Updated Policy Projections and Improvement in the Unemployment Rate
In March, the Federal Open Market Committee (FOMC) released its updated Summary of Economic Projections (SEP). The SEP includes the FOMC’s forecasts for GDP, inflation, and the unemployment rate. It also includes the Committee members’ expectations for when the federal funds rate will be raised above the 0 to 0.25 percent range, and where they expect the rate to be at the end of the next few years and in the long run. Most of the FOMC members see the funds rate going above the 0 to 0.25 percent range some time in 2015, as they did in the December SEP. However, changes from December to March in where participants see the rate at the end of the next few years suggest some shifting in the policy expectations of Committee members, and changes in the forecasts for other key variables provide evidence as to why this might be the case.
As in December, the March SEP showed that most FOMC participants believe that the federal funds rate will start to increase in 2015. In fact, 13 of the 16 participants in March believed this to be the case (compared with 12 of 17 in December). However, the opinions about when in 2015 and how fast the funds rate will rise are a bit more divergent. For example, the expected federal funds rate at the end of 2015 in the March SEP ranged from 0.25 percent to 3.0 percent, and for 2016, it ranged from 0.75 to 4.25 percent.
Regardless of these differing opinions, there seems to have been some shifting of policy expectations from December to March. In December, 10 of the 17 FOMC participants saw the federal funds rate below 1.0 percent at the end of 2015, while in March, 9 of the 16 FOMC participants saw it at 1.0 percent or above. Likewise, in December, 9 of the 17 FOMC participants saw the rate below 2.0 percent at the end of 2016, while in March, 12 of the 16 FOMC participants saw it at 2.0 percent or higher. A higher expected policy rate at these fixed dates would suggest one of two scenarios for any given participant. Either they see the federal funds rate coming out of the 0 to 0.25 percent range earlier in 2015 than they previously projected, or they see the rate increasing faster once it does exit that range. Without more detail on participants’ projections, it would be tough to indicate which of these is driving the change from December to March for a given FOMC member. However, these changes do indicate that the participants on the FOMC generally see a slightly tighter policy environment over the next few years than they saw in December of 2013.
Given that the FOMC has a dual mandate to maintain price stability and maximum employment, it would not be surprising that the Committee’s outlook for the unemployment rate and inflation play a primary role in determining its projection for the path of the federal funds rate. Therefore, changes in FOMC participants’ forecasts for these primary variables over the next couple of years will likely influence the way they see funds-rate policy evolving over the same time period. The unemployment rate continued to fall in late 2013 and early 2014. The rate declined from 7.2 percent to 7.0 percent from November to December, and then from 7.0 percent to 6.7 percent from December to February.
The recent improvement in the unemployment rate is expected to persist, as is evident in the lower projected path for unemployment in the projections from the March SEP. The central tendency of FOMC forecasts for the unemployment rate at the end of 2014 declined from 6.3 to 6.6 percent in December to 6.1 to 6.3 percent in March. For 2015, it declined from 5.8 to 6.1 percent to 5.6 to 5.9 percent, and for 2016, it declined from 5.3 to 5.8 percent to 5.2 to 5.6 percent. Therefore, there was a general downward shift in the FOMC’s expectation for the unemployment rate over the next few years.
Unlike the unemployment rate, however, FOMC projections for inflation were largely unchanged from December to March. The central tendency for PCE inflation in 2014 went from 1.4 to 1.6 percent in December to 1.5 to 1.6 percent in March. For 2015, it stayed at 1.5 to 2.0 percent, and for 2016, it stayed at 1.7 to 2.0 percent.
The fact that the FOMC’s outlook for the unemployment rate generally improved from December to March and the outlook for inflation generally remained the same explains why there might have been some slight shifting in the expected path of the federal funds rate. As these employment and inflation variables are projected to return to their longer-run values over time, the federal funds rate will be projected to return its longer-run value accordingly. Given that the outlook for inflation remained steady, and the outlook for the unemployment rate improved, this means that the unemployment rate is expected to reach its longer-run value sooner than previously projected, and so the federal funds rate may be expected to return closer to its longer-run value sooner than previously projected as well.