Part 1: Recent Economic and Financial Developments

Monetary Policy Report submitted to the Congress on February 25, 2022, pursuant to section 2B of the Federal Reserve Act

Domestic Developments

The labor market has continued to recover rapidly

Payroll employment increased by 3.5 million jobs in the second half of 2021, bringing the gains for the year to a robust 6.7 million. And despite the headwind caused by the Omicron wave, employment growth in January remained robust at 467,000 (figure 1). Payroll gains over the past year have been widespread across industries, with a particularly large increase in the leisure and hospitality sector as people continued their return to many activities that had been curtailed by the pandemic.

Meanwhile, the unemployment rate continued to move down rapidly, declining from 6.7 percent at the end of 2020 to 4.0 percent this January (figure 2). Notably, the nearly 2 percentage point decline in the unemployment rate since June of last year was the fastest half-year decline since the 1950s, apart from the unprecedented rebound when the economy first reopened in 2020. Moreover, this decline was broad based across racial and ethnic groups and was particularly large for Hispanics and African Americans (figure 3). While these recent declines brought the gaps between Hispanic and African American unemployment rates and those of whites and Asians to near historic lows, the gaps nevertheless remain and largely reflect long-standing structural issues.

Labor demand is very strong, but labor supply remains constrained...

Last year's job gains were driven by an appreciable and steady rise in labor demand as the economy reopened and activity bounced back. By the end of the year, the number of unfilled job openings was about 60 percent above pre-pandemic levels and at an all-time high. However, labor supply struggled to keep up. In particular, the labor force participation rate—which measures the share of people either working or actively seeking work—moved up only a little over the past year and remains below its February 2020 level (figure 4).3 Several pandemic-related factors appear to be holding back labor supply, including a pandemic-induced surge in retirements, increased caregiving responsibilities, and fears of contracting COVID-19. (See the box "The Limited Recovery of Labor Supply.") As a result, the recovery in employment—though rapid—has been incomplete, with payrolls nearly 3 million below their pre-pandemic level as of January.

The Limited Recovery of Labor Supply

Although labor demand has bounced back strongly over the past year, labor supply has been much slower to rebound, resulting in an extremely tight labor market. In particular, the labor force participation rate (LFPR)—the share of working-age adults either employed or actively seeking work—fell early in the pandemic and changed little last year despite plentiful job openings and rapidly rising wages (figure A).1

A. Change in labor force participation in the United States


Metric Dec. 2020 June 2021 Dec. 2021
Change since Feb. 2020 -1.9 -1.7 -1.5
Contribution of
Retirement -.8 -1.1 -1.1
Expected retirement -.3 -.4 -.6
Excess retirements -.5 -.7 -.6
Caregiving -.8 -.5 -.4
Parents of school-age children -.3 -.1 -.1
Parents of only young children -.1 .0 .0
Nonparents -.4 -.4 -.4
Disability, illness, and schooling .2 .1 .5
Other reasons, including COVID-19 fears -.6 -.2 -.4

Note: The data are monthly and extend through December 2021. The data comprise individuals aged 16 and over. Contributions are derived from Current Population Survey (CPS) non-labor-force participants' answers to the question "What best describes your current situation at this time?" We break out categories for the answers "in retirement"; "taking care of home or family," which we categorize as caregiving; "ill or disabled" and "in school," which we combine; and "other." Contribution lines are seasonally adjusted by Federal Reserve Board staff. Details may not sum to totals due to rounding.

* Adults with at least one child between ages 6 and 17.

** Adults with at least one child only between ages 0 and 5.

Source: Bureau of Labor Statistics; Federal Reserve Board staff calculations using CPS microdata.

The behavior of the LFPR reflects a combination of factors that have limited the recovery of labor supply following the pandemic. The most important of these factors are listed in turn.

Retirements: The retired share of the population is now substantially higher than before the pandemic, accounting for more than two-thirds of the net decline in the LFPR. About half (0.6 percentage point) of this increase was to be expected even in the absence of the pandemic, as additional members of the large baby-boom generation have reached retirement age in the past two years.2 The other half of the increase comes from excess retirements, above and beyond what would have been expected in the absence of the pandemic, due to individuals "pulling forward" their planned future retirements by a couple of years.3 The effect of this factor is likely to dwindle as the date when these individuals had previously planned to retire is reached, provided that younger cohorts continue to retire at expected rates.

Caregiving: Many individuals who have left the labor force have taken on caregiving responsibilities during the pandemic, accounting for an additional 0.4 percentage point of the LFPR shortfall as of December 2021.4 Caregiving responsibilities among parents of school-aged children exerted a large drag on labor supply in 2020, when schools were largely closed. This drag on labor supply eased over the course of 2021 as schools reopened, although the ongoing pandemic may leave parents unsure whether in-person schooling could be disrupted again. Other caregiving responsibilities (for example, elder care) remain a drag on labor supply, accounting for nearly all of the negative contribution of this category to the LFPR.

Additional factors: Labor supply has also been held back by other short-term factors related to the pandemic, including fear of contracting the virus and—especially during the Omicron wave—high numbers of quarantining workers.5 As of early January 2022, nearly 3 percent of out-of-work adults reported fear of contracting or spreading the virus as their main reason for being out of work; the rate is even higher among individuals with no college education, who are more likely to work in contact-intensive sectors when employed.6 This factor may exacerbate other labor supply factors, as retirees or caregivers may be especially fearful of contracting or spreading the virus. Additionally, many households, especially those with lower incomes, built up larger-than-normal savings during the pandemic, which may have enabled workers to retire, spend time on caregiving, or remain out of the labor force until virus conditions subside. Finally, reduced immigration likely has held back total labor supply, even though the effect on the LFPR is likely to be much smaller.7

1. The table shows changes only through December 2021 to maintain comparability with pre-pandemic data. With the release of January 2022 data, the BLS revised the population base for labor force statistics, which complicates comparisons with pre-pandemic data. Return to text

2. For estimates of the effects of population aging on the LFPR during the 2020–22 period that predate the pandemic, see Joshua Montes (2018), "CBO's Projection of Labor Force Participation Rates," Working Paper Series 2018-04 (Washington: Congressional Budget Office, March), Return to text

3. Federal Reserve Board staff calculations from the Current Population Survey indicate that many of the excess retirements are concentrated among individuals aged 71 to 73 at the beginning of the pandemic, who had likely planned to retire in the next few years. Return to text

4. The contribution of caregiving responsibilities is measured by the increase in nonparticipants in the Current Population Survey who report "taking care of home or family" as their current situation. Note that this question refers to the respondent's current situation rather than the causal reason why they left the labor force; nonetheless, it is reasonable to infer that caregiving responsibilities are an important factor contributing to the net decline in LFPR. Return to text

5. Many workers have had to quarantine during the Omicron wave, resulting in the number of workers absent from work due to illness being more than 600,000 higher in December 2021 than is typical for this time of year and about 2.5 million higher in January 2022. However, because these workers are counted as employed in the Current Population Survey, these absences do not affect the LFPR. In addition, some vaccine-hesitant workers who are subject to vaccine mandates may have left the labor force and may be reluctant to return. Return to text

6. See the data from week 41 of the Household Pulse Survey, which can be found on the Census Bureau's website at Return to text

7. Slower immigration during the pandemic period has reduced population growth—and labor force growth—since 2019, lowering the foreign-born working-age population in the United States by about 2 million people, according to one estimate. See Giovanni Peri and Reem Zaiour (2022), "Labor Shortages and the Immigration Shortfall," Econofact, January 11, Although foreign-born individuals tend to have higher LFPRs than the overall population, the difference is not large enough for the reduced immigration to have a substantial effect on the (overall) LFPR. Return to text

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...resulting in an extremely tight labor market...

