unemployment rate gap, measured as the difference between an estimate of the rate of unemployment that is sustainable in the longer run (u t L) and the current unemployment rate; the first-difference rule includes the change in the unemployment gap rather than its level.5 In addition, four of the five rules include the difference between recent inflation and the FOMC's longer-run objective of 2 percent, whereas the price-level rule includes the gap between the level of prices today and the level of prices that would have been realized if inflation had been constant at 2 percent from a specified starting year.6 The price-level rule thereby takes account of the deviation of inflation from the longer-run objective in earlier periods as well as in the current period, in contrast with the other rules that do not make up past misses of the inflation objective.
The adjusted Taylor (1993) rule recognizes that the federal funds rate cannot be reduced materially below zero and that following the prescriptions of the standard Taylor (1993) rule after a recession during which the federal funds rate has fallen to its effective lower bound may therefore not provide enough policy accommodation. To make up for the cumulative shortfall in accommodation, the adjusted Taylor (1993) rule prescribes only a gradual return of the policy rate to the (positive) levels prescribed by the standard Taylor (1993) rule after the economy begins to recover. Similarly, the price-level rule specified in figure A recognizes that the federal funds rate cannot be reduced materially below zero. If inflation runs below the 2 percent objective during periods when the policy rate is constrained by the effective lower bound, this rule will, over time, call for more accommodation to make up for the past inflation shortfall.
Figure B shows historical prescriptions for the federal funds rate from the five rules described earlier. For each period, the figure reports the policy rates prescribed by the rules given prevailing economic conditions and estimates of u t LR and r t LR at the time. The prescribed values often vary widely across rules. Because there is no definitive standard for favoring one rule over another, consulting a range of rules is generally preferable to relying on any particular rule.
Estimates of r t LR and u t LR: Uncertainty and Revisions
As already noted, the level of the neutral real interest rate and the unemployment rate that is sustainable in the longer run is not directly observable and can be estimated only imprecisely. The neutral real interest rate in the longer run is determined by structural features of the economy, including trend productivity growth, demographics, and risk-taking behavior. The unemployment rate that can be sustained in the longer run is also determined largely by nonmonetary factors, such as demographics, educational attainment, and the structure and dynamics of the labor market. These various determining factors may change over time and may not be directly measurable, hence leading to time-varying and uncertain estimates of u t L and r t L.
Since 2000, forecasters in the Blue Chip survey have markedly reduced their estimates of the longer-run level of the real short-term interest rate (figure C). FOMC participants have also lowered their estimates of the real federal funds rate in the longer run since the Summary of Economic Projections, or SEP, began reporting this information in 2012. Similarly, in recent years, FOMC participants as well as outside forecasters and analysts generally have lowered their estimates of the longer-run unemployment rate considerably.7
Figure D illustrates the imprecision with which the longer-run neutral real interest rate is estimated by reporting values from several time-series models, along with measures of the uncertainty surrounding these values.8 The models use statistical techniques to capture the variations among inflation, interest rates, real gross domestic product, unemployment, and other data series. The point estimates are dispersed across models, ranging from 0.3 to 2.1 percent. Moreover, the 95 percent uncertainty bands around the estimates illustrate the substantial uncertainty inherent in such estimates.9
D. Point estimates and uncertainty bands for the neutral real interest rate in the longer run
|Study||Point estimate||95 percent uncertainty bands|
|Christensen and Rudebusch (2019)||.3||(-.7,1.3)|
|Del Negro and others (2017)||1.3||(1, 1.6)|
|Holston and others (2017)||.6||(-1.1,2.3)|
|Johannsen and Mertens (2016)||.4||(-.4,1.2)|
|Laubach and Williams (2003)||.9||(-1.7, 3.5)|
|Lewis and Vazquez-Grande (2019)||2.1||(1.4, 2.8)|
|Lubik and Matthes (2015)||.7||(-.5,1.7)|
Note: The estimates use data through 2019:Q3.
Source: Federal Reserve Board staff calculations, along with references listed in box note 9.
