Board of Governors of the Federal Reserve System

Monetary Policy and Economic Developments

The Federal Reserve conducts the nation's monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. This section reviews U.S. monetary policy and economic developments in 2020, with excerpts and select figures from the Monetary Policy Report published in February 2021 and June 2020.¹ The report, submitted semiannually to the Congress, is delivered concurrently with testimony from the Federal Reserve Board Chair.²

February 2021 Summary

The COVID-19 pandemic continues to weigh heavily on economic activity and labor markets in the United States and around the world, even as the ongoing vaccination campaigns offer hope for a return to more normal conditions later this year. While unprecedented fiscal and monetary stimulus and a relaxation of rigorous social-distancing restrictions supported a rapid rebound in the U.S. labor market last summer, the pace of gains has slowed and employment remains well below pre-pandemic levels. In addition, weak aggregate demand and low oil prices have held down consumer price inflation. In this challenging environment, the Federal Open Market Committee (FOMC) has held its policy rate near zero and has continued to purchase Treasury securities and agency mortgage-backed securities to support the economic recovery. These measures, along with the Committee's strong guidance on interest rates and the balance sheet, will ensure that monetary policy will continue to deliver powerful support to the economy until the recovery is complete.

Economic and Financial Developments

Economic activity and the labor market. The initial wave of COVID-19 infections led to a historic contraction in economic activity as a result of both mandatory restrictions and voluntary changes in behavior by households and businesses. The level of gross domestic product (GDP) fell a cumulative 10 percent over the first half of 2020, and the measured unemployment rate spiked to a post–World War II high of 14.8 percent in April. As mandatory restrictions were subsequently relaxed and households and firms adapted to pandemic conditions, many sectors of the economy recovered rapidly and unemployment fell back. Momentum slowed substantially in the late fall and early winter, however, as spending on many services contracted again amid a worsening of the pandemic. All told, GDP is currently estimated to have declined 2.5 percent over the four quarters of last year and payroll employment in January was almost 10 million jobs below pre-pandemic levels, while the unemployment rate remained elevated at 6.3 percent and the labor force participation rate was severely depressed (figure 2.1). Job losses have been most severe and unemployment remains particularly elevated among Hispanics, African Americans, and other minority groups as well as those who hold lower-wage jobs (figure 2.2).

Inflation. After declining sharply as the pandemic struck, consumer price inflation rebounded along with economic activity, but inflation remains below pre-COVID levels and the FOMC's longer-run objective of 2 percent. The 12-month measure of personal consumption expenditures inflation was 1.3 percent in December, while the measure that excludes food and energy items—so-called core inflation, which is typically less volatile than total inflation—was 1.5 percent (figure 2.3). Both total and core inflation were held down in part by prices for services adversely affected by the pandemic, and indicators of longer-run inflation expectations are now at similar levels to those seen in recent years.

Financial conditions. Financial conditions have improved notably since the spring of last year and remain generally accommodative. Low interest rates, the Federal Reserve's asset purchases, the establishment of emergency lending facilities, and other extraordinary actions, together with fiscal policy, continued to support the flow of credit in the economy and smooth market functioning. The nominal Treasury yield curve steepened and equity prices continued to increase steadily in the second half of last year as concerns over the resurgence in COVID-19 cases appeared to have been outweighed by positive news about vaccine prospects and expectations of further fiscal support. Spreads of yields on corporate bonds over those on comparable-maturity Treasury securities narrowed significantly, partly because the credit quality of firms improved and market functioning remained stable. Mortgage rates for households remain near historical lows. However, financing conditions remain relatively tight for households with low credit scores and for small businesses.

Financial stability. While some financial vulnerabilities have increased since the start of the pandemic, the institutions at the core of the financial system remain resilient. Asset valuation pressures have returned to or exceeded pre-pandemic levels in most markets, including in equity, corporate bond, and residential real estate markets. Although government programs have supported business and household incomes, some businesses and households have become more vulnerable to shocks, as earnings have fallen and borrowing has risen. Strong capital positions before the pandemic helped banks absorb large losses related to the pandemic. Financial institutions, however, may experience additional losses as a result of rising defaults in the coming years, and long-standing vulnerabilities at money market mutual funds and open-end investment funds remain unaddressed. Although some facilities established by the Federal Reserve in the wake of the pandemic have expired, those remaining continue to serve as important backstops against further stress. (See the box "Developments Related to Financial Stability" on pages 30–31 of the February 2021 Monetary Policy Report.)

