Monetary Policy and Economic Developments

As required by section 2B of the Federal Reserve Act, the Federal Reserve Board submits written reports to the Congress that contain discussions of "the conduct of monetary policy and economic developments and prospects for the future." The Monetary Policy Report, submitted semiannually to the Senate Committee on Banking, Housing, and Urban Affairs and to the House Committee on Banking and Financial Services, is delivered concurrently with testimony from the Federal Reserve Board Chair.

The following discussion is a review of U.S. monetary policy and economic developments in 2019, excerpted from the Monetary Policy Report published in February 2020 and July 2019. Those complete reports are available on the Board's website at https://www.federalreserve.gov/monetarypolicy/files/20200207_mprfullreport.pdf (February 2020) and https://www.federalreserve.gov/monetarypolicy/files/20190705_mprfullreport.pdf (July 2019).

Monetary Policy Report February 2020

Summary

The U.S. economy continued to grow moderately last year and the labor market strengthened further. With these gains, the current expansion entered its 11th year, becoming the longest on record. However, inflation was below the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the FOMC lowered the target range for the federal funds rate at its July, September, and October meetings, bringing it to the current range of 1-1/2 to 1-3/4 percent. In the Committee's subsequent meetings, it judged that the prevailing stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to the Committee's symmetric 2 percent objective.

Economic and Financial Developments

The labor market. The labor market continued to strengthen last year. Payroll employment growth remained solid in the second half of 2019, and while the pace of job gains during the year as a whole was somewhat slower than in 2018, it was faster than what is needed to provide jobs for new entrants to the labor force. The unemployment rate moved down from 3.9 percent at the end of 2018 to 3.5 percent in December, and the labor force participation rate increased. Meanwhile, wage gains remained moderate although above the pace of gains seen earlier in the expansion.

Inflation. After having been close to the FOMC's objective of 2 percent in 2018, consumer price inflation, as measured by the price index for personal consumption expenditures, moved back below 2 percent last year, where it has been during most of the current expansion. The 12-month change was 1.6 percent in December 2019, as was the 12-month measure that excludes consumer food and energy prices (so-called core inflation), which historically has been a better indicator of where inflation will be in the future than the overall figure. The downshift relative to 2018 partly results from particularly low readings in the monthly price data in the early part of last year that appear to reflect transitory influences. Survey-based measures of longer-run inflation expectations have been broadly stable since the middle of last year, and market-based measures of inflation compensation are little changed on net.

Economic growth. Real gross domestic product (GDP) is reported to have increased at a moderate rate in the second half of 2019, although growth was somewhat slower than in the first half of the year and in 2018. Consumer spending rose at a moderate pace, on average, and residential investment turned up after having declined in 2018 and the first half of 2019. In contrast, business fixed investment declined in the second half of last year, reflecting a number of factors that likely include trade policy uncertainty and weak global growth. Downside risks to the U.S. outlook seem to have receded in the latter part of the year, as the conflicts over trade policy diminished somewhat, economic growth abroad showed signs of stabilizing, and financial conditions eased. More recently, possible spillovers from the effects of the coronavirus in China have presented a new risk to the outlook.

Financial conditions. Domestic financial conditions for businesses and households remained supportive of spending and economic activity. After showing some volatility over the summer, nominal Treasury yields declined and equity prices increased notably, on balance, supported by accommodative monetary policy actions and easing of investors' concerns regarding trade policy prospects and the global economic outlook. Spreads of yields on corporate bonds over those on comparable-maturity Treasury securities continued to narrow, and mortgage rates remained low. Moreover, loans remained widely available for most businesses and households, and credit provided by commercial banks continued to expand at a moderate pace.

Financial stability. The U.S. financial system is substantially more resilient than it was before the financial crisis. Leverage in the financial sector appears low relative to historical norms. Total household debt has grown at a slower pace than economic activity over the past decade, in part reflecting that mortgage credit has remained tight for borrowers with low credit scores, undocumented income, or high debt-to-income ratios. In contrast, the levels of business debt continue to be elevated compared with the levels of either business assets or GDP, with the riskiest firms accounting for most of the increase in debt in recent years. While overall liquidity and maturity mismatches and funding risks in the financial system remain low, the volatility in repurchase agreement (repo) markets in mid-September 2019 highlighted the possibility for frictions in repo markets to spill over to other markets. Finally, asset valuations are elevated and have risen since July 2019, as investor risk appetite appears to have increased. (See the box "Developments Related to Financial Stability" on pages 24–25 of the February 2020 Monetary Policy Report.)

International developments. After weakening in 2018, foreign economic growth slowed further in 2019, held down by a slump in global manufacturing, elevated trade tensions, and political and social unrest in several countries. Growth in Asian economies slowed markedly, especially in Hong Kong and India, and many Latin American economies continued to underperform. The pace of economic activity weakened in several advanced foreign economies as well. However, recent indicators provide tentative signs of stabilization. The global slowdown in manufacturing and trade appears to be nearing an end, and consumer spending and services activity around the world continue to hold up. Moreover, in some economically important regions, such as China and the euro area, data through early this year suggested that growth was steadying. The recent emergence of the coronavirus, however, could lead to disruptions in China that spill over to the rest of the global economy. Amid weak economic activity and dormant inflation pressures, foreign central banks generally adopted a more accommodative policy stance.

Financial conditions abroad eased in the second half of last year, supported by accommodative actions by central banks and, later in the period, positive political developments, including progress on the U.S.–China trade negotiations and diminished risks of a disorderly Brexit. On balance, since July global equity prices moved higher, sovereign bond spreads in the European periphery narrowed, and measures of sovereign spreads in emerging market economies decreased somewhat. In many advanced foreign economies, long-term interest rates remained well below the levels seen at the end of 2018.

Monetary Policy

Interest rate policy. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the FOMC lowered the target range for the federal funds rate over the second half of 2019. Specifically, at its July, September, and October meetings, the FOMC lowered the target range a cumulative 75 basis points, bringing it to the current range of 1-1/2 to 1-3/4 percent. In its subsequent meetings, the Committee judged that the prevailing stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to the Committee's symmetric 2 percent objective. The Committee noted that it will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate.

Balance sheet policy. At its July meeting, the FOMC decided to conclude the reduction of its aggregate securities holdings in the System Open Market Account, or SOMA, in August. Ending the runoff earlier than initially planned was seen as having only very small effects on the balance sheet, with negligible implications for the economic outlook; it was also seen as helpful in simplifying communications regarding the use of the Committee's policy tools at a time when the Committee was lowering the target range for the federal funds rate. As discussed further in the next paragraph, since October 2019, the size of the balance sheet has been expanding to provide an ample level of reserves to ensure that the federal funds rate trades within the FOMC's target range.

Monetary policy implementation. Domestic short-term funding markets were volatile in mid-September—amid large flows related to corporate tax payments and settlement of Treasury securities—and experienced a significant tightening of conditions. Since then, the Federal Reserve has been conducting open market operations—repo operations and Treasury bill purchases—in order to maintain ample reserve balances over time. While the balance sheet has expanded in light of the open market operations to maintain ample reserves, these operations are purely technical measures to support the effective implementation of the FOMC's monetary policy, are not intended to change the stance of monetary policy, and reflect the Committee's intention to implement monetary policy in a regime with an ample supply of reserves. The Committee will continue to monitor money market developments as it assesses the level of reserves most consistent with efficient and effective policy implementation and stands ready to adjust the details of its technical operations as necessary to foster efficient and effective implementation of monetary policy. (See the box "Money Market Developments and Monetary Policy Implementation"on pages 42–43 of the February 2020 Monetary Policy Report.)

Special Topics

Manufacturing and U.S. business cycles. After increasing solidly in 2017 and 2018, manufacturing output turned down last year. This decline raised fears among some observers that the weakness could spread and potentially lead to an economy-wide recession. In general, a decline in manufacturing similar to that in 2019 would not be large enough to initiate a major downturn for the economy. Furthermore, after accounting for changing trends in growth of manufacturing output, mild slowdowns have often occurred during expansionary phases of business cycles. In contrast, a more pronounced contraction in manufacturing has historically been associated with an economy-wide recession. (See the box "Manufacturing and U.S. Business Cycles" on pages 14–15 of the February 2020 Monetary Policy Report.)

Monetary policy rules. Prescriptions for the policy interest rate from monetary policy rules often depend on judgments and assumptions about economic variables that are inherently uncertain and may change over time. Notably, many policy rules depend on estimates of resource slack and of the longer-run neutral real interest rate, both of which are not directly observable and are estimated with a high degree of uncertainty. As a result, the amount of policy accommodation that these rules prescribe—and whether that amount is appropriate in light of underlying economic conditions—is also uncertain. Such a situation cautions against mechanically following the prescriptions of any specific rule. (See the box "Monetary Policy Rules and Uncertainty in Monetary Policy Settings" on pages 33–37 of the February 2020 Monetary Policy Report.)

Framework review and Fed Listens events. In 2019, the Federal Reserve System began a broad review of the monetary policy strategy, tools, and communication practices it uses to pursue its statutory dual-mandate goals of maximum employment and price stability. The Federal Reserve sees this review as particularly important at this time because the U.S. economy appears to have changed in ways that matter for monetary policy. For example, the neutral level of the policy interest rate appears to have fallen in the United States and abroad, increasing the risk that the effective lower bound on interest rates will constrain central banks from reducing their policy interest rates enough to effectively support economic activity during downturns. The review is considering what monetary policy strategy will best enable the Federal Reserve to meet its dual mandate in the future, whether the existing monetary policy tools are sufficient to achieve and maintain the dual mandate, and how communication about monetary policy can be improved.

A key component of the review has been a series of public Fed Listens events engaging with a broad range of stakeholders in the U.S. economy about how the Federal Reserve can best meet its statutory goals. During 14 Fed Listens events in 2019, policymakers heard from individuals and groups around the country on issues related to the labor market, inflation, interest rates, and the transmission of monetary policy. (See the box "Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices" on pages 40–41 of the February 2020 Monetary Policy Report.)

Part 1: Recent Economic and Financial Developments

Domestic Developments
The labor market strengthened further last year but at a slower pace than in 2018...

Payroll employment gains were solid in the second half of 2019 and averaged 176,000 per month during the year as a whole. This pace is somewhat slower than the average monthly gains in 2018, even accounting for the anticipated effects of the Bureau of Labor Statistics' upcoming benchmark revision to payroll employment (figure 1).1 However, the pace of job gains appears to have remained faster than what is needed to provide jobs for net new entrants to the labor force as the population grows.2

Figure 1. Net change in payroll employment
Figure 1. Net change in payroll employment
Accessible Version | Return to text

Note: The data are 3-month and 12-month moving averages.

Source: Bureau of Labor Statistics via Haver Analytics.

Reflecting the employment gains over this period, the unemployment rate declined further in 2019 and stood at 3.5 percent in December, 0.4 percentage point below its year-earlier level and at its lowest level since 1969 (figure 2). In addition, the unemployment rate is 0.6 percentage point below the median of Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level.3

Figure 2. Measures of labor underutilization
Figure 2. Measures of labor underutilization
Accessible Version | Return to text

Note: Unemployment rate measures total unemployed as a percentage of the labor force. U-4 measures total unemployed plus discouraged workers, as a percentage of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work because they believe no jobs are available for them. U-5 measures total unemployed plus all marginally attached to the labor force, as a percentage of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not in the labor force, want and are available for work, and have looked for a job in the past 12 months. U-6 measures total unemployed plus all marginally attached workers plus total employed part time for economic reasons, as a percentage of the labor force plus all marginally attached workers. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research.

Source: Bureau of Labor Statistics via Haver Analytics.