Some Implications for Monetary Policy
The longer-run neutral level of the federal funds rate—equal to the sum of the neutral real interest rate in the longer run and the FOMC's 2 percent inflation objective—is one benchmark for evaluating the current stance of monetary policy. Uncertainty about estimates of the longer-run neutral real interest rate leads to uncertainty about how far the current federal funds rate is from its longer-run neutral level. For the Taylor (1993), balanced-approach, adjusted Taylor (1993), and price-level rules, a decrease in the assumed longer-run neutral real interest rate translates one-for-one into a decline in these rules' prescribed settings for the federal funds rate. Therefore, to the extent that the downward revisions to estimates of r t L reflect learning that the longer-run neutral rate was lower than had been assessed previously, the historical prescriptions of these rules would be less accommodative than previously thought. Uncertainty about estimates of the longer-run normal unemployment rate also imparts uncertainty to these rules' prescriptions. For example, given current economic conditions, the assumption of a lower sustainable rate of unemployment in the longer run translates one-for-one into reduced unemployment gaps in the rules and, in turn, leads to lower prescribed values of the policy rate.
Figure E compares the prescriptions of the Taylor (1993) rule based on the historical median estimates of u t L and r t L from the Blue Chip survey (shown in figure C) and the prescriptions generated based on the latest median estimates of these variables. The federal funds rate prescriptions based on the latest estimates (black line) are lower than the prescriptions based on the historical estimates (red line). For example, using the latest median estimates, the rule's prescribed federal funds rates for 2012 are about 3 percentage points lower than the values prescribed based on the historical estimates. Figure E also shows that revisions to the estimates of u t L and r t L contribute roughly equally to the difference in the policy rate prescriptions of the Taylor (1993) rule based on the historical and the latest estimates of u t L and r t L.10
To conclude, this discussion illustrates that policy rules crucially entail an important element of judgment. Moreover, the inherent uncertainty about some of the variables included in these rules leads to significant uncertainty regarding their policy settings, which cautions against strict adherence to any particular rule.
1. FOMC policymakers first discussed prescriptions from monetary policy rules in 1995 and have consulted them routinely since 2004. Return to text
2. The effectiveness of monetary policy is enhanced when it is well understood by the public. For a discussion of how the public's understanding of monetary policy matters for the effectiveness of monetary policy, see Janet L. Yellen (2012), "Revolution and Evolution in Central Bank Communications," speech delivered at the Haas School of Business, University of California, Berkeley, November 13, https://www.federalreserve.gov/newsevents/speech/yellen20121113a.htm. For a discussion regarding principles for the conduct of monetary policy, see Board of Governors of the Federal Reserve System (2018), "Monetary Policy Principles and Practice," webpage, https://www.federalreserve.gov/monetarypolicy/monetary-policy-principles-and-practice.htm. Return to text
3. The Taylor(1993) rule was 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-Inflation 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. The first-difference rule is based on a rule suggested 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. Return to text
4. The expression of the first-difference rule shown in figure A does not involve 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 often results in greater volatility in employment and inflation relative to what would be obtained under the Taylor(1993) and balanced-approach rules. Return to text
5. The original 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 the level that GDP would be if the economy were operating at maximum employment, measured in percent of the latter). The rules in figure 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. However, movements in these alternative measures of resource utilization are highly correlated. For more information, see the note below figure A. Return to text
6. Calculating the prescriptions of the price-level rule requires selecting a starting year for the price level from which to cumulate the 2 percent annual rate of inflation. Figure B uses 1998 as the starting year. Around that time, the underlying trend of inflation and longer-term inflation expectations stabilized at levels consistent with PCE (personal consumption expenditures) price inflation being close to 2 percent. Return to text
7. The SEP median for the longer-run unemployment rate is available since April 2009. Return to text
8. The estimates are based on data through 2019:Q3. Return to text