International developments. Mirroring the United States, economic activity abroad bounced back last summer after the spread of the virus moderated and restrictions eased. Subsequent infections and renewed restrictions have again depressed economic activity, however. Relative to the spring, the current slowdown in economic activity has been less dramatic. Fiscal and monetary policies continue to be supportive, and people have adapted to containment measures that have often been less stringent than earlier.

Despite the resurgence of the pandemic in many economies, financial markets abroad have recovered since the spring, buoyed by continued strong fiscal and monetary policy support and the start of vaccination campaigns in many countries. With the abatement of financial stress, the broad dollar has depreciated, more than reversing its appreciation at the onset of the pandemic. On balance, global equity prices have recovered and sovereign credit spreads in emerging market economies and in the European periphery have narrowed. In major advanced economies, sovereign yields remained near historical low levels amid continued monetary policy accommodation.

Monetary Policy

Review of the strategic framework for monetary policy. The Federal Reserve concluded the review of its strategic framework for monetary policy in the second half of 2020. The review was motivated by changes in the U.S. economy that affect monetary policy, including the global decline in the general level of interest rates and the reduced sensitivity of inflation to labor market tightness. In August, the FOMC issued a revised Statement on Longer-Run Goals and Monetary Policy Strategy.³ The revised statement acknowledges the changes in the economy over recent decades and articulates how policymakers are taking these changes into account in conducting monetary policy. In the revised statement, the Committee indicates that it aims to attain its statutory goals by seeking to eliminate shortfalls from maximum employment—a broad-based and inclusive goal—and achieve inflation that averages 2 percent over time. Achieving inflation that averages 2 percent over time helps ensure that longer-term inflation expectations remain well anchored at the FOMC's longer-run 2 percent objective. Hence, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time. (See the box "The FOMC's Revised Statement on Longer-Run Goals and Monetary Policy Strategy" on pages 40–41 of the February 2021 Monetary Policy Report.)

In addition, in December the FOMC introduced two changes to the Summary of Economic Projections (SEP) intended to enhance the information provided to the public. First, the release of the full set of SEP exhibits was accelerated by three weeks, from the publication of the minutes three weeks after the end of an FOMC meeting to the day of the policy decision, the second day of an FOMC meeting. Second, new charts were included that display how FOMC participants' assessments of uncertainties and risks have evolved over time.

Interest rate policy. In light of the effects of the continuing public health crisis on the economy and the associated risks to the outlook, the FOMC has maintained the target range for the federal funds rate at 0 to 1/4 percent since last March (figure 2.4). In pursuing the strategy outlined in its revised statement, the Committee noted that it expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.

Balance sheet policy. With the federal funds rate near zero, the Federal Reserve has also continued to undertake asset purchases to increase its holdings of Treasury securities by $80 billion per month and its holdings of agency mortgage-backed securities by $40 billion per month. These purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses. The Committee expects these purchases to continue at least at this pace until substantial further progress has been made toward its maximum-employment and price-stability goals.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee is prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals.

Special Topics

Disparities in job loss. The COVID-19 crisis has exacerbated pre-existing disparities in labor market outcomes across job types and demographic groups. Job losses last spring were disproportionately severe among lower-wage workers, less-educated workers, and racial and ethnic minorities, as in previous recessions, but also among women, in contrast to previous recessions. While all groups have experienced at least a partial recovery in employment rates since April 2020, the shortfall in employment remains especially large for lower-wage workers and for Hispanics, African Americans, and other minority groups, and the additional childcare burdens resulting from school closures have weighed more heavily on women's labor force participation than on men's labor force participation. (See the box "Disparities in Job Loss during the Pandemic" on pages 12–14 of the February 2021 Monetary Policy Report.)