A wide range of indicators have been pointing to a very tight labor market, reflecting robust demand for workers and constrained supply. There were two job openings per unemployed person at year-end, the highest level on record (figure 5). Both households' and small businesses' perceptions of labor market tightness were near or above the highest levels observed in the history of these series. The share of workers quitting jobs each month, an indicator of the availability of attractive job prospects, climbed from 2.4 percent to 2.9 percent last year, reaching an all-time high. Moreover, employers continued to report widespread hiring difficulties.

...and a broad-based acceleration in wages

Measures of hourly labor compensation growth have risen sharply over the past year in nominal terms, reflecting the influences of strong labor demand and pandemic-related reductions in labor supply. Total hourly compensation as measured by the employment cost index, which includes both wages and benefits, rose at an annual rate of 5.2 percent in the second half of 2021, lifting the 12-month change to 4.4 percent, well above pre-pandemic rates (figure 6). Wage growth as computed by the Federal Reserve Bank of Atlanta, which tracks the median 12-month wage growth of individuals responding to the Current Population Survey, has also been rising smartly, as have average hourly earnings and compensation per hour in the business sector.4 Indeed, nominal wages are increasing at the fastest pace in at least 20 years. This wage growth has been widespread across most sectors and particularly large in the leisure and hospitality sector and for lower-wage workers. (See the box "Differences in Wage and Employment Growth across Jobs and Workers.") Even so, in the aggregate, these wage gains did not keep pace with the rise in prices last year.

Differences in Wage and Employment Growth across Jobs and Workers

Wages have increased strongly during the past year, especially for workers in lower-paying jobs and industries. For example, figure A shows that compensation growth for leisure and hospitality jobs as measured by the employment cost index was stronger than for goods-producing and service-producing industries overall in the second half of 2021. The leisure and hospitality industry was substantially affected by social distancing earlier in the pandemic, leading to outsized employment losses relative to other industries and a much weaker recovery. However, job openings for this industry are very high, which, in combination with strong wage growth, indicates that the comparatively weak employment rebound in leisure and hospitality now largely reflects a lack of available workers.

The industry-specific effects of the pandemic are also apparent in the patterns of employment and wages for lower-paying jobs relative to higher-paying jobs. As shown in figure B, job losses initially aligned closely with workers' level of earnings, with the lowest-wage jobs (which are disproportionately found in service-producing industries) experiencing the greatest employment declines. As the economy has reopened, lower-wage employment has rebounded more. Consistent with the rebound in labor demand for these jobs coupled with hiring difficulties, figure C shows that wage growth has been especially strong for lower-wage jobs.

Finally, figure D illustrates how wages have evolved across racial and ethnic groups over the course of the pandemic. In 2019, median hourly wages were around $1 higher for Asian and white workers relative to Black and Hispanic workers. From 2019 to 2021, median wages increased between $1.10 and $1.90 for all groups, leaving the disparities in wage levels across these groups little changed relative to 2019.1

1. The wage estimates in figure D are only for workers paid hourly and exclude the incorporated self-employed. Because hourly wages for demographic groups are published at only an annual frequency by the Bureau of Labor Statistics, it is not possible to infer from these data whether some demographic groups experienced faster wage gains more recently (for example, whether wage growth has been faster for demographic groups with lower median wages in the second half of 2021, mirroring the more rapid wage growth for lower-paying jobs, as illustrated in figure C). Return to text

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Labor productivity also appears to have accelerated

The extent to which sizable wage gains raise firms' costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. In that regard, the behavior of labor productivity since the start of the pandemic has been encouraging. Over the 2020–21 period, productivity growth in the business sector averaged 2.3 percent per year—about 1 percentage point faster than its average pace since the mid-2000s (figure 7). Some of this acceleration in productivity might be the result of transitory factors. For example, worker effort, which surged in response to employment shortages and hiring difficulties, appears to be elevated, possibly above sustainable levels.5 But other pandemic-related developments could have a more persistent effect on productivity growth. For example, the pandemic has resulted in a high rate of new business formation, the widespread adoption of remote work technology, and a wave of labor-saving investments. Nevertheless, it is too early to tell what the ultimate effect of the pandemic will be on productivity growth in coming years.

Inflation increased significantly last year...

Consumer prices posted further sizable increases in the second half of 2021. Monthly increases in personal consumption expenditures (PCE) prices averaged about the same in the second half as in the first half, bringing the 12-month change in December to 5.8 percent—far above the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent (figure 8). The core PCE price index, which excludes the more volatile food and energy prices categories, rose 4.9 percent last year as supply chain bottlenecks, hiring difficulties, and other capacity constraints amid strong demand exerted pervasive upward pressure on prices. Notably, these were the largest price increases since the early 1980s. In January, a further sizable rise in the consumer price index (CPI) indicated that price pressures had not yet begun to abate.

...and became more broad based in the second half...

Whereas the sizable price increases seen last spring were concentrated in a few key items, inflationary pressures broadened over the second half of 2021. As an illustration, the Federal Reserve Bank of Dallas trimmed mean index, which removes the PCE categories with the largest price increases and decreases each month, rose only modestly in the first half of last year but picked up in the second half and increased 3.1 percent for the year as a whole—its highest reading since 1991.

The broadening of price inflation is further evident when examining the price indexes for major PCE categories (figure 9). In the first half of 2021, rising inflation was driven by sharp increases in prices for certain goods such as motor vehicles, which experienced strong demand coupled with severe supply chain bottlenecks; a recovery in demand for nonhousing services, where many prices rebounded after having softened earlier in the pandemic; and rapid increases in energy prices. In the second half, prices of those items continued to move higher, and prices began to rise more rapidly for food and beverages (as increases in the costs of food commodities, labor, and transportation were passed on to consumers) as well as for housing services (as rents began to reflect the large increase in housing demand). (See the box "How Widespread Has the Rise in Inflation Been?")

How Widespread Has the Rise in Inflation Been?

