Part 1: Recent Economic and Financial Developments

Monetary Policy Report submitted to the Congress on March 1, 2024, pursuant to section 2B of the Federal Reserve Act

Domestic Developments

Inflation has eased but remains elevated

After surging in 2021 and 2022, inflation slowed notably last year. The price index for personal consumption expenditures (PCE) rose 2.4 percent over the 12 months ending in January, down from a peak of 7.1 percent in 2022, though still above the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent (figure 1). The core PCE price index—which excludes volatile food and energy prices—rose 2.8 percent over the 12 months ending in January. More recently, core PCE prices increased at an annual rate of 2.5 percent over the six months ending in January, though measuring inflation over relatively short periods risks exaggerating the influence of idiosyncratic or temporary factors (figure 2). The trimmed mean measure of PCE prices constructed by the Federal Reserve Bank of Dallas—which provides an alternative approach to reducing the influence of idiosyncratic price movements—increased 3.3 percent over the 12 months ending in December, somewhat higher than the core index (figure 1).

Consumer energy prices have declined, while food price inflation has slowed markedly

After hovering around $80 per barrel in the first half of last year, oil prices rose notably in late summer, albeit to levels still well below those seen in 2022, but have since declined, on net, to around $83 per barrel (figure 3). Gasoline prices have followed a similar pattern. The moderation in oil prices last fall reflects weak economic activity abroad and increases in U.S. and other non-OPEC (Organization of the Petroleum Exporting Countries) oil production. Since late last year, geopolitical tensions in the Middle East and rerouting of shipping away from the Red Sea have placed some upward pressure on oil prices. Continuing geopolitical tensions pose an upside risk to energy prices. Natural gas prices remain well below the elevated 2022 levels due to strong production and high inventory levels. All told, consumer energy prices fell 4.9 percent in the 12 months ending in January (figure 4, left panel).

Food price inflation slowed markedly last year, as prices of agricultural commodities and livestock fell (figure 5). This moderation brought the 12-month change in food prices down to 1.4 percent in January, a substantial slowing from the 11 percent increase recorded over 2022 (figure 4, left panel).

Prices of both energy and food products are of particular importance for lower-income households, for which such necessities account for a large share of expenditures. Reflecting the sharp increases seen in 2021 and 2022, these price indexes are about 25 percent higher than before the pandemic.

Core goods prices have been declining as supply bottlenecks ease and import price inflation falls...

Outside of food and energy prices, there has been significant deceleration across the main spending categories, though disinflation has been more pronounced in some than in others (figure 4, right panel). Core goods prices fell 0.6 percent in the 12 months ending in January, and the deceleration was broad based, as the supply chain issues and other capacity constraints that had earlier boosted inflation so much eased substantially. For example, suppliers' delivery times had lengthened considerably during the pandemic but have been getting shorter over the past year (figure 6). Core goods inflation was also held down last year by a net decline in nonfuel import prices, which, in turn, largely reflected falling commodity prices (figure 7).

...while core services price inflation has been slowing but remains elevated

Price inflation for both housing services and core services other than housing slowed over the past year, though it remains elevated. Increases in housing services prices began to moderate, coming in at 6.1 percent in the 12 months ending in January, down from a peak of more than 8 percent (figure 4, right panel). This slowing is consistent with the notably smaller increases in market rents on new housing leases to new tenants seen since late 2022 (figure 8). Because prices for housing services measure the rents paid by all tenants (and the equivalent rent implicitly paid by all homeowners)—including those whose leases have not yet come up for renewal—they tend to adjust slowly to changes in rental market conditions. The softening in market rents therefore points to a continued deceleration in housing services prices over the year ahead.

Prices for nonhousing core services—a broad group that includes services such as travel and dining, financial services, and car repair—rose 3.5 percent in the 12 months ending in January, down from their recent peak of 5.2 percent (figure 4, right panel). As labor costs are a significant input in these service sectors, the ongoing softening of labor demand and improvements in labor supply should contribute to a further slowing in core services price inflation as labor cost growth moderates.

Measures of longer-term inflation expectations have been stable, while shorter-term expectations have fallen back

The generally held view among economists and policy analysts is that inflation expectations influence actual inflation by affecting wage- and price-setting decisions. Survey-based measures of expected inflation over a longer horizon have generally been moving sideways over the past year, within the range seen during the decade before the pandemic, and they appear broadly consistent with the FOMC's longer-run 2 percent inflation objective. This development is seen for surveys of households, such as the University of Michigan Surveys of Consumers, and for surveys of professional forecasters (figure 9). For example, the median forecaster in the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, continued to expect PCE price inflation to average 2 percent over the five years beginning five years from now.

Moreover, inflation expectations over a shorter horizon—which tend to follow observed inflation more closely—have been reversing their earlier run-ups. In the Michigan survey, the median value for inflation expectations over the next year was 3.0 percent in February, well below the peak rate of 5.4 percent observed in spring 2022. Expected inflation for the next year as measured in the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, has also declined, on net, over this period and has returned to the range of values seen before the pandemic.

Market-based measures of longer-term inflation compensation, which are based on financial instruments linked to inflation such as Treasury Inflation-Protected Securities, are also broadly in line with readings seen in the years before the pandemic and consistent with inflation returning to 2 percent. These measures have been little changed, on net, since last summer (figure 10).