High-frequency indicators. The unprecedented magnitude, speed, and nature of the COVID-19 shock to the economy rendered traditional statistics insufficient for monitoring economic activity in a timely manner. As a result, policymakers turned to nontraditional high-frequency indicators of activity, especially for the labor market and consumer spending. These indicators presented a more timely and granular picture of the drop and subsequent rebound in economic activity last spring. The most recent readings obtained from those indicators suggest that economic activity began to edge up again in January, likely reflecting in part the disbursement of additional stimulus payments to households. (See the box "Monitoring Economic Activity with Nontraditional High-Frequency Indicators" on pages 7–9 of the February 2021 Monetary Policy Report.)

Monetary policy rules. Simple monetary policy rules, which relate a policy interest rate to a small number of other economic variables, can provide useful guidance to policymakers. This discussion presents the policy rate prescriptions from a number of rules that have received attention in the research literature, many of which mechanically prescribe raising the federal funds rate as employment rises above estimates of its longer-run level. A rule that instead responds only to shortfalls of employment from assessments of its maximum level is featured to illustrate one aspect of the FOMC's revised approach to policy, as described in the revised Statement on Longer-Run Goals and Monetary Policy Strategy. (See the box "Monetary Policy Rules and Shortfalls from Maximum Employment" on pages 45–48 of the February 2021 Monetary Policy Report.)

June 2020 Summary

The COVID-19 outbreak is causing tremendous human and economic hardship across the United States and around the world. The virus and the measures taken to protect public health have induced a sharp decline in economic activity and a surge in job losses, with the unemployment rate, which had been at a 50-year low, soaring to a postwar record high. Weaker demand and significantly lower oil prices are holding down consumer price inflation. The disruptions to economic activity here and abroad significantly affected financial conditions and impaired the flow of credit to U.S. households and businesses. In response to these developments, the Federal Reserve quickly lowered its policy rate to close to zero to support economic activity and took extraordinary measures to stabilize markets and bolster the flow of credit to households, businesses, and communities. Financial conditions have improved, in part reflecting policy measures to support the economy and the flow of credit. The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum-employment and price-stability goals.

Economic and Financial Developments

Economic activity. In response to the public health emergency precipitated by the spread of COVID-19, many protective measures were adopted to limit the transmission of the virus. These social-distancing measures effectively closed parts of the economy, resulting in a sudden and unprecedented fall in economic activity and historic increases in joblessness. Although virus mitigation efforts in many places did not begin until the final two weeks of March, real personal consumption expenditures (PCE) plummeted 6.7 percent in March and an unprecedented 13.2 percent in April. Indicators suggest spending rose in May, but the April data and May indicators taken together point to a collapse in second-quarter real PCE. Likewise, in the housing market, residential sales and construction in April posted outsized declines that are close to some of the largest ever recorded, and heightened uncertainty and weak demand have led many businesses to put investment plans on hold or cancel them outright. These data, along with other information, suggest that real gross domestic product will contract at a rapid pace in the second quarter after tumbling at an annual rate of 5 percent in the first quarter of 2020.

The labor market. The severe economic repercussions of the pandemic have been especially visible in the labor market. Since February, employers have shed nearly 20 million jobs from payrolls, reversing almost 10 years of job gains. The unemployment rate jumped from a 50-year low of 3.5 percent in February to a post–World War II high of 14.7 percent in April and then moved down to a still very elevated 13.3 percent in May. The most severe job losses have been sustained by those with lower earnings and by the socioeconomic groups that are disproportionately represented among low-wage jobs.

Inflation. Consumer price inflation has slowed abruptly. The 12-month change in the price index for PCE was just 0.5 percent in April. The 12-month measure of PCE inflation that excludes food and energy items (so-called core inflation), which historically has been a better indicator of where overall inflation will be in the future than the total figure, fell from 1.8 percent in February to 1.0 percent in April. This slowing reflected monthly readings for March and April that were especially low because of large price declines in some categories most directly affected by social distancing. Overall inflation also has been held down by substantially lower energy prices, which more than offset the effects of surging prices for food. Despite the sharp slowing in inflation, survey-based measures of longer-run inflation expectations have generally been stable at relatively low levels. However, market-based measures of inflation compensation have moved down to some of the lowest readings ever seen.