Strengthening labor market conditions are also evident in rising labor force participation rates (LFPRs)—that is, the shares of the population either working or actively seeking work. The LFPR for individuals aged 16 and over was 63.2 percent in December, above its level a year ago despite the downward pressure of about 1/4 percentage point per year associated with the aging of the population. The LFPR for prime-age individuals (between 25 and 54 years old), which is much less sensitive to the effects of population aging, has been rising over the past few years and continued to increase in 2019 (figure 3). The employment-to-population ratio for individuals aged 16 and over—that is, the share of people who are working—was 61.0 percent in December and has been increasing since 2011.

Figure 3. Labor force participation rates and employment-to-population ratio
Figure 3. Labor force participation rates and employment-to-population ratio
Accessible Version | Return to text

Note: The data are monthly. The prime-age labor force participation rate is a percentage of the population aged 25 to 54. The labor force participation rate and the employment-to-population ratio are percentages of the population aged 16 and over.

Source: Bureau of Labor Statistics via Haver Analytics.

Other indicators are also consistent with strong labor market conditions, albeit with some slowing in the pace of improvement since 2018. As reported in the Job Openings and Labor Turnover Survey (JOLTS), job openings have remained plentiful, although the private-sector job openings rate has come down over the past year. Similarly, the quits rate in the JOLTS has remained near the top of its historical range, an indication that workers are being bid away from their current jobs or have become more confident that they can successfully switch jobs if they so wish. These data accord well with surveys of consumers that indicate households perceive jobs as plentiful. The JOLTS layoff rate and the number of people filing initial claims for unemployment insurance benefits—historically, a good early indicator of economic downturns—have both remained quite low.

. . . and unemployment rates have fallen, on net, for all major demographic groups over the past several years

Differences in unemployment rates across ethnic and racial groups have narrowed in recent years, on net, as they typically do during economic expansions, after having widened during the 2007–09 recession. The decline in the unemployment rate for African Americans has been particularly sizable, and its average rate in the second half of October 2019 was the lowest recorded since the data began in 1972. Although the unemployment rates for African Americans and for Hispanics remain substantially above those for whites and for Asians, those differentials in the second half of 2019 were at their narrowest levels on record. The rise in LFPRs for prime-age individuals over the past few years has also been apparent in each of these racial and ethnic groups.

Increases in labor compensation have remained moderate by historical standards...

Despite strong labor market conditions, the available indicators generally suggest that increases in hourly labor compensation have remained moderate, averaging about 3 percent over the past two years. These indicators include the employment cost index, a measure of both wages and the cost to employers of providing benefits; compensation per hour in the business sector, a broad-based but volatile measure of wages, salaries, and benefits; and average hourly earnings from the payroll survey, a monthly index that is timely but does not account for benefits. The median 12-month wage growth of individuals reporting to the Current Population Survey calculated by the Federal Reserve Bank of Atlanta, which tends to be higher than broader-based measures of wage growth, remains near the upper portion of its range over the past couple of years.4 Interestingly, wage growth over the past few years has been strongest for workers in relatively low-paying jobs, suggesting that the strong labor market is having a more pronounced benefit for these workers.

. . . and likely have been restrained by slow growth in labor productivity over much of the expansion

These moderate rates of hourly compensation gains likely reflect the offsetting influences of a strengthening labor market and productivity growth that has been weak through much of the expansion. From 2008 to 2018, labor productivity increased a little more than 1 percent per year, on average, well below the average pace from 1996 to 2007 of nearly 3 percent and also below the average gain in the 1974–95 period. Although considerable debate remains about the reasons for the slowdown in productivity growth over this period, the weakness may be partly attributable to the sharp pullback in capital investment, including on research and development, during the most recent recession and the relatively slow recovery that followed. More recently, labor productivity is estimated to have increased 1.5 percent over the four quarters ending in 2019:Q3—a small improvement from the preceding year, especially given the volatility of the productivity data, but still moderate relative to earlier periods. While it is uncertain whether productivity growth will continue to improve, a sustained pickup in productivity growth, as well as additional labor market strengthening, would support stronger gains in labor compensation.

Inflation was below 2 percent last year

After having been close to the FOMC's objective of 2 percent in 2018, inflation moved back below 2 percent last year, where it has been for most of the time since the end of the most recent recession. The 12-month change in the price index for personal consumption expenditures (PCE) was 1.6 percent in December 2019, as was the 12-month measure of inflation that excludes food and energy items (so-called core inflation), which historically has been a better indicator of where inflation will be in the future than the overall index (figure 4). Both measures are down from the rates recorded a year ago; the slowing partly results from particularly low readings in the monthly price data in the first quarter of 2019, which appear to reflect idiosyncratic price declines in a number of specific categories such as apparel, used cars, banking services, and portfolio management services. Indeed, core inflation picked up after the first quarter and was at an average annual rate of 1.9 percent over the remainder of the year.

Figure 4. Change in the price index for personal consumption expenditures
Figure 4. Change in the price index for personal consumption expenditures
Accessible Version | Return to text

Source: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Bureau of Economic Analysis; all via Haver Analytics.

The trimmed mean PCE price index, calculated by the Federal Reserve Bank of Dallas, also suggests a transitory element to inflation readings early last year. The trimmed mean provides an alternative way to purge inflation of transitory influences, and it is less sensitive than the core index to idiosyncratic price movements such as those noted earlier.5 The 12-month change in this measure was about the same in December 2019 as it was in 2018.

Oil prices fluctuated in 2019

After falling from more than $80 per barrel to less than $60 per barrel in late 2018, the Brent spot price of crude oil fluctuated between $60 and $70 for most of 2019. Prices generally moved up in the second half of last year, supported by expectations of supply cuts in OPEC member countries and, later on, diminished concerns about the global outlook (figure 5). Prices also spiked briefly in early January over tensions with Iran. In recent weeks, however, oil prices moved lower amid heightened fears that the coronavirus outbreak that started in China might weigh on economic growth and the demand for oil. Despite these fluctuations in oil prices, retail gasoline prices generally edged lower since mid-2019. For 2019 as a whole, consumer energy prices rose modestly more than the core index. Meanwhile, food prices posted only a small increase in 2019, held down by soft prices for farm commodities, and contributed very little to overall consumer price inflation.

Figure 5. Spot and futures prices for crude oil
Figure 5. Spot and futures prices for crude oil
Accessible Version | Return to text

Note: The data are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020.

Source: ICE Brent Futures via Bloomberg.

Reported prices of imports other than energy fell

Nonfuel import prices, before accounting for the effects of tariffs on the price of imported goods, have continued to decline from their mid-2018 peak, responding to lower foreign inflation and declines in non-oil commodity prices.6 After declining in the first half of 2019, prices of industrial metals appear to have bottomed out in recent months, consistent with increased optimism about global demand following positive trade developments.

Survey-based measures of inflation expectations have been broadly stable...

Expectations of inflation likely influence actual inflation by affecting wage- and price-setting decisions. Survey-based measures of inflation expectations at medium- and longer-term horizons have remained broadly stable over the past year. In the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, the median expectation for the annual rate of increase in the PCE price index over the next 10 years has been very close to 2 percent for the past several years (figure 6). In the University of Michigan Surveys of Consumers, the median value for inflation expectations over the next 5 to 10 years has fluctuated within a narrow range around 2-1/2 percent since the end of 2016, though this level is between 1/4 and 1/2 percentage point lower than had prevailed through 2014. In the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, the median of respondents' expected inflation rate three years hence moved lower, on net, in the second half of last year and averaged 2.5 percent, 1/4 percentage point below its average over the preceding three years.

Figure 6. Surveys of inflation expectations
Figure 6. Surveys of inflation expectations
Accessible Version | Return to text

Note: The series are medians of the survey responses. The Michigan survey data are monthly and extend through January 2020. The Survey of Professional Forecasters data for inflation expectations for personal consumption expenditures are quarterly and begin in 2007:Q1. The NY Fed survey data are monthly and begin in June 2013.

Source: University of Michigan Surveys of Consumers; Federal Reserve Bank of New York, Survey of Consumer Expectations; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters.

. . . and market-based measures of inflation compensation have also been little changed

Inflation expectations can also be gauged by market-based measures of inflation compensation. However, the inference is not straightforward, because market-based measures can be importantly affected by changes in premiums that provide compensation for bearing inflation and liquidity risks. Measures of longer-term inflation compensation—derived either from differences between yields on nominal Treasury securities and those on comparable-maturity Treasury Inflation-Protected Securities (TIPS) or from inflation swaps—have been little changed, on net, since the middle of 2019, with both measures below their respective ranges that persisted for most of the 10 years before the start of notable declines in mid-2014.7 The TIPS-based measure of 5-to-10-year-forward inflation compensation and the analogous measure from inflation swaps are now about 1-3/4 percent and 2 percent, respectively.8

Growth of gross domestic product was moderate in the second half of 2019...

Real gross domestic product (GDP) is reported to have increased at a moderate average annual rate of 2.1 percent in the second half of 2019, although growth was somewhat slower than in the first half of the year and in 2018 (figure 7). Consumer spending rose at a moderate pace, on average, and residential investment turned up after having declined since the end of 2017. In contrast, business fixed investment declined in the second half of last year, reflecting a number of factors that likely include uncertainty regarding trade tensions and the weak global growth outlook. Those factors also continued to weigh on manufacturing output, which declined over the first half of 2019 and has moved roughly sideways since then. (See the box "Manufacturing and U.S. Business Cycles" on pages 14–15 of the February 2020 Monetary Policy Report.) Despite those headwinds, the economic expansion continues to be supported by steady job gains, increases in household wealth, expansionary fiscal policy, and supportive domestic financial conditions that include moderate borrowing costs and easy access to credit for many households and businesses.

Figure 7. Change in real gross domestic product and gross domestic income
Figure 7. Change in real gross domestic product and gross domestic income
Accessible Version | Return to text

Note: Gross domestic income is not yet available for 2019:H2.

Source: Bureau of Economic Analysis via Haver Analytics.

. . . and downside risks to the outlook receded somewhat

Downside risks to the economic outlook seem to have receded somewhat in the latter part of 2019. Labor market conditions and economic growth in the United States have been resilient to the global headwinds in 2019, and conflicts over trade policy diminished somewhat toward the end of the year. Economic growth abroad also shows signs of stabilizing, though the coronavirus outbreak presents a more recent risk. Reflecting these factors as well as more accommodative monetary policy stances in the United States and some foreign economies, financial conditions eased somewhat over the second half of the year. Statistical models designed to gauge the probability of recession using various indicators, including the Treasury yield curve, suggest that the likelihood of a recession occurring over the next year has fallen noticeably in recent months. Similarly, as shown in Part 3, when Federal Reserve policymakers most recently presented their economic projections, in December, fewer participants judged the risks to the outlook to be tilted to the downside compared with their projections from last June.

Ongoing improvements in the labor market continue to support household income and consumer spending

Consumer spending rose at a moderate pace, on average, in the third and fourth quarters of 2019 and posted another solid gain for the year as a whole (figure 8). The growth in real PCE in recent years reflects the continued improvements in the labor market, which have supported further increases in household income. Real disposable personal income, a measure of households' after-tax purchasing power, increased 2.6 percent in 2019, a solid gain albeit below the robust increase in 2018 that was bolstered by a reduction in personal income taxes. The personal saving rate, at 7.7 percent in the fourth quarter, was little changed from the previous year.

Figure 8. Change in real personal consumption expenditures and disposable personal income
Figure 8. Change in real personal consumption expenditures and disposable personal income
Accessible Version | Return to text

Source: Bureau of Economic Analysis via Haver Analytics.

Spending was also supported by high household wealth...