Consumer price inflation increased markedly in 2021, with the price index for personal consumption expenditures (PCE) rising 5.8 percent over the 12 months through December, following a subdued increase of 1.3 percent in 2020. In the first half of last year, the increase in inflation was driven by a fairly small number of categories. In contrast, over the second half of the year, relatively high price increases became more widespread, suggesting that broader-based inflationary pressures had taken hold. This discussion reviews how inflation evolved across a comprehensive set of product categories last year to help shed light on the forces generating higher inflation.

Although price increases driven by bottlenecks and production constraints have been more concentrated in a relatively small set of product categories that have been particularly affected by these supply–demand imbalances, labor shortages, rising wages, and other broad-based cost pressures likely contributed to a pickup in inflation across a wide range of goods and services.

Figure A divides PCE into 146 product categories and presents the share of those categories for which prices were increasing by over 3 percent.1 This share was stable at around 35 percent between 2016 and 2019—close to the average share observed since the mid-1990s—and continued to be stable in 2020. However, the share of products with more than 3 percent inflation increased last year to above 60 percent. And, as is evident from the black line, the share of categories with price increases of more than 3 percent (annual rate) over a three-month window increased gradually over the course of the year. As shown by the left panel, the share of product categories with inflation above 3 percent temporarily reached a similar level on two other occasions since the 1990s (in 2001 and 2007), but this share is still notably lower than that in the high-inflation regime of the 1970s.

As seen in figure B, which reports the shares of product categories with 12-month price changes above 3 percent separately for goods and services, the increase in the breadth of large price increases was especially unusual for goods. Yet the share of higher inflation in services has also been moving up in the past few months, likely in part because of mounting inflation pressures from the labor market.

While robust price increases became more prevalent across product categories in the past year, the size of price increases still varied significantly across product categories. To better understand the drivers of the high aggregate inflation last year, figure C presents the full distribution of price changes for different products and further emphasizes the different roles being played by prices of goods versus services in explaining changes in this distribution compared with the 2016–19 period.

In figure C, the blue line depicts the distribution of annualized monthly price changes observed from 2016 to 2019, while the black line depicts the distribution in 2021.2 In both periods, this distribution is very wide, reflecting the sizable heterogeneity in price behavior across items. The higher and broader inflation during 2021 is reflected in the chart as a rightward shift in the distribution of price changes relative to the 2016–19 period.3 Four aspects of the change in the distribution are worth noting:

(1) fewer items with price decreases, which are depicted in the blue shaded areas below zero on the horizontal axis

(2) a notable decline in the occurrence of price increases of between 1 and 4 percent, shown by the blue shaded area in the middle of the distribution

(3) more items with inflation between 5 and 12 percent as well as slightly more with inflation between 13 and 24 percent, shown in the gray shaded area in those ranges on the horizontal axis

(4) a striking 6 percentage point increase at the very top of the distribution, indicated by the large (gray shaded) spike in the share of items with price increases of at least 25 percent

These features of the distribution of price changes can be better understood by considering the contributions of goods and services to the changes. First, the left panel of figure D shows the contribution of goods to the total price change distribution between 2016 and 2019 (the blue line) and 2021 (the black line). Goods account for about 4 percentage points of the 6 percentage point increase in the spike at the top of the price change distribution in figure C as well as nearly all of the rightward shift in the price change distribution in excess of 12 percent inflation. Moreover, the increased occurrence of high inflation for goods is a stark departure from small positive or slightly negative price changes between 2016 and 2019 (seen in the blue shading). These observations are consistent with the very large price increases in goods categories such as motor vehicles and other categories disrupted by supply constraints against the backdrop of strong demand as consumption shifted away from services during the pandemic.

Second, the right panel of figure D shows the contribution of services to the total price change distribution. Services account for the vast majority of the shift from the middle of the distribution of price changes (the blue shaded area) to inflation between 5 and 12 percent (the gray shaded area), while they account for less than one-third of the increase in the spike at the top of the distribution.

In summary, the share of products experiencing notable price increases moved appreciably higher in 2021, with the broadening due to both goods and services prices. That said, most of last year's very high inflation readings were concentrated in goods—a reflection of strong demand in the face of supply bottlenecks that have particularly affected these items. Finally, although currently more widespread than in recent history, large price increases were considerably less widespread than was seen during the high-inflation regime of the 1970s. In the period ahead, the large price changes in goods may ease once supply chain disruptions finally resolve, but, if labor shortages continue and wages rise faster than productivity in a broad-based way, inflation pressures may persist and continue to broaden out.

1. The figure presents the consumption-weighted share of product categories with 12-month price changes—and, for the recent period, annualized three-month price changes—over 3 percent. The calculation based on three-month changes provides a timely account of broadening in total PCE price inflation but is somewhat more volatile. A price increase of 3 percent is one standard deviation above the mean of annualized price increases for the different PCE product categories from 2016 to 2019. Return to text

2. For each of the 146 disaggregated product categories mapped back to 1972, the chart presents one-month annualized inflation rates for each of the months indicated in the legend. From 2016 to 2019 there are 7,008 observations (48 months times 146 categories) sorted into 51 bins (negative 25 or lower, negative 24, . . . , negative 1, 0, 1, . . . , 24, and 25 or higher), while in 2021 there are 1,752 observations (12 months times 146 categories). The product categories are weighted according to their share in overall PCE. The comparison shown in figure C does not importantly depend on the length of the pre-pandemic comparison period; for example, the distribution of price changes over 2000 to 2019 looks similar to the distribution over 2016 to 2019. Return to text

3. As the price change distribution shifts rightward and inflation becomes more broadly experienced across product categories, a greater percent of spending occurs on products with inflation exceeding 3 percent, as depicted in figure A. However, by combining all increases of at least 3 percent, figure A does not portray the marked increase in the number of very large price increases, particularly for goods affected by supply chain disruptions. Return to text

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...with further upward pressure on inflation from rising commodity and import prices

Oil prices continued climbing over the second half of last year and into this year, reaching their highest level in over seven years (figure 10). Demand for oil rose as the global economy recovered further, and oil supply was constrained by U.S. oil production disruptions due to Hurricane Ida and by only modest production increases by OPEC (Organization of the Petroleum Exporting Countries) and its partners. Geopolitical tensions with Russia have also contributed to higher energy prices, including oil and natural gas.

Nonfuel commodity prices have risen with the global economic recovery since the first half of last year, reflecting considerable increases in the prices of both industrial metals and agricultural commodities. Although still below their peak last year, lumber prices have increased sharply again in recent months because of elevated demand from residential construction and supply disruptions.

Import prices and the cost of transporting imported goods—a cost not included in measured import prices—are rising, and bottlenecks in supply chains have exacerbated the rise (see the box "Supply Chain Bottlenecks in U.S. Manufacturing and Trade"). Import price inflation has also remained elevated largely because of continued increases in commodity prices, bringing the 12-month change through January 2022 to 6.9 percent (figure 11).

