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Taking Stock Of The Fed's Policy Stance During The Current Recovery

The year 2020 was an extraordinary one for the U.S. Federal Reserve (Fed) due to its critical role in addressing financial market volatility. Unlike the Great Recession of 2008–2009, which was triggered by a housing bubble, the 2020 recession had its origins in a pandemic. Efforts to control the spread of COVID-19 led to a partial lockdown of the economy, which, in turn, froze the financial markets. As the crisis unfolded, the focus of policymakers was one of prioritizing smooth market-functioning to minimize market dislocations. For the most part, they were able to execute this strategy effectively. The widely followed St. Louis Fed Financial Stress Index was relatively high during the summer, but has since returned to baseline levels (see chart 1).

Now that the stress level in the financial markets has subsided to lower-than-average levels, the Fed's focus has shifted to returning the economy to a state of maximum "inclusive" employment.(i) With current core personal consumption expenditure (PCE) inflation at 1.4% as of February and the unemployment rate at 6.0% in March (versus 3.5% pre-pandemic, the lowest in a half-century), the Fed is still far from its dual goal of sustained inflation of 2% and maximum employment. The composite level of labor market activity (which provides a wholistic picture of the labor market beyond the unemployment rate), measured by the Kansas City Fed's Labor Market Conditions Index (LMCI), remains shy of its historical average—a shortfall that is magnified when considering that the Fed's guidepost is the pre-pandemic level, not just the historical average. This implies that there is still a substantial recovery that needs to come about before the Fed will ease up on its current monetary policy stance (see chart 2).

Chart 1

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Chart 2

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The Fed's Moves Since The Onset Of COVID-19

With this macro-financial backdrop in mind, we have taken stock of the Fed's overall monetary stance one year since the onset of the pandemic. When the COVID-19 pandemic first began to affect the U.S. economy, the Fed cut the federal funds rate (the benchmark policy rate for other short-term rates) to an effective zero-lower bound (see chart 3), deployed large-scale asset purchases of government bonds, and employed a wide array of temporary regulatory changes and emergency lending programs in conjunction with the Treasury Department. The introduction of new programs, such as the Primary Market Corporate Credit Facility and Main Street Lending programs, strongly signaled the Fed's willingness to be a backstop lender. While the emergency lending facilities brought the intended response of stability to the markets, the utilization levels were low (see table 1).

Chart 3

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Chart 4

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Table 1

Federal Reserve Policy Support During COVID-19
Since Feb. 26, 2020
Program/facility Targeted sector Purchases, direct lending, or SPV Description Announced Treasury support (Bil. $) Capacity Significant announcement Termination Balance (as of 3/17/2021) (Bil. $)
Asset purchases(i)(ii) Treasuries, agency MBS Purchases Outright purchases of Treasuries and MBS (residential and commercial) 0 Not stated Several -- 3,287.2
Repurchase agreements(i) Short-term loans to financial intermediaries Direct loans 0 Not stated Several -- 0.0
Discount window(i) Banks Direct loans 0 Not stated 3/15/20 -- 0.9
Commercial paper funding facility(i) Commercial paper SPV Purchase commercial paper from eligible issuers 10 Not stated 3/17/20 3/31/21 8.6
Primary dealer credit facility(i) Primary dealers/liquidity Direct loans "Discount window" to primary dealers 0 Not stated 3/17/20 12/31/20 0.1
Money market mutual fund liquidity facility(i) Money market mutual funds SPV Lending facility that helps money market funds meet redemptions 10 Not stated, but likely unlimited 3/18/20 12/31/20 0.6
Term asset-backed securities loan facility(i) Asset-backed securities SPV Lending facility that takes ABS as collateral 10 Up to $100 billion 3/23/20 12/31/20 5.6
Central bank swap lines(i) Central banks/dollar liquidity Direct loans Unsecured lending of dollars to foreign central banks 0 Not stated 3/15/20, 3/19/20 9/30/21 0.8
FIMA repo facility Foreign monetary/Treasury liquidity Direct loans Secured lending of dollars to foreign central banks 0 Not stated 3/31/20 9/30/21 0.0
Paycheck Protection Program (PPP) liquidity facility Bank loans to small businesses for PPP Direct loans Lending facility that takes PPP loans as collateral 0 Limited by PPP, $659 billion 4/6/20 3/31/21 55.6
Corporate credit facilities Corporate debt SPV Purchase corporate bonds from eligible issuers in the primary and secondary market 75 Up to $750 billion 3/23/20 12/31/20 26.0
Main Street loan facilities Small to midsize businesses SPV Provide loans to small and mid-sized business 75 Up to $600 billion 3/23/20, 4/9/20 1/8/21 30.9
Municipal liquidity facility Municipal debt SPV Purchase short-term municipal notes from eligible issuers 35 Up to $500 billion 4/9/20 12/31/20 11.6
Total 215 >$2,609 bil. 3,427.8
Note: The CARES Act authorized Treasury to provide up to $454 billion in equity investment in the Fed's emergency lending facilities. So far $215 has been earmarked officially, although some of this may be held in reserve in case losses are bigger than expected in some of the programs. (i)Similar to analogous programs used to provide support during the 2008–2009 financial crisis. (ii)Asset purchases since Feb. 26, 2020. Total Treasuries plus Agency MBS stands at $7.135 trillion as of March 17, 2021. SPV--Special purpose vehicle. MBS--Mortgage-backed securities. ABS--Asset-backed securities.
Source: The Federal Reserve H.4.1 Statistical Release, IHS Markit, S&P Global Economics.

Regardless, these Fed actions cushioned the blow of the fallout from the pandemic as they: lowered the cost of borrowing across the yield curve, facilitated smooth functioning of financial markets, averted a freeze on bank lending, and supported funding to small businesses, companies, and state and local authorities. In many cases, the announcement of Fed support has itself caused conditions in targeted financial sectors to improve. The result has been narrower bond bid-ask spreads, declines in risk spreads, and more orderly trading in markets for risky assets. Arguably, the Fed effectively signaled its intentions and thus has needed to carry out fewer market/program operations.(ii)

That said, it is the quantitative easing (QE) that has done most of the heavy lifting, especially with the policy rate restricted at a zero effective lower bound. Specifically, the central bank deliberately expands the size of its balance sheet to ease monetary conditions by acquiring assets (usually government debt securities, but in principle any asset) paid for by creating reserves.(iii) This process has no limit or, more accurately, the only theoretical limit is the stock of assets in existence. The Fed's balance sheet has increased by more than $3 trillion in the 12 months since the onset of crisis. That is, the Fed dramatically accumulated assets on its balance sheet to stave off a liquidity crunch.

When the New York Fed starts implementing QE, it appeals to primary dealers (the big banks) to continue making markets for the Fed, essentially encouraging them to purchase Treasuries and other bonds. In return, the Fed gives them reserve deposits by swapping those bonds.(iv) The Fed essentially backstops the financial system, reducing the likelihood that a crisis develops into a banking panic, which, in turn, could lead to mass businesses failures.

Since late February 2020, the Fed has poured sufficient liquidity into the banking system, as indicated by the doubling of excess reserves at banks (by $1.6 trillion) over the last several months to a total of $3.3 trillion (see chart 5). Swings in the U.S. government's general account also matter on the level of bank reserves. The U.S. Treasury was sitting on a $1.6 trillion pile of deposits as recently as in February--ready to be disbursed--with the Treasury's bill issuance outpacing release of the funds. Currently, after stimulus check transfers to households went through, the government has $1.1 trillion in cash and intends to run it down to a target balance of $500 billion. If the target is met, it would add to the banking sector's reserve liquidity buffers by $600 billion. (Bank reserves go up when government deposits go down; net government transfers to the public show up in commercial bank deposits.)

Chart 5

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Currently, most of these emergency lending programs have expired. This leaves the policy rate and QE as the tools still active in supporting the recovery.(v) The federal funds rate is set at a target of 0%-0.25%, together with ongoing large-scale asset purchases (LSAP) of approximately $120 billion in assets per month, broken out as $80 billion in Treasury securities and $40 billion in agency mortgage-backed securities, in order to support the flow of credit to households and businesses.(vi)

Monetary Policy Gas Pedal Firmly Entrenched In Forward Guidance

Via its post-meeting statements, the Fed communicates to the public the likely course of its monetary policy. In this way, individuals and businesses can make informed decisions about spending and investing. This practice, called forward guidance, has been used since the early 2000s (see table 2).(vii)

Table 2

Federal Funds Rate: Forward Guidance And Futures Implied Rate
Notable dates
Date Futures implied federal funds rate (30 days) (%) Fed guidance
1/16/2008 4.135 Exceptionally low for some time
3/18/2009 0.203 For an extended period
8/9/2011 0.088 At least through mid-2013
1/25/2012 0.082 At least through late-2014
9/13/2012 0.142 At least through mid-2015
12/12/2012 0.157 Threshold-based guidance
3/19/2014 0.078 Considerable time afer LSAP ends
12/17/2014 0.115 Patient
3/18/2015 0.118 Further labor improvement
7/29/2015 0.130 Some further labor improvement
10/28/2015 0.125 At its next meeting
12/16/2015 0.233 Only gradual increases
3/15/2017 0.785 Gradual increases
1/31/2018 1.413 Further gradual increases
6/13/2018 1.820 Forward guidance largely eliminated
1/30/2019 2.403 Will be patient
6/19/2019 2.373 Will monitor
1/29/2020 1.553 Current stance appropriate
3/15/2020 0.720 Maintain until weather events
9/16/2020 0.093 Until max employment, inflation 2% and on track to exceed for some time

Forward guidance provides information about the course of policy tools, which influences other market interest rates. In this sense, it functions in a similar way to standard monetary policy. In contrast to conventional measures employed by the Fed, however, forward guidance is subject to a greater risk of misinterpretation. For example, if the Fed states that it will extend the period of low rates, this could be taken as a signal of an even weaker economic outlook. In such a situation, forward guidance could have a negative impact on economic sentiment and could end up lowering economic demand.

The policy statement following the April 27-28 Federal Open Market Committee (FOMC) meeting and the summary of forecasts published (quarterly) following the March 16–17 FOMC meeting underscored the FOMC's accommodative forward guidance on overall interest rate policy since September. Specifically, the conditions for lift-off are: the economy reaches maximum employment, inflation rises to 2%, and policymakers are confident that inflation will stay moderately above 2% for some time. Unlike in the past, policy will not tighten solely because the unemployment rate has fallen below any particular econometric estimate of its long-run natural level and/or 2% inflation is met or expected in the near term. The Fed's latest summary of economic projections suggests the Fed is highly unlikely to raise rates this year or next despite a stronger economy. This is also consistent with the Fed's updated monetary policy framework announced last August, which calls for a patient approach to rake hikes.

There had been speculation among some market participants that the FOMC may soon announce plans to taper its asset purchases; however, there was no mention of tapering in the April statement. Rather, the FOMC reaffirmed that the Fed will continue to purchase assets at the current monthly rate (at least) "until substantial further progress has been made toward the committee's maximum employment and price stability goals." It is not exactly clear what constitutes "substantial further progress," however. In the last monetary cycle, when the Fed began tapering (in 2013), total nonfarm payrolls were 0.7% below the pre-recession peak (in January 2008). Currently, payrolls are 5.5% below their pre-pandemic peak, which translates into a shortfall of 8.4 million jobs. Using the last monetary cycle as guidance, this implies that tapering is at least seven million jobs away--likely a 2022 event at the earliest.

The forward guidance is consistent with the Fed's new strategic framework, which favors higher inflation and reflects the Fed's fears of prematurely unwinding its expansive policies in a way that would jar financial markets and interfere with the "inclusive for all" economic recovery. The Fed has voiced its appreciation for the benefits of a strong labor market during the past year, particularly for many in low- and moderate-income communities.(viii)

A More Accommodative Monetary Policy Than During The Great Financial Crisis

Monetary policy is said to be "accommodative" when interest rates are reduced to a level at which economic growth is encouraged, fostering a reduction of unemployment (or at least preventing it from rising). With the implementation of policies such as LSAP and forward guidance, there currently is no single directly observable indicator that can summarize the stance of policy. One way to evaluate the monetary stance is to compare the prescriptions from a Taylor-type policy rule estimated over a period of relative macroeconomic stability with shadow short rates.(ix)

Shadow short rates provide an estimate of what the federal funds rate would be, given asset purchases and forward guidance, when the federal funds rate is at the effective lower bound of zero and could not be negative (see chart 6). More precisely, it represents the policy rate that would generate the observed yield curve if the zero lower bound were not binding. Comparing the prescriptions from the estimated rules with the shadow federal funds rate provides insight into whether LSAP and forward guidance provided enough accommodation to overcome the zero lower bound constraint on the federal funds rate.

We estimated an ordinary least squares (OLS) framework using a specification of the Taylor Rule that reflects the Federal Reserve's dual mandate of price stability and maximum employment (see table 3). It prescribes a setting for the federal funds rate that depends on (1) the deviation of inflation from the FOMC's medium- to long-term objective of 2% (although this mandate has slightly shifted since the August FOMC meeting when the 2% target was taken as an average rather than an absolute bound) and (2) two indicators of labor market activity (momentum and level) that summarize a wide range of variables (principal component of 24 variables, published by the Kansas Fed). The composite labor market indicators replace the unemployment or output gaps traditionally used in policy rules based on the concern that the current unemployment rate may not be a reliable indicator of economic slack and that the output gap is difficult to measure in real time.

Chart 6

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Table 3

Regression Model Output
Dependent: Fed funds rate
Coefficients Newey-West std errors p-value
Rstar 1.64 0.12 0.00
Inflation gap 0.88 0.49 0.08
Labor market conditions index level 1.54 0.42 0.00
Labor market conditions index momentum (0.12) 0.28 0.66
Number of observations: 111.

Even with the QE policies currently in place, the shadow rate indicates that the stance of monetary policy was less accommodative than prescribed during the period 2008–2011, and it wasn't until after 2011 that monetary policy became more accommodative. In the period during and immediately following the Great Financial Crisis, Krippner's shadow short rates were above the prescription. During the recent crisis, however, the opposite is true. These results suggest that even with the deployment of unconventional tools, monetary policy was not necessarily accommodative and constrained recovery during early periods after the Great Recession. This time around, we find the economy is given the accommodation it needs to recover.

Fed Announcements Tighten Corporate Spreads

While there are many ways to measure the impact of forward guidance on the health of the economy, a simple idea is to construct a linear framework that determines the impact of Fed announcements on corporate bond spreads, while controlling for various economic variables. The dependent variable in the linear framework is taken to be corporate bond spreads, which are a measure of investor sentiment: With increased market uncertainty, risky bond spreads tend to widen as demand for these credit instruments wanes.

Our sample set includes over 10,500 S&P Global Ratings-rated bonds with a tenor of one year or more issued in the U.S. corporate bond market. (For this survey, we have included only those bonds that had face amounts outstanding of at least $100 million denominated in U.S. dollars and traded in U.S. bond markets.) Some of the issues may have embedded call, put, and sinking fund options, and the coupons are all fixed rate. The sample excludes convertibles, step-ups, and preferred securities.

Other than the Fed announcements, the most important predictors of corporate bond spreads were found to be the U.S. GDP, Inflation-Consumer Price Index (CPI), the 10-Year Treasury bond yield, the unemployment rate, and the degree to which the Treasury purchases securities. These five covariates were transformed into relative changes (expressed in percent terms), which appear to be largely stationary. All series have a monthly frequency.

The focus variable (Fed announcements) was taken to be a binary indicator: unity if the Fed made an announcement during a month of observation, and zero otherwise. Because the corporate bond spreads and the other control variables were either monthly averages or values taken at the end or beginning of the month of observation, we lagged them by one month (as appropriate) such that we could detect a causal relationship between the bond spreads and the Fed announcements.

The frameworks

To determine the relationship between corporate bond spreads and Fed announcements, we used a multivariate linear regression with autoregressive integrated moving average (ARIMA) errors. In addition to being stationary, the covariates exhibited only minimal collinearity as evidenced by the correlation matrix.

We carried out separate regressions for investment-grade and non-investment-grade series, allowing the framework structure to vary in such a way that the degree of autoregression, integration, and moving averaging was determined by the best fit, as measured by the Aikake Information Criterion (AIC).

The final frameworks for investment-grade (IG) spreads and speculative-grade (SG) spreads are shown below. Note that the IG framework employs one degree of autoregression and one degree of averaging, while the SG framework employs only one degree of averaging. Neither framework is integrated.

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Results

The framework fits are presented in table 4. While the standard errors may appear wide, this is acceptable in the context of this type of analysis, in which we are focusing on the best overall fit. Most important are the sizes and signs of the fitted parameters, which are consistent between the two regressions. The only notable difference is that the SG framework has no intercept.

Table 4

Framework Fits
Investment-grade bond spread
Covariate Intercept AR MA Treasury Purchase GDP CPI 10-Year Yield FOMC Announcement UER
Estimate (2.4832) (0.4874) 0.7097 0.7450 (0.9507) 14.9818 (0.3152) (1.8324) 0.1928
S.E. 1.2859 0.2028 0.1612 0.0854 0.8310 7.1213 0.0661 1.3939 0.1677
Speculative-grade bond spread
Covariate Intercept AR MA Treasury Purchase GDP CPI 10-Year Yield FOMC Announcement UER
Estimate 0.1543 0.5899 (1.8726) 4.9818 (0.3834) (2.0003) 0.2149
S.E. 0.0854 0.1060 1.0869 4.1829 0.0843 1.7966 0.2187

We observe that the impact of the Fed announcement is negatively correlated with corporate bond spread movements. That is, an announcement--regardless of content in the prior month--has the effect of tightening spreads. This is consistent with the hypothesis that the Fed is injecting clarity and information into a volatile market. The announcement assuages investor fears to some extent, encouraging them to either buy more, or sell less, corporate debt.

Further, we see that Treasury bond purchases tend to increase when spreads widen, which makes sense because both actions are associated with market uncertainty and weakening. Similarly, spreads tend to widen as the GDP falls and as unemployment increases. The 10-year Treasury note yield, meanwhile, tends to fall with market volatility. The movement out of corporate bonds and into (perceived) credit-risk-free Treasury notes explains the negative coefficient. However, the Fed is also responsible for some of this bond buying. Inflation appears to widen with increasing bond spreads, which could be a result of increased inflation risk premiums.

This framework produces forecasts of the dependent variable (corporate bond spreads). These would typically take the form of scenario analyses: By assuming reasonable future paths of the control variables, expected bond spreads could be projected up to several years into the future. Although assuming paths for such variables as inflation and unemployment is somewhat straightforward, anticipating dates for which the Fed will make announcements is nearly impossible. Because such a forecasting framework would be largely driven by baseless assumptions, we have refrained from providing it here. Nevertheless, the framework is instructive in that it suggests that the Fed's forward guidance has been effective in stabilizing markets.

What The New Monetary Framework Means For The Policy Rate Outlook

The Fed's revised monetary policy operational framework incorporates two key changes: (1) a shift to flexible average inflation targeting (FAIT), and (2) a move to a "patient shortfall" strategy. FAIT resembles a shift in the direction of price-level targeting in which the FOMC intends to make up for past inflation misses. Patient shortfall strategy is best explained by Fed Governor Brainard in her September speech: "…the strategy of increased patience, embedded in language that focuses on employment shortfalls rather than deviations--that reflects reduced willingness to act preemptively against inflation when the unemployment rate declines below estimates of its sustainable level."

In other words, under the revised framework, the Fed will not raise rates, even when the unemployment rate falls below the estimated nonaccelerating inflation rate of employment level (approximately 4%) until inflation is persistently above the 2% target, in order to meet the target on average over a period of time, making up for past shortfalls from the target. The Fed will instead focus on shortfalls from maximum employment--described as a "broad-based and inclusive goal that is not directly measurable and changes over time" (not just the standard unemployment rate), and wait to see evidence of labor market-driven inflation before it tightens policy on those grounds.

The Fed's introduction of FAIT comes after its failure to meet its inflation target of 2% since 2012 when it was officially codified (the average inflation since 2012 has been only 1.4%). The persistent undershoot may have helped in lowering market-based inflation expectations as well. Until now, the Fed did not attempt to compensate for undershooting the inflation target, at least officially, even though Chairman Powell reiterated time and again in his speeches that the Fed would let inflation overshoot that target. By not codifying in a statement, the Fed appeared to be treating the 2% inflation target as a ceiling in that it tightened policy to prevent inflation from rising above 2%. Now the policy allows for overshooting and the Fed's average inflation target will become more of a backward-looking exercise. In other words, if inflation was undershooting the target in the past, it will catch up in the future by overshooting the target in order to bring average inflation to 2%. The effect of FAIT, then, is to raise inflation target when inflation is low.

The FAIT framework is implemented not only through the aforementioned outcome-based conditions for the liftoff of the policy rate, but also through the commitment that monetary policy will remain accommodative after liftoff for some time in order to achieve "inflation moderately above 2% for some time so that inflation averages 2% over time." This is consistent with longer-term inflation expectations anchored at 2%. This implies there likely will be a period after liftoff when the policy rate remains below neutral to support the inflation makeup strategy and maximum employment.(x)

Governor Brainard further stated, "By eliminating the rationale for removing accommodation preemptively when the unemployment rate nears estimates of the natural rate in anticipation of high inflation that is unlikely to materialize, the new framework will avoid an unwarranted loss of opportunity for many Americans. The broad-based and inclusive definition of maximum employment calls for a more comprehensive assessment of areas of slack in the labor market, such as the disparities in employment outcomes… by gender, race, occupation, and education level."

Since the announcement of the new monetary framework, the Fed hasn't been entirely clear on several points, such as what time frame to use for averaging inflation, what constitutes a "moderate" overshoot of 2% inflation, and how the employment and inflation will be interpreted in policymaking if there is a conflict (such as stagflation). This leaves the Fed with plenty room for discretion.

S&P Global Ratings economists expect the Fed to sustain its current accommodative policies over the near term. Keeping in mind the new guidance that incorporates the new framework, our forecast of employment and inflation suggests that the first rate hike in this cycle will not come before mid-2023 (see "Economic Outlook U.S. Q2 2021: Let The Good Times Roll," March 24, 2021). The unemployment rate, which is forecast to be under 5% by 2021 year-end, will likely remain short of the pre-pandemic level of 3.5% throughout 2022, after which it should start to approach the inclusive full-employment level. Consumer price inflation as measured by the Personal Consumption Expenditures Price Index is forecast to average 2.5% for 2021 and 2022, which is slightly above the Fed's target of 2%, but more or less on target when the average includes the shortfalls of 2019 and 2020.

Appendix

Forward guidance on policy interest rate
  • Dec. 16, 2008: The FOMC lowers its target for the federal funds rate to a range of 0%-0.25%, which the FOMC considers to be an effective lower bound. In addition, the FOMC states that "weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."
  • March 18, 2009: The FOMC replaces "for some time" with "for an extended period" in its post-meeting statement.
  • Aug. 9, 2011: The FOMC announces it will likely keep the federal funds rate at exceptionally low levels "at least through mid 2013."
  • Jan. 25, 2012: The FOMC replaces "at least through mid-2013" with "at least through late 2014."
  • Sept. 13, 2012: In conjunction with the announcement of its third large-scale asset purchase program (LSAP3), the FOMC states that it "expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens." In addition, it indicates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.
  • Dec. 12, 2012: In conjunction with the announcement of the extension of longer-term Treasury purchases under LSAP3, the FOMC introduces threshold-based forward guidance by stating that it expects to keep the federal funds rate between a range of 0%-0.25% percent and that it anticipates that this exceptionally low range would be maintained at least as long as: "the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the FOMC's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored."
  • Dec. 18, 2013: The FOMC announces that it will likely "be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the FOMC's 2% longer-run goal."
  • March 19, 2014: The FOMC replaces its threshold-based forward guidance with the statement that it expects it likely will be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the FOMC's 2% longer-run goal, and provided that longer-term inflation expectations remain well anchored." The FOMC also states its anticipation that "even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the FOMC views as normal in the longer run."
  • Oct. 29, 2014: The FOMC states that "it likely will be appropriate to maintain the 0%-0.25% target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the FOMC's 2% longer-run goal, and provided that longer-term inflation expectations remain well anchored." The conditional nature of this period is emphasized: "However, if incoming information indicates faster progress toward the FOMC's employment and inflation objectives than the FOMC now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated."
  • Dec. 17, 2014: The FOMC announces that "it can be patient in beginning to normalize the stance of monetary policy."
  • March 18, 2015: The FOMC replaces the indication that "it can be patient" with the indication that an increase in the target range "remains unlikely at the April FOMC meeting" and that such an increase will be appropriate when the FOMC "has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term." The FOMC further indicates that this change in the forward guidance "does not indicate that the FOMC has decided on the timing of the initial increase in the target range."
  • July 29, 2015: The FOMC alters the guidance referring to "further improvement" in the labor market to "some further improvement."
  • Oct. 28, 2015: The FOMC replaces the clause "how long it will be appropriate to maintain [the target range]" with "whether it will be appropriate to raise the target range at its next meeting."
  • Dec. 16, 2015: The FOMC raises the target range for the first time since before the financial crisis. The FOMC indicates that "the stance of monetary policy remains accommodative after this increase." The FOMC expects that "economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run." The FOMC also states that it anticipates that it would maintain its reinvestment policy "until normalization of the level of the federal funds rate is well under way."
  • March 15, 2017: The mention of "only gradual increases" in the future path of the federal funds rate is changed to "gradual increases." Also, the statement now emphasizes the FOMC's "symmetric inflation goal" instead of its "inflation goal."
  • Jan. 31, 2018: The expression "gradual increases" is changed to "further gradual increases."
  • June 13, 2018: The FOMC drops the sentence indicating that the federal funds rate is "likely to remain, for some time, below levels that are expected to prevail in the longer run."
  • Sept. 26, 2018: The FOMC drops a sentence indicating that "the stance of monetary policy remains accommodative," which had been in place since December 2015.
  • Jan. 30, 2019: The FOMC no longer indicates a judgment that "some further gradual increases [in the target range for the federal funds rate] will be consistent" with sustained expansion of economic activity, strong labor market conditions, and inflation near the FOMC's symmetric 2% objective. Instead, the FOMC conveys that it "will be patient as it determines what future adjustments to the target range may be appropriate to support these outcomes."
  • Jan. 29, 2020: The FOMC judges that "the current stance…is appropriate" to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to the FOMC's symmetric 2% objective. The FOMC will continue to monitor the implications of incoming information for the economic outlook, including global developments and muted inflation pressures, as it assesses the appropriate path of the target range for the federal funds rate.
  • March 15, 2020: The FOMC expects to maintain its current stance until "the economy has weathered recent events" and is on track to achieve its maximum employment and price stability goals.
  • June 19, 2020: The FOMC continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near its symmetric 2% objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the FOMC "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 its symmetric 2% objective.
  • July 29, 2020: As the FOMC contemplates the future path of the target range for the federal funds rate, it "will continue to 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 its symmetric 2% objective.
  • Sept. 16, 2020: The FOMC decided to keep the target range for the federal funds rate at 0%-0.25% percent and expects it will be appropriate to "maintain this target range until…maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time."

Source: S&P Global Ratings and The Board of Governors of the Federal Reserve System (https://www.federalreserve.gov/monetarypolicy/timeline-forward-guidance-about-the-federal-funds-rate.htm)

End Notes

(i)An important evolution in the new monetary framework is that the FOMC now defines maximum employment as the highest level of employment that does not generate sustained pressures that put the price-stability mandate at risk.

(ii)This is often referred to as the "announcement effect." It refers to the psychological impact on the public's expectations about the future course of the Fed's actions. Arguably, the announcement effect has been in full display during the last two months.

(iii)Reserves, sometimes called "central bank money" (not to be confused with foreign exchange reserves, which sometimes make an appearance on the asset side), are the deposits at the central bank and other financial institutions that maintain an account with it. The interest rate that the central bank sets on reserves anchors and influences the whole of the term structure of interest rates.

(iv)The reserves that the central bank creates, conditional on the impact of bank notes and government deposits, have to be held by the banks in aggregate. (Individual banks of course may borrow and lend those reserves among themselves.)

(v)Large scale asset purchases, widely known as "quantitative easing," are the purposeful expansion by a central bank of its balance sheet beyond its normal size by acquiring assets financed by creating excess reserves. This can be viewed variously as: what central banks do at the zero-interest rate bound, a central bank-engineered asset swap that changes the composition of the aggregate portfolio held by the public, or a debt management/refinancing operation of the consolidated government.

(vi)https://www.federalreserve.gov/newsevents/pressreleases/monetary20201216a.htm

(vii)https://www.federalreserve.gov/faqs/what-is-forward-guidance-how-is-it-used-in-the-federal-reserve-monetary-policy.htm

(viii)Many of the gains in the labor force participation rate and wages for the population without college degrees (at the lower end of income spectrum) emerged only in the later years of the 2010-2019 expansion.

(ix)The Taylor Rule states that the appropriate federal funds target rate is a function of the real equilibrium fed funds rate, inflation target, inflation gap, and output gap (i.e., actual GDP – potential GDP). r = p + 0.5y + 0.5 (p – 2) + 2, where r is the target policy rate, p is inflation target (2%), y is the output gap and 2 is the real equilibrium fed funds rate that John Taylor used in his original equation in 1992. A variant of the original Taylor rule uses unemployment gap (i.e., actual unemployment minus the longer-run equilibrium unemployment rate in place of output gap). Evolution in the structure of the economy has also meant the real equilibrium rate has declined since Taylor's original equation.

(x)More in speeches by Brainard and Clarida: https://www.federalreserve.gov/newsevents/speech/brainard20201021a.htm; https://www.federalreserve.gov/newsevents/speech/clarida20201116a.htm

This report does not constitute a rating action.

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