The labor market remains strong

Payroll employment gains have been robust, averaging 239,000 since June of last year. The pace of job gains has nevertheless been softening, having averaged more than 375,000 per month in 2022 and about 290,000 in the first half of 2023 (figure 11). This slowing has come primarily from the professional and business services, manufacturing, and leisure and hospitality sectors, which tend to be cyclically sensitive. In contrast, employment growth has remained strong in the health-care and social assistance sector and at state and local governments, which tend to be less cyclically sensitive and are still recovering from pandemic-era staffing shortages.

The unemployment rate edged up, on net, since the middle of last year, but at 3.7 percent in January, it is only slightly above its pre-pandemic level and remains very low by historical standards (figure 12). Indeed, unemployment rates among most age, educational attainment, sex, and ethnic and racial groups are near their respective historical lows (figure 13). (The box "Employment and Earnings across Demographic Groups" provides further details.)

Employment and Earnings across Demographic Groups

Economic expansions have tended to narrow long-standing disparities in employment and earnings across demographic groups, which can help make up for disproportionate losses experienced during downturns. These benefits have been especially pronounced during the current expansion, which has been characterized by an exceptionally tight labor market and robust demand for workers over the past two years.

Among prime-age individuals (ages 25 to 54), employment for Black or African American workers, which declined more relative to white and Asian workers in early 2020, reached a historical peak in 2023 (figure A, left panel). As a result, the gap in the employment-to-population (EPOP) ratio between prime-age Black and white workers fell to its lowest point in almost 50 years.1 Hispanic or Latino workers experienced especially large employment losses in 2020, due in part to greater exposure to the industries most affected by the pandemic.2 By early 2022, however, this group's EPOP ratio gap relative to prime-age white workers had recovered to its 2019 average and has remained near this historically low level for the past two years. The EPOP ratio for prime-age Asian workers was also historically high in early 2023, although it has since moved down closer to its 2019 level.3

Similarly, the EPOP ratio for prime-age women increased steadily over the past two years and reached a record high in 2023 (figure A, right panel). As a result, the EPOP ratio gap between prime-age men and women fell to a record low. The recent increase in female employment is mostly attributable to rising labor force participation, which had also been increasing briskly before the pandemic, bolstered by a growing share of women with a college degree.4 Other factors, including tight labor market conditions and greater availability of remote-work options, may have also contributed to rising prime-age female labor force participation.5

Robust labor demand over the past two years has also reversed pandemic-induced employment losses across education groups. For both prime-age men and women, the EPOP ratio fell significantly more for workers with a high school diploma or less compared with those with at least some college education, largely reflecting industry exposure to pandemic-related closures or some differences in the ability to work remotely across jobs. Notably, the EPOP ratio declined similarly for men and women with the same education level, a result that contrasts with those in previous recessions, in which male EPOP losses have historically outpaced female losses.6 The unusually large effect on women during the pandemic also reflects the industry composition of job losses, as well as caregiving needs.7

While employment disparities across many demographic groups are now within historically narrow ranges, substantial gender, racial, and ethnic gaps remain, underscoring long-standing structural factors. Currently, prime-age women are employed at a rate 11 percentage points less than men, while prime-age Black and Hispanic workers are employed at a rate 3 to 4 percentage points less than white workers. Further, the differential effect of the pandemic on the employment of older workers has proven highly persistent. The EPOP ratio for workers aged 55 or older remains approximately 2 percentage points below its pre-pandemic level and has changed little since late 2021 (figure B). This shortfall is wholly attributable to decreases in labor force participation stemming from increased retirements concentrated among workers aged 60 or older.8

In addition to narrowing many employment gaps, historically tight labor market conditions over the past two years have also led to strong nominal wage growth, especially for groups at the lower end of the earnings distribution. As shown in the top-left panel of figure C, real wage growth—as measured by the Federal Reserve Bank of Atlanta's Wage Growth Tracker and deflated by the personal consumption expenditures price index—has been consistently stronger for workers in lower wage quartiles.9

Stronger wage growth at the bottom of the income distribution is reflected in the experiences of different education and demographic groups. In the first two years of the recovery, real wage growth was stronger for workers with a high school diploma or less relative to workers with a bachelor's degree or more (figure C, top-right panel) and, in the past two years, has also been stronger for nonwhite workers relative to white workers (figure C, bottom-left panel). Wages for men and women, by contrast, have largely grown in tandem (figure C, bottom-right panel).10 In addition to the influence of a tight labor market, differences in wage growth across groups partially reflect factors specific to the post-pandemic recovery, such as the sectoral composition of labor demand and supply. Wages, for instance, grew faster than average in the leisure and hospitality industry, a relatively low-wage sector that suffered disproportionate employment losses during the pandemic, followed by a surge in vacancies that employers struggled to fill as the economy reopened.

Over the past year, real wages have been rising for all groups shown here, and differences in real wage growth across groups have narrowed considerably. While the labor market is still tight by historical standards, factors disproportionately boosting wage growth for the lowest earners have largely faded. In 2023, nominal wage growth slowed for workers with below-median earnings but stepped up for workers above the median. Even so, the gaps in relative wages between workers in the first three quartiles and those in the highest quartile continue to close, albeit at a slower pace.