9. The range of estimates is computed using published values or values computed using the methodology from the following studies: Jens H.E. Christensen and Glenn D. Rudebusch (2019), "A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt," Review of Economics and Statistics, vol. 101 (December), pp. 933–49; Marco Del Negro, Domenico Giannone, Marc P. Giannoni, and Andrea Tambalotti (2017), "Safety, Liquidity, and the Natural Rate of Interest," Brookings Papers on Economic Activity,Spring, pp. 235–94, https://www.brookings.edu/wp-content/uploads/2017/08/delnegrotextsp17bpea.pdf; Kathryn Holston, Thomas Laubach, and John C. Williams (2017), "Measuring the Natural Rate of Interest: International Trends and Determinants," Journal of International Economics, supp. 1, vol. 108 (May), pp. S59–75; Benjamin K. Johannsen and Elmar Mertens (2016), "The Expected Real Interest Rate in the Long Run: Time Series Evidence with the Effective Lower Bound," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, February 9), https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/the-expected-real-interest-rate-in-the-long-run-time-series-evidence-with-the-effective-lower-bound-20160209.html; Michael T. Kiley (2015), "What Can the Data Tell Us about the Equilibrium Real Interest Rate?" Finance and Economics Discussion Series 2015-77 (Washington: Board of Governors of the Federal Reserve System, August), http://dx.doi.org/10.17016/FEDS.2015.077; Thomas Laubach and John C. Williams (2003), "Measuring the Natural Rate of Interest," Review of Economics and Statistics, vol. 85 (November), pp. 1063–70; Kurt F. Lewis and Francisco Vazquez-Grande (2019), "Measuring the Natural Rate of Interest: A Note on Transitory Shocks," Journal of Applied Econometrics, vol. 34 (April), pp. 425–36; Thomas A. Lubik and Christian Matthes (2015), "Calculating the Natural Rate of Interest: A Comparison of Two Alternative Approaches," Economic Brief 15-10 (Richmond: Federal Reserve Bank of Richmond, October), https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_brief/2015/pdf/eb_15-10.pdf. Return to text
10. The extent to which these downward revisions to estimates of r t LR and utLR lead to downward revisions in historical policy rate prescriptions varies across policy rules. For example, the historical prescriptions of the balanced-approach rule, which responds more strongly to the unemployment gap than the Taylor (1993) rule, would decrease more than shown in figure E when conditioned on the latest estimates of r t LR and u t LR. By contrast, the historical prescriptions of the first-difference rule are essentially unaffected by the downward revisions to r t LR and u t LR. Return to textReturn to text
The FOMC concluded the reduction of its aggregate securities holdings in the System Open Market Account...
At its July meeting, along with its decision to lower the target range for the federal funds rate, the FOMC also announced that it was ending the runoff of securities holdings two months earlier than the initially planned termination at the end of September.12 Ending the runoff earlier than initially planned was seen as having only very small effects on the balance sheet, with negligible implications for the economic outlook. Moreover, doing so avoided the appearance of inconsistency in continuing to allow the balance sheet to run off while simultaneously lowering the target range for the federal funds rate.
Since then, the Federal Reserve has rolled over at auction all principal payments from its holdings of Treasury securities and has reinvested all principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) received during each calendar month. The Committee intends to continue to reduce its holdings of agency debt and agency MBS, consistent with the aim of holding primarily Treasury securities in the long run. To allow for a gradual runoff of the MBS portfolio, principal payments from agency debt and agency MBS of up to $20 billion per month have been reinvested in Treasury securities; agency MBS principal payments in excess of $20 billion each month have been reinvested in agency MBS.13
. . . and reaffirmed its intention to implement monetary policy in a regime with an ample supply of reserves
In a monetary policy regime with an ample supply of reserves, control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates, and active management of the supply of reserves is not required. The Federal Reserve will still conduct periodic open market operations as necessary to accommodate the trend growth in the demand for its nonreserve liabilities, such as currency in circulation, and maintain an ample supply of reserves over time. Separate from such periodic open market operations, beginning in October 2019, the Federal Reserve has implemented a temporary program of open market operations, specifically Treasury bill purchases, aimed at durably raising reserves to levels at or above those prevailing in early September (see the box "Money Market Developments and Monetary Policy Implementation" at the end of Part 2). These actions are purely technical measures to support the effective implementation of the FOMC's monetary policy and are not intended to change the stance of monetary policy. These Treasury bill purchases are distinct from the large-scale asset purchase programs that the Federal Reserve deployed after the financial crisis. In those programs, the Federal Reserve purchased longer-term securities to put downward pressure on longer-term interest rates and ease broader financial conditions.
