Patience: a virtue in normalizing monetary policy

Economic Pulse
December 18, 2014
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Yesterday’s announcement from the Federal Open Market Committee (FOMC) marked the first step in eventual monetary policy tightening. The Committee judged that it “can be patient in beginning to normalize the stance of monetary policy”—guidance it saw as “consistent” with its previous statement that a 0 to 1/4 percent target range for the Fed Funds rate would be appropriate for a “considerable time” following the end of the asset purchase program in October. In this way, the statement managed to assuage those who feared an imminent rate hike in Q1 2015, while still setting up a backdrop for an eventual increase in the target rate—perhaps sometime in Q2 2015.

The U.S. bond and equity markets reacted favorably to the announcement, in large part because more optimistic forecasts were accompanied by a slower pace of rate hikes than had been forecast in September. While expectations for GDP growth over the next several years were largely unchanged from earlier forecasts, unemployment rate expectations were trimmed by 0.1 to 0.3 percentage points for the next two years as expectations for inflation remained tame, suggesting limited pass-through from any upward wage pressures. The median policy rate at the end of 2016, which the FOMC had forecast at 2.875% in September, was revised to just 2.50% with yesterday’s forecast.

Chart 1. Economic Projections of Federal Reserve Board Members and Presidents, December 2014 and Prior
Economic Projections of Federal Reserve Board Members and Presidents, December 2014 and Prior

Note: Excludes the three highest and three lowest projections for each variable in each year (except average and median Fed Funds rate figures, which include all participants.)
Bolded figures are December 2014 forecasts (versus September 2014).
Arrows (↑,↓ and ≈ ) indicate direction of change in forecast from September 2014 to December 2014.
Real GDP and inflation projections are from Q4 of the previous year to Q4 of the year indicated. PCE inflation refers to the price index for personal consumption expenditures. Projections for the unemployment rate are for the average rate during Q4 of the year indicated.

As a reminder: once “Policy Normalization” begins, the Committee has stated that it will: 1) move the target rate by adjusting (upward) the interest rate it pays on excess reserves, 2) use overnight reverse repo agreements, and 3) reduce its securities holdings by ceasing to reinvest principal repayments.