Supply Chain Bottlenecks in U.S. Manufacturing and Trade

Over the past year, global transportation and distribution networks have been overwhelmed, and manufacturers have struggled to find the materials and labor needed to meet demand for their products. Demand for goods has been notably boosted, as ongoing concerns about COVID-19 have led consumers and businesses to shift spending away from services, such as travel, in favor of goods, such as those related to increased time at home. While some distribution and production bottlenecks showed signs of improvement toward the end of last year, other bottlenecks are expected to remain for some time.

The surge in demand for imports has strained shipping networks worldwide, and U.S. ports have been particularly congested. About one-third of all U.S. goods imports (by value) arrive via seaborne containers, and, consistent with the strength in imports of consumer and capital goods in 2021, the number of containers processed at domestic ports last year was significantly higher than in any previous year (figure A). The combined ports of Los Angeles and Long Beach have faced substantial congestion, with the number of ships waiting for a berth recently reaching an all-time high.1 Elevated levels of port congestion in the United States and abroad have caused on-time arrivals of global shipping vessels to plunge and have resulted in dramatic increases in charter rates for container ships (figure B). Moreover, once goods arrive in port, major bottlenecks in U.S. trucking and rail transportation have further delayed their movement. Trucking cargo rates have risen sharply since mid-2020, and some measures are now more than 15 percent above the levels prevailing in 2019.

Distribution problems have also weighed heavily on domestic production. In 2021, a record number of manufacturers reported that an insufficient supply of materials was one reason they were unable to produce at full capacity (figure C). Together with increasingly strong demand for goods, these limitations on production led to backlogs of orders and to supplier delivery times well above historical norms (figure D). With supply unable to satisfy demand, prices for a wide range of goods increased last year, sometimes sharply. Indeed, the producer price index for overall manufacturing was more than 15 percent higher in the fourth quarter of 2021 than its year-earlier level (figure E).

Domestic production has been further hampered by manufacturers' inability to hire and retain skilled labor. Despite adding about 350,000 workers in 2021, by the end of the year manufacturing employment was still about 250,000 below where it was just before the pandemic. Although manufacturers have long noted difficulties in finding workers, labor market conditions were particularly tight in 2021. At the end of the year, factory workers were quitting their jobs at near-record rates, and manufacturing plants had listed approximately 850,000 job openings—about twice as many openings as in the 2017–19 period.

The motor vehicle sector has faced a particularly acute and well-publicized shortage of semiconductor chips, reflecting a combination of factors. On the demand side, consumers' appetite for cars and trucks has remained remarkably strong, and the chip content per vehicle has increased.2 Meanwhile, the supply of semiconductors was disrupted by COVID-induced shutdowns in foreign countries—such as Malaysia and Vietnam—that are major players in the semiconductor supply chain. Even when enough of certain types of chips have been available, an undersupply of complementary chips has, at times, created problems for manufacturers. These chip shortages have led to widespread shutdowns and production slowdowns at U.S. motor vehicle assembly plants. Without an ample supply of new vehicles, many dealerships sold off remaining inventories and raised prices. The lean inventories and high prices weighed heavily on vehicle sales for much of 2021. Recently, however, semiconductor shortages have begun to ease somewhat, as indicated by an increase in U.S. vehicle production (figure F). Nevertheless, these shortages have persisted, and statements by some auto industry executives suggest that they expect production bottlenecks to continue well into this year.

Outside the auto sector, supply chain bottlenecks show some signs of improvement. Capacity expansion at some ports in late 2021 and waning seasonal demand likely contributed to recent declines in the cost of shipping. Additionally, inland rail hubs have decongested somewhat, facilitating the flow of containers inland. Also, late last year, domestic manufacturers saw slower increases in the price of inputs, improving delivery times, and fewer items in short supply than they had earlier. A few commodities have experienced a notable increase in availability. One example is steel, for which delivery times and prices have fallen sharply after having been elevated for much of last year.

1. Though primarily driven by strong demand for goods, the congestion has been worsened by COVID-19 outbreaks in emerging Asia, where port delays have tied up vessels and containers, sending ripple effects through the global network. Return to text

2. Although the chip content per vehicle has been rising for a while, demand for some vehicles particularly rich in semiconductors—notably, electric vehicles and luxury models—has risen especially sharply during the pandemic. Return to text

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Measures of near-term inflation expectations rose notably, but longer-term expectations moved up less

Inflation expectations likely influence actual inflation by affecting wage- and price-setting decisions. In the University of Michigan Surveys of Consumers, households' expectations for inflation over the next 12 months continued to climb, reaching levels that are among the highest observed since the early 1980s (figure 12). In contrast, expectations for average inflation over the next 5 to 10 years from the same survey flattened out in the second half of 2021 after having moved up modestly in the first half, and they now stand near levels observed about a decade ago. Meanwhile, 10-year PCE inflation expectations in the Survey of Professional Forecasters edged up, on net, since mid-2021 and stood at 2.2 percent in the first quarter of this year. That increase was driven by higher expectations for the next five years, with expectations for inflation remaining at 2 percent over years 6 through 10.

Market-based measures of inflation compensation, which are based on financial instruments linked to inflation, are sending a similar message. A measure of CPI inflation compensation over the next five years implied by Treasury Inflation-Protected Securities (TIPS) continued to rise, on net, through the second half of 2021, reaching its highest level over the past decade.6 In contrast, the TIPS-based measure of CPI inflation compensation 5 to 10 years ahead rose over the first half of 2021 but has settled around 2-1/4 to 2-1/2 percent since then (figure 13). While elevated relative to pre-pandemic levels, this measure is well within the range of values observed in the first half of the previous decade and, because CPI inflation tends to run around 1/4 percentage point above PCE price inflation, it suggests inflation compensation close to 2 percent on a PCE basis.

The common inflation expectations (CIE) index constructed by Federal Reserve Board staff combines a wide variety of inflation expectations measures—including the measures cited earlier—into a single indicator that is rescaled to match the level and volatility of existing inflation expectation indicators.7 The measures used in the CIE differ along several key dimensions—the type of economic agent, data source (survey- or market-based measure), time horizon, and inflation measure. Both CIE indexes shown in figure 12 look most similar to the measures of longer-term expectations: They trended up in the first half of last year, reversing the downward drift observed in the years before the pandemic, but then flattened out at a level similar to those observed roughly a decade ago.

Gross domestic product growth stepped down modestly in the second half of last year...

The level of real gross domestic product (GDP) recovered further in the second half of 2021, but growth was somewhat slower, on average, than in the first half (figure 14). GDP growth is reported to have slowed notably to 2.3 percent at an annual rate in the third quarter but rebounded to a brisk 7 percent in the fourth quarter. Despite the solid average growth in the second half, several factors—including last summer's Delta wave and waning fiscal stimulus—likely weighed on demand growth. Moreover, supply chain bottlenecks, hiring difficulties, and other capacity constraints continued to significantly restrain economic activity. While there have been some recent signs of these constraints easing, the time frame for further improvement is highly uncertain. All told, at the end of 2021 GDP stood 3 percent above its level in the fourth quarter of 2019, before the pandemic began, but 1.5 percent below its level if growth had continued at its average pace over the five years before the pandemic.