The Federal Reserve's total assets have increased from about $3.8 trillion last July to about $4.1 trillion at present, with holdings of Treasury securities at approximately $2.4 trillion and holdings of agency debt and agency MBS at approximately $1.4 trillion (figure 48). The increase in the size of the balance sheet partly reflects an increase in the level of nonreserve liabilities—such as currency in circulation and the TGA—and a rise in the level of reserve balances, which have increased from approximately $1.5 trillion last July to approximately $1.6 trillion at present.
Meanwhile, interest income on the Federal Reserve's securities holdings has continued to result in substantial remittances to the U.S. Treasury. Preliminary data indicate that the Federal Reserve remitted about $55 billion in 2019.
Money Market Developments and Monetary Policy Implementation
Consistent with its decision at the January 2019 meeting, the Federal Open Market Committee (FOMC) reaffirmed, in its Statement Regarding Monetary Policy Implementation on October 11, 2019, the intention to implement monetary policy in a regime with an ample supply of reserves.1 In such a system, active management of reserves through frequent open market operations is not required, and control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates.
In recent years, depository institutions' reserve balances held at the Federal Reserve have declined as a result of the normalization of the Federal Reserve's balance sheet as well as growth in nonreserve liabilities. Reserves dropped from a peak of about $2.8 trillion in 2014 to about $2.2 trillion in late September 2017, largely reflecting the expansion of nonreserve liabilities. Subsequently, reserves declined further, reflecting the FOMC's decision to allow a gradual runoff of maturing securities, and, by the time the FOMC decided to conclude the reduction of its aggregate securities holdings in August 2019, reserves had fallen to about $1.5 trillion. Despite the cessation of balance sheet runoff in August 2019, reserves subsequently continued to decline because of increases in currency and other nonreserve liabilities and reached a multiyear low of about $1.4 trillion in September 2019.
Against a backdrop of declining reserves and high levels of Treasury securities outstanding, in mid-September 2019, imbalances in the supply of and demand for short-term funding led to pressures in the repurchase agreement (repo) market—a money market segment in which banks, securities dealers, money market funds (MMFs), and other financial market participants lend to and borrow from each other for short periods against high-quality collateral. On the demand side, dealers' and other investors' needs for financing securities had increased following the settlement of Treasury auctions at mid-month. On the supply side, some institutional investors, such as government-only MMFs and banks, may have been reluctant to increase lending because they faced uncertainty regarding cash outflows as their clients were making corporate tax payments due in mid-September. As a result, repo rates rose sharply in mid-September (figure A). Pressures in the repo market spilled over to other short-term funding markets, including the federal funds market. The federal funds rate firmed, moving out of its target range for one day (as shown in figure A). In response to elevated rates, the Federal Reserve began conducting repo operations to help stabilize money markets and provide reserves to keep the federal funds rate within its target range (figure B). These operations have been effective in meeting these goals.
Consistent with its decision to implement monetary policy in a regime with an ample supply of reserves, on October 11, 2019, the Committee announced its decision to purchase Treasury bills at least into the second quarter of 2020 in order to maintain reserves at or above the level that prevailed in early September (as shown in figure B).2 In addition, the FOMC announced term and overnight repo operations to ensure that the supply of reserves remains ample even during periods of sharp increases in nonreserve liabilities and to mitigate the risk of money market pressures that could adversely affect policy implementation.3 Repos outstanding, consisting of both overnight and term operations, have been about $209 billion per day, on average, since the announcement on October 11, 2019. These operations are expected to decline over time as Treasury bill purchases supply a larger base of reserves.
