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Board of Governors of the Federal Reserve System
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Board of Governors of the Federal Reserve System


Monetary Policy Report submitted to the Congress on February 26, 2013, pursuant to section 2B of the Federal Reserve Act

The U.S. economy continued to expand at a moderate rate, on average, over the second half of 2012. The housing recovery appeared to gain additional traction, consumer spending rose moderately, and business investment advanced further. Financial conditions eased over the period but credit remained tight for many households and businesses, and concerns about the course of federal fiscal policy and the ongoing European situation likely restrained private-sector demand. In addition, total government purchases continued to move lower in an environment of budget restraint, while export growth was held back by slow foreign economic growth. All told, real gross domestic product (GDP) is estimated to have increased at an average annual rate of 1-1/2 percent in the second half of the year, similar to the pace in the first half.

Conditions in the labor market gradually improved. Employment increased at an average monthly pace of 175,000 in the second half of the year, about the same as in the first half. The unemployment rate moved down from 8-1/4 percent last summer to a little below 8 percent in January. Even so, the unemployment rate was still well above levels observed prior to the recent recession. Moreover, it remained the case that a large share of the unemployed had been out of work for more than six months, and that a significant portion of the employed had part-time jobs because they were unable to find full-time employment. Meanwhile, consumer price inflation remained subdued amid stable long-term inflation expectations and persistent slack in labor markets. Over the second half of the year, the price index for personal consumption expenditures increased at an annual rate of 1-1/2 percent.

During the summer and fall, the Federal Open Market Committee (FOMC) judged that the economic recovery would strengthen only gradually over time, as some of the factors restraining activity--including restrictive credit for some borrowers, continuing concerns about the domestic and international economic environments, and the ongoing shift toward tighter federal fiscal policy--were thought likely to recede only slowly. Moreover, the Committee judged that the possibility of an escalation of the financial crisis in Europe and uncertainty about the course of fiscal policy in the United States posed significant downside risks to the outlook for economic activity. However, the Committee expected that, with appropriate monetary accommodation, economic growth would proceed at a moderate pace, with the unemployment rate gradually declining toward levels consistent with the FOMC's dual mandate of maximum employment and price stability. Against this backdrop, and with long-run inflation expectations well anchored, the FOMC projected that inflation would remain at or below the rate consistent with the Committee's dual mandate.

Accordingly, to promote its objectives, the FOMC provided additional monetary accommodation during the second half of 2012 by both strengthening its forward guidance regarding the federal funds rate and initiating additional asset purchases. In September, the Committee announced that it would continue its program to extend the average maturity of its Treasury holdings and would begin purchasing additional agency-guaranteed mortgage-backed securities (MBS) at a pace of $40 billion per month. The Committee also stated its intention to continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy tools as appropriate until the outlook for the labor market improves substantially in a context of price stability. The Committee agreed that in determining the size, pace, and composition of its asset purchases, it would, as always, take account of the likely efficacy and costs of such purchases. The Committee also modified its forward guidance regarding the federal funds rate at the September meeting, noting that exceptionally low levels for the federal funds rate were likely to be warranted at least through mid-2015, longer than had been indicated in previous FOMC statements. Moreover, the Committee stated its expectation that a highly accommodative stance of monetary policy would remain appropriate for a considerable time after the economic recovery strengthens.

In December, the Committee announced that in addition to continuing its purchases of agency MBS, it would purchase longer-term Treasury securities, initially at a pace of $45 billion per month, starting after the completion at the end of the year of its program to extend the maturity of its Treasury holdings. It also further modified its forward rate guidance, replacing the earlier date-based guidance with numerical thresholds for the unemployment rate and projected inflation. In particular, the Committee indicated that it expected the exceptionally low range for the federal funds rate would remain appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than 1/2 percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Partly in response to this additional monetary accommodation, as well as to improved sentiment regarding the situation in Europe, broad financial conditions eased over the second half of 2012. Although yields on nominal Treasury securities rose, on net, yields on inflation-protected Treasury securities declined, and longer-term interest rates paid by households and firms generally fell. Yields on agency MBS and investment- and speculative-grade corporate bonds touched record lows, and broad equity price indexes rose. Conditions in short-term dollar funding markets eased over the summer and remained stable thereafter, and market sentiment toward the banking industry improved. Nonetheless, credit remained tight for borrowers with lower credit scores, and borrowing conditions for small businesses continued to improve more gradually than for large firms.

At the time of the most recent FOMC meeting in January, Committee participants saw the economic outlook as little changed or modestly improved from the time of their December meeting, when the most recent Summary of Economic Projections (SEP) was compiled. (The December SEP is included as Part 3 of this report.) Participants generally judged that strains in global financial markets had eased somewhat, and that the downside risks to the economic outlook had lessened. Under the assumption of appropriate monetary policy--that is, policy consistent with the Committee's Statement on Longer-Run Goals and Monetary Policy Strategy (see box)--FOMC participants expected the economy to expand at a moderate pace, with the unemployment rate gradually declining and inflation remaining at or below the Committee's 2 percent longer-run goal.

Statement on Longer-Run Goals and Monetary Policy Strategy As amended effective on January 29, 2013

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, unchanged from one year ago but substantially higher than the corresponding interval several years earlier.

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.

The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.

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Last update: February 26, 2013