...while the rapid spread of the Omicron variant appears to have slowed the pace of economic activity early this year

Fueled by the highly transmissible Omicron variant, new cases of COVID-19 began rising sharply in mid-December, peaked in mid-January with daily cases about three times as high as last winter's surge, and have fallen quickly since then. Although Omicron appears to cause less severe symptoms than previous variants, several indicators suggest it has damped the pace of economic activity early this year. High-frequency indicators reveal that flight cancellations, school closures, and temporary closings of small businesses jumped as the new year began, while demand for COVID-sensitive services like air travel, lodging, and restaurant meals flagged. Nevertheless, with cases rapidly declining and spending indicators having rebounded, Omicron seems likely to cause the continued reopening of the economy to slow only briefly.

Real consumer spending growth eased...

Consumer spending on goods edged lower, on balance, over the second half of 2021 as the boost from fiscal stimulus waned and low inventories held back purchases of some goods, particularly motor vehicles. Even so, goods spending remains quite elevated relative to its pre-pandemic trend (figure 15). The further reopening of the economy boosted spending on services in the second half, albeit at a less rapid pace than last spring, as the Delta wave weighed on demand for in-person services in the summer and the Omicron wave began to do so late in the year. Despite the continued recovery in services spending, this spending remains well below its pre-pandemic trend. In all, the data over the second half of 2021 indicate only a moderate amount of rebalancing of consumer demand toward services and away from goods. higher prices damped otherwise healthy income and wealth positions...

Real consumer spending has been supported by further gains in household income and wealth, but that support was curbed by the marked rise in prices over the past year, especially for households that have not benefited from higher asset prices. Household disposable income in nominal terms has proven resilient due to the improving labor market, even as fiscal stimulus has waned, but after factoring in the higher prices, real disposable incomes edged lower over the year. Nevertheless, also supporting consumption, in the aggregate, are the substantial savings households have accumulated from curtailed services spending and historic levels of household-focused fiscal stimulus distributed earlier in the pandemic, as evidenced by a personal saving rate that, while no longer elevated, has not fallen below its pre-pandemic trend (figure 16). Furthermore, as a result of the large gains in home and equity prices since mid-2020, the wealth position of households that own these assets remains very solid (figure 17).

...and contributed to declining consumer sentiment

Amid the continued acceleration in prices in the second half of last year and despite solid household balance sheets, a closely watched index of consumer sentiment plunged (figure 18). Since the middle of 2021, the University of Michigan index fell below the levels seen at the onset of the pandemic, as survey respondents' concerns over inflation weighed heavily on their outlooks. The Conference Board index, an alternative measure of consumer sentiment, also deteriorated but, in contrast to the Michigan index, remains well above its earlier pandemic lows.

Meanwhile, consumer credit conditions continued to normalize

Financing has been generally available to support these gains in consumer spending. Standards for consumer loans, which banks reported eased in 2021 relative to 2020, are now generally in line with the standards that persisted before the pandemic; as a result, financing conditions are now largely accommodative for borrowers with high credit scores, though lending standards and terms remain somewhat tighter than pre-pandemic levels for borrowers with low credit scores. After initial declines at the onset of the pandemic, the growth rate of consumer credit recovered strongly in 2021, driven by the continued expansion of auto loans and an appreciable rebound in credit card balances (figure 19). Delinquency rates for nonprime auto and credit card borrowers remained well below pre-pandemic levels, likely stemming from forbearance programs and fiscal support.

Housing construction fell as supply constraints held back activity...

Residential investment is well above pre-pandemic levels but fell back somewhat last year, as construction was limited by persistent bottlenecks that led to materials shortages. In recent months, the sector has shown signs of a rebound, as single-family permits have risen steadily (figure 20). Nevertheless, the timing of the resolution of these supply constraints remains highly uncertain. Prices of lumber and other materials have moved up appreciably, and shortages of other construction inputs—such as labor and lots ready for development—remain acute.

...amid surging demand for housing...

Demand for housing surged earlier during the pandemic and has remained strong, with home sales well above levels seen in the years before the pandemic despite very tight inventory of homes available for sale (figure 21). This surge in demand is likely due to a combination of factors, including increased work-from-home arrangements; shifts away from other types of consumer spending, such as travel and leisure; and mortgage rates that remain low despite notable recent increases (figure 22). Meanwhile, mortgage credit remained broadly available for a wide range of potential borrowers. Although mortgage credit for borrowers with low credit scores remained tighter than before the pandemic, it eased over the second half of last year.

...which has contributed to record house price growth

As a result of supply constraints and surging demand, house price growth reached record levels, and, even after adjusting for overall inflation, home prices have surpassed their peak of the mid-2000s (figure 23). According to data from Zillow, national house prices rose almost 20 percent last year. Moreover, strong house price growth has been widespread across the United States, as nearly 80 percent of metropolitan areas experienced annual house price increases of at least 10 percent. Homebuying sentiment, as measured by the Michigan survey, remains depressed, reflecting the low inventory of homes and high prices.

Business investment slowed in response to supply constraints...

Investment in equipment and intangibles grew at an annual rate of just 4 percent in the second half of last year, a marked step-down from the nearly 14 percent pace in the first half. As with other sectors of the economy, investment demand has remained strong, while supply constraints have limited spending, as evidenced by shipments of capital goods increasingly lagging orders and equipment prices rising sharply. Supply bottlenecks in the motor vehicle sector have been particularly acute, and business spending on vehicles declined appreciably in the second half of 2021. Investment in nonresidential structures declined further last year despite a sharp rebound in oil drilling and remains well below pre-pandemic levels (figure 24). This sector typically lags in recoveries, and shortages of building materials may be further restraining activity.

...while financing conditions remain accommodative

Corporate financing conditions through capital markets remained broadly accommodative for nonfinancial firms and continued to be supported by corporate bond yields that remain very low by historical standards. Amid these low yields and ample investor demand, gross issuance of corporate bonds continued at a robust pace, albeit down from the exceptional pace seen in 2020. In contrast, bank lending to businesses was, on net, subdued last year. While commercial real estate loans grew at a modest pace similar to the years just before the pandemic, commercial and industrial loan balances contracted as a result of loan forgiveness associated with the Paycheck Protection Program (PPP), elevated paydowns, and generally weak borrower demand.

Meanwhile, financing conditions for small businesses have improved notably over the past year and have generally been stable in recent months. Lending standards have eased, and loan origination volumes are in line with pre-pandemic levels, though loan demand remains weak for the smallest firms. Moreover, default and delinquency rates are now within their pre-pandemic range. Nevertheless, the pandemic continues to negatively affect the operations of small businesses, especially in the most affected industries (accommodation and food services, arts, entertainment, and recreation).

