Recent Changes in FOMC Communication and the Committee’s Updated Projections
Over time, the Federal Open Market Committee (FOMC) has sought to improve its public communications by providing more guidance on the likely future path of monetary policy. That is, the FOMC has tried to better explain to the public the direction the Committee expects its target for the federal funds rate to take in the future. In one historic example, in August 2003, the Committee extended its usual post-meeting statement to provide unprecedented forward guidance about the future path of the federal funds rate, which the FOMC had lowered to 1 percent in June 2003: “…the Committee believes that policy accommodation can be maintained for a considerable period.” In the last few years, the FOMC has taken several additional steps to extend the forward guidance on policy.
In the more recent set of enhancements, the FOMC gave its first new bit of forward guidance about the path of the federal funds rate in the beginning of 2009, when it stated that exceptionally low interest rate levels were expected to be warranted for “an extended period of time.” In August 2011, the Committee replaced this initial qualitative guidance with a more explicit, date-based guidance approach, reporting in its post-meeting statement that exceptionally low levels of the federal funds rate were expected “at least through mid-2013.” Arguably the biggest innovation, however, came in December 2012, when the Committee replaced the date-based guidance with specific thresholds related to economic activity. Since the Committee’s December 2012 meeting, FOMC statements have indicated that exceptionally low federal funds rates “will be appropriate at least as long as the unemployment rate remains above 6.5 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
The current threshold-based forward guidance allows the public to more easily relate the likely future path of the federal funds rate to the Committee’s outlook for inflation and unemployment. From the most recent release of the FOMC’s projections, a majority of participants see very low short-term interest rates extending into 2015. This makes sense considering their projected paths for GDP growth, the unemployment rate, and inflation.
In terms of overall economic activity, most participants see GDP growth in the range of 2.3 percent to 2.8 percent over the next year, 2.9 percent to 3.4 percent in 2014, and 2.9 percent to 3.7 percent in 2015. These projections reflect an economy continuing to recover from the deep 2007-2009 recession, with GDP growing at a rate at or above the long-term growth rate of GDP, which most FOMC participants put at 2.3 percent to 2.5 percent.
The expectation of continued recovery is also reflected in the FOMC’s most recent projections of unemployment, which show unemployment gradually declining over the next few years. While there is some variation among participants in terms of the expected length of time it will take to reach more normal employment levels, the central tendency of the unemployment rate projections for FOMC participants reaches the 6.5 percent threshold sometime during 2015. For the longer term, most participants expect an unemployment rate of between 5.0 percent and 6.0 percent.
Turning to inflation, most FOMC participants project PCE inflation rates below the 2.5 percent threshold mentioned in the statement. The top end of the central-tendency-projection range for PCE inflation is 1.7 percent in 2013 and 2.0 percent in 2014 and 2015.
Consistent with these projections for GDP growth, unemployment, and inflation and with the sense that longer-term inflation expectations currently remain well anchored, the most recent Summary of Economic Projections indicates that most FOMC participants see the federal funds rate increasing above the current 0 to 0.25 percent target sometime during 2015. While most participants project that inflation will remain lower than the 2.5 percent threshold in 2015, most also expect the unemployment rate to hit or fall below the 6.5 percent threshold.
Still, some caution about the importance of these unemployment and inflation thresholds is needed, as the FOMC has stated that they are not automatic triggers for action on the fed funds rate. For example, the most recent FOMC statement indicates that, “in determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.
It is also important to note that the thresholds are intended for guidance on the path of the federal funds rate and not for guidance on asset purchases, the other main policy tool currently in use. However, what the thresholds do provide is a way of viewing the projected path of the fed funds rate in terms of the projected path of the overall economy, and they provide some context for the timing in which FOMC members expect that this target interest rate may begin to adjust toward a more normal long-term level.