Board of Governors of the Federal Reserve System

Summary

Monetary Policy Report submitted to the Congress on July 5, 2019, pursuant to section 2B of the Federal Reserve Act

Economic activity increased at a solid pace in the early part of 2019, and the labor market has continued to strengthen. However, inflation has been running below the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent. At its meeting in June, the FOMC judged that current and prospective economic conditions called for maintaining the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. Nonetheless, in light of increased uncertainties around the economic outlook and muted inflation pressures, the Committee indicated that it 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 the Committee's symmetric 2 percent objective.

Economic and Financial Developments

The labor market. The labor market has continued to strengthen. Over the first five months of 2019, payrolls increased an average of 165,000 per month. This rate is down from the average pace of 223,000 in 2018, but it is faster than what is needed to provide jobs for new entrants into the labor force. The unemployment rate moved down from 3.9 percent in December to 3.6 percent in May; meanwhile, wage gains have remained moderate.

Inflation. Consumer price inflation, as measured by the 12-month change in the price index for personal consumption expenditures, moved down from a little above the FOMC's objective of 2 percent in the middle of last year to a rate of 1.5 percent in May. The 12-month measure of inflation that excludes food and energy items (so-called core inflation), which historically has been a better indicator than the overall figure of where inflation will be in the future, was 1.6 percent in May—down from a rate of 2 percent from a year ago. However, these year-over-year declines mainly reflect soft readings in the monthly price data earlier this year, which appear to reflect transitory influences. Survey-based measures of longer-run inflation expectations are little changed, while market-based measures of inflation compensation have declined recently to levels close to or below the low levels seen late last year.

Economic growth. In the first quarter, real gross domestic product (GDP) is reported to have increased at an annual rate of 3.1 percent, bolstered by a sizable contribution from net exports and business inventories. By contrast, consumer spending in the first quarter was lackluster but appears to have picked up in recent months. Meanwhile, following robust gains last year, business fixed investment slowed in the first quarter, and indicators suggest that investment decelerated further in the spring. All told, incoming data for the second quarter suggest a moderation in GDP growth—despite a pickup in consumption—as the contributions from net exports and inventories reverse and the impetus from business investment wanes further.

Financial conditions. Nominal Treasury yields moved significantly lower over the first half of 2019, largely reflecting investors' concerns about trade tensions and the global economic outlook, as well as expectations of a more accommodative path for the federal funds rate than had been anticipated earlier. On net, since the end of 2018, spreads of yields on corporate bonds over those on comparable-maturity Treasury securities have narrowed, and stock prices have increased. Moreover, loans remained widely available for most households, and credit provided by commercial banks continued to expand at a moderate pace. Overall, domestic financial conditions for businesses and households continued to be supportive of economic growth over the first half of 2019.

Financial stability. The U.S. financial system continues to be substantially more resilient than in the period leading up to the financial crisis. Asset valuations remain somewhat elevated in a number of markets, with investors continuing to exhibit high appetite for risk. Borrowing by businesses continues to outpace GDP, with the most rapid increases in debt concentrated among the riskiest firms. In contrast, household borrowing remains modest relative to income, and the debt growth is concentrated among borrowers with high credit scores. Key financial institutions, including the largest banks, continue to be well capitalized and hold large quantities of liquid assets. Funding risks in the financial system remain low relative to the period leading up to the crisis.

International developments. After slowing in 2018, foreign economic growth appears to have stabilized in the first half of the year, but at a restrained pace. While aggregate activity in the advanced foreign economies (AFEs) increased slowly from the soft patch of late last year, activity in emerging Asia generally struggled to gain a solid footing, and several Latin American economies continued to underperform. Growth abroad has been held down in part by a slowdown in the manufacturing sector against the backdrop of softening global trade flows. With both inflation and activity in the AFEs remaining subdued, AFE central banks took a more accommodative policy stance.

Despite trade tensions that weighed on financial markets, financial conditions abroad generally eased in the first half of the year, supported by accommodative communications by major central banks. On balance, global equity prices moved higher, sovereign yields in major foreign economies declined, and sovereign bond spreads in the emerging market economies were little changed. Market-implied paths of policy rates in AFEs generally declined.

Monetary Policy

Interest rate policy. In its meetings over the first half of 2019, the FOMC judged that the stance of monetary policy was appropriate to achieve the Committee's objectives of maximum employment and 2 percent inflation, and it decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. These decisions reflected incoming information showing the solid fundamentals of the U.S. economy supporting continued growth and strong employment. For most of this period, the Committee indicated that, in light of global economic and financial developments and muted inflation pressures, it would be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate. At the June FOMC meeting, however, the Committee noted that uncertainties about the global and domestic economic outlook had increased. In light of these uncertainties and muted inflation pressures, the Committee indicated that it will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

In the most recent Summary of Economic Projections, which was compiled at the time of the June FOMC meeting, participants generally revised down their individual assessments of the appropriate path for monetary policy relative to their assessments at the time of the March meeting. (The participants' most recent economic projections—released after the June FOMC meeting—are discussed in more detail in Part 3 of this report.) However, as the Committee has continued to emphasize, the timing and size of future adjustments to the target range for the federal funds rate will depend on the Committee's assessment of realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.

Balance sheet policy. Over the first half of the year, the FOMC made two announcements regarding the longer-run policy implementation framework and its plans for normalizing the balance sheet. Following its January meeting, the Committee noted that it decided to continue to implement monetary policy in a regime with ample reserves. Consistent with that decision, in March, the Committee announced plans to conclude the reduction of its aggregate securities holdings at the end of September 2019. (See the box "Framework for Monetary Policy Implementation and Normalization of the Federal Reserve's Balance Sheet" in Part 2.) The Committee is prepared to adjust the details for completing balance sheet normalization in light of economic and financial developments, consistent with its policy objectives of maximum employment and price stability.

Special Topics

Labor market conditions for lower- and higher-educated workers. The labor market has strengthened since the end of the last recession, but the pattern of recovery has varied across workers with different levels of education. Workers with a college degree or more experienced a swifter recovery in employment, while those with a high school degree or less had a much more delayed recovery in employment. This pattern is typical of business cycles, and recent research sheds light on mechanisms that may lead to differences in the timing of recovery for lower- and higher-educated workers. (See the box "How Have Lower-Educated Workers Fared since the Great Recession?" in Part 1.)

Global manufacturing and trade. Growth in global trade and manufacturing has weakened significantly since 2017 even as growth in services has held up. Trade policy developments appear to have lowered trade flows to some extent, while uncertainty surrounding trade policy may be weighing on investment. The global tech cycle and a general slowdown in global demand, reflecting idiosyncratic factors specific to different economies, have also likely weighed on demand for traded goods. (See the box "The Persistent Slowdown in Global Trade and Manufacturing" in Part 1.)

Monetary policy rules. Monetary policy rules are mathematical formulas that relate a policy interest rate, such as the federal funds rate, to a small number of other economic variables, typically including the deviation of inflation from its target value and a measure of resource slack in the economy. The prescriptions for the policy interest rate from these rules can provide helpful guidance for the FOMC. This discussion presents five policy rules—illustrative of the many rules that have received attention in the research literature—and provides examples of two ways to compute historical prescriptions of policy rules. (See the box "Monetary Policy Rules and Their Interactions with the Economy" in Part 2.)

Monetary policy implementation and balance sheet normalization. Since the beginning of this year, the FOMC has made important decisions regarding its framework for monetary policy implementation and the process of normalizing the size of its balance sheet. The Committee decided to continue to implement monetary policy in a regime with an ample supply of reserves and announced that it intends to conclude the reduction of its aggregate securities holdings in the System Open Market Account at the end of September 2019. (See the box "Framework for Monetary Policy Implementation and Normalization of the Federal Reserve's Balance Sheet" in Part 2.)