The strong U.S. demand has partly been met through a rapid rise in imports

Driven by the strength in U.S. economic activity, particularly the strong demand for goods and a desire to restock inventories, U.S. imports have continued to increase at a notable pace. High levels of imported goods have kept international logistics channels operating under high pressure, which has continued to impair the timely delivery of goods to U.S. customers. By contrast, U.S. exports increased modestly over the second half of 2021 and remain below pre-pandemic levels (figure 25). Given the relative strength in imports compared with exports, both the nominal trade deficit and the current account deficit have increased as a share of GDP relative to 2019 (figure 26).

Federal fiscal actions provided a diminishing degree of support to economic activity...

In response to the pandemic, the federal government enacted a historic set of fiscal policies to ameliorate hardship caused by the viral outbreak and support the economic recovery. Policies such as stimulus checks, supplemental unemployment insurance, and child tax credit payments have aided households; grants-in-aid have supported state and local governments; and business support programs such as the PPP have helped sustain firms. Although these temporary policies continue to support the level of GDP, they have begun to unwind and are now likely imposing a drag on GDP growth as the effects on spending wane over time. In addition to pandemic-support policies, the Infrastructure Investment and Jobs Act will gradually boost spending on infrastructure over the next 10 years and is only partially offset by new revenues and other spending reductions.

...while significantly raising the budget deficit and federal debt

Overall, the Congressional Budget Office estimates that fiscal policies enacted since the start of the pandemic—including the infrastructure bill—will increase federal deficits by roughly $5.4 trillion by the end of fiscal year 2030, with the largest deficit effects in fiscal 2020 and 2021.8 These policies, combined with the effects of automatic stabilizers—the reduction in tax receipts and increase in transfers that occur as a consequence of depressed economic activity—caused the federal deficit to surge to 15 percent of nominal GDP in fiscal 2020 and remain elevated at 12-1/2 percent in fiscal 2021. But with fiscal support fading, the deficit is expected to fall sharply this year to a level closer to that observed in the years just before the pandemic (figure 27).

As a result of the unprecedented fiscal support over the past two years, federal debt held by the public jumped to around 100 percent of nominal GDP in 2020—the highest debt-to-GDP ratio since 1947—and remained at a similar level in 2021. Nevertheless, net interest outlays—primarily reflecting debt service payments—have remained relatively flat over the past two years due to historically low interest rates on government borrowing (figure 28).

State and local government finances have been bolstered by federal aid and strong growth in tax revenue...

Federal policymakers have provided a historic level of fiscal support to state and local governments, with aid totaling nearly $1 trillion—more than covering pandemic-related budget shortfalls in the aggregate. Moreover, following the pandemic-induced slump, total state tax collections rose smartly in 2021, pushed up by the economic expansion (figure 29). At the local level, property taxes have continued to rise apace, and the typically long lags between changes in the market value of real estate and changes in taxable assessments suggest that property tax revenues will continue to rise going forward, given the rise in house prices. Meanwhile, conditions in municipal bond markets remained accommodative: Yields stayed near historical lows, and issuance continued at a solid pace, on par with pre-pandemic issuance.

...but hiring and construction outlays continued to lag

Despite the return to in-person schooling this year and the strong fiscal position of state and local governments, employment levels have regained only about one-half of their sizable pandemic losses, with the shortfall concentrated in public education (figure 30). One reason appears to be that public-sector wages have not kept pace with the rapid gains in the private sector, which is likely inhibiting the ability of these governments to staff back up to pre-pandemic levels. Meanwhile, real construction outlays by state and local governments appear to have declined significantly in 2021, and real infrastructure spending by these governments is currently about 10 percent below pre-pandemic levels.

Financial Developments

The path of the federal funds rate expected to prevail over the next few years steepened notably

The market-based expected path of the federal funds rate steepened notably amid news about the labor market recovery, rising inflation pressures, and the accompanying prospect of tighter monetary policy. Market-based measures suggest that investors anticipate the federal funds rate will soon begin to rise and move above 1 percent in the middle of this year, about two and a half years earlier than expected in July (figure 31).9 Similarly, according to the results of the Survey of Primary Dealers and the Survey of Market Participants, both conducted by the Federal Reserve Bank of New York in January, the median respondent views the target range as most likely to increase later in the current quarter, about one and a half years earlier than in the June surveys.10

Treasury yields increased substantially across maturities...

Yields on nominal Treasury securities across maturities have risen notably since early July, with much of the increase having occurred in the past couple of months as the anticipation for an imminent start to the removal of monetary accommodation has firmed (figure 32). Uncertainty about longer-term interest rates—as measured by the implied volatility embedded in the prices of near-term swap options on 10-year swap interest rates—also increased markedly, reportedly reflecting an increase in uncertainty about inflation and the policy outlook.

...while spreads of other long-term debt to Treasury securities widened moderately

Across credit categories, corporate bond yields have risen substantially, and their spreads over yields on comparable-maturity Treasury securities have widened moderately since early July (figure 33). Still, both yields and spreads remain near the bottom of their historical distributions, and corporate credit quality is generally healthy and stable. News about the spread of new coronavirus variants appeared to have only limited and temporary effects on corporate bond spreads.

Since early July, yields on 30-year agency mortgage-backed securities—an important pricing factor for home mortgage rates—increased, and spreads over comparable-maturity Treasury securities widened moderately but stayed near the low end of their historical range (figure 34). Municipal bond yields moved higher, and spreads over comparable-maturity Treasury securities widened to levels close to their historical medians.

Broad equity price indexes declined slightly on net

Broad indexes of equity prices decreased a little, on net, since early July. Recent declines amid expectations of an earlier beginning to the removal of policy accommodation have offset previous gains, which were supported by strong corporate earnings that had seemed resilient to pandemic developments (figure 35). Stocks of small-capitalization firms underperformed notably, as the likelihood for a tighter stance of monetary policy has increased. Bank stock prices rose, on net, buoyed by an improved economic outlook and expectations of higher levels of interest rates and net interest margins in the future. Measures of volatility for the S&P 500 index, both an option-implied metric (the VIX) and a comparable forward-looking measure based on realized volatility, increased somewhat amid evolving monetary policy expectations and concerns over the Omicron variant and stand above their respective historical medians (figure 36). (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability.")

Developments Related to Financial Stability

This discussion reviews vulnerabilities in the U.S. financial system. The framework used by the Federal Reserve Board for assessing the resilience of the U.S. financial system focuses on financial vulnerabilities in four broad areas: asset valuations, business and household debt, leverage in the financial sector, and funding risks. Although some asset valuations are elevated, measures of household and business leverage have declined, and the banking system has shown considerable resilience since the onset of the pandemic. Structural vulnerabilities in other parts of the financial system are still being addressed, including those related to various types of investment funds and vulnerabilities in Treasury market functioning.

Prices of risky assets remain elevated, supported in part by a low interest rate environment and low term premiums on Treasury securities. One common measure of equity valuations, the ratio of equity prices to forecast earnings, remains high compared with historical values. Spreads on corporate bonds and leveraged loans continue to be low. Price indexes for a range of commercial real estate sectors are at or near historical highs, and vacancy rates have declined. Residential home prices have continued to rise, with nearly 80 percent of metropolitan statistical areas seeing double-digit annual growth rates during 2021.

