Summary
Monetary Policy Report submitted to the Congress on February 7, 2025, pursuant to section 2B of the Federal Reserve Act
Inflation moderated a little further last year after having slowed notably in 2023, but it remains somewhat above the Federal Open Market Committee's (FOMC) objective of 2 percent. The labor market appears to have stabilized following a period of easing, with the unemployment rate flattening out at a relatively low level over the second half of last year. Real gross domestic product (GDP) increased solidly last year, supported by strength in consumer spending.
As labor market tightness continued to ease and inflation moderated a bit further, the FOMC lowered the target range for the policy rate by a cumulative 100 basis points over its September, November, and December meetings, bringing it to the current range of 4-1/4 to 4-1/2 percent. The Federal Reserve has also continued to reduce its holdings of Treasury and agency mortgage-backed securities. The FOMC is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective, and it remains attentive to the risks to both sides of its dual mandate. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.
Recent Economic and Financial Developments
Inflation. After stepping down notably in 2023, consumer price inflation eased a bit more last year, although recent progress has been bumpy and inflation remains somewhat above 2 percent. The price index for personal consumption expenditures (PCE) rose 2.6 percent over the 12 months ending in December, down from a peak of 7.2 percent in 2022. The core PCE price index—which excludes often-volatile food and energy prices and is generally considered a better guide to the future of inflation—rose 2.8 percent last year, only a little less than its increase in 2023, as core services price inflation remained elevated. However, some other approaches to removing the influence of volatile components of inflation, such as the trimmed mean PCE measure produced by the Federal Reserve Bank of Dallas, showed more marked deceleration in prices last year. Measures of longer-term inflation expectations are within the range of values seen in the decade before the pandemic and continue to be broadly consistent with the FOMC's longer-run objective of 2 percent inflation.
The labor market. The labor market remains solid and appears to have stabilized after a period of easing. The unemployment rate moved up over the first half of last year but was mostly flat thereafter, ending the year at 4.1 percent—still low by historical standards—while job vacancies, which had been trending down, also flattened out over the second half at a solid level. As labor demand cooled somewhat further last year, monthly job gains slowed to a moderate pace on average. Labor supply likely increased less robustly than in previous years, with immigration appearing to have slowed over the second half of last year. Given the further rebalancing of labor demand and supply last year, the labor market no longer appears especially tight. Reflecting this further balancing, nominal wage gains continued to slow in 2024 and are now closer to the pace consistent with 2 percent inflation over the longer term.
Economic activity. Real GDP is reported to have increased last year by 2.5 percent, a little slower than in 2023. Consumer spending continued to grow robustly, supported by a solid labor market and rising real wages, while real business fixed investment increased moderately. In the housing market, new home construction was solid but existing home sales remained depressed, with mortgage rates still elevated. In contrast to GDP, manufacturing output was little changed, in part reflecting weak production in interest-sensitive sectors.
Financial conditions. Financial conditions continue to appear to be somewhat restrictive on balance. Short-term Treasury yields declined, in line with the easing of monetary policy since September; however, the market-implied path for the federal funds rate over the next year shifted up notably, and long-term Treasury yields increased markedly in the fourth quarter. Broad equity prices continued to increase despite the rise in longer-term Treasury yields, and yields on corporate bonds were little changed, as spreads narrowed. Credit continued to be broadly available to large-to-midsize businesses, most households, and municipalities but remained relatively tight for small businesses and households with lower credit scores. Bank lending to households and businesses continued to decelerate in the second half of 2024, likely reflecting still-elevated interest rates and tight lending standards.
Financial stability. The financial system remains sound and resilient. Valuations remained high relative to fundamentals in a range of markets, including those for equity, corporate debt, and residential real estate. Total debt of households and nonfinancial businesses as a fraction of GDP continued to trend down to a level that is very low relative to that in the past two decades. Most banks continued to report capital levels well above regulatory requirements and have reduced their reliance on uninsured deposits, but fair value losses on fixed-rate assets were still sizable for some banks. In terms of funding risks, while the 2023–24 Securities and Exchange Commission reforms on money market funds (MMFs) have partially mitigated vulnerabilities of prime MMFs, other less regulated short-term investment vehicles remain vulnerable and somewhat opaque, and their assets have been growing. Meanwhile, hedge fund leverage appears to be high and concentrated. (See the box "Developments Related to Financial Stability".)
International developments. Foreign growth remained modest in the second half of 2024. Foreign manufacturing in general was weak, as the cumulative effects of restrictive monetary policy weighed on the sector and, in Europe, energy-intensive industries continued to grapple with elevated energy costs. That said, high-tech manufacturing and exports remained strong in Asia on robust U.S. artificial intelligence (AI) and data center demand. In China, while exports were strong, domestic demand remained sluggish despite stimulus measures to shore up the ailing property sector. Meanwhile, foreign headline inflation continued to decline, but progress on inflation reduction was uneven across economies.
Many foreign central banks cut policy rates further since mid-2024, citing declining inflationary pressures, easing labor markets, and concerns about economic growth. Policymakers generally stressed the importance of maintaining vigilance amid persistent geopolitical risks and, in some economies, still-somewhat-elevated services inflation and wage pressures. Since mid-2024, the trade-weighted exchange value of the U.S. dollar has increased significantly, on net, reflecting widening gaps of U.S. interest rates over those of major advanced foreign economies, the relative strength of the U.S. economy, and political and fiscal developments in some foreign economies.
Monetary Policy
Interest rate policy. After having held the target range for the policy rate at 5-1/4 to 5-1/2 percent between late July 2023 and mid-September 2024, the FOMC lowered the target range for the policy rate by a cumulative 100 basis points over its September, November, and December meetings, bringing it to the current range of 4-1/4 to 4-1/2 percent. The FOMC's decision to begin reducing the degree of policy restraint reflected the FOMC's greater confidence in inflation moving sustainably toward 2 percent and the judgment that it was appropriate to recalibrate the policy stance. The FOMC remains attentive to the risks to both sides of its dual mandate. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.
Balance sheet policy. The Federal Reserve has continued the process of significantly reducing its holdings of Treasury and agency securities in a predictable manner. Beginning in June 2022, principal payments from securities held in the System Open Market Account have been reinvested only to the extent that they exceeded monthly caps. Under this policy, the Federal Reserve has reduced its securities holdings by $297 billion since June 2024, bringing the total reduction in securities holdings since the start of balance sheet reduction to about $2 trillion. The FOMC has stated that it intends to maintain securities holdings at amounts consistent with implementing monetary policy efficiently and effectively in its ample-reserves regime. To ensure a smooth transition, the FOMC slowed the pace of decline of its securities holdings in June 2024 and intends to stop reductions in its securities holdings when reserve balances are somewhat above the level that the FOMC judges to be consistent with ample reserves.
Special Topics
Employment and earnings across groups. The tight labor market in recent years has been especially beneficial for historically disadvantaged groups of workers, and many of the disparities in employment and wages by sex, race, ethnicity, education, and geography have narrowed. Over the past year, even as labor market conditions have eased, employment disparities continue to be near their recent lows, while wage growth has remained solid across many groups despite slowing a bit from post-pandemic highs. Even so, in absolute levels, significant disparities in groups remain. (See the box "Employment and Earnings across Demographic Groups".)
Strong productivity growth. Labor productivity in the business sector increased 1.9 percent per year, on average, since the fourth quarter of 2019, stronger than its 1.5 percent average annual pace over the previous expansion. Should this faster pace of productivity growth persist, it can support stronger GDP growth without adding inflationary pressure. Some factors that have boosted productivity growth recently may continue providing support, such as new business formation, which surged early into the pandemic and has remained strong. Other factors may have had more short-lived influences on productivity growth, including a temporary burst in worker reallocation across jobs earlier in the pandemic. Any measured productivity gains from integration of AI technologies into production processes have likely been small so far, but productivity gains may grow as AI use becomes more widespread. (See the box "Labor Productivity since the Start of the Pandemic".)
Federal Reserve's balance sheet and money markets. The size of the Federal Reserve's balance sheet has declined since June as the FOMC has continued to reduce its securities holdings. Usage of the overnight reverse repurchase agreement facility decreased further, while reserve balances were little changed. Conditions in money markets remained stable. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets".)
Framework review. The Federal Reserve has begun its periodic public review of the monetary policy framework it uses to pursue its dual-mandate goals of maximum employment and price stability. The review is focused on the FOMC's Statement on Longer-Run Goals and Monetary Policy Strategy, which articulates the Committee's approach to monetary policy, and the Committee's policy communications tools. Like the Federal Reserve's 2019–20 review of its monetary policy framework, the current review will include outreach and public events attended by policymakers, community leaders, experts from outside the Federal Reserve System, and other members of the public. (See the box "Periodic Review of Monetary Policy Strategy, Tools, and Communications".)
Monetary policy rules. Simple monetary policy rules, which prescribe a setting for the policy interest rate in response to the behavior of a small number of economic variables, can provide useful guidance to policymakers. With inflation easing and the unemployment rate having increased somewhat, the policy rate prescriptions of most simple monetary policy rules have generally declined since 2023. Currently, most of the rules call for levels of the federal funds rate that are within the current target range. (See the box "Monetary Policy Rules in the Current Environment".)