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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 24, 2015, pursuant to section 2B of the Federal Reserve Act

The labor market improved further during the second half of last year and into early 2015, and labor market conditions moved closer to those the Federal Open Market Committee (FOMC) judges consistent with its maximum employment mandate. Since the middle of last year, monthly payrolls have expanded by about 280,000, on average, and the unemployment rate has declined nearly 1/2 percentage point on net. Nevertheless, a range of labor market indicators suggest that there is still room for improvement. In particular, at 5.7 percent, the unemployment rate is still above most FOMC participants' estimates of its longer-run normal level, the labor force participation rate remains below most assessments of its trend, an unusually large number of people continue to work part time when they would prefer full-time employment, and wage growth has continued to be slow.

A steep drop in crude oil prices since the middle of last year has put downward pressure on overall inflation. As of December 2014, the price index for personal consumption expenditures was only 3/4 percent higher than a year earlier, a rate of increase that is well below the FOMC's longer-run goal of 2 percent. Even apart from the energy sector, price increases have been subdued. Indeed, the prices of items other than food and energy products rose at an annual rate of only about 1 percent over the last six months of 2014, noticeably less than in the first half of the year. The slow pace of price increases during the second half was likely associated, in part, with falling import prices and perhaps also with some pass-through of lower oil prices. Survey-based measures of longer-term inflation expectations have remained stable; however market-based measures of inflation compensation have declined since last summer.

Economic activity expanded at a strong pace in the second half of last year. Notably reflecting solid gains in consumer spending, real gross domestic product (GDP) is estimated to have increased at an annual rate of 3-3/4 percent after a reported increase of just 1-1/4 percent in the first half of the year. The growth in GDP was supported by accommodative monetary policy, a reduction in the degree of restraint imparted by fiscal policy, and the increase in households' purchasing power arising from the drop in oil prices. The gains in GDP have occurred despite continued sluggish growth abroad and a sizable appreciation of the U.S. dollar, both of which have weighed on net exports.

Financial conditions in the United States have generally remained supportive of economic growth. Longer-term interest rates in the United States and other advanced economies have continued to move down, on net, since the middle of 2014 amid disappointing economic growth and low inflation abroad as well as the associated anticipated and actual monetary policy actions by foreign central banks. Broad indexes of U.S. equity prices have risen moderately, on net, since the end of June. Credit flows to nonfinancial businesses largely remained solid in the second half of last year. Overall borrowing conditions for households eased further, but mortgage lending standards are still tight for many potential borrowers.

The vulnerability of the U.S. financial system to financial instability has remained moderate, primarily reflecting low-to-moderate levels of leverage and maturity transformation. Asset valuation pressures have eased a little, on balance, but continue to be notable in some sectors. The capital and liquidity positions of the banking sector have improved further. Over the second half of 2014, the Federal Reserve and other agencies finalized or proposed several more rules related to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which were designed to further strengthen the resilience of the financial system.

At the time of the FOMC meeting in late January of this year, the Committee saw the outlook as broadly similar to that at the time of its December meeting, when the most recent Summary of Economic Projections (SEP) was compiled. (The December SEP is included as Part 3 of this report.) The FOMC expects that, with appropriate monetary policy accommodation, economic activity will expand at a moderate pace, and that labor market indicators will continue to move toward levels the Committee judges consistent with its dual mandate of maximum employment and price stability. In addition, the Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further in the near term, mainly reflecting the pass-through of lower oil prices to consumer energy prices. However, the Committee expects inflation to rise gradually toward its 2 percent longer-run objective over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate.

At the end of October, and after having made further measured reductions in the pace of its asset purchases at its July and September meetings, the FOMC concluded the asset purchase program that began in September 2012. The decision to end the purchase program reflected the substantial improvement in the outlook for the labor market since the program's inception--the stated aim of the asset purchases--and a judgment that the underlying strength of the broader economy was sufficient to support ongoing progress toward the Committee's policy objectives.

Nonetheless, the Committee continued to judge that a high degree of policy accommodation remained appropriate. As a result, the FOMC has maintained the exceptionally low target range of 0 to 1/4 percent for the federal funds rate and kept the Federal Reserve's holdings of longer-term securities at sizable levels. The Committee has also continued to provide forward guidance bearing on the anticipated path of the federal funds rate. In particular, the FOMC has stressed that in deciding how long to maintain the current target range, it will consider a broad set of indicators to assess realized and expected progress toward its objectives. On the basis of its assessment, the Committee indicated in its two most recent postmeeting statements that it can be patient in beginning to normalize the stance of monetary policy.

To further emphasize the data-dependent nature of its policy stance, the FOMC has stated that if incoming information indicates faster progress toward its policy objectives than the Committee currently expects, increases in the target range for the federal funds rate will likely occur sooner than the Committee anticipates. The FOMC has also indicated that in the case of slower-than-expected progress, increases in the target range will likely occur later than currently anticipated. Moreover, the Committee continues to expect 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 announced updated principles and plans for the normalization process following its September meeting and has continued to test the operational readiness of its monetary policy tools. The Committee remains confident that it has the tools it needs to raise short-term interest rates when doing so becomes appropriate, despite the very large size of the Federal Reserve's balance sheet.

Statement on Longer-Run Goals and Monetary Policy StrategyAdopted effective January 24, 2012; as amended effective January 27, 2015

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 5.5 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: February 24, 2015