1. In fact, for the population aged 16 or older, the EPOP ratio was the same for Black and white individuals in January 2024 (not shown). This equivalence, however, partly reflects the fact that these groups have different age distributions, with whites older, on average, and thus more likely to be retired. Return to text

2. On the relationship between occupation, industry, and the differential effect of the COVID-19 pandemic across demographic groups, see Guido Matias Cortes and Eliza Forsythe (2023), "Heterogeneous Labor Market Impacts of the COVID-19 Pandemic," ILR Review, vol. 76 (January), pp. 30–55. Return to text

3. As monthly series have greater sampling variability for smaller groups, we do not plot EPOP ratio estimates for American Indians or Alaska Natives. Return to text

4. For a discussion of the contribution of educational attainment to prime-age female labor force participation before the pandemic, see Didem Tüzemen and Thao Tran (2019), "The Uneven Recovery in Prime-Age Labor Force Participation," Federal Reserve Bank of Kansas City, Economic Review, vol. 104 (Third Quarter), pp. 21–41, Return to text

5. For a discussion on access to remote work and participation rates, see Maria D. Tito (2024), "Does the Ability to Work Remotely Alter Labor Force Attachment? An Analysis of Female Labor Force Participation," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, January 19), Return to text

6. See Claudia Goldin (2022), "Understanding the Economic Impact of COVID-19 on Women," Brookings Papers on Economic Activity, Spring, pp. 65–110,; and Stefania Albanesi and Jiyeon Kim (2021), "Effects of the COVID-19 Recession on the US Labor Market: Occupation, Family, and Gender," Journal of Economic Perspectives, vol. 35 (Summer), pp. 3–24. Return to text

7. On the role of caregiving, see Joshua Montes, Christopher Smith, and Isabel Leigh (2021), "Caregiving for Children and Parental Labor Force Participation during the Pandemic," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, November 5), Return to text

8. For an analysis on the increase in retirements following the pandemic, see Joshua Montes, Christopher Smith, and Juliana Dajon (2022), "‘The Great Retirement Boom': The Pandemic-Era Surge in Retirements and Implications for Future Labor Force Participation," Finance and Economics Discussion Series 2022-081 (Washington: Board of Governors of the Federal Reserve System, November), Return to text

9. To reduce noise due to sampling variation, which can be pronounced when considering disaggregated groups' wage changes, the series shown in figure C are the 12-month moving averages of the groups' median 12-month real wage changes. Thus, by construction, these series lag the actual real wage changes. Return to text

10. The measure of real earnings growth shown in the figure uses the same price index for all groups, but inflation experiences can differ across demographic groups because of differences in what they purchase or where they shop. See Jacob Orchard (2021), "Cyclical Demand Shifts and Cost of Living Inequality," working paper, February (revised September 2022). Return to text

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Labor demand has been gradually cooling...

Demand for labor continued to cool last year but remains robust. The Job Openings and Labor Turnover Survey (JOLTS) indicated that there were nearly 9 million job openings at the end of 2023—down about 3 million from the all-time high recorded in March 2022 but still around 2 million above pre-pandemic levels. An alternative measure of job vacancies constructed by the Federal Reserve Board staff using job postings data from the large online job board Indeed also shows that vacancies continued to move gradually lower through mid-February but remained above pre-pandemic levels. In addition, measures of layoffs, such as initial claims for unemployment insurance and the rate of layoffs and discharges in the JOLTS, have remained very low by historical standards.

...and labor supply has increased further...

Meanwhile, the supply of labor has continued to increase on net. The labor force participation rate, which measures the share of people either working or actively seeking work, continued to trend higher for most of last year but has softened in recent months (figure 14). Importantly, labor force participation for prime-age workers increased notably through last September and, although it has edged down more recently, remains above its pre-pandemic level.

Labor supply was also boosted last year by relatively strong population growth. The Census Bureau estimates that the resident population increased 1.7 million (0.5 percent) in 2023, with almost 70 percent of that increase coming from immigration.2 Last year's rate of population growth was slightly faster than in 2022 and about twice as fast as in 2020 and 2021, when growth was held down by COVID-19-related increases in mortality and restrictions on immigration. Although population growth has largely returned to its pace from the years preceding the pandemic, it remains well below its average from 1990 to 2015.

...but the labor market remains relatively tight

Even with easing labor demand and rising labor supply, the labor market remains relatively tight. Some indicators suggest that the labor market remains tighter than before the pandemic, while others have returned to their 2019 ranges, when the labor market was also relatively tight. The number of total available jobs (measured by employed workers plus job openings) still exceeds the number of available workers (measured by the labor force). This jobs–workers gap was around 2.8 million in December, down markedly from its peak of 6.0 million recorded in March 2022 but still above its 2019 average of 1.1 million (figure 15).3 In contrast, the percentage of workers quitting their jobs each month, an indicator of the availability of attractive job prospects, was 2.2 percent in December, close to its 2019 average. Surveys indicate that households' and small businesses' perceptions of labor market tightness have also come down from their recent peaks. In addition, business contacts in nearly all Federal Reserve Districts cited signs of a cooling labor market, such as larger applicant pools and lower turnover rates; however, some employers continued to report difficulty finding workers, particularly employers seeking specialized skills.4

Wage growth has slowed but remains elevated

Consistent with the easing in labor market tightness, nominal wage growth slowed in 2023 but remains elevated (figure 16). Total hourly compensation as measured by the employment cost index increased 4.2 percent over the 12 months ending in December, a noticeable slowing from the 5.1 percent increase in 2022. Other aggregate measures, such as average hourly earnings (a less comprehensive measure of compensation) and the Federal Reserve Bank of Atlanta's Wage Growth Tracker, which reports the median 12-month wage growth of individuals responding to the Current Population Survey, have slowed as well. With PCE prices having risen 2.6 percent in 2023, these measures suggest that most workers saw increases in the purchasing power of their wages over the past year.

Labor productivity strengthened last year

The extent to which nominal wage gains raise firms' costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. Labor productivity in the business sector has been extremely variable since the pandemic began, increasing sharply in 2020 and then declining, on average, over 2021 and 2022 (figure 17). Productivity is reported to have risen a robust 2.7 percent last year. When averaged over the pandemic period, output per hour rose at a moderate average annual rate of 1-1/2 percent, in line with the average rate of growth observed during the business cycle from the fourth quarter of 2007 to the fourth quarter of 2019.

As always, the pace of future productivity growth remains highly uncertain. It is possible that productivity growth could remain at around this same moderate pace. However, it is also possible that the rapid adoption of new technologies like artificial intelligence and robotics—as well as the high rate of new business formation that the pandemic brought about—could boost productivity growth above that pace in coming years.

Gross domestic product rose at a solid pace last year

Real gross domestic product (GDP) is reported to have increased at an annual rate of 4.0 percent in the second half of 2023, up from 2.2 percent in the first half. For 2023 as a whole, GDP increased 3.1 percent, notably faster than in 2022 despite restrictive financial conditions, including elevated longer-term interest rates (figure 18).5 Among the components of GDP, consumer spending rose solidly in the second half of last year, and residential investment started to turn back up following its earlier sharp declines, but growth of business investment slowed.

In contrast to GDP, manufacturing output was little changed, on net, last year, a downshift following two years of robust post-pandemic gains. Motor vehicle production continued to rebound from supply chain disruptions in 2021 and 2022, although last year's production was held down by strikes at several major automakers. Outside of motor vehicles, industrial production generally moved sideways last year, but it was down from its post-pandemic peak in early 2022, as inventories normalized and new orders fell back.

Consumer spending growth was resilient even as household finances deteriorated

Consumer spending adjusted for inflation grew at a solid rate of 3.0 percent in the second half of 2023 and 2.7 percent for last year as a whole (figure 19). Consumers' resilience in the face of tight financial conditions was supported by the strong labor market and rising real incomes. Indeed, after declining, on average, in 2021 and 2022, real disposable personal income increased robustly last year. However, last year's spending was also accompanied by households drawing down their liquid assets, such as checking accounts, and by relying more on credit. Indeed, the saving rate was 3.9 percent in the fourth quarter of 2023, well below pre-pandemic levels (figure 20). In addition, although household wealth relative to income remains high in the aggregate, it has declined, on net, since the end of 2021 and so is likely providing less support to consumer spending. Consumer spending since the pandemic has been more robust than measures of consumer sentiment would suggest. Although sentiment in the Michigan survey has improved markedly in recent months, it remains much further below its pre-pandemic level than does a similar measure from the Conference Board, which puts more weight on labor market conditions (figure 21).

Consumer financing conditions tightened last year

Credit remains available for most consumers, though interest rates on both credit cards and auto loans remain higher than the levels observed in 2018 at the peak of the previous monetary policy tightening cycle. Indeed, interest rates on credit cards have continued to increase since the first half of last year. In addition, banks reported continued tightening of lending standards across consumer credit products, in part reflecting lenders' concerns about further deterioration in credit performance and higher funding costs. Delinquency rates for credit cards rose further over the second half of 2023, while those for auto loans flattened out; both rates are notably above levels observed just before the pandemic. Reflecting these and other factors, consumer credit expanded moderately during the second half of last year, driven by robust growth in credit card balances and modest growth in auto loans (figure 22). In contrast, student loan balances fell in the second half of last year, in large part driven by the cancellation of debt for certain borrowers in income-driven repayment plans.

Residential investment turned around and grew modestly in the second half of 2023

After declining steeply in 2022 on the heels of the substantial rise in mortgage interest rates, residential investment fell a bit further in the first half of 2023 but picked up in the second half of the year. The pickup in housing activity since mid-2023 masked some important differences across components of the market, with sales of existing homes much weaker than sales of new homes and with construction of single-family homes remaining relatively solid while multifamily construction declined. (The box "Recent Housing Market Developments" provides further discussion.)

Recent Housing Market Developments

The rise in mortgage interest rates since early 2022 has reduced the overall demand for housing and slowed activity in the housing sector appreciably. The change in mortgage rates was unusually large and rapid, with 30-year fixed rates rising from about 3.2 percent in January 2022 to almost 8 percent in October 2023, the highest level since 2000 (figure A). Although mortgage rates have declined somewhat since October, they still averaged around 7 percent in February 2024.

The run-up in mortgage rates through late 2023, combined with a further rise in house prices, resulted in a sharp increase in typical mortgage payments and has reduced housing demand and home sales. The median monthly principal and interest payment on newly originated home-purchase mortgages for owner-occupied properties increased from below $1,400 in January 2022 to around $1,800 in early 2023 and has remained around that elevated level (figure B). As a result, home sales (including both new and existing properties) have fallen sharply over the past two years. Home purchases by low-income households have fallen disproportionately more, because mortgage lenders impose maximums on the ratio of a borrower's debt service payments to the borrower's income.1

However, several other factors have supported underlying demand for housing, somewhat limiting the effect of higher mortgage rates. First, the labor market has remained strong, with historically low unemployment and real wage growth turning positive last year. Second, households may still be gradually adjusting to long-term remote or hybrid work flexibility by seeking additional space. Third, a rising fraction of buyers have been able to purchase homes with cash rather than taking out mortgages. The share of homes purchased with cash was about 15 percent in 2020 and increased to about 25 percent in 2023, with the drop in home sales concentrated in mortgage borrowers.

Housing supply has also faced constraints, due to both short- and long-term factors. In the short term, higher interest rates and tighter underwriting by banks significantly increased builders' costs of financing, discouraging new construction. In the long term, despite a surge in construction in late 2020 and 2021, it appears that a variety of factors—including zoning and other regulatory hurdles—have prevented construction from keeping up with underlying demand, resulting in a gross housing vacancy rate that is at a historical low.2

The recent performance of home prices reflects this interplay between housing demand and supply. House price growth slowed rapidly from its historically high pace in response to the jump in interest rates, but it has bounced back recently on a year-over-year basis, leaving house price levels near record highs (figure C).

The interplay between demand and supply has played out quite differently across segments of the housing market. In particular, the contrast between the evolution of new and existing home sales has been notable (figure D). Many households purchased homes or refinanced when fixed mortgage rates were at historically low levels in 2020 and 2021, and, as a result, the majority of outstanding mortgages have interest rates below 4 percent (figure E). If these homeowners with low mortgage rates want to move to a different home with a new mortgage, their new mortgage payment would be much higher. As a result, many homeowners who might otherwise have moved have instead opted to remain in their current home. The net effect has been an unusually thin market for existing homes, with a dramatic reduction in the number of people both selling and bidding on homes. The decline in the supply of existing homes for sale also makes it difficult for the remaining buyers in the market to find their preferred home and may be driving some to the new home market even as overall sales are depressed. New homebuilders have also been able to offer buyers significant incentives while still maintaining positive profit margins. The relative strength in the new home demand has encouraged builders to increase the rate of new construction after having sharply pulled back in 2022 when rates first started to rise (figure F).

The balance between supply and demand in the multifamily market—which is dominated by rental units—is fundamentally different from that in the single-family market. Initially, as the pandemic eased, market rents surged along with single-family home prices in response to the increased demand for living space, whether owned or rented. These higher rents encouraged a dramatic increase in multifamily starts from what were already quite strong historical levels, averaging 510,000 units per year in 2021 and 2022, compared with an average of 314,000 units per year from 2000 to 2020. Construction of multifamily properties remained strong through 2022 even as single-family construction declined sharply. Unlike the cost of buying a home, rental demand is not directly harmed by higher mortgage rates and may even be supported, to some extent, by a shift away from home purchases as rates rise. Multifamily projects also take significantly longer to plan and build than single-family projects and are slower to react to changing economic conditions. Over the past year, we have seen more new properties delivered to the market, which contributed to increases in multifamily vacancy rates and a significant deceleration in market rents. These developments, combined with concerns about the effect of the large amount of new supply still scheduled to be delivered to market over the next year, have started to drive down prices of existing multifamily properties. As a result, the rate of new multifamily construction has come back down over the past year even as single-family construction has picked back up.

1. See Daniel Ringo (2022), "Declining Affordability and Home Purchase Borrowing by Lower Income Households," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, July 8), Return to text

2. See Joseph Gyourko and Raven Molloy (2015), "Chapter 19—Regulation and Housing Supply," Handbook of Regional and Urban Economics, vol. 5, pp. 1289–337. Return to text

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Capital spending growth softened amid tighter financial conditions and subdued sentiment

Tighter financial conditions and downbeat business sentiment led to a slowdown in business investment spending growth in the second half of 2023 (figure 23). Equipment investment spending declined in the second half of the year, while investment in intellectual property products—which include software and research and development—continued to decelerate from its solid pace of growth over the previous few years. Investment in nonresidential structures, which had surged in early 2023 because of a boom in manufacturing construction—especially for factories that produce semiconductors or electric vehicle batteries—also decelerated in the second half of 2023, although the level of structures investment remained much higher than in previous years. Although indicators of business sentiment and profit expectations have improved in recent months, sentiment remains subdued.

Business financing conditions were moderately restrictive overall, but credit remained generally available

Credit remained generally available to most nonfinancial corporations but at elevated interest rates and amid moderately restrictive financial conditions overall. Banks continued to tighten lending standards for all loan types over the second half of last year, and business loan growth at banks continued to slow. In contrast, issuance of corporate bonds remained solid across credit categories, although well below the levels prevailing at the beginning of the tightening cycle.

For small businesses, which are more reliant on bank financing than large businesses, credit conditions tightened further over the second half of last year. Surveys indicate that credit supply for small businesses has tightened further, and interest rates on loans to small businesses moved higher and now stand near the top of the range observed since 2008. Loan default and delinquency rates have also increased and now slightly exceed their pre-pandemic rates.

Trade recovered in the second half of 2023

Real imports remained relatively unchanged for the year as a whole after declining in the first half of last year and then recovering over the second half as domestic demand picked up (figure 24). Despite lackluster foreign growth, exports picked up more strongly than imports over the second half of the year. As such, net exports added about 0.3 percentage point to GDP growth in the fourth quarter of 2023 after being neutral for growth in the previous two quarters. The current account deficit narrowed slightly in the third quarter of 2023 to 2.9 percent of GDP, remaining larger than before the pandemic.

Federal fiscal policy actions were roughly neutral for GDP growth in 2023

Federal purchases grew modestly in 2023, and several recently enacted policies began to boost investment and consumption. This support to economic activity was about offset by the unwinding of the remaining pandemic-related fiscal policy support. All told, the contribution of discretionary changes in federal fiscal policy to real GDP growth was roughly neutral last year.

The budget deficit and federal debt remain elevated

After surging to 15 percent of GDP in fiscal year 2020, the budget deficit declined through 2022 as the imprint of the pandemic faded (figure 25). The budget deficit edged up to 6.3 percent of GDP in fiscal 2023 as tax receipts declined from their elevated level in 2022 and net interest outlays increased.6

As a result of the unprecedented fiscal support enacted early in the pandemic, federal debt held by the public jumped roughly 20 percentage points to 100 percent of GDP in fiscal 2020—the highest debt-to-GDP ratio since 1947 (figure 26). After falling slightly through 2022, the debt-to-GDP ratio edged up in 2023, as rising interest rates contributed to higher net interest outlays. The Congressional Budget Office projects that further increases in interest costs, along with positive primary deficits—that is, total deficits less interest payments—will produce a steady rise in the debt-to-GDP ratio in the years to come.

Most state and local government budget positions remained strong...

Federal policymakers provided a historically high level of fiscal support to state and local governments during the pandemic; this aid, together with robust state tax collections in 2021 and 2022, left the sector in a strong budget position overall (figure 27). Although state tax revenues weakened in 2023—mainly reflecting a normalization of receipts from elevated levels in the previous year as well as the effects of recently enacted tax cuts in some states—taxes as a percentage of GDP remained above recent historical norms. Moreover, states' total balances (that is, including rainy day fund balances and previous-year surplus funds) continued to be near all-time highs. Nevertheless, budget situations varied widely across the states, with some states—particularly those that depend heavily on capital gains tax collections—facing tighter budget conditions. At the local level, overall property tax receipts rose briskly in 2023.

...contributing to brisk growth in employment and construction spending

Employment in state and local governments rose strongly in 2023, as some pandemic-related headwinds, such as an increase in retirements, have abated and wages became more competitive relative to those in the private sector (figure 28). Similarly, real construction outlays grew rapidly, reflecting easing bottlenecks and support from federal grants. By the end of 2023, both employment and construction spending were roughly back to their pre-pandemic levels.

Financial Developments

The expected level of the federal funds rate over the next few years is now higher than it was last June on net

Market-based measures of the expected federal funds rate rose considerably over the summer and early fall before moving down toward the end of 2023. On net, the market-implied policy rate path rose notably for year-end 2024, and somewhat more modestly for year-end 2025 and 2026 (figure 29).7 Financial market prices imply that the federal funds rate will decline from current levels following the March 2024 FOMC meeting, reaching about 4.6 percent and about 3.7 percent by year-end 2024 and year-end 2025, respectively. Consistent with these market-implied measures, survey respondents in the Blue Chip Financial Forecasts published at the beginning of February expect the policy rate to begin to decrease in the second quarter of 2024 and reach 4.4 percent by year-end 2024. On net, respondents have significantly revised upward their expectations of the federal funds rate path since last June's survey.

Yields on long-term U.S. nominal Treasury securities fluctuated considerably

Yields on long-term nominal Treasury securities began to increase in the spring of 2023 and rose markedly through mid-October before reversing course sharply, with the 10‑year Treasury yield reaching a peak of about 5 percent before falling to just below 4 percent by the end of last year (figure 30). So far this year, long-term nominal Treasury yields have increased, with the 10-year Treasury yield rising to about 4.4 percent by late February. In contrast, short-term Treasury yields have been little changed, on net, since early June.

Yields on other long-term debt fluctuated with Treasury yields

Corporate bond yields declined across credit categories since June, on net, amid sizable fluctuations that accompanied the observed large movements in long-term Treasury yields (figure 31). Spreads on corporate bonds over comparable-maturity Treasury securities narrowed notably, on net, especially for speculative-grade bonds, to levels in the lower range of their historical distributions. Similarly, municipal bond spreads over comparable-maturity Treasury securities narrowed substantially since June and are now fairly low relative to their historical distributions across credit ratings. Overall, corporate and municipal credit quality remained solid, with a low volume of defaults in both markets despite some increase in corporate bond defaults.

Yields on agency mortgage-backed securities (MBS)—an important pricing factor for home mortgage interest rates—rose notably over the summer before falling back down toward the end of last year (figure 32). So far this year, yields on agency MBS have increased, standing in late February at levels notably above those in June 2023. The MBS spread decreased slightly since June, on net, but remained elevated relative to pre-pandemic levels, at least partly due to high interest rate volatility, which reduces the value of holding MBS.

Broad equity price indexes increased

The S&P 500 index increased significantly since June, on net, above the record-high levels seen at the end of 2021 (figure 33). Following a substantial decline over late summer and early fall, the S&P 500 index recovered toward the end of the year, as long-term interest rates declined, and continued to rise over the start of 2024. Meanwhile, small-cap firms, whose equity prices have significantly underperformed broad equity indexes, experienced substantial increases in their equity valuations in recent months amid better economic prospects, including expectations of a less restrictive monetary policy. Bank equity prices rose, on net, retracing some of the declines that had occurred over the first half of 2023 and that had been associated with strains in the banking sector. In the case of the largest banks, equity prices rose above their early-2023 levels; regional bank equity prices had only a partial retracement. One-month option-implied volatility on the S&P 500 index—the VIX—increased moderately until late October but subsequently declined to reach levels somewhat lower than those prevailing in early June. (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. Acute stress in the banking system has receded since last spring, and banks' regulatory risk-based capital ratios remained solid and increased broadly, as bank profits were robust and banks reduced capital distributions. Nonetheless, declines in the fair value of fixed-rate assets at some banks have been sizable relative to regulatory capital. Valuation pressures increased modestly, with equity markets close to all-time highs in real terms and real estate prices still high relative to fundamentals. Credit to nonfinancial businesses and households continued to decrease relative to gross domestic product (GDP), and this ratio now sits close to its 20-year low. However, funding vulnerabilities remain notable. Hedge fund leverage is elevated, partly due to elevated activity in the cash–futures basis trade.

Broad equity prices are now at levels close to historical highs, driven mostly by performance of the largest companies. Nominal long-term Treasury yields rose to a 15-year peak in October but have now fallen to levels close to those from a year ago. Commercial real estate (CRE) prices continued to decline, especially in the office, retail, and multifamily sectors, and low levels of transactions in the office sector likely indicated that prices had not yet fully reflected the sector's weaker fundamentals. Prices of single-family residential properties, which held steady through the first quarter of 2023, have started rising again, albeit modestly, and remain high relative to market rents.

Vulnerabilities arising from household and nonfinancial business leverage remain moderate. The combined debt of both sectors as a share of GDP sat close to its lowest level in 20 years and continues to decrease (figure A). In the household sector, balance sheets remain strong, and homeowners' equity shares of houses are now at their highest levels in at least 30 years. Nonfinancial businesses' ability to service debt also remains adequate, as the pass-through of higher policy rates has so far been muted by the large share of long-term fixed-rate debt. Direct lending to nonfinancial businesses by private credit funds and other private investors has been growing rapidly. While risks from leverage and investor redemption appear limited, the sector remains opaque, making it difficult to assess vulnerabilities.

Vulnerabilities in the financial sector remain notable, as losses in the fair value of long-dated bank assets remain significant. Risk-based capital ratios increased broadly across all bank categories and sit well above regulatory minimums, driven both by robust bank profitability and by a decrease in shareholder payouts at the largest banks. Credit quality at banks remained strong, although the quality of CRE loans backed by office, retail, and multifamily buildings continued its decline, a result of the lower demand for downtown real estate prompted by the shift toward telework. Some smaller regional and community banks with high concentrations of CRE loans are also highly reliant on uninsured deposits, potentially compounding vulnerabilities. Leverage at hedge funds stabilized at a high level as the Treasury cash–futures basis trade continued to grow, suggesting a risk of sudden deleveraging if volatility in Treasury markets increases unexpectedly. Leverage at life insurers also increased, although to levels near the middle of its historical distribution.

In terms of funding risks, liquidity remains ample, and deposits have stabilized recently. The number of banks with large declines in fair value relative to their regulatory capital and heavy reliance on uninsured deposits has declined significantly since March 2023. Overall, banks' reliance on short-term wholesale funding remained much lower than the typical range before the banking reforms of the previous decade. Money market funds continued to grow throughout the second half of 2023, mostly because of increases in retail prime funds.

A routine survey of market contacts on salient shocks to financial stability highlights several important risks. Adverse developments in longer-term interest rates could potentially strain credit supply in vulnerable sectors. A related risk, the reemergence of banking-sector stress at some institutions, might further constrain the supply of credit, particularly at banks with large CRE concentration and a high fraction of uninsured deposits. Geopolitical risks remain salient, including Russia's war against Ukraine and potential spillovers of the Israel–Hamas war, and could cause strains in parts of the U.S. financial system.

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Major asset markets functioned in an orderly way, but liquidity has remained low

Treasury securities market functioning has continued to be orderly, but liquidity remained low by historical standards. The persistence of low liquidity is broadly in line with enduring high interest rate volatility, as future economic conditions and the policy rate path remain particularly uncertain. Market depth—a measure of the availability of contracts at the best quoted prices—for Treasury securities remains near historically low levels, particularly in the case of short-term Treasury securities. With regard to liquidity in the equity market, market depth based on S&P 500 futures was little changed and remained somewhat low compared with pre-COVID levels. Corporate and municipal secondary bond markets continued to function well; transaction costs in these markets were fairly low by historical standards.

Short-term funding market conditions remained stable

Conditions in overnight bank funding and repurchase agreement (repo) markets remained stable. Since June, the effective federal funds rate and other unsecured overnight rates have been a few basis points below the interest rate on reserve balances, while the Secured Overnight Financing Rate has been at or slightly above the offering rate on the overnight reverse repurchase agreement (ON RRP) facility. Take-up at the ON RRP facility has declined substantially since June. This decline reflects a significant increase in the net supply of Treasury bills and relatively more attractive rates on alternative short-term investments such as private repo.

Money market funds (MMFs), the largest investors in the ON RRP facility, accounted for much of the decline in ON RRP take-up as they made a substantial reallocation of their investments toward Treasury bills and private repo. Both prime and government MMFs have seen a notable increase in assets under management since June, as relatively favorable yields continue to attract funds previously held on deposit in the banking sector. Weighted average maturities at both prime and government MMFs increased in anticipation of fewer policy rate increases.

Bank credit growth continued to slow over the second half of 2023

The slowdown in bank credit growth was broad based, with growth in outstanding balances for all major loan categories slowing from earlier in the year, likely reflecting the effects of higher interest rates, tighter credit availability, and economic uncertainty (figure 34). Banks in the Senior Loan Officer Opinion Survey on Bank Lending Practices reported tighter standards and weaker demand over the third and fourth quarters, continuing trends for standards and demand that have been reported since the middle of 2022. Delinquency rates on bank loans generally rose in the second half of 2023—with the largest increases for commercial real estate and consumer loans—but remained around ranges observed before the pandemic except for consumer loans. Bank profitability moved down in the second half of 2023 to levels below those that prevailed before the pandemic (figure 35).

International Developments

Foreign economic growth slowed in the second half of 2023

Following a rebound in early 2023, foreign activity was subdued overall in the second half of last year, although with some variation across countries. In advanced foreign economies (AFEs), several factors restrained growth, including the tightening of monetary policy over the past two years—which weighed on credit growth and investment—and an erosion of real household incomes amid high inflation rates. In Europe, ongoing structural adjustment to higher energy prices also continued to hinder the performance of energy-intensive sectors. Economic indicators point to continued weakness in AFE growth in early 2024.

In China, a post-pandemic boost to economic growth early in 2023 faded by the second quarter, and property-sector weakness and sluggish domestic demand have remained a constraint on economic activity. Policy stimulus targeting infrastructure and manufacturing investment bolstered Chinese growth in the second half of the year, enabling the government to meet its 2023 growth target.

In emerging market economies (EMEs) other than China, economic activity slowed in the second half of last year but was more resilient overall than in the AFEs. Industrial production in emerging Asia excluding China began recovering, supported by a rebound in global demand for high-tech products that was driven in part by the artificial intelligence and electric vehicle sectors.

Inflation abroad has continued to ease but remains elevated

Foreign headline inflation has continued to decline since the middle of last year, reflecting lower core and food inflation (figure 36). Both the subsiding effects of past global supply bottlenecks and the drag on demand from monetary policy tightening have eased inflationary pressures (figure 37). However, the pace of disinflation has varied across sectors and countries. The deceleration in goods prices abroad has generally outpaced that in services prices, as in the U.S. Inflation remains above target in Europe but has been running near zero in China. Although the flare-up in geopolitical tensions in the Middle East and accompanying disruptions to shipping through the Red Sea have had only limited effects on consumer prices in general and on global energy prices in particular, further escalation in tensions could disrupt global momentum toward restoring lower inflation.

Foreign central banks are maintaining a restrictive monetary policy stance

Most foreign central banks paused their interest rate hikes in the second half of last year and have since held policy rates steady, acknowledging the cumulative tightening of policy and progress in lowering inflation. Policy rate paths implied by financial market pricing suggest that many AFE central banks are expected to begin reducing interest rates in 2024. Several EME central banks have already begun easing monetary policy. However, foreign central banks have generally continued to emphasize in their communications that progress toward achieving their inflation goals could slow or even reverse, including from resilience in labor markets, wage growth, or geopolitical developments leading to higher commodity prices and trade costs.

Financial conditions abroad have been volatile but have eased, on balance, since mid-2023

Near-dated AFE sovereign yields declined toward the end of last year as central banks signaled they had reached or neared the end of policy rate tightening. Longer-term sovereign yields unwound most of the increase registered earlier in 2023 (figure 38). One exception was Japan, where the central bank widened the band around its yield curve control target, allowing yields on 10-year government securities to increase, on net, in 2023.

Since mid-2023, the broad dollar index—a measure of the exchange value of the dollar against a trade-weighted basket of foreign currencies—increased slightly on net (figure 39). The dollar index was volatile, increasing significantly as U.S. yields rose from July to October and then reversing most of these increases as U.S. yields declined.

Many major foreign equity indexes rose across AFEs and EMEs, although gains were near zero in the U.K., consistent with stagnant economic activity (figure 40). Chinese equity prices were an exception, with declines amid pessimism about growth prospects and a pullback by foreign investors from Chinese markets. Flows to EME-focused investment funds turned negative in mid-2023, as yields on advanced-economy bonds rose more than those in emerging economies. These outflows eased toward the end of the year as AFE yields fell. EME sovereign spreads narrowed moderately last year.


 2. A recent report from the Congressional Budget Office estimates that immigration has been considerably higher than in the Census Bureau's estimates in recent years; see Congressional Budget Office (2024), The Demographic Outlook: 2024 to 2054 (Washington: CBO, January), The labor force estimates published by the Bureau of Labor Statistics are based on the civilian noninstitutionalized population aged 16 or older, which constitutes about 80 percent of the resident population. Return to text

 3. The ratio of job openings to unemployment shows that there were 1.4 job openings per unemployed person in December 2023. For comparison, this ratio averaged 1.2 in 2019 and 0.6 over the 10-year period from 2010 to 2019. Return to text

 4. See the January 2024 Beige Book, available on the Board's website at to text

 5. Real gross domestic income (GDI) has been notably weaker than GDP in recent quarters; both series measure the same economic concept, and any difference between the two figures reflects measurement error. GDI reportedly increased at a 0.8 percent pace in the first three quarters of last year after having been unchanged over the four quarters of 2022—well below the corresponding figures for GDP. As a result, productivity calculated from the income side of the national accounts would also be considerably weaker than the published figures over the past couple of years. Return to text

 6. The growth of the deficit between fiscal years 2022 and 2023 would have been larger had it not been for the Administration's announced student debt relief program, which raised the fiscal 2022 deficit $380 billion, and the Supreme Court's reversal of the policy, which lowered it $330 billion in fiscal 2023. Return to text

 7. These measures are based on market prices for overnight index swaps for the effective federal funds rate and are not adjusted for term premiums. Return to text

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Last Update: March 18, 2024