The Federal Reserve's open market operations—repo operations and bill purchases—lifted reserves to levels averaging about $1.6 trillion in early 2020. Besides adding reserves, the repo operations damped funding pressures in repo markets that may otherwise have passed through to the federal funds market. As such, the combination of repo operations and bill purchases fostered conditions that helped maintain the federal funds rate within the target range. Notably, with the provision of about $250 billion in liquidity via the Federal Reserve's repo operations, money market conditions were quite calm on year-end. Both secured and unsecured overnight funding rates printed in line with the interest rate on excess reserves (as indicated in figure A).
1. See the Statement Regarding Monetary Policy Implementation, which is available on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20191011a.htm. Return to text
2. For additional information on the FOMC's plans to implement monetary policy over the longer run, see the Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization, which can be found on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm. Return to text
3. The Statement Regarding Monetary Policy Implementation indicated that the Federal Reserve would conduct term and overnight repo operations at least through January 2020. Such operations will now be continued at least through April 2020; see "Implementation Note Issued January 29, 2020," which is available on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200129a1.htm. Return to textReturn to text
The effective federal funds rate moved down in line with the FOMC's target range for the federal funds rate
The Federal Reserve reduced the effective federal funds rate following the FOMC's decisions in July, September, and October to lower the target range for the federal funds rate by reducing the interest rate paid on required and excess reserve balances and the interest rate offered on overnight reverse repurchase agreements (ON RRPs). Specifically, the Federal Reserve lowered the interest rate paid on required and excess reserve balances to 2.10 percent in July, 1.80 percent in September, and 1.55 percent in October. In addition, the Federal Reserve lowered the ON RRP offering rate to 2 percent in July, 1.70 percent in September, and 1.45 percent in October. The Federal Reserve also approved a 1/4 percentage point decrease in the discount rate (the primary credit rate) in July, September, and October. Yields on a broad set of money market instruments also moved lower, roughly in line with the effective federal funds rate, in response to the FOMC's policy decisions in July, September, and October.
The Federal Reserve continued the review of its strategic framework for monetary policy
In the second half of 2019, the Federal Reserve continued the review of its monetary policy strategy, tools, and communication practices. The goal of this assessment is to identify possible ways to improve the Committee's current policy framework in order to ensure that the Federal Reserve is best positioned going forward to achieve its statutory mandate of maximum employment and price stability. (The box "Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices" discusses the review and the public outreach that has accompanied it.)
Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices
In 2019, the Federal Reserve began a broad review of the monetary policy strategy, tools, and communication practices it uses to pursue its statutory dual-mandate goals of maximum employment and price stability. The Federal Reserve is undertaking the review because the U.S. economy appears to have changed in ways that matter for monetary policy. For example, the neutral level of the policy interest rate appears to have fallen in the United States and abroad, increasing the risk that the effective lower bound on interest rates will constrain central banks from reducing their policy interest rates enough to effectively support economic activity during downturns. The review is considering what monetary policy strategy will best enable the Federal Reserve to meet its dual mandate in the future, whether the existing monetary policy tools are sufficient to achieve and maintain the dual mandate, and how its communication about monetary policy can be improved.
Fed Listens Initiative
A key component of the review has been a series of public Fed Listens events aimed at consulting with a broad range of stakeholders in the U.S. economy. The goal of Fed Listens was for policymakers to engage directly with a range of individuals and groups on issues pertaining to the dual-mandate objectives of maximum employment and stable prices.
From February to October 2019, the Federal Reserve hosted 14 public Fed Listens events—one at the Board of Governors, one at each of the 12 Reserve Banks, and a System research conference at the Federal Reserve Bank of Chicago. The events featured a broad range of participants drawn from the System's existing advisory councils and community networks and from outreach conducted specifically for the Fed Listens initiative. The participants represented small businesses, labor unions, state and local governments, schools and community colleges, workforce development organizations, housing groups, community development financial institutions (CDFIs), retirees, and academia.
Most of the events were conducted in a town hall format with one or more panel sessions. A few incorporated site visits to schools and businesses to learn about local initiatives in underserved communities to increase education, combine high school completion with work experience, or offer after-hours vocational training to enhance skill levels.
At the events, participants were asked how they viewed the relative importance of maximum employment and price stability and how monetary policy actions affected them and the people they represent. Participants commented on labor market conditions and whether they saw those conditions as consistent with the dual-mandate objective of maximum employment; they also offered perspectives on inflation, lending conditions, and how people in their organizations or communities responded to interest rate changes. In addition, participants often compared economic conditions today with conditions a few years or a decade ago and assessed the Federal Reserve's public communications. In keeping with the transparency of the review, all of the events were livestreamed, with written summaries of the events posted on System websites afterward.1
Takeaways from Fed Listens
While the Fed Listens events covered a broad range of topics, participants consistently highlighted a few points. Representatives of disadvantaged communities generally saw the strong labor market as providing significant benefits to their constituents—primarily by providing job opportunities for people who had had difficulty finding jobs in the past. These representatives also expressed concern about how newly hired workers would fare in the next downturn and whether the job experience they will have acquired by then would allow them to retain their jobs during the downturn or obtain jobs easily after the economy recovers.
Small business owners and representatives from business organizations said finding qualified workers to fill available positions was a challenge in the current labor market conditions. As a result, businesses are partnering with workforce development agencies or community colleges to devise training programs or specialized curriculums to prepare would-be workers. In addition, firms have been more willing to hire people who would not have been considered in less favorable labor market conditions. However, businesses generally are not increasing wages to attract and retain workers. Instead, they are offering new training or education programs and adding or augmenting health-care and other benefits.
While businesses and CDFIs generally found low interest rates to be beneficial, representatives of underserved populations and retirees conveyed different views. Many people in lower-income communities generally have little or no access to conventional credit. Consequently, they often do not benefit when interest rates on conventional credit fall as a result of the Fed's actions. In addition, we heard that retirees with savings have seen interest income on their savings decline.
Participants acknowledged that inflation is low, and representatives of small businesses or business associations emphasized the importance of stable and predictable inflation for planning and decisionmaking. Participants representing retirees said rising costs of health care and prescription drugs pose challenges for people on fixed incomes, while representatives of low- and middle-income communities said the people they represent still struggle to afford basic necessities such as housing, utilities, and food. Participants generally did not regard the fact that aggregate inflation is running modestly below the Federal Reserve's 2 percent objective as a problem. That perception highlights a challenge for the Federal Reserve as it publicly communicates about the rationale for the review and the importance of anchoring inflation expectations at 2 percent for keeping policy interest rates sufficiently above the effective lower bound.
Since the summer of 2019, Federal Reserve policymakers have been discussing issues associated with the monetary policy strategy review at meetings of the Federal Open Market Committee (FOMC). At its July, September, and October meetings, the FOMC reviewed the performance of its current approach to monetary policy, discussed possible alternative policy strategies, and reviewed policy tools. Key points of these discussions have been summarized in publicly released meeting minutes. In December, the FOMC considered the views offered at the Fed Listens events together with staff analysis on the distributional effects of monetary policy. The FOMC's discussions are continuing into 2020. Policymakers expect to complete the review around the middle of this year. At that time, policymakers will report their findings to the public.
1. Information on the Fed Listens events is available on the Board's website at https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-fed-listens-events.htm. Return to textReturn to text
11. See the FOMC statements issued after the July, September, and October meetings, which are available (along with other postmeeting statements) on the Monetary Policy portion of the Board's website at https://www.federalreserve.gov/monetarypolicy.htm. Return to text
12. The Committee had initially indicated in its Balance Sheet Normalization Principles and Plans, issued in March 2019, that it intended to conclude the reduction of its aggregate securities holdings in the System Open Market Account at the end of September 2019. The document is available on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20190320c.htm. Return to text
13. See the Balance Sheet Normalization Principles and Plans in note 12. Since August, the Federal Reserve has reinvested, on average, about $7 billion per month in agency MBS. Return to text