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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 July 15, 2014, pursuant to section 2B of the Federal Reserve Act

The overall condition of the labor market continued to improve during the first half of 2014. Gains in payroll employment picked up to an average monthly pace of about 230,000, and the unemployment rate fell to 6.1 percent in June, nearly 4 percentage points below its peak in 2009. Notwithstanding those improvements, a broad array of labor market indicators--such as labor force participation, hiring and quit rates, and the number of people working part time for economic reasons--generally suggests that significant slack remains in the labor market. Continued slow increases in most measures of labor compensation also corroborate the view that labor resources are not being fully utilized.

Inflation has moved up this year following unusually low readings in 2013, but it has remained somewhat below the Federal Open Market Committee's (FOMC) longer-run goal of 2 percent. The price index for personal consumption expenditures (PCE) rose 1-3/4 percent over the 12 months ending in May, up from an increase of only 1 percent a year earlier. The PCE price index excluding food and energy items rose 1-1/2 percent over the past 12 months. Meanwhile, both survey- and market-based measures of longer-term inflation expectations have remained stable.

Real gross domestic product is reported to have declined in the first quarter of this year, but a number of recent indicators suggest that economic activity rebounded in the second quarter. The pace of economic growth abroad also appears to have quickened in the second quarter following weakness earlier this year, which should provide support for export sales. Moreover, expansion in economic activity continues to be supported by ongoing job gains, a waning drag from fiscal policy, and accommodative financial conditions. However, the housing sector has shown little recent progress. While it has recovered notably from its earlier trough, activity in the sector leveled off in the wake of last year's increase in mortgage rates, and readings this year have, overall, continued to be disappointing.

The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to move gradually toward levels that the Committee judges consistent with its dual mandate of maximum employment and price stability. In addition, the Committee anticipates that with stable inflation expectations and strengthening economic activity, inflation will, over time, return to the Committee's 2 percent objective. Those expectations are reflected in the June Summary of Economic Projections, which is included as Part 3 of this report.

Financial conditions have generally remained supportive of economic growth. Longer-term interest rates have continued to be low by historical standards, and over the first half of the year those interest rates moved down significantly in the United States as well as in most other advanced economies. Overall, borrowing conditions for households have continued to slowly improve amid rising house and equity prices and the faster pace of employment growth so far this year. Credit flows to large nonfinancial businesses have remained strong, and small business lending activity has shown signs of improvement in recent months.

With respect to financial stability, signs of risk-taking that could leave segments of the U.S. financial sector vulnerable to possible adverse events have increased modestly this year, albeit from a subdued level. Prices for real estate, equities, and corporate debt have risen and valuation measures have increased, but valuations remain roughly in line with historical norms. Signs of excesses that could lead to higher future defaults and losses have emerged in some sectors, including for speculative-grade corporate bonds and leveraged loans. At the same time, financial firms' use of short-term wholesale funding has not increased materially and the capital and liquidity position of the banking sector continued to improve. The Federal Reserve and other agencies took further supervisory and regulatory steps to improve resilience, including conducting the 2014 stress tests of the largest bank holding companies (BHCs); finalizing rules to strengthen prudential standards for the largest domestic BHCs and for the U.S. operations of foreign banking firms; and raising leverage ratio standards for the largest, most interconnected firms.

To support continued progress toward maximum employment and price stability, the FOMC has maintained a highly accommodative stance of monetary policy. Specifically, the Committee has kept its target range for the federal funds rate at 0 to 1/4 percent; updated its forward guidance regarding the path of the federal funds rate; and continued to increase its sizable holdings of longer-term securities, though at a gradually diminishing pace. In particular, the Committee made additional measured reductions at each of its first four regularly scheduled meetings in 2014 in the monthly pace of its asset purchases. The FOMC also stated at each meeting that, if incoming information continued to broadly support the Committee's assessment of the economic outlook, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. However, the Committee also noted that its asset purchases are not on a preset course, and that decisions about their pace will remain contingent on the economic outlook.

The FOMC has provided forward guidance for the federal funds rate based on its assessment of economic and financial conditions. As 2014 began, the Committee's forward rate guidance included quantitative thresholds relating to the unemployment rate and inflation. However, with the unemployment rate having neared its 6-1/2 percent threshold, the Committee decided at its March meeting to replace the numerical thresholds with a qualitative characterization of its approach to determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate. Specifically, the Committee stated that it will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation, taking into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends. The Committee additionally stated its anticipation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

As part of prudent planning, the Federal Reserve has continued to prepare for the eventual normalization of the stance and conduct of monetary policy. The FOMC remains confident that it has the tools it needs to raise short-term interest rates when the time is right and to achieve the desired level of short-term interest rates thereafter, even while the Federal Reserve is holding a very large balance sheet. The Committee intends to continue its discussions about policy normalization at upcoming meetings while it proceeds with testing the operational readiness of its tools; it expects to provide to the public more information about its normalization plans later this year.

Statement on Longer-Run Goals and Monetary Policy Strategy

As amended effective January 28, 2014

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 reaffirms its judgment 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 5.8 percent.

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: July 15, 2014