The relatively high level of aggregate household net worth also supported consumer spending last year. House prices, which are of particular importance for the value of assets held by a large portion of households, continued to increase in 2019, although at a more moderate pace than in recent years. In addition, U.S. equity prices, which fell sharply at the end of 2018, have rebounded since then. Equity wealth is more concentrated among high-wealth households with high propensities to save than is housing wealth, however, and may therefore provide less support for consumption. The ratio of aggregate household net worth to household income held steady through the third quarter of last year at 6.9, near its all-time high.

. . . and consumer sentiment remains strong

Consumers have remained upbeat during the past year. The Michigan index of consumer sentiment, which declined last summer as trade tensions spiked, recovered in recent months and currently stands at a high level by historical standards. The sentiment measure from the Conference Board, which has been more stable, also suggests consumers are fairly upbeat.

Borrowing conditions for households remain generally favorable, and borrowing costs have moved down since the middle of 2019...

Financing conditions for consumers remain supportive of growth in household spending. Interest rates on credit cards and auto loans declined, on net, during the second half of 2019, and consumer credit continued to expand at a moderate pace. Standards and delinquency rates for these loans have been generally stable. For student loans, credit remains widely available, with over 90 percent of such credit being extended by the federal government. After peaking in 2013, delinquencies on such loans have been gradually declining, reflecting in part the continued improvements in the labor market. In the mortgage market, credit has continued to be readily available for households with solid credit profiles but remains noticeably tighter than before the most recent recession for borrowers with low credit scores.

. . . and activity in the housing sector has picked up, likely reflecting lower interest rates

Residential investment picked up in the second half of 2019 after declining for six straight quarters. Housing starts for single-family and multifamily housing units increased sharply in the second half of last year and posted appreciable gains for the year as a whole, with starts and permits for new construction rising to the highest levels in more than 10 years (figure 9). Sales of new and existing homes also increased during 2019. This improvement appears to have importantly reflected the reduction in mortgage interest rates; after increasing appreciably from mid-2017 through 2018, rates declined markedly last year, fully reversing those earlier increases. Despite the lower mortgage rates, households' perceptions of homebuying conditions have remained low, likely reflecting ongoing increases in housing prices.

Figure 9. Private housing starts and permits
Figure 9. Private housing starts and permits
Accessible Version | Return to text

Source: U.S. Census Bureau via Haver Analytics.

In contrast, business fixed investment weakened in the second half of 2019...

After increasing more than 5 percent per year in 2017 and 2018, business fixed investment—spending by businesses on structures, equipment, and intangibles such as research and development—stalled in 2019, as a moderate gain in the first quarter was offset by small declines over the rest of the year. The softness in business investment last year was evident in each of the three main components, and a portion of the weakening appears to reflect concerns over trade policy and slower foreign growth; other factors included the suspension of deliveries of the Boeing 737 Max aircraft and the continued decline in drilling and mining structures investment amid oil prices that fell back from the levels reached in 2018. Forward-looking indicators of business spending—such as orders of capital goods, surveys of business conditions and sentiment, and profit expectations from industry analysts—all appear to have stabilized in recent months but suggest that investment is likely to remain subdued (figure 10).

Figure 10. Change in real business fixed investment
Figure 10. Change in real business fixed investment
Accessible Version | Return to text

Note: Business fixed investment is known as "private nonresidential fixed investment" in the National Income and Product Accounts.

Source: Bureau of Economic Analysis via Haver Analytics.

. . . despite corporate financing conditions that remained accommodative overall

Financing conditions for nonfinancial firms have remained accommodative amid lower interest rates. Flows of credit to large nonfinancial firms remained solid overall in the third quarter of 2019. The gross issuance of corporate bonds, although lower than in the first half of last year, was robust across credit categories. Yields on both investment- and speculative-grade corporate bonds continued to decrease and are near historical lows. Spreads on corporate bond yields over comparable-maturity Treasury securities have continued to narrow, on net, since the middle of last year and are at the lower end of their historical distributions. Respondents to the January Senior Loan Officer Opinion Survey on Bank Lending Practices, or SLOOS, reported that banks eased several terms on commercial and industrial (C&I) loans but that demand for C&I loans has continued to weaken, consistent with the slowdown in business investment. C&I loan growth at banks has slowed since the first half of last year, while commercial real estate loan growth has continued to be strong. Meanwhile, financing conditions for small businesses have remained generally accommodative, but credit growth has been subdued.

Net exports added to GDP growth in 2019, as exports grew little but imports declined

Real exports grew only a touch in 2019, as tariffs on U.S. exports increased and foreign growth weakened. Real imports declined last year, in part reflecting higher tariffs on imported goods and weakness in investment and manufacturing. As a result, real net exports—after having subtracted from U.S. real GDP growth in 2018—provided a modest boost to GDP growth in 2019. Relative to 2018, the nominal trade deficit is slightly less negative, and the current account deficit is little changed as a percent of GDP (figure 11).

Figure 11. U.S. trade and current account balances
Figure 11. U.S. trade and current account balances
Accessible Version | Return to text

Note: GDP is gross domestic product. Current account data for 2019 are the average of the first three quarters of the year.

Source: Bureau of Economic Analysis via Haver Analytics.

Federal fiscal policy actions continued to boost economic growth in 2019 while raising the federal unified budget deficit...

The effects of fiscal policy actions enacted at the federal level in earlier years continued to boost GDP growth in 2019; the Tax Cuts and Jobs Act of 2017 lowered personal and business income taxes, and rising appropriations consistent with the Bipartisan Budget Act of 2018 boosted federal purchases.9 In 2019, federal purchases rose 4.3 percent, well above the 2.7 percent increase of 2018.

The federal unified budget deficit widened further in fiscal year 2019 to 4-1/2 percent of nominal GDP from 3-3/4 percent of GDP in 2018, as expenditures moved up as a share of the economy while receipts moved sideways. Expenditures, at 21 percent of GDP, are above the level that prevailed in the decade before the start of the 2007–09 recession, while receipts have continued to run below their average levels. The ratio of federal debt held by the public to nominal GDP rose to 79 percent in fiscal 2019 and was quite elevated relative to historical norms. The Congressional Budget Office projects that this ratio will rise further over the next several years, reflecting large and rising deficits under current fiscal policy.

. . . and the fiscal position of most state and local governments is stable

The fiscal position of most state and local governments remains stable, although there is a range of experiences across these governments. Revenues for these governments have continued to grow in recent quarters, as the economic expansion pushes up income and sales tax collections for state governments, and past house price gains continue to push up property tax collections for local governments. Boosted by a rebound in construction spending following two years of weak growth, real purchases by state and local governments rose moderately last year but still remained quite restrained, partly reflecting budget pressures associated with pension and retiree health-care obligations. State and local government payrolls increased moderately in 2019 but have only roughly regained the peak observed before the current expansion, and real outlays for construction are more than 10 percent below their pre-recession peak. The debt of these governments as a share of the economy has continued to edge lower and currently equals around 14 percent of GDP, well below the previous peak of 21 percent following the most recent recession.

Financial Developments
The expected path of the federal funds rate over the next several years shifted down

Market-based measures of the expected path of the federal funds rate over the next several years have moved down, on net, since the middle of last year and show about a 30 basis point decrease in the federal funds rate over 2020 and a relatively flat path thereafter. Survey-based measures of the expected path of the policy rate also shifted down from the levels observed in the middle of 2019 but indicate no change to the target range for the federal funds rate over 2020 from its level at the end of 2019. According to the results of the most recent Survey of Primary Dealers and Survey of Market Participants, both conducted by the Federal Reserve Bank of New York in December, the median of respondents' modal projections implies a flat trajectory for the target range of the federal funds rate for the next few years.10 Additionally, market-based measures of uncertainty about the policy rate approximately one to two years ahead declined, on balance, from their levels at the end of last June and are close to their average level in recent years.

U.S. nominal Treasury yields decreased on net

After moving significantly lower over the first half of 2019, nominal Treasury yields also fell sharply in August, largely in response to investors' concerns regarding trade tensions between the United States and China and the global economic outlook (figure 12). Later in the year, as these concerns abated, Treasury yields rose, the yield curve steepened, and uncertainty about near-term Treasury yields—measured by option-implied volatility on short- and longer-dated swap rates—declined. However, in the second half of January, investors' concerns about the implications of the coronavirus outbreak for the economic outlook weighed on Treasury yields and led to a flattening of the yield curve as well as some increase in uncertainty about near-term Treasury yields. Since the middle of last year, Treasury yields ended lower on net.

Figure 12. Yields on nominal Treasury securities
Figure 12. Yields on nominal Treasury securities
Accessible Version | Return to text

Source: Department of the Treasury via Haver Analytics.

Consistent with changes in the yields on nominal Treasury securities, yields on 30-year agency mortgage-backed securities (MBS)—an important determinant of mortgage interest rates— decreased, on balance, since the middle of last year and remained low by historical standards. Meanwhile, yields on both investment- and speculative-grade corporate bonds continued to decline and also stayed low by historical standards. Spreads on corporate bond yields over comparable-maturity Treasury yields narrowed moderately, on net, over the second half of 2019 and remained in the lower end of their historical distribution.

Broad equity price indexes increased notably

Equity prices fluctuated in August and September along with investors' concerns about trade developments and the economic outlook. Later in 2019 and into 2020, as these concerns abated, equity prices rose substantially and were reportedly boosted by greater certainty among investors that monetary policy would remain accommodative in the near term (figure 13). Gains were spread across most major economic sectors, with the exception of the energy sector, for which stock prices declined markedly. Measures of implied and realized stock price volatility for the S&P 500 index—the VIX and the 20-day realized volatility—increased in August to fairly elevated levels but declined later in the year (figure 14). (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability" on pages 24–25 of the February 2020 Monetary Policy Report.)

Figure 13. Equity prices
Figure 13. Equity prices
Accessible Version | Return to text

Source: S&P's Dow Jones Indices via Bloomberg. (For Dow Jones Indices licensing information, see the note on the Contents page.)

Figure 14. S&P 500 volatility
Figure 14. S&P 500 volatility
Accessible Version | Return to text

Note: The VIX is a measure of implied volatility that represents the expected annualized change in the S&P 500 index over the following 30 days. For realized volatility, five-minute S&P 500 returns are used in an exponentially weighted moving average with 75 percent of weight distributed over the past 20 days.

Source: Cboe Volatility Index® (VIX®) accessed via Bloomberg; Federal Reserve Board staff estimates.

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

While available indicators of Treasury market functioning have generally remained stable since the first half of 2019—including bid-ask spreads, bid sizes, and estimates of transaction costs—some, such as measures of market depth, have decreased. However, the decline in measures of market depth has reportedly not led to any concerns about Treasury market liquidity. Liquidity conditions in the agency MBS market were also generally stable. Credit conditions in municipal bond markets remained stable as well, with yield spreads on 20-year general obligation municipal bonds over comparable-maturity Treasury securities declining notably and standing near historically low levels.

Money market rates moved down in line with decreases in the FOMC's target range, except for some notable volatility in mid-September

Decreases in the FOMC's target range for the federal funds rate in July, September, and October transmitted effectively through money markets, with yields on a broad set of money market instruments moving lower in response to the FOMC's policy actions.

The effective federal funds rate moved nearly in parity with the interest rate paid on reserves and was closely tracked by the overnight Eurodollar rate. Other short-term interest rates, including those on commercial paper and negotiable certificates of deposit, also moved down in line with decreases in the policy rate. Domestic short-term funding markets were volatile in mid-September—amid large flows related to corporate tax payments and settlement of Treasury securities—and experienced significant tightening of conditions. The effective federal funds rate rose above the target range on September 17 but then moved back within the target range following the Federal Reserve's open market operations, which eased pressures in money markets (see the box "Money Market Developments and Monetary Policy Implementation" on pages 42–43 of the February 2020 Monetary Policy Report).

Bank credit continued to expand, and bank profitability remained robust

Aggregate credit provided by commercial banks continued to expand through the second half of 2019, as the strength in commercial real estate and residential real estate loan growth, helped by falling interest rates, more than offset the slowdown in C&I and consumer loans. In the second half of last year, the pace of bank credit expansion was about in line with that of nominal GDP, leaving the ratio of total commercial bank credit to current-dollar GDP little changed from its value last June (figure 15). Overall, measures of bank profitability ticked down a bit in the third quarter because of narrower net interest margins but remain near their post-crisis highs.

Figure 15. Ratio of total commercial bank credit to nominal gross domestic product
Figure 15. Ratio of total commercial bank credit to nominal gross domestic product
Accessible Version | Return to text

Source: Federal Reserve Board, Statistical Release H.8, "Assets and Liabilities of Commercial Banks in the United States"; Bureau of Economic Analysis via Haver Analytics.

International Developments
Growth in advanced foreign economies weakened, but it appears to be stabilizing

Real GDP growth in several advanced foreign economies (AFEs) appears to have stepped down in the second half of the year. However, incoming data suggest that the slowdown in the AFEs may have bottomed out. Household spending has generally remained resilient, sustained by low unemployment rates and rising wages. Financial conditions have improved further, supported in part by accommodative monetary policy actions. The protracted slump in global manufacturing, which weighed on external demand across the AFEs, is showing tentative signs of nearing an end. In the euro area, where manufacturing activity was particularly weak, recent indicators suggest that growth may be steadying. In Japan, real GDP appears to have contracted sharply at the end of 2019, following a consumption tax hike in October, but its effects are likely to be transitory. In the United Kingdom, Brexit-related uncertainty weighed on economic activity throughout 2019; around the turn of the year, U.K. and European Union authorities took the necessary steps to prevent a disorderly Brexit from occurring on January 31, 2020, but they still need to negotiate a new trade arrangement.

Inflationary pressures remained subdued in many advanced foreign economies

Against a backdrop of slower economic growth, consumer prices in many AFEs continued to rise at a subdued pace, especially in the euro area and Japan. Canada remains an exception, as inflation there hovered around 2 percent.

Central banks in several advanced foreign economies provided accommodation

In response to subdued growth and below-target inflation, the European Central Bank introduced a new stimulus package in September of last year, including a deposit rate cut of 10 basis points to negative 0.5 percent, a restart of its Asset Purchase Programme, and more favorable terms for its targeted longer-term refinancing operations. Similarly, the Reserve Bank of Australia and the Reserve Bank of New Zealand reduced their policy rates in the second half of last year, citing concerns about the global outlook. The Bank of Canada, the Bank of England, and the Bank of Japan kept their policy rates unchanged, although communications by their officials took a more dovish tone, emphasizing increased downside risks to the global economy. In contrast, Sweden's Riksbank and Norway's Norges Bank increased their policy rates, citing favorable macroeconomic conditions and concerns about growing financial imbalances.

Financial conditions in advanced foreign economies eased further

Notwithstanding slowing global growth and bouts of political tensions, financial conditions in the AFEs, on balance, eased further in the second half of 2019, supported by accommodative central bank actions, progress on trade negotiations between the United States and China, and diminished fears of a hard Brexit. Long-term interest rates in many AFEs remained well below the levels seen at the end of 2018. Equity prices, as well as prices of other risky assets, increased moderately. Sovereign bond spreads over German bund yields for euro-area peripheral countries narrowed slightly. In recent weeks, however, equity and bond markets gave up some of their gains as uncertainty about the economic effects of the coronavirus weighed on investors' sentiment.

Growth slowed markedly in many emerging market economies, but there are tentative signs of stabilization

Chinese GDP growth slowed further in the second half of 2019 against the backdrop of increased tariffs on Chinese exports, global weakness in trade and manufacturing, and authorities' deleveraging campaign that continued to exert a drag on the economy. However, recent data suggest that China's economic activity picked up at the end of last year, in part supported by some fiscal and monetary policy stimulus and some easing of trade tensions. In emerging Asia excluding China, economic growth was dragged down by a sharp contraction in Hong Kong, where social and political unrest resulted in severe economic disruptions, and by weakness in India, where an ongoing credit crunch continues to weigh on activity. In several other Asian economies, GDP growth held steady but at a lackluster pace amid headwinds from moderating global growth. GDP growth in Korea, Taiwan, and the Philippines rebounded in the last quarter of 2019, consistent with signs of stabilization in the global manufacturing cycle, especially in the high-tech sector. However, the recent emergence of the coronavirus could lead to disruptions in China that spill over to other Asian countries and, more generally, to the rest of the global economy.

Many Latin American economies continued to underperform. Economic stagnation persisted in Mexico, reflecting both domestic factors—including market concerns about economic policies—and external factors, notably, renewed weakness in U.S. manufacturing production. Severe social unrest in several countries—including Chile, Ecuador, and Bolivia—disrupted economic activity. Argentina's financial crisis continued, while Venezuela's economy likely continued to contract. Growth in Brazil, in contrast, edged up as aggregate demand continued to recover, supported by further reductions in policy interest rates.

Financial conditions in emerging market economies fluctuated but, on net, eased somewhat

Notwithstanding social and political tensions as well as concerns about the global outlook, financial conditions in the emerging market economies (EMEs) eased somewhat in the second half of 2019. Conditions were supported by the accommodative actions of the FOMC and several foreign central banks and, later in the year, by progress in the negotiations between the United States and its major trading partners as well as improved prospects about global growth. EME equity prices generally increased, especially for Brazil. And measures of EME sovereign bond spreads over U.S. Treasury yields generally decreased. Political tensions in Hong Kong contributed to an underperformance of Chinese risky assets. After several months of withdrawals, flows to dedicated EME mutual funds resumed in the fourth quarter of 2019, consistent with the improved sentiment toward global prospects. However, in reaction to the emergence of the coronavirus, in late January equity and bond markets gave up some of their gains.

The dollar fluctuated but is, on balance, little changed

The foreign exchange value of the U.S. dollar fluctuated but is, on balance, little changed compared with last July (figure 16). While concerns about global growth and trade tensions contributed to the appreciation of the dollar over the summer, monetary policy easing by the Federal Reserve and progress on U.S.–China trade negotiations led to a depreciation of the dollar, especially with respect to the Chinese renminbi. The British pound appreciated notably against the dollar as fears of a disorderly Brexit diminished.

Figure 16. U.S. dollar exchange rate indexes
Figure 16. U.S. dollar exchange rate indexes
Accessible Version | Return to text

Note: The data, which are in foreign currency units per dollar, are weekly averages of daily data. The weekly data begin on Thursdays and extend through January 29, 2020. As indicated by the left most arrow, increases in the data represent U.S. dollar appreciation, and decreases represent U.S. dollar depreciation.

Source: Federal Reserve Board, Statistical Release H.10, "Foreign Exchange Rates."

Part 2: Monetary Policy

The Federal Open Market Committee reduced the federal funds rate to support sustained economic expansion and foster a return of inflation to the Committee's 2 percent objective

After having gradually increased its target range for the federal funds rate from late 2015 through the end of 2018, the Committee maintained its target range for the federal funds rate at 2-1/4 to 2-1/2 percent during the first half of 2019. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Federal Open Market Committee (FOMC) lowered the target range for the federal funds rate at its July, September, and October meetings by 25 basis points each, bringing it to 1-1/2 to 1-3/4 percent (figure 17).11 At its December and January meetings, the Committee judged that the prevailing stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to its symmetric 2 percent objective.

Figure 17. Selected interest rates
Figure 17. Selected interest rates
Accessible Version | Return to text

Note: The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities.

Source: Department of the Treasury; Federal Reserve Board.

Future changes in the federal funds rate will depend on the economic outlook and risks to the outlook as informed by incoming data

The FOMC has continued to emphasize that the actual path of monetary policy will depend on the evolution of the economic outlook and risks to the outlook as informed by incoming data. Specifically, in deciding on the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and symmetric 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

In addition to evaluating a wide range of economic and financial data and information gathered from business contacts and other informed parties around the country, policymakers routinely consult prescriptions for the policy interest rate from various monetary policy rules, which can provide useful guidance to the FOMC. Although many practical considerations make it undesirable for the FOMC to mechanically follow the prescriptions of any specific rule, the FOMC's framework for conducting systematic monetary policy respects key principles of good monetary policy embodied by these rules, while at the same time, providing flexibility to address many of the limitations of these policy rules (see the box "Monetary Policy Rules and Uncertainty in Monetary Policy Settings" on pages 33–37 of the February 2020 Monetary Policy Report).

The FOMC concluded the reduction of its aggregate securities holdings in the System Open Market Account...

At its July meeting, along with its decision to lower the target range for the federal funds rate, the FOMC also announced that it was ending the runoff of securities holdings two months earlier than the initially planned termination at the end of September.12 Ending the runoff earlier than initially planned was seen as having only very small effects on the balance sheet, with negligible implications for the economic outlook. Moreover, doing so avoided the appearance of inconsistency in continuing to allow the balance sheet to run off while simultaneously lowering the target range for the federal funds rate.

Since then, the Federal Reserve has rolled over at auction all principal payments from its holdings of Treasury securities and has reinvested all principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) received during each calendar month. The Committee intends to continue to reduce its holdings of agency debt and agency MBS, consistent with the aim of holding primarily Treasury securities in the long run. To allow for a gradual runoff of the MBS portfolio, principal payments from agency debt and agency MBS of up to $20 billion per month have been reinvested in Treasury securities; agency MBS principal payments in excess of $20 billion each month have been reinvested in agency MBS.13

. . . and reaffirmed its intention to implement monetary policy in a regime with an ample supply of reserves

In a monetary policy regime with an ample supply of reserves, control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates, and active management of the supply of reserves is not required. The Federal Reserve will still conduct periodic open market operations as necessary to accommodate the trend growth in the demand for its nonreserve liabilities, such as currency in circulation, and maintain an ample supply of reserves over time. Separate from such periodic open market operations, beginning in October 2019, the Federal Reserve has implemented a temporary program of open market operations, specifically Treasury bill purchases, aimed at durably raising reserves to levels at or above those prevailing in early September (see the box "Money Market Developments and Monetary Policy Implementation" on pages 42–43 of the February 2020 Monetary Policy Report). These actions are purely technical measures to support the effective implementation of the FOMC's monetary policy and are not intended to change the stance of monetary policy. These Treasury bill purchases are distinct from the large-scale asset purchase programs that the Federal Reserve deployed after the financial crisis. In those programs, the Federal Reserve purchased longer-term securities to put downward pressure on longer-term interest rates and ease broader financial conditions.

The Federal Reserve's total assets have increased from about $3.8 trillion last July to about $4.1 trillion at present, with holdings of Treasury securities at approximately $2.4 trillion and holdings of agency debt and agency MBS at approximately $1.4 trillion (figure 18). The increase in the size of the balance sheet partly reflects an increase in the level of nonreserve liabilities—such as currency in circulation and the TGA—and a rise in the level of reserve balances, which have increased from approximately $1.5 trillion last July to approximately $1.6 trillion at present.

Figure 18. Federal Reserve assets and liabilities
Figure 18. Federal Reserve assets and liabilities
Accessible Version | Return to text

Note: "Credit and liquidity facilities" consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. "Other assets" includes repurchase agreements as well as unamortized premiums and discounts on securities held outright. "Capital and other liabilities" includes reverse repurchase agreements, the U.S. Treasury General Account, and the U.S. Treasury Supplementary Financing Account. The data extend through January 29, 2020.

Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances."

Meanwhile, interest income on the Federal Reserve's securities holdings has continued to result in substantial remittances to the U.S. Treasury. Preliminary data indicate that the Federal Reserve remitted about $55 billion in 2019.

The effective federal funds rate moved down in line with the FOMC's target range for the federal funds rate

The Federal Reserve reduced the effective federal funds rate following the FOMC's decisions in July, September, and October to lower the target range for the federal funds rate by reducing the interest rate paid on required and excess reserve balances and the interest rate offered on overnight reverse repurchase agreements (ON RRPs). Specifically, the Federal Reserve lowered the interest rate paid on required and excess reserve balances to 2.10 percent in July, 1.80 percent in September, and 1.55 percent in October. In addition, the Federal Reserve lowered the ON RRP offering rate to 2 percent in July, 1.70 percent in September, and 1.45 percent in October. The Federal Reserve also approved a 1/4 percentage point decrease in the discount rate (the primary credit rate) in July, September, and October. Yields on a broad set of money market instruments also moved lower, roughly in line with the effective federal funds rate, in response to the FOMC's policy decisions in July, September, and October.

The Federal Reserve continued the review of its strategic framework for monetary policy

In the second half of 2019, the Federal Reserve continued the review of its monetary policy strategy, tools, and communication practices. The goal of this assessment is to identify possible ways to improve the Committee's current policy framework in order to ensure that the Federal Reserve is best positioned going forward to achieve its statutory mandate of maximum employment and price stability. (The box "Federal Reserve Review of Monetary Policy Strategy, Tools, and Communication Practices" on pages 40–41 of the February 2020 Monetary Policy Reportdiscusses the review and the public outreach that has accompanied it.)

Monetary Policy Report July 2019

Summary

Economic activity increased at a solid pace in the early part of 2019, and the labor market has continued to strengthen. However, inflation has been running below the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent. At its meeting in June, the FOMC judged that current and prospective economic conditions called for maintaining the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. Nonetheless, in light of increased uncertainties around the economic outlook and muted inflation pressures, the Committee indicated that it will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near the Committee's symmetric 2 percent objective.

Economic and Financial Developments

The labor market. The labor market has continued to strengthen. Over the first five months of 2019, payrolls increased an average of 165,000 per month. This rate is down from the average pace of 223,000 in 2018, but it is faster than what is needed to provide jobs for new entrants into the labor force. The unemployment rate moved down from 3.9 percent in December to 3.6 percent in May; meanwhile, wage gains have remained moderate.

Inflation. Consumer price inflation, as measured by the 12-month change in the price index for personal consumption expenditures, moved down from a little above the FOMC's objective of 2 percent in the middle of last year to a rate of 1.5 percent in May. The 12-month measure of inflation that excludes food and energy items (so-called core inflation), which historically has been a better indicator than the overall figure of where inflation will be in the future, was 1.6 percent in May—down from a rate of 2 percent from a year ago. However, these year-over-year declines mainly reflect soft readings in the monthly price data earlier this year, which appear to reflect transitory influences. Survey-based measures of longer-run inflation expectations are little changed, while market-based measures of inflation compensation have declined recently to levels close to or below the low levels seen late last year.

Economic growth. In the first quarter, real gross domestic product (GDP) is reported to have increased at an annual rate of 3.1 percent, bolstered by a sizable contribution from net exports and business inventories. By contrast, consumer spending in the first quarter was lackluster but appears to have picked up in recent months. Meanwhile, following robust gains last year, business fixed investment slowed in the first quarter, and indicators suggest that investment decelerated further in the spring. All told, incoming data for the second quarter suggest a moderation in GDP growth—despite a pickup in consumption—as the contributions from net exports and inventories reverse and the impetus from business investment wanes further.

Financial conditions. Nominal Treasury yields moved significantly lower over the first half of 2019, largely reflecting investors' concerns about trade tensions and the global economic outlook, as well as expectations of a more accommodative path for the federal funds rate than had been anticipated earlier. On net, since the end of 2018, spreads of yields on corporate bonds over those on comparable-maturity Treasury securities have narrowed, and stock prices have increased. Moreover, loans remained widely available for most households, and credit provided by commercial banks continued to expand at a moderate pace. Overall, domestic financial conditions for businesses and households continued to be supportive of economic growth over the first half of 2019.

Financial stability. The U.S. financial system continues to be substantially more resilient than in the period leading up to the financial crisis. Asset valuations remain somewhat elevated in a number of markets, with investors continuing to exhibit high appetite for risk. Borrowing by businesses continues to outpace GDP, with the most rapid increases in debt concentrated among the riskiest firms. In contrast, household borrowing remains modest relative to income, and the debt growth is concentrated among borrowers with high credit scores. Key financial institutions, including the largest banks, continue to be well capitalized and hold large quantities of liquid assets. Funding risks in the financial system remain low relative to the period leading up to the crisis.

International developments. After slowing in 2018, foreign economic growth appears to have stabilized in the first half of the year, but at a restrained pace. While aggregate activity in the advanced foreign economies (AFEs) increased slowly from the soft patch of late last year, activity in emerging Asia generally struggled to gain a solid footing, and several Latin American economies continued to underperform. Growth abroad has been held down in part by a slowdown in the manufacturing sector against the backdrop of softening global trade flows. With both inflation and activity in the AFEs remaining subdued, AFE central banks took a more accommodative policy stance.

Despite trade tensions that weighed on financial markets, financial conditions abroad generally eased in the first half of the year, supported by accommodative communications by major central banks. On balance, global equity prices moved higher, sovereign yields in major foreign economies declined, and sovereign bond spreads in the emerging market economies were little changed. Market-implied paths of policy rates in AFEs generally declined.

Monetary Policy

Interest rate policy. In its meetings over the first half of 2019, the FOMC judged that the stance of monetary policy was appropriate to achieve the Committee's objectives of maximum employment and 2 percent inflation, and it decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. These decisions reflected incoming information showing the solid fundamentals of the U.S. economy supporting continued growth and strong employment. For most of this period, the Committee indicated that, in light of global economic and financial developments and muted inflation pressures, it would be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate. At the June FOMC meeting, however, the Committee noted that uncertainties about the global and domestic economic outlook had increased. In light of these uncertainties and muted inflation pressures, the Committee indicated that it will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

In the most recent Summary of Economic Projections, which was compiled at the time of the June FOMC meeting, participants generally revised down their individual assessments of the appropriate path for monetary policy relative to their assessments at the time of the March meeting. (The participants' most recent economic projections—released after the June FOMC meeting—are discussed in more detail in Part 3 of the July 2019 Monetary Policy Report.) However, as the Committee has continued to emphasize, the timing and size of future adjustments to the target range for the federal funds rate will depend on the Committee's assessment of realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.

Balance sheet policy. Over the first half of the year, the FOMC made two announcements regarding the longer-run policy implementation framework and its plans for normalizing the balance sheet. Following its January meeting, the Committee noted that it decided to continue to implement monetary policy in a regime with ample reserves. Consistent with that decision, in March, the Committee announced plans to conclude the reduction of its aggregate securities holdings at the end of September 2019. (See the box "Framework for Monetary Policy Implementation and Normalization of the Federal Reserve's Balance Sheet" on pages 42–43 of the July 2019 Monetary Policy Report.) The Committee is prepared to adjust the details for completing balance sheet normalization in light of economic and financial developments, consistent with its policy objectives of maximum employment and price stability.

Special Topics

Labor market conditions for lower- and higher-educated workers. The labor market has strengthened since the end of the last recession, but the pattern of recovery has varied across workers with different levels of education. Workers with a college degree or more experienced a swifter recovery in employment, while those with a high school degree or less had a much more delayed recovery in employment. This pattern is typical of business cycles, and recent research sheds light on mechanisms that may lead to differences in the timing of recovery for lower- and higher-educated workers. (See the box "How Have Lower-Educated Workers Fared since the Great Recession?" on pages 8–9 of the July 2019 Monetary Policy Report.)

Global manufacturing and trade. Growth in global trade and manufacturing has weakened significantly since 2017 even as growth in services has held up. Trade policy developments appear to have lowered trade flows to some extent, while uncertainty surrounding trade policy may be weighing on investment. The global tech cycle and a general slowdown in global demand, reflecting idiosyncratic factors specific to different economies, have also likely weighed on demand for traded goods. (See the box "The Persistent Slowdown in Global Trade and Manufacturing" on pages 30–31 of the July 2019 Monetary Policy Report.)

Monetary policy rules. Monetary policy rules are mathematical formulas that relate a policy interest rate, such as the federal funds rate, to a small number of other economic variables, typically including the deviation of inflation from its target value and a measure of resource slack in the economy. The prescriptions for the policy interest rate from these rules can provide helpful guidance for the FOMC. This discussion presents five policy rules—illustrative of the many rules that have received attention in the research literature—and provides examples of two ways to compute historical prescriptions of policy rules. (See the box Monetary Policy Rules and Their Interactions with the Economy" on pages 37–41 of the July 2019 Monetary Policy Report.)

Monetary policy implementation and balance sheet normalization. Since the beginning of this year, the FOMC has made important decisions regarding its framework for monetary policy implementation and the process of normalizing the size of its balance sheet. The Committee decided to continue to implement monetary policy in a regime with an ample supply of reserves and announced that it intends to conclude the reduction of its aggregate securities holdings in the System Open Market Account at the end of September 2019. (See the box "Framework for Monetary Policy Implementation and Normalization of the Federal Reserve's Balance Sheet" on pages 42–43 of the July 2019 Monetary Policy Report.)

Part 1: Recent Economic and Financial Developments

Domestic Developments
The labor market strengthened further during the first half of 2019 but at a slower pace than last year...

Labor market conditions have continued to strengthen so far this year but at a pace slower than last year. Total nonfarm payroll employment has averaged gains of about 165,000 per month over the first five months of 2019, according to the Bureau of Labor Statistics. This pace is slower than the average monthly gains in 2018, but it is faster than what is needed to provide jobs for net new entrants into the labor force as the working-age population grows.14

In April and May of this year, the unemployment rate stood at 3.6 percent, 1/4 percentage point lower than its level in December 2018 and its lowest level since 1969. In addition, the unemployment rate is 1/2 percentage point below the median of Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level.15

In May, the labor force participation rate (LFPR) for individuals 16 and over—that is, the share of the population either working or actively seeking work—was 62.8 percent, and it has changed little, on net, since late 2013. The aging of the population is an important contributor to an underlying downward trend in the overall participation rate. In particular, members of the baby-boom cohort are increasingly moving into their retirement years, ages when labor force participation typically falls. The flat trajectory in the overall LFPR is therefore consistent with strengthening labor market conditions; indeed, the LFPR for prime-age individuals (between 25 and 54 years old), which is much less sensitive to the effects of population aging, has been rising over the past few years. Combining both the unemployment rate and the LFPR, the employment-to-population ratio (EPOP) for individuals 16 and over—the share of that segment of the population who are working—was 60.6 percent in May and has been gradually increasing throughout the expansion. The increase has been considerably larger for those with at least some college education than for those with no more than a high school diploma. (The box "How Have Lower-Educated Workers Fared since the Great Recession?"on pages 8–9 of the July 2019 Monetary Policy Report discusses movements in the EPOP by educational level over the current expansion.)

Other indicators are also consistent with strong labor market conditions. As reported in the Job Openings and Labor Turnover Survey (JOLTS), the average of the private-sector job openings rate over the first four months of the year was near its historical high, consistent with surveys indicating that businesses see vacancies as hard to fill. Similarly, the quits rate in the JOLTS is also near the top of its historical range, an indication that workers are being bid away from their current jobs or have become more confident that they can successfully switch jobs if they wish to. This interpretation accords well with surveys of consumers that indicate households perceive jobs as plentiful. The JOLTS layoff rate and the number of people filing initial claims for unemployment insurance benefits have both remained quite low.

. . . and unemployment rates have fallen for all major demographic groups over the past several years

Differences in unemployment rates across ethnic and racial groups have narrowed in recent years, as they typically do during economic expansions, after having widened during the recession. However, unemployment rates for African Americans and Hispanics remain substantially above those for whites and Asians. The rise in LFPRs for prime-age individuals over the past few years has also been apparent in each of these racial and ethnic groups.

Increases in labor compensation have picked up but remain moderate by historical standards...

Despite strong labor market conditions, the available indicators generally suggest that increases in hourly labor compensation have remained moderate. The employment cost index—a measure of both wages and the cost to employers of providing benefits—was 2-3/4 percent higher in March of 2019 relative to its year-earlier level. Compensation per hour in the business sector—a broad-based but volatile measure of wages, salaries, and benefits—rose 1-1/2 percent over the four quarters ending in 2019:Q1, less than the annual increases over the preceding couple of years. Among measures that do not account for benefits, average hourly earnings rose 3.1 percent in May relative to 12 months earlier, a slightly faster rate of increase than during the same period of a year ago. According to the Federal Reserve Bank of Atlanta, the median 12-month wage growth of individuals reporting to the Current Population Survey increased about 3-3/4 percent in May, near the upper portion of its range over the past couple of years.16

. . . and likely have been restrained by slow growth in labor productivity over much of the expansion

These moderate rates of hourly compensation gains likely reflect the offsetting influences of a strengthening labor market and productivity growth that has been weak through much of the expansion. From 2008 to 2017, labor productivity increased a little more than 1 percent per year, on average, well below the average pace from 1996 to 2007 of nearly 3 percent and also below the average gain in the 1974–95 period. Although considerable debate remains about the reasons for the slowdown in productivity growth over this period, the weakness may be partly attributable to the sharp pullback in capital investment during the most recent recession and the relatively slow recovery that followed. More recently, however, labor productivity rose 1-3/4 percent in 2018 and picked up further in the first quarter of 2019.17 While it is uncertain whether this faster rate of growth will persist, a sustained pickup in productivity growth, as well as additional labor market strengthening, would support stronger gains in labor compensation.

Price inflation has dipped below 2 percent this year

Consumer price inflation has moved down below the FOMC's objective of 2 percent this year.18 As measured by the 12-month change in the price index for personal consumption expenditures (PCE), inflation is estimated to have been 1.5 percent in May after being at or above 2 percent for much of 2018. Core PCE inflation—which excludes consumer food and energy prices that are often quite volatile, and which therefore typically provides a better indication than the total measure of where overall inflation will be in the future—also moved lower in recent months and is estimated to have been 1.6 percent over the 12 months ending in May. The slowing in core inflation to date reflects particularly low readings in the first three months of the year that appear due to idiosyncratic price declines in a number of specific categories such as apparel, used cars, and banking services and portfolio management services. Indeed, in April and May, core inflation accelerated, posting larger average monthly gains than in the first quarter.

The trimmed mean PCE price index, produced by the Federal Reserve Bank of Dallas, provides an alternative way to purge inflation of transitory influences, and it is less sensitive than the core index to idiosyncratic price movements such as those noted earlier.19 The 12-month change in this measure was 2 percent in May.

Oil prices rebounded through the spring but have moved down recently...

After dropping sharply late last year, the Brent price of crude oil moved up to almost $75 per barrel in mid-April, partly reflecting declines in production in Iran and Venezuela and voluntary supply cuts by other OPEC members and partner countries. More recently, however, prices have fallen back to around $65 per barrel because of concerns about global growth. The changes in oil prices have contributed to similar movements in retail gasoline prices, which rose through early spring but have also fallen back recently.

. . . and prices of imports other than energy fell

Nonfuel import prices, before accounting for the effects of tariffs on the price of imported goods, have continued to decline from their mid-2018 peak, responding to dollar appreciation, lower foreign inflation, and declines in non-oil commodity prices.20 In particular, prices of industrial metals have fallen in recent months, partly on concerns about weak global demand.

Survey-based measures of inflation expectations have been stable...

Expectations of inflation likely influence actual inflation by affecting wage- and price-setting decisions. Survey-based measures of inflation expectations at medium- and longer-term horizons have remained generally stable over the past year. In the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, the median expectation for the annual rate of increase in the PCE price index over the next 10 years has been very close to 2 percent for the past several years. In the University of Michigan Surveys of Consumers, the median value for inflation expectations over the next 5 to 10 years has fluctuated around 2-1/2 percent since the end of 2016, though this level is about 1/4 percentage point lower than had prevailed through 2014. In the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, the median of respondents' expected inflation rate three years hence has fluctuated between 2-1/2 percent and 3 percent over the past five years.

. . . while market-based measures of inflation compensation have come down since the first half of 2018

Inflation expectations can also be gauged by market-based measures of inflation compensation. However, the inference is not straightforward, because market-based measures can be importantly affected by changes in premiums that provide compensation for bearing inflation and liquidity risks. Measures of longer-term inflation compensation—derived either from differences between yields on nominal Treasury securities and those on comparable-maturity Treasury Inflation-Protected Securities (TIPS) or from inflation swaps—tend to fall when markets are volatile because of the incorporation of liquidity risks. Such declines occurred around the turn of the year and again in May and June, when market volatility picked up again. Despite the fluctuations this year, these measures of inflation compensation remain notably below levels that prevailed in the summer of 2018.21 The TIPS-based measure of 5-to-10-year-forward inflation compensation and the analogous measure from inflation swaps are now about 1-3/4 percent and 2 percent, respectively, with both measures below their respective ranges that prevailed for most of the 10 years before the start of the notable declines in mid-2014.22

Real gross domestic product growth was strong in the first quarter, but there are recent signs of slowing

Real gross domestic product (GDP) rose at an annual rate of 3 percent in 2018. In the first quarter, real GDP again moved up at an annual rate of around 3 percent. However, there are indications that growth will moderate in the second quarter.23 Net exports and business inventories provided a sizable boost to first-quarter GDP growth, but their contributions appear to have reversed in the months following. Notably, private domestic final purchases—that is, final purchases by households and businesses, which tend to provide a better indication of future GDP growth than most other components of overall spending—posted only a modest increase in the first quarter. The slowing that occurred in consumer spending appears to have been temporary, but the slowing in business fixed investment appears to be more persistent. Manufacturing output fell in the first quarter, and it moved down further in April before posting a small gain in May. Although lower production levels of motor vehicles and aircraft were important contributors to the weakness, the recent declines in manufacturing were broad based.24 Nevertheless, the economic expansion continues to be abetted by steady job gains, increases in household wealth, expansionary fiscal policy, and still-supportive domestic financial conditions, including moderate borrowing costs and easy access to credit for many households and businesses.

Growth in business fixed investment has softened after strong gains in 2018

Investment spending by businesses rose rapidly in 2018 but appears to have decelerated sharply this year. In the first quarter, growth slowed to an annual rate of 4-1/2 percent, while new orders for nondefense capital goods, excluding the volatile aircraft category, have declined modestly, on balance, in recent months. In addition, forward-looking indicators of business spending such as capital spending plans have deteriorated amid downbeat business sentiment and profit expectations from industry analysts, reportedly reflecting trade tensions and concerns about global growth.

By contrast, activity in the housing sector had been declining but recently shows signs of stabilizing

Residential investment fell in 2018 and declined further in the first quarter. More recently, the pace of construction activity appears to have stabilized as housing starts for single-family and multifamily housing units rose, on average, in April and May. Existing home sales moved higher as well over the same period, while new home sales moved down a bit following a sizable increase in the first quarter. Consumers' perceptions of homebuying conditions and housing affordability have improved, which is consistent with the declines in mortgage rates this year and the slowing in growth of home prices.

Ongoing improvements in the labor market and gains in wealth continue to support household income and consumer spending...

After increasing at a moderate pace of 2-1/2 percent in 2018 as a whole, real consumer spending slowed considerably in the first quarter. However, incoming data suggest that consumer spending picked up in recent months, with PCE in May up at an annual rate of 2-1/2 percent relative to the average level in the fourth quarter.

Real disposable personal income (DPI), a measure of households' after-tax purchasing power, increased at a solid annual rate of 3 percent in 2018; however, so far this year, growth in real DPI has been more moderate despite strong gains in wage and salary income. With consumer spending rising more than disposable income so far this year, the personal saving rate moved down from an average of 6-1/2 percent in the fourth quarter to around 6 percent in May.

Ongoing gains in household wealth have likely continued to support consumer spending. House prices, which are of particular importance for the balance sheet positions of a large portion of households, continued to increase through May, although at a more moderate pace than in recent years. In addition, U.S. equity prices, which fell sharply at the end of 2018, have rebounded this year. Buoyed by increases in home and equity prices, aggregate household net worth moved up to 6.8 times household income in the first quarter.

. . . and consumer sentiment remains strong

Consumers have remained upbeat. Although the Michigan index of consumer sentiment dipped at the turn of the year, it has since rallied, and the sentiment measure from the Conference Board survey also climbed in the second quarter from its first-quarter level. In June, both the Michigan and the Conference Board indexes of consumer sentiment were about in the middle of their ranges over the past few years.

Borrowing conditions for households remain generally favorable...

Despite increases in interest rates for consumer loans and some reported further tightening in credit card lending standards, financing conditions for consumers largely remain supportive of growth in household spending. Consumer credit expanded at a moderate pace in the first quarter, rising faster than disposable income. Mortgage credit has continued to be readily available for households with solid credit profiles but remains noticeably tighter than before the most recent recession for borrowers with low credit scores. Standards for automotive loans have been generally stable, and overall delinquency rates for these loans were little changed in the first quarter at a moderate level. Financing conditions in the student loan market remain firm, with over 90 percent of such credit being extended by the federal government. After peaking in 2013, delinquencies on such loans have been gradually declining, reflecting in part the continued improvements in the labor market.

. . . while corporate financing conditions tightened somewhat relative to last year but remained accommodative overall

Aggregate flows of credit to large nonfinancial firms remained strong in the first quarter, supported in part by relatively low interest rates and accommodative financing conditions. The gross issuance of corporate bonds, which had fallen substantially in December, rebounded in the first quarter as market volatility receded. After increasing notably in late 2018, spreads on both investment- and speculative-grade corporate bonds over comparable-maturity Treasury securities have both declined, on net, this year as investors' risk appetite seems to have recovered. In April, respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices, or SLOOS, reported that demand for commercial and industrial loans weakened in the first quarter even as lending standards remained unchanged and terms for such loans eased.25 However, banks reported tightening lending standards on all categories of commercial real estate loans. Meanwhile, financing conditions for small businesses have remained generally accommodative, but credit growth has been subdued.

Net exports supported GDP growth in the first quarter

After being a small drag on U.S. real GDP growth last year, net exports, which can have sizable swings from quarter to quarter, added about 1 percentage point to the rate of growth in the first quarter. Real U.S. exports increased at an annual rate of about 5-1/2 percent, as exports of agricultural products and automobiles expanded robustly. Real imports fell 2 percent following solid increases in 2018. Nominal goods trade data through May suggest that exports edged down in the second quarter, while imports were about flat. The available data suggest that the trade deficit and the current account in the first half of the year were little changed as a percent of GDP from 2018.

Federal fiscal policy actions boosted economic growth in 2018 but had a smaller effect on first-quarter real GDP because of the partial government shutdown...

Fiscal policy at the federal level boosted GDP growth in 2018 because of lower personal and business income taxes from the Tax Cuts and Jobs Act of 2017 and because of an increase in federal purchases due to the Bipartisan Budget Act of 2018.26 After increasing 2-3/4 percent in 2018, federal government purchases were flat in the first quarter of 2019, reflecting the effects of the partial federal government shutdown. The government shutdown, which was in effect from December 22 through January 25, held down GDP growth in the first quarter, largely because of the lost work of furloughed federal government workers and affected federal contractors. That said, federal purchases are expected to rebound in the second quarter.

The federal unified budget deficit widened in fiscal year 2018 to around 4 percent of nominal GDP from 3-1/2 percent of GDP in 2017 because receipts moved lower, to 16 percent of GDP. Expenditures are currently around 21 percent of GDP, slightly above the level that prevailed in the decade before the start of the 2007–09 recession. The ratio of federal debt held by the public to nominal GDP rose to around 77 percent in fiscal 2018 and was quite elevated relative to historical norms. The Congressional Budget Office projects that this ratio will rise further over the next several years.

. . . and the fiscal position of most state and local governments is stable

The fiscal position of most state and local governments is stable, although there is a range of experiences across these governments. The revenue of state governments has grown moderately in recent quarters, as the economic expansion continues to push up income and sales tax collections. At the local level, property tax collections continue to rise, pushed higher by past house price gains. Real state and local government purchases grew modestly last year; however, outlays have surged so far this year, driven largely by a boost in construction spending. State and local infrastructure spending was weak for many years, and there appears to be demand for higher expenditures in this area. State and local government payrolls expanded slowly last year and over the first five months of 2019, and employment by these governments remains below its peak before the current expansion.

Financial Developments
The expected path of the federal funds rate over the next several years has moved down

Market-based measures of the expected path for the federal funds rate over the next several years have declined substantially since the end of 2018. Various factors contributed to this shift, including increased investor concerns about downside risks to the global economic outlook and rising trade tensions. In addition, investors reportedly interpreted FOMC communications over the first half of 2019 as signaling the Federal Reserve is likely to lower the target range for the federal funds rate in light of muted inflation pressures and uncertainties about the global economic outlook.

Survey-based measures of the expected path of the policy rate also shifted down relative to the levels observed at the end of 2018. According to the results of the most recent Survey of Primary Dealers and Survey of Market Participants, both conducted by the Federal Reserve Bank of New York just before the June FOMC meeting, the median of respondents' modal projections implies a declining trajectory for the target range of the federal funds rate for 2019, which flattens out in 2020. Relative to the December survey, the median of these projections moved down 50 basis points for July 2019 and 100 basis points for December 2019.27 Additionally, market-based measures of uncertainty about the policy rate approximately one to two years ahead increased, on balance, from their levels at the end of last December.

The nominal Treasury yield curve has moved down and continued to flatten

Since the end of 2018, the nominal Treasury yield curve shifted down and flattened further, with the 2-, 5-, and 10-year nominal Treasury yields all declining about 70 basis points on net. The decrease in Treasury yields, which is consistent with the revision in market participants' expectations for the path of policy rates, largely reflects FOMC communications as well as investors' concerns about the global economic outlook and the escalation of trade disputes. Option-implied volatility on swap rates—an indicator of uncertainty about Treasury yields—has increased notably, on net, since the beginning of the year. In particular, measures of near-term interest rate uncertainty have reached the levels seen at the end of 2018.

Yields on 30-year agency mortgage-backed securities (MBS)—an important factor influencing mortgage interest rates—decreased in line with the decline in the 10-year nominal Treasury yield and remained low by historical standards. Likewise, yields on both investment-grade and high-yield corporate debt declined significantly from the levels in late 2018 and stayed very low. Despite widening in May, the spreads on corporate bond yields over comparable-maturity Treasury yields have narrowed, on net, over the first half of 2019 and are close to their historical medians.

Broad equity price indexes increased on net

After declining sharply at the end of 2018, broad U.S. stock market indexes have recovered, on net, over the first half of 2019. The broad rebound in stock prices—which included all major economic sectors—was reportedly supported by Federal Reserve communications that were perceived as more accommodative than previously anticipated. Stocks fluctuated in May and June as downside risks and trade tensions were offset by further expectations of easier monetary policy.

Measures of implied and realized stock price volatility for the S&P 500 index declined notably on net. Following the highs seen at the end of 2018, these volatility measures declined until late April, with the VIX—a measure of implied volatility—returning to near the 10th percentile of its historical distribution and with realized volatility close to the 30th percentile of its historical range. At the beginning of May, following the escalation of trade tensions, these volatility measures increased and have remained elevated since then, but they have stayed well below the high levels of December and now stand close to their historical medians. Several measures of financial conditions that aggregate large sets of financial data into summary indexes eased considerably since the end of 2018 but have tightened a bit since the beginning of May, in line with the decline in stock prices over that month, and have remained relatively elevated since then. (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability" on pages 24–25 of the July 2019 Monetary Policy Report.)

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

Available indicators of Treasury market functioning have generally remained stable since the beginning of 2019, with a variety of measures—including bid-ask spreads, bid sizes, and estimates of transaction costs—displaying few signs of liquidity pressures. Liquidity conditions in the agency MBS market were also generally stable. Credit conditions in municipal bond markets remained stable as well, with yield spreads on 20-year general obligation municipal bonds over comparable-maturity Treasury securities declining somewhat on net.

Money market rates were little changed

Rates across money markets were little changed, on balance, in the first half of 2019. Conditions in domestic short-term funding markets continued to be broadly stable since the end of 2018. Overnight secured and unsecured rates declined in line with the technical adjustment announced after the May FOMC meeting, which lowered the interests paid on required and excess reserve balances by 5 basis points. Other short-term interest rates, including those on commercial paper and negotiable certificates of deposit, were also little changed since the beginning of the year.

Bank credit continued to expand, and bank profitability remained robust

Credit provided by commercial banks to fund businesses as well as commercial and residential real estate continued to grow in 2019, albeit at a slower pace than in the second half of 2018. By contrast, consumer loan growth accelerated since the beginning of the year. In the first quarter of 2019, the pace of total bank credit expansion was about in line with that of nominal GDP, leaving the ratio of total commercial bank credit to current-dollar GDP little changed relative to last December. Overall, measures of bank profitability remained solid in the first quarter of 2019, supported by wider net interest margins and steady loan growth.

International Developments
Advanced foreign economies have been slowly emerging from the recent soft patch

After a significant slowdown in the second half of last year, growth picked up in many advanced foreign economies (AFEs) at the start of 2019, but at a still restrained pace. Notwithstanding continued weakness in the manufacturing sector and softening external demand, domestic demand in the AFEs generally improved amid rising employment and wages as well as easier financial conditions. The pickup in growth also reflected temporary factors. Economic activity in the euro area was boosted by the fading effects of car production disruptions in Germany and protests in France in 2018. Growth in the United Kingdom surged as expectations of trade disruptions surrounding the original date of the United Kingdom's exit from the European Union, or Brexit, led to stockpiling by households and firms. Economic activity in Canada, by contrast, remained depressed by oil production cuts, but recent indicators point to a rebound in growth in the second quarter.

Core inflation remained low in advanced foreign economies

The rebound in energy prices earlier in the year pushed up consumer price inflation in many AFEs. However, despite further improvement in labor market conditions, inflationary pressures remained contained, with core inflation readings notably muted in the euro area and Japan. In Canada and the United Kingdom, by contrast, core inflation rates moved close to 2 percent.

AFE central banks took a more accommodative policy stance

With activity only slowly picking up and core inflation persistently low, European Central Bank (ECB) communications took a more accommodative tone. In March, the ECB indicated that it would keep its policy rate in negative territory through at least the middle of next year and rolled out a new round of loans for euro-area banks to reduce the risk of renewed funding pressures. In June, ECB President Mario Draghi added that the ECB would introduce new stimulus measures if the economic outlook did not improve. The Bank of Canada and Bank of England signaled more-gradual increases in interest rates, given a moderation in the pace of global economic activity. The Reserve Bank of Australia in June and July cut its policy rate in response to below-target inflation and weak economic growth.

Central banks' more accommodative policy stances supported AFE asset prices

The more accommodative policy stance in major AFEs contributed to an overall easing of financial conditions in the first half of the year. Market-implied paths of policy rates and long-term interest rates on sovereign bonds have generally fallen sharply, as in the United States. Broad stock market indexes across AFEs are up, on net, since January. However, concerns about global growth and rising trade tensions weighed on risky asset prices over the course of May and June. Sovereign bond spreads in Italy fluctuated amid uncertainty about the country's fiscal outlook.

Economic activity in emerging Asia struggled to gain a solid footing

In China, real GDP growth picked up in the first quarter, supported in part by fiscal and monetary policy measures that targeted smaller businesses and infrastructure spending, as well as by the more favorable financial conditions amid investor optimism on a U.S.–China trade deal. Recent activity indicators, however, suggest that the underlying momentum in the economy remains relatively subdued against the backdrop of reemerging trade tensions, global weakness in trade and manufacturing, and the Chinese authorities' continued caution about providing substantial further credit stimulus. Amid moderating global trade and activity, real GDP growth in other Asian economies in the first quarter generally remained below their 2018 pace, with growth in Korea turning negative (see the box "The Persistent Slowdown in Global Trade and Manufacturing" on pages 30–31 of the July 2019 Monetary Policy Report).

Latin American economies continued to underperform

In Mexico, real GDP contracted in the first quarter following generally weak performance in the past two years. Tighter fiscal policy and disruptions from labor unrest weighed on activity amid a backdrop of softening U.S. manufacturing demand and persistent declines in petroleum production. Recent indicators suggest some improvement in the second quarter, although uncertainty regarding trade relations with the United States appears to have increased. In Brazil, real GDP also contracted in the first quarter, as a mining disaster and ongoing weakness in the Argentine economy weighed on Brazilian economic activity. Investment continued to decline, held down by uncertainty over whether Brazil's government would enact major fiscal and other economic reforms.

Financial conditions in many emerging market economies improved, on net, despite the reemergence of trade tensions

Financial conditions in many emerging market economies (EMEs) eased earlier in the year in response to the more accommodative policy stance of the Federal Reserve and major AFE central banks. However, in recent months, political uncertainties in some EMEs and renewed trade tensions between the United States and major trading partners have weighed on EME asset prices. On net, broad measures of EME sovereign bond spreads over U.S. Treasury rates are down a little, while benchmark EME equity indexes are a bit higher since the beginning of the year. Flows to dedicated EME mutual funds increased earlier in the year but turned negative in the second quarter. While deteriorations in asset prices and capital flows have been sizable for some economies, particularly Turkey and Argentina, broad indicators of financial stress in EMEs are below those seen during other periods of significant stress in recent years.

The dollar depreciated a little

Over the first half of the year, the foreign exchange value of the U.S. dollar fluctuated but was, on net, a little lower. Increased investor optimism about prospects for trade negotiations early this year as well as downward-revised expectations for U.S. interest rates led to a depreciation of the dollar. But the more accommodative tone of communications from major foreign central banks and safe-haven flows—in part in response to trade tensions and concerns about global growth—helped push the dollar up. In addition, the Chinese renminbi has come under some downward pressure since trade tensions escalated in recent months.

Part 2: Monetary Policy

The FOMC maintained its target range for the federal funds rate

From late 2015 through the end of 2018, the Federal Open Market Committee (FOMC) gradually increased its target range for the federal funds rate as the economy continued to make progress toward the Committee's congressionally mandated objectives of maximum employment and price stability. In its meetings over the first half of 2019, the Committee judged that the stance of monetary policy was appropriate to achieve its dual mandate, and it decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. These decisions reflected incoming information showing the solid fundamentals of the U.S. economy supporting continued growth and strong employment.

Looking ahead, the FOMC will act as appropriate to sustain the expansion, with a strong labor market and inflation near its 2 percent objective

At its meetings since the beginning of the year, the Committee stated that it continued to view a sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes.

At the June meeting, however, the Committee noted that uncertainties about the outlook had increased.28 Since the beginning of May, the tenor of incoming information on economic activity, on balance, has become somewhat more downbeat, and uncertainties about the economic outlook have increased. Growth indicators from around the world have disappointed, on net, raising concerns about the strength of the global economy. Meanwhile, contacts in business and agriculture have reported heightened concerns over trade developments. In light of these uncertainties and muted inflation pressures, the Committee indicated that it will act as appropriate to sustain the expansion, with a strong labor market and inflation near its objective. The Committee is firmly committed to its symmetric 2 percent inflation objective. In the Committee's economic projections released after the June meeting, participants generally revised down their individual assessments of the appropriate path for the policy rate from their assessments at the time of the March meeting (see Part 3 of the July 2019 Monetary Policy Report for more details).

Future changes in the federal funds rate will depend on the economic outlook and risks to the outlook as informed by incoming data

The FOMC has continued to emphasize that the actual path of monetary policy will depend on the evolution of the economic outlook and risks to the outlook as informed by incoming data. Specifically, in deciding on the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and symmetric 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

In addition to weighing a wide range of economic and financial data and information received from business contacts and other informed parties around the country, policymakers regularly consult prescriptions for the interest rate arising from various monetary policy rules. These rule prescriptions can serve as useful guidelines to the FOMC in the course of arriving at its policy decisions. Nonetheless, numerous practical considerations make clear that the FOMC cannot mechanically set the policy rate by following the prescriptions of any specific rule. The FOMC's framework for conducting monetary policy involves a systematic approach in keeping with key principles of good monetary policy but allows for more flexibility than is implied by simple policy rules (see the box "Monetary Policy Rules and Their Interactions with the Economy" on pages 37–41 of the July 2019 Monetary Policy Report).

Since the beginning of the year, the FOMC has issued two statements regarding monetary policy implementation and balance sheet normalization

At its January meeting, the Committee indicated that it intends to continue to implement monetary policy in a regime in which the provision of an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates, and in which active management of the supply of reserves is not required.29 After the March FOMC meeting, the Committee issued a statement indicating that it plans to conclude the reduction of the Federal Reserve's securities holdings at the end of September.30 (The box "Framework for Monetary Policy Implementation and Normalization of the Federal Reserve's Balance Sheet" on pages 42–43 of the July 2019 Monetary Policy Reportdetails the recent decision about policy implementation and balance sheet normalization.)

The Committee is prepared to adjust the details for completing balance sheet normalization in light of economic and financial developments, consistent with its congressionally mandated objectives of maximum employment and price stability.

The Federal Reserve's total assets have continued to decline from about $4.1 trillion last December to about $3.8 trillion at present, with holdings of Treasury securities at approximately $2.1 trillion and holdings of agency debt and agency mortgage-backed securities at approximately $1.5 trillion.

As the Federal Reserve has continued to gradually reduce its securities holdings, the level of reserve balances in the banking system has declined. In particular, the level of reserve balances has decreased by about $150 billion since the end of last year and by about $1.3 trillion since its peak in 2014.31

Meanwhile, interest income on the Federal Reserve's securities holdings has continued to result in sizable remittances to the U.S. Treasury. Preliminary data indicate that the Federal Reserve remitted about $27 billion in the first half of 2019.

The Federal Reserve's implementation of monetary policy has continued smoothly

Since the middle of March, the effective federal funds rate has traded slightly above the interest rate paid on reserve balances. At the May meeting, the Committee made a third small technical adjustment to lower the setting of the interest rate on excess reserves by 5 basis points to a level 15 basis points below the top of the target range for the federal funds rate; this adjustment successfully fostered trading in the federal funds market at rates well within the FOMC's target range. Overall, rates across money markets were broadly stable since the beginning of 2019, and the usage of the overnight reverse repurchase agreement facility has remained low.

The Federal Reserve has started the review of its strategic framework for monetary policy

With labor market conditions close to maximum employment and inflation near the Committee's 2 percent objective, the FOMC judged it an appropriate time for the Federal Reserve to conduct a public review of its strategic framework for monetary policy—including the policy strategy, tools, and communication practices. The goal of this assessment is to identify possible ways to improve the Committee's current policy framework in order to ensure that the Federal Reserve is best positioned going forward to achieve its statutory mandate of maximum employment and price stability.

The review includes outreach to and consultation with a broad range of people and groups interested in the U.S. economy. The Federal Reserve System is currently conducting a series of Fed Listens events around the country, typically with a town hall format, to hear perspectives from representatives of business and industry, labor leaders, community and economic development officials, academics, nonprofit organization executives, and others. Policymakers plan to report their findings to the public during the first half of 2020.

Footnotes

 1. The annual benchmark revision to payroll employment will be published on February 7, after this report has gone to print. According to the Bureau of Labor Statistics' preliminary estimates, increases in payrolls will be revised downward roughly 40,000 per month from April 2018 through March 2019. Payroll figures after March 2019 are subject to revision as well. Return to text

 2. To keep up with population growth, roughly 115,000 to 145,000 payroll jobs per month need to be created, on average, to maintain a constant unemployment rate with an unchangedlabor force participation rate. There is considerable uncertainty around these estimates, as the difference between monthly payroll gains and employment changes from the Current Population Survey (the source of the unemployment and participation rates) can be quite volatile over short periods. Return to text

 3. See the most recent economic projections that were released after the December FOMC meeting in Part 3 of the February 2020 Monetary Policy ReportReturn to text

 4. The Atlanta Fed's measure differs from others in that it measures the wage growth only of workers who were employed both in the current survey month and 12 months earlier. Return to text

 5. The trimmed mean index excludes prices that showed particularly large increases or decreases in a given month. Note that, since 1995, 12-month changes in the trimmed mean index have averaged about 0.3 percentage point above core PCE inflation and 0.2 percentage point above total PCE inflation. Return to text

 6. Published import price indexes exclude tariffs. However, tariffs add to the prices that purchasers of imports actually pay, and tariff-inclusive import prices have likely increased, rather than declined, since mid-2018. Return to text

 7. Inflation compensation implied by the TIPS breakeven inflation rate is based on the difference, at comparable maturities, between yields on nominal Treasury securities and yields on TIPS, which are indexed to the total consumer price index (CPI). Inflation swaps are contracts in which one party makes payments of certain fixed nominal amounts in exchange for cash flows that are indexed to cumulative CPI inflation over some horizon. Inflation compensation derived from inflation swaps typically exceeds TIPS-based compensation, but week-to-week movements in the two measures are highly correlated. Return to text

 8. As these measures are based on CPI inflation, one should probably subtract about 1/4 percentage point—the average differential with PCE inflation over the past two decades—to infer inflation compensation on a PCE basis. Return to text

 9. The Congressional Budget Office (CBO) estimated that the Tax Cuts and Jobs Act would reduce annual tax revenue by around 1 percent of GDP, on average, from fiscal years 2018 through 2021. This revenue projection includes the CBO's estimated macroeconomic effects of the legislation, which add almost 1/4 percentage point to GDP growth, on average, over the same period. 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 https://www.newyorkfed.org/markets/primarydealer_survey_questions.html and https://www.newyorkfed.org/markets/survey_market_participants, respectively. Return to text

 11. See the FOMC statements issued after the July, September, and October meetings, which are available (along with other postmeeting statements) on the Monetary Policy portion of the Board's website at https://www.federalreserve.gov/monetarypolicy.htmReturn to text

 12. The Committee had initially indicated in its Balance Sheet Normalization Principles and Plans, issued in March 2019, that it intended to conclude the reduction of its aggregate securities holdings in the System Open Market Account at the end of September 2019. The document is available on the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/monetary20190320c.htmReturn to text

 13. See the Balance Sheet Normalization Principles and Plans in note 12. Since August, the Federal Reserve has reinvested, on average, about $7 billion per month in agency MBS. Return to text

 14. Owing to population growth, roughly 115,000 to 145,000 jobs per month need to be created, on average, to keep the unemployment rate constant with an unchangedlabor force participation rate. However, the participation rate fell over the December to May period, reducing the number of job gains that would have been needed. There is considerable uncertainty around these estimates, as the difference between monthly payroll gains and employment changes from the Current Population Survey (the source of the unemployment and participation rates) can be quite volatile over short periods. Return to text

 15. See the most recent economic projections that were released after the June FOMC meeting in Part 3 of the July 2019 Monetary Policy ReportReturn to text

 16. The Atlanta Fed's measure differs from others in that it measures the wage growth only of workers who were employed both in the current survey month and 12 months earlier. Return to text

 17. In the first quarter, labor productivity surged 3-1/2 percent at an annual rate, bringing the four-quarter change to 2-1/2 percent, reflecting a strong pickup in business-sector output and unusual weakness in hours relative to measured gains in payroll employment. This weakness is attributable to a steep decline in a volatile component of hours that is not directly measured in the Bureau of Labor Statistics' establishment survey. Return to text

 18. The increases in tariffs on imported goods last year likely provided only a small boost to inflation in 2018 and in the first half of this year. Return to text

 19. The trimmed mean index excludes whichever prices showed the largest increases or decreases in a given month. Note that, since 1995, changes in the trimmed mean index have averaged about 0.3 percentage point above core PCE inflation and 0.2 percentage point above total PCE inflation. Return to text

 20. Published import price indexes exclude tariffs. However, tariffs add to the prices that purchasers of imports actually pay. Return to text

 21. Inflation compensation implied by the TIPS breakeven inflation rate is based on the difference, at comparable maturities, between yields on nominal Treasury securities and yields on TIPS, which are indexed to the total consumer price index (CPI). Inflation swaps are contracts in which one party makes payments of certain fixed nominal amounts in exchange for cash flows that are indexed to cumulative CPI inflation over some horizon. Inflation compensation derived from inflation swaps typically exceeds TIPS-based compensation, but week-to-week movements in the two measures are highly correlated. Return to text

 22. As these measures are based on the CPI inflation index, one should probably subtract about 1/4 percentage point—the average differential with PCE inflation and CPI inflation over the past two decades—to infer inflation compensation on a PCE price basis. Return to text

 23. It is worth noting that gross domestic income (GDI) has been notably weaker than GDP. GDI is reported to have risen only 1.7 percent in the first quarter relative to the same period of a year ago, 1-1/2 percentage points less than measured GDP growth. GDP and GDI measure the same economic concept, and any difference between the two figures reflects measurement error. Return to text

 24. Recently, a large aircraft manufacturer slowed its production and temporarily halted deliveries of an aircraft model. This production slowdown lowers manufacturing output and generates a small drag on real GDP growth in the first half of the year. Return to text

 25. The SLOOS is available on the Board's website at https://www.federalreserve.gov/data/sloos/sloos.htmReturn to text

 26. The Joint Committee on Taxation estimated that the Tax Cuts and Jobs Act would reduce average annual tax revenue by a little more than 1 percent of GDP starting in 2018 and for several years thereafter. This revenue estimate does not account for the potential macroeconomic effects of the legislation. Return to text

 27. 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 https://www.newyorkfed.org/markets/primarydealer_survey_questions.html and https://www.newyorkfed.org/markets/survey_market_participants, respectively. Return to text

 28. See the FOMC statement issued after the June meeting, which is available on the Monetary Policy portion of the Board's website at https://www.federalreserve.gov/monetarypolicy.htmReturn to text

 29. See the Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization, which is available on the Board's website at https://www.federalreserve.gov/monetarypolicy/policy-normalization.htmReturn to text

 30. See the Balance Sheet Normalization Principles and Plans, which can be found on the Board's website at https://www.federalreserve.gov/monetarypolicy/policy-normalization.htmReturn to text

 31. Since the start of the normalization program, reserve balances have dropped by approximately $700 billion. Return to text

Back to Top
Last Update: July 16, 2020