Nonfinancial-sector leverage has broadly declined. The rapid growth of nominal gross domestic product (GDP) has brought the ratio of nominal credit to nominal GDP, which measures the aggregate debt owed by the private nonfinancial sector relative to the size of the economy, down to near its pre-pandemic levels (figure A). Household debt relative to nominal GDP remains firmly below its long-run trend, and household credit growth has been driven almost exclusively by prime-rated borrowers. Homeowner equity is high, and mortgage delinquency and foreclosure rates are below their pre-pandemic levels despite the end of pandemic-related relief and forbearance programs. Because of high corporate cash holdings, aggregate net nonfinancial business leverage sits at its lowest level since 2014. Fueled by strong earnings and low borrowing costs, most businesses saw a sharp increase in their ability to service their debt burdens, with the interest coverage ratio (the ratio of earnings to interest expenses) for the median firm solidly above pre-pandemic levels and near historical highs. However, for firms in industries hit hardest by the pandemic, including airlines, hotels, and restaurants, leverage remains elevated and interest coverage ratios are lower.

Vulnerabilities from financial-sector leverage are well within their historical range. Risk-based capital ratios at domestic bank holding companies reached a 20-year high during the first quarter of 2021. These capital ratios declined modestly over the rest of the year as banks increased their share repurchases and dividend payouts amid an improved economic outlook and the Federal Reserve's lifting of restrictions on capital distributions. Throughout 2021, robust economic growth and strong capital markets contributed to high bank profitability, which fosters resilience through greater loss absorption capacity and an ability to retain earnings to raise capital if needed. In contrast, leverage at certain nonbank financial institutions, including life insurers and hedge funds, has remained near historical highs. Data limitations and the complexity of hedge fund strategies can obscure the true nature of leverage in that sector. However, one common measure of hedge fund leverage, the ratio of gross notional exposures to equity capital, is near its peak since data became available in 2012.

Funding markets remain relatively stable. Domestic banks continue to maintain significant levels of high-quality liquid assets. Assets under management at prime and tax-exempt money market funds (MMFs), which experienced significant outflows during the March 2020 turmoil, continued to decline, on net, since mid-2021, while those at government MMFs remained near historical highs. In December 2021, the Securities and Exchange Commission (SEC) proposed reforms to MMFs intended to mitigate the financial stability risks they pose, including the adoption of swing pricing for certain fund types, increased liquidity requirements, and other measures meant to make them more resilient to redemptions. The market for digital assets, including stablecoins, has grown rapidly. The market value of stablecoins exceeded $150 billion as of January 2022. As detailed in a November 2021 report released by the President's Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, some stablecoins are partially backed by assets that may lose value or become illiquid, making them susceptible to runs.1 Prefunded resources at central counterparties (CCPs) are high, particularly relative to current market volatility, reducing the likelihood of margin shortfalls and liquidity strains if volatility increases. Nevertheless, increased retail trading has exposed new challenges for the risk-management frameworks of the CCPs that clear equities and equity options. Financial institutions with significant holdings of long-term fixed-rate debt instruments (for example, Treasury securities, agency mortgage-backed securities (MBS), corporate bonds, and mortgage loans), such as banks and mutual funds, may recognize revaluation losses if long-term interest rates increase further, though some of those losses could be offset by higher interest income.

Treasury Market Resilience

In November 2021, the Interagency Working Group composed of staff from the Department of the Treasury, Federal Reserve Board, Federal Reserve Bank of New York, SEC, and Commodity Futures Trading Commission released a report detailing ongoing vulnerabilities in the U.S. Treasury market and principles to promote a well-functioning Treasury market.2 The report also outlined multiple ongoing workstreams designed to further enhance the group's understanding of Treasury market vulnerabilities and to consider policy options that may further strengthen the market.

LIBOR Transition

The shift away from the widely used U.S. dollar (USD) LIBOR reference rates stepped up notably in recent months, in line with regulatory guidance to end most new use of USD LIBOR by December 31, 2021, and well ahead of the cessation of those rates on June 30, 2023. The transition away from USD LIBOR has largely been completed in floating-rate debt markets, where nearly 90 percent of new issuance now references the Secured Overnight Financing Rate (SOFR). In securitization markets, the government-sponsored enterprises had stopped accepting LIBOR adjustable-rate mortgages (ARMs) in 2020, are now accepting only SOFR ARMs, and have tied all of their associated MBS issuance to SOFR. Interest rate swap markets saw increases in volumes for SOFR-based trades in the second half of 2021, and this pace accelerated rapidly in January such that SOFR-based swaps trading now accounts for the majority of risk traded in this market, indicating widespread awareness and adoption of risk-free reference rates. Eurodollar futures have lagged the swap market, although volumes for SOFR-based futures contracts are increasing there also. The transition in business lending has been slower, although recent data suggest that the use of USD LIBOR as a reference rate for business loans has fallen sharply since the start of the year and that the pace of SOFR adoption is accelerating.

1. See President's Working Group on Financial Markets, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency (2021), Report on Stablecoins (Washington: PWGFM, FDIC, and OCC, November), Return to text

2. See U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission (2021), Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report (Washington: Department of the Treasury, Board of Governors, FRBNY, SEC, and CFTC, November), Return to text

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Markets for Treasury securities, mortgage-backed securities, and corporate and municipal bonds functioned well...

Markets for Treasury securities and mortgage-backed securities functioned smoothly since July even as some measures of liquidity conditions for Treasury securities deteriorated moderately, which reflected increased yield volatility due, in part, to uncertainty about the path of monetary policy. Measures of market functioning in corporate and municipal bond markets indicated liquid and stable trading conditions. Bid-ask spreads for corporate bonds across credit ratings currently stand below pre-pandemic levels and near the bottom of their historical distributions.

...while short-term funding market conditions remained stable

Short-term funding markets continued to function smoothly. The effective federal funds rate and other overnight unsecured rates declined slightly relative to the interest rate on reserve balances since early July. Secured overnight rates remained stable, with the Secured Overnight Financing Rate steady at the offering rate on the overnight reverse repurchase agreement (ON RRP) facility on most days since early July. Ample liquidity and a limited supply of Treasury bills kept short-term interest rates low and led to increased usage of the ON RRP facility. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets" in Part 2.)

Bank credit expanded and bank profitability remained strong

Total loans and leases outstanding at commercial banks expanded significantly in the second half of last year, driven by continued solid growth in commercial real estate, residential real estate, and consumer loans, which outweighed declines in commercial and industrial loans (figure 37). In both October and January, the Senior Loan Officer Opinion Survey on Bank Lending Practices, conducted by the Federal Reserve, reported easier standards for most loan categories over the second half of 2021.11 In the January survey, respondents generally anticipated a further easing of lending standards and stronger loan demand over the current year. Bank profitability remained strong, declining slightly over the second half of last year but remaining at pre-pandemic levels, helped by the continued release of loan loss reserves, given solid credit quality indicators (figure 38). Delinquency rates on bank loans remained low relative to historical averages throughout the second half of 2021.

International Developments

The recovery abroad continued in the second half of the year...

Economic activity abroad continued to recover briskly in the second half of last year (figure 39), as a noticeable pickup in vaccinations and greater adaptability allowed many foreign economies to further reopen. Unemployment rates in advanced foreign economies (AFEs) have now generally returned to levels near those that prevailed before the pandemic. That said, the emergence of the Delta variant of the virus last summer slowed the recovery of some economies, especially in Asia, and resulted in factory and port closures, which, in turn, exacerbated supply bottlenecks. More recently, the Omicron outbreak has been a headwind and a risk, especially for countries with lower vaccination rates; and order backlogs in industries such as automobile manufacturing remain high. Still, production bottlenecks in Asia have started to unwind.

...and foreign inflation increased significantly in most economies

As in the United States, foreign inflation has picked up noticeably since late 2020 (figure 40). This higher inflation has been mostly driven by soaring prices for energy and food, which, combined, account for well over half of the level of inflation abroad (figure 41). Higher prices for core goods have also contributed to the rise of inflation, but core inflation abroad has risen less than in the United States, in part because demand for durable goods in foreign economies appears to have increased relatively less sharply.

Many foreign central banks are tightening monetary policy or have signaled a future shift in stance

In light of elevated inflation, many policymakers are moving to reduce the significant monetary stimulus undertaken since the start of the pandemic. Several emerging market central banks, including those of Brazil, Korea, and Mexico, have already raised their policy rates because of concerns over the persistence of inflationary pressures.

In AFEs, a few central banks, including those of New Zealand, Norway, and the United Kingdom, have started raising their policy rates, and the Bank of Canada has signaled its intention to raise its policy rate soon (figure 42). Others have taken steps to normalize their balance sheet policies: The Bank of Canada, the Bank of England, and the Reserve Bank of Australia have ceased net asset purchases, and the European Central Bank plans to reduce its asset purchases this year. In contrast, the Bank of Japan has communicated that it is not in a rush to tighten policy, noting that measures of underlying inflation in Japan remain below its 2 percent target.

Foreign financial conditions tightened some but remain accommodative...

Expectations for faster removal of monetary policy accommodation, amid higher inflation and easing concerns about the pandemic, led to notable increases in sovereign yields in several AFEs (figure 43). Despite expectations for tighter monetary policy, the strength in corporate earnings and reduced concerns about the pandemic have supported AFE equities, which are little changed, on net, since mid-2021.

The change in financial conditions in emerging market economies (EMEs) has been relatively muted despite the shift in advanced-economy monetary policy expectations and increased geopolitical tensions. Net inflows to EME-dedicated funds stepped down and hovered around zero, in contrast with notable outflows during the 2013–14 period, and EME sovereign spreads widened only somewhat (figure 44). In China, solvency problems in the real estate sector and regulatory uncertainty appeared to weigh on stock prices of large Chinese firms listed in Hong Kong, with the Hang Seng Index decreasing notably. Brazilian equity prices also decreased amid political uncertainty, while some other EME stock indexes registered moderate gains. More recently, geopolitical tensions surrounding Russia and Ukraine have led to the underperformance of Eastern European equity indexes.

...and the dollar appreciated moderately on net

The broad dollar index—a measure of the trade-weighted value of the dollar against foreign currencies—has risen modestly since mid-2021 (figure 45). The dollar appreciated against Latin American currencies amid increased political uncertainty in some countries, while it was mixed against Asian EME currencies. The dollar appreciated against many AFE currencies, in part reflecting the more notable increase in the U.S. near-term yields compared with the AFE counterparts.


 3. The 0.3 percentage point jump in the labor force participation rate (LFPR) in January 2022 is the result of revisions to the Current Population Survey (CPS) population controls, which introduced a discontinuity in the LFPR between December and January. (The Bureau of Labor Statistics (BLS) does not revise its published estimates for December 2021 and earlier months.) Population controls—population estimates for disaggregated demographic groups that are used to weight the CPS sample to make it representative of the U.S. population—are updated annually based on information provided by the Census Bureau. The BLS has indicated that the LFPR revision was mostly due to an increase in the size of the population in age groups that participate in the labor force at high rates (those aged 35 to 64) and a large decrease in the size of the population aged 65 and older, which participates at a low rate. Return to text

 4. The average hourly earnings and compensation per hour measures are no longer likely to be as significantly affected by changes in the composition of the workforce as they were early in the pandemic, when job losses were much larger for lower-wage workers, which raised average wages and measured wage growth. This process then reversed as many lower-wage workers, particularly in services, were rehired, thus lowering average wages and measured wage growth. The employment cost index and Federal Reserve Bank of Atlanta wage growth measure are largely free of such composition effects. Return to text

 5. The November 2021 Beige Book—in which the Federal Reserve reports on discussions with our business and other contacts throughout the country—reported that many employers were planning to increase hiring because of concerns that their current workforce was being overworked. Return to text

 6. Inflation compensation implied by the yields on Treasury securities, known as the TIPS breakeven inflation rate, is defined as the difference between yields on conventional Treasury securities and yields on TIPS, which are linked to actual outcomes regarding headline CPI inflation. Inferring inflation expectations from such market-based measures of inflation compensation is not straightforward, because these measures are affected by changes in premiums that provide compensation for bearing inflation and liquidity risks. These measures likely also capture shifts in the demand and supply of TIPS relative to those of nominal Treasury securities. Return to text

 7. The CIE is estimated using a dynamic factor model. The level of the model's estimated factor does not have an economic interpretation and therefore must be rescaled to match an existing indicator of inflation expectations to yield a level interpretation. For more details, see Hie Joo Ahn and Chad Fulton (2021), "Research Data Series: Index of Common Inflation Expectations," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, March 5), to text

 8. For more information, see Congressional Budget Office (2020), "The Budgetary Effects of Laws Enacted in Response to the 2020 Coronavirus Pandemic, March and April 2020," June,; Congressional Budget Office (2021), "The Budgetary Effects of Major Laws Enacted in Response to the 2020–21 Coronavirus Pandemic, December 2020 and March 2021," September,; and Congressional Budget Office (2021), "Senate Amendment 2137 to H.R. 3684, the Infrastructure Investment and Jobs Act, as Proposed on August 1, 2021," August 9, to text

 9. These measures are based on a straight read of market quotes and are not adjusted for term premiums. Return to text

 10. The results of the Survey of Primary Dealers and the Survey of Market Participants are available on the Federal Reserve Bank of New York's website at and, respectively. Return to text

 11. The survey is available on the Federal Reserve Board's website at to text

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Last Update: August 11, 2022