Financial conditions. In late February and over much of March as COVID-19 spread, equity prices plunged and nominal Treasury yields dropped substantially, with yields on longer-term securities reaching all-time record lows. Spreads of yields on corporate bonds over those on comparable-maturity Treasury securities widened significantly as the credit quality of firms declined and market functioning deteriorated; in addition, loans were unavailable for most firms, particularly firms below investment grade. At the most acute phase of this period, trading conditions became extremely illiquid and some critical markets stopped functioning properly. Consumer borrowing also fell as spending slumped. Several markets supporting consumer lending experienced severe strains around this period, including the agency residential mortgage-backed securities (MBS) market as well as the auto, credit card, and student loan securitization markets. In response, the Federal Reserve took unprecedented measures to restore smooth market functioning and to support the flow of credit in the economy, including the creation of a number of emergency credit and liquidity facilities.⁴ These actions, along with the aggressive response of fiscal policy, stabilized financial markets and led to a notable improvement in financial conditions for both firms and households as well as state and local governments. Even so, lending standards for both households and businesses have become less accommodative, and borrowing conditions are tight for low-rated households and businesses.

Financial stability. The COVID-19 pandemic has abruptly halted large swaths of economic activity and led to swift financial repercussions. Despite increased resilience from the financial and regulatory reforms adopted since 2008, financial system vulnerabilities—most notably those associated with liquidity and maturity transformation in the nonbank financial sector—have amplified some of the economic effects of the pandemic. Accordingly, financial-sector vulnerabilities are expected to be significant in the near term. The strains on household and business balance sheets from the economic and financial shocks since March will likely create persistent fragilities. Financial institutions may experience strains as a result. The Federal Reserve, with approval of the Secretary of the Treasury, established new credit and liquidity facilities under section 13(3) of the Federal Reserve Act to alleviate severe dislocations that arose in a number of financial markets and to support the flow of credit to households, businesses, and state and local governments. Furthermore, as financial stresses abroad risked spilling over into U.S. credit markets, the Federal Reserve and several other central banks announced the expansion and enhancement of dollar liquidity swap lines. In addition, the Federal Reserve introduced a new temporary repurchase agreement facility for foreign monetary authorities. The Federal Reserve has also made a number of adjustments to its regulatory and supervisory regime to facilitate market functioning and reduce regulatory impediments to banks supporting households, businesses, and municipal customers affected by COVID-19. (See the box "Developments Related to Financial Stability" on pages 30–33 of the June 2020 Monetary Policy Report.)

International developments. The spread of COVID-19 throughout the world and the measures taken to contain it have produced devastating effects on the global economy. Amid widespread and stringent shutdowns, recent data suggest that global economic activity in the first half of the year has experienced a sharp and synchronized contraction greater than that in the Global Financial Crisis. The many mandated closures of nonessential businesses abroad and the collapse in consumer demand contributed to a significant deterioration in labor markets and subdued inflation. Unlike past recessions, services activity in the foreign economies has dropped more sharply than manufacturing, with restrictions on movement having severely curtailed spending on travel, tourism, restaurants, and recreation. Against this backdrop, foreign governments and central banks have responded strongly and swiftly to support incomes and to improve market liquidity and the provision of credit. More recently, economic activity has begun to revive in some foreign economies as authorities eased social-distancing restraints.

The rapid spread of COVID-19 weighed heavily on global risk sentiment, with financial stresses intensifying and liquidity conditions deteriorating in many foreign financial markets. Aggressive fiscal and monetary policy responses in the United States and abroad, however, helped boost sentiment and improve market functioning. On balance, financial conditions abroad remain tighter than at the beginning of the year, especially in some emerging market economies. Since February, global equity prices moved lower, sovereign interest rates in the European periphery increased somewhat, and measures of sovereign spreads in emerging market economies widened significantly. In many advanced economies, long-term interest rates reached historically low levels.

Monetary Policy

Easