Board of Governors of the Federal Reserve System

Minutes of the Federal Open Market Committee

January 24-25, 2012

In conjunction with the January 24-25, 2012, Federal Open Market Committee (FOMC) meeting, the members of the Board of Governors and the presidents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted projections for growth of real output, the unemployment rate, and inflation for the years 2012 to 2014 and over the longer run. The economic projections were based on information available at the time of the meeting and participants' individual assumptions about factors likely to affect economic outcomes, including their assessments of appropriate monetary policy. Starting with the January meeting, participants also submitted their assessments of the path for the target federal funds rate that they viewed as appropriate and compatible with their individual economic projections. Longer-run projections represent each participant's assessment of the rate to which each variable would be expected to converge over time under appropriate monetary policy and in the absence of further shocks. "Appropriate monetary policy" is defined as the future path of policy that participants deem most likely to foster outcomes for economic activity and inflation that best satisfy their individual interpretation of the Federal Reserve's objectives of maximum employment and stable prices.

As depicted in figure 1, FOMC participants projected continued economic expansion over the 2012-14 period, with real gross domestic product (GDP) rising at a modest rate this year and then strengthening further through 2014. Participants generally anticipated only a small decline in the unemployment rate this year. In 2013 and 2014, the pace of the expansion was projected to exceed participants' estimates of the longer-run sustainable rate of increase in real GDP by enough to result in a gradual further decline in the unemployment rate. However, at the end of 2014, participants generally expected that the unemployment rate would still be well above their estimates of the longer-run normal unemployment rate that they currently view as consistent with the FOMC's statutory mandate for promoting maximum employment and price stability. Participants viewed the upward pressures on inflation in 2011 from factors such as supply chain disruptions and rising commodity prices as having waned, and they anticipated that inflation would fall back in 2012. Over the projection period, most participants expected inflation, as measured by the annual change in the price index for personal consumption expenditures (PCE), to be at or below the FOMC's objective of 2 percent that was expressed in the Committee's statement of longer-run goals and policy strategy. Core inflation was projected to run at about the same rate as overall inflation.

As indicated in table 1, relative to their previous projections in November 2011, participants made small downward revisions to their expectations for the rate of increase in real GDP in 2012 and 2013, but they did not materially alter their projections for a noticeably stronger pace of expansion by 2014. With the unemployment rate having declined in recent months by more than participants had anticipated in the previous Summary of Economic Projections (SEP), they generally lowered their forecasts for the level of the unemployment rate over the next two years. Participants' expectations for both the longer-run rate of increase in real GDP and the longer-run unemployment rate were little changed from November. They did not significantly alter their forecasts for the rate of inflation over the next three years. However, in light of the 2 percent inflation that is the objective included in the statement of longer-run goals and policy strategy adopted at the January meeting, the range and central tendency of their projections of longer-run inflation were all equal to 2 percent.

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, January, 2012

Percent

As shown in figure 2, most participants judged that highly accommodative monetary policy was likely to be warranted over coming years to promote a stronger economic expansion in the context of price stability. In particular, with the unemployment rate projected to remain elevated over the projection period and inflation expected to be subdued, six participants anticipated that, under appropriate monetary policy, the first increase in the target federal funds rate would occur after 2014, and five expected policy firming to commence during 2014 (the upper panel). The remaining six participants judged that raising the federal funds rate sooner would be required to forestall inflationary pressures or avoid distortions in the financial system. As indicated in the lower panel, all of the individual assessments of the appropriate target federal funds rate over the next several years were below the longer-run level of the federal funds rate, and 11 participants placed the target federal funds rate at 1 percent or lower at the end of 2014. Most participants indicated that they expected that the normalization of the Federal Reserve's balance sheet should occur in a way consistent with the principles agreed on at the June 2011 meeting of the FOMC, with the timing of adjustments dependent on the expected date of the first policy tightening. A few participants judged that, given their current assessments of the economic outlook, appropriate policy would include additional asset purchases in 2012, and one assumed an early ending of the maturity extension program.

A sizable majority of participants continued to judge the level of uncertainty associated with their projections for real activity and the unemployment rate as unusually high relative to historical norms. Many also attached a greater-than-normal level of uncertainty to their forecasts for inflation, but, compared with the November SEP, two additional participants viewed uncertainty as broadly similar to longer-run norms. As in November, many participants saw downside risks attending their forecasts of real GDP growth and upside risks to their forecasts of the unemployment rate; most participants viewed the risks to their inflation projections as broadly balanced.

Figure 1. Central tendencies and ranges of economic projections, 2012-14 and over the longer run*

Accessible version of figure 1 | Return to figure 1

The Outlook for Economic Activity
The central tendency of participants' forecasts for the change in real GDP in 2012 was 2.2 to 2.7 percent. This forecast for 2012, while slightly lower than the projection prepared in November, would represent a pickup in output growth from 2011 to a rate close to its longer-run trend. Participants stated that the economic information received since November showed continued gradual improvement in the pace of economic activity during the second half of 2011, as the influence of the temporary factors that damped activity in the first half of the year subsided. Consumer spending increased at a moderate rate, exports expanded solidly, and business investment rose further. Recently, consumers and businesses appeared to become somewhat more optimistic about the outlook. Financial conditions for domestic nonfinancial businesses were generally favorable, and conditions in consumer credit markets showed signs of improvement.

However, a number of factors suggested that the pace of the expansion would continue to be restrained. Although some indicators of activity in the housing sector improved slightly at the end of 2011, new homebuilding and sales remained at depressed levels, house prices were still falling, and mortgage credit remained tight. Households' real disposable income rose only modestly through late 2011. In addition, federal spending contracted toward year-end, and the restraining effects of fiscal consolidation appeared likely to be greater this year than anticipated at the time of the November projections. Participants also read the information on economic activity abroad, particularly in Europe, as pointing to weaker demand for U.S. exports in coming quarters than had seemed likely when they prepared their forecasts in November.

Participants anticipated that the pace of the economic expansion would strengthen over the 2013-14 period, reaching rates of increase in real GDP above their estimates of the longer-run rates of output growth. The central tendencies of participants' forecasts for the change in real GDP were 2.8 to 3.2 percent in 2013 and 3.3 to 4.0 percent in 2014. Among the considerations supporting their forecasts, participants cited their expectation that the expansion would be supported by monetary policy accommodation, ongoing improvements in credit conditions, rising household and business confidence, and strengthening household balance sheets. Many participants judged that U.S. fiscal policy would still be a drag on economic activity in 2013, but many anticipated that progress would be made in resolving the fiscal situation in Europe and that the foreign economic outlook would be more positive. Over time and in the absence of shocks, participants expected that the rate of increase of real GDP would converge to their estimates of its longer-run rate, with a central tendency of 2.3 to 2.6 percent, little changed from their estimates in November.

The unemployment rate improved more in late 2011 than most participants had anticipated when they prepared their November projections, falling from 9.1 to 8.7 percent between the third and fourth quarters. As a result, most participants adjusted down their projections for the unemployment rate this year. Nonetheless, with real GDP expected to increase at a modest rate in 2012, the unemployment rate was projected to decline only a little this year, with the central tendency of participants' forecasts at 8.2 to 8.5 percent at year-end. Thereafter, participants expected that the pickup in the pace of the expansion in 2013 and 2014 would be accompanied by a further gradual improvement in labor market conditions. The central tendency of participants' forecasts for the unemployment rate at the end of 2013 was 7.4 to 8.1 percent, and it was 6.7 to 7.6 percent at the end of 2014. The central tendency of participants' estimates of the longer-run normal rate of unemployment that would prevail in the absence of further shocks was 5.2 to 6.0 percent. Most participants indicated that they anticipated that five or six years would be required to close the gap between the current unemployment rate and their estimates of the longer-run rate, although some noted that more time would likely be needed.

Figures 3.A and 3.B provide details on the diversity of participants' views regarding the likely outcomes for real GDP growth and the unemployment rate over the next three years and over the longer run. The dispersion in these projections reflected differences in participants' assessments of many factors, including appropriate monetary policy and its effects on economic activity, the underlying momentum in economic activity, the effects of the European situation, the prospective path for U.S. fiscal policy, the likely evolution of credit and financial market conditions, and the extent of structural dislocations in the labor market. Compared with their November projections, the range of participants' forecasts for the change in real GDP in 2012 narrowed somewhat and shifted slightly lower, as some participants reassessed the outlook for global economic growth and for U.S. fiscal policy. Many, however, made no material change to their forecasts for growth of real GDP this year. The dispersion of participants' forecasts for output growth in 2013 and 2014 remained relatively wide. Having incorporated the data showing a lower rate of unemployment at the end of 2011 than previously expected, the distribution of participants' projections for the end of 2012 shifted noticeably down relative to the November forecasts. The ranges for the unemployment rate in 2013 and 2014 showed less pronounced shifts toward lower rates and, as was the case with the ranges for output growth, remained wide. Participants made only modest adjustments to their projections of the rates of output growth and unemployment over the longer run, and, on net, the dispersions of their projections for both were little changed from those reported in November. The dispersion of estimates for the longer-run rate of output growth is narrow, with only one participant's estimate outside of a range of 2.2 to 2.7 percent. By comparison, participants' views about the level to which the unemployment rate would converge in the long run are more diverse, reflecting, among other things, different views on the outlook for labor supply and on the extent of structural impediments in the labor market.

Figure 2. Overview of FOMC participants' assessments of appropriate monetary policy*

Accessible version of figure 2 | Return to figure 2

The Outlook for Inflation
Participants generally viewed the outlook for inflation as very similar to that in November. Most indicated that, as they expected, the effects of the run-up in prices of energy and other commodities and the supply disruptions that occurred in the first half of 2011 had largely waned, and that inflation had been subdued in recent months. Participants also noted that inflation expectations had remained stable over the past year despite the fluctuations in headline inflation. Assuming no further supply shocks, most participants anticipated that both headline and core inflation would remain subdued over the 2012-14 period at rates at or below the FOMC's longer-run objective of 2 percent. Specifically, the central tendency of participants' projections for the increase in inflation, as measured by the PCE price index, in 2012 was 1.4 to 1.8 percent, and it edged up to a central tendency of 1.6 to 2.0 percent in 2014; the central tendencies of the forecasts for core PCE inflation were largely the same as those for the total measure.

Figures 3.C and 3.D provide information about the diversity of participants' views about the outlook for inflation. Compared with their November projections, expectations for inflation in 2012 shifted down a bit, with some participants noting that the slowing in inflation at the end of 2011 had been greater than they anticipated. Nonetheless, the range of participants' forecasts for inflation in 2012 remained wide, and the dispersion was only slightly narrower in 2013. By 2014, the range of inflation forecasts narrowed more noticeably, as participants expected that, under appropriate monetary policy, inflation would begin to converge to the Committee's longer-run objective. In general, the dispersion of views on the outlook for inflation over the projection period represented differences in judgments regarding the degree of slack in resource utilization and the extent to which slack influences inflation and inflation expectations. In addition, participants differed in their estimates of how the stance of monetary policy would influence inflation expectations.

Figure 3.A. Distribution of participants' projections for the change in real GDP, 2012-14 and over the longer run*

Accessible version of figure 3.A. | Return to figure 3.A.

Figure 3.B. Distribution of participants' projections for the unemployment rate, 2012-14 and over the longer run*

Accessible version of figure 3.B. | Return to figure 3.B.

Figure 3.C. Distribution of participants' projections for PCE inflation, 2012-14 and over the longer run*

Accessible version of figure 3.C. | Return to figure 3.C.

Figure 3.D. Distribution of participants' projections for core PCE inflation, 2012-14 and over the longer run*

Accessible version of figure 3.D. | Return to figure 3.D.

Appropriate Monetary Policy
Most participants judged that the current outlook--for a moderate pace of economic recovery with the unemployment rate declining only gradually and inflation subdued--warranted exceptionally low levels of the federal funds rate at least until late 2014. In particular, five participants viewed appropriate policy firming as commencing during 2014, while six others judged that the first increase in the federal funds rate would not be warranted until 2015 or 2016. As a result, those 11 participants anticipated that the appropriate federal funds rate at the end of 2014 would be 1 percent or lower. Those who saw the first increase occurring in 2015 reported that they anticipated that the federal funds rate would be 1/2 percent at the end of that year. For the two participants who put the first increase in 2016, the appropriate target federal funds rate at the end of that year was 1 1/2 and 1 3/4 percent. In contrast, six participants expected that an increase in the target federal funds rate would be appropriate within the next two years, and those participants anticipated that the target rate would need to be increased to around 1 1/2 to 2 3/4 percent at the end of 2014.

Participants' assessments of the appropriate path for the federal funds rate reflected their judgments of the policy that would best support progress in achieving the Federal Reserve's mandate for promoting maximum employment and stable prices. Among the key factors informing participants' expectations about the appropriate setting for monetary policy were their assessments of the maximum level of employment, the Committee's longer-run inflation goal, the extent to which current conditions deviate from these mandate-consistent levels, and their projections of the likely time horizons required to return employment and inflation to such levels. Several participants commented that their assessments took into account the risks to the outlook for economic activity and inflation, and a few pointed specifically to the relevance of financial stability in their policy judgments. Participants also noted that because the appropriate stance of monetary policy depends importantly on the evolution of real activity and inflation over time, their assessments of the appropriate future path of the federal funds rate could change if economic conditions were to evolve in an unexpected manner.

All participants reported levels for the appropriate target federal funds rate at the end of 2014 that were well below their estimates of the level expected to prevail in the longer run. The longer-run nominal levels were in a range from 3 3/4 to 4 1/2 percent, reflecting participants' judgments about the longer-run equilibrium level of the real federal funds rate and the Committee's inflation objective of 2 percent.

Participants also provided qualitative information on their views regarding the appropriate path of the Federal Reserve's balance sheet. A few participants' assessments of appropriate monetary policy incorporated additional purchases of longer-term securities in 2012, and a number of participants indicated that they remained open to a consideration of additional asset purchases if the economic outlook deteriorated. All but one of the participants continued to expect that the Committee would carry out the normalization of the balance sheet according to the principles approved at the June 2011 FOMC meeting. That is, prior to the first increase in the federal funds rate, the Committee would likely cease reinvesting some or all payments on the securities holdings in the System Open Market Account (SOMA), and it would likely begin sales of agency securities from the SOMA sometime after the first rate increase, aiming to eliminate the SOMA's holdings of agency securities over a period of three to five years. Indeed, most participants saw sales of agency securities starting no earlier than 2015. However, those participants anticipating an earlier increase in the federal funds rate also called for earlier adjustments to the balance sheet, and one participant assumed an early end of the maturity extension program.

Figure 3.E details the distribution of participants' judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year from 2012 to 2014 and over the longer run. Most participants anticipated that economic conditions would warrant maintaining the current low level of the federal funds rate over the next two years. However, views on the appropriate level of the federal funds rate at the end of 2014 were more widely dispersed, with two-thirds of participants seeing the appropriate level of the federal funds rate as 1 percent or below and five seeing the appropriate rate as 2 percent or higher. Those participants who judged that a longer period of exceptionally low levels of the federal funds rate would be appropriate generally also anticipated that the pace of the economic expansion would be moderate and that the unemployment rate would decline only gradually, remaining well above its longer-run rate at the end of 2014. Almost all of these participants expected that inflation would be relatively stable at or below the FOMC's longer-run objective of 2 percent until the time of the first increase in the federal funds rate. A number of them also mentioned their assessment that a longer period of low federal funds rates is appropriate when the federal funds rate is constrained by its effective lower bound. In contrast, the six participants who judged that policy firming should begin in 2012 or 2013 indicated that the Committee would need to act decisively to keep inflation at mandate-consistent levels and to limit the risk of undermining Federal Reserve credibility and causing a rise in inflation expectations. Several were projecting a faster pickup in economic activity, and a few stressed the risk of distortions in the financial system from an extended period of exceptionally low interest rates.

Figure 3.E. Distribution of participants' projections for the target federal funds rate, 2012-14 and over the longer run*

Accessible version of figure 3.E. | Return to figure 3.E.

Uncertainty and Risks
Figure 4 shows that most participants continued to share the view that their projections for real GDP growth and the unemployment rate were subject to a higher level of uncertainty than was the norm during the previous 20 years.¹ Many also judged the level of uncertainty associated with their inflation forecasts to be higher than the longer-run norm, but that assessment was somewhat less prevalent among participants than was the case for uncertainty about real activity. Participants identified a number of factors that contributed to the elevated level of uncertainty about the outlook. In particular, many participants continued to cite risks related to ongoing developments in Europe. More broadly, they again noted difficulties in forecasting the path of economic recovery from a deep recession that was the result of a severe financial crisis and thus differed importantly from the experience with recoveries over the past 60 years. In that regard, participants continued to be uncertain about the pace at which credit conditions would ease and about prospects for a recovery in the housing sector. In addition, participants generally saw the outlook for fiscal and regulatory policies as still highly uncertain. Regarding the unemployment rate, several expressed uncertainty about how labor demand and supply would evolve over the forecast period. Among the sources of uncertainty about the outlook for inflation were the difficulties in assessing the current and prospective margins of slack in resource markets and the effect of such slack on prices.

Table 2. Average historical projection error ranges

Percentage points

A majority of participants continued to report that they saw the risks to their forecasts of real GDP growth as weighted to the downside and, accordingly, the risks to their projections for the unemployment rate as skewed to the upside. All but one of the remaining participants viewed the risks to both projections as broadly balanced, while one noted a risk that the unemployment rate might continue to decline more rapidly than expected. The most frequently cited downside risks to the projected pace of the economic expansion were the possibility of financial market and economic spillovers from the fiscal and financial issues in the euro area and the chance that some of the factors that have restrained the recovery in recent years could persist and weigh on economic activity to a greater extent than assumed in participants' baseline forecasts. In particular, some participants mentioned the downside risks to consumer spending from still-weak household balance sheets and only modest gains in real income, along with the possible effects of still-high levels of uncertainty regarding fiscal and regulatory policies that might damp businesses' willingness to invest and hire. A number of participants noted the risk of another disruption in global oil markets that could not only boost inflation but also reduce real income and spending. The participants who judged the risks to be broadly balanced also recognized a number of these downside risks to the outlook but saw them as counterbalanced by the possibility that the resilience of economic activity in late 2011 and the recent drop in the unemployment rate might signal greater underlying momentum in economic activity.

In contrast to their outlook for economic activity, most participants judged the risks to their projections of inflation as broadly balanced. Participants generally viewed the recent decline in inflation as having been in line with their earlier forecasts, and they noted that inflation expectations remain stable. While many of these participants saw the persistence of substantial slack in resource utilization as likely to keep inflation subdued over the projection period, a few others noted the risk that elevated resource slack might put more downward pressure on inflation than expected. In contrast, some participants noted the upside risks to inflation from developments in global oil and commodity markets, and several indicated that the current highly accommodative stance of monetary policy and the substantial liquidity currently in the financial system risked a pickup in inflation to a level above the Committee's objective. A few also pointed to the risk that uncertainty about the Committee's ability to effectively remove policy accommodation when appropriate could lead to a rise in inflation expectations.

Figure 4. Uncertainty and risks in economic projections*

Accessible version of figure 4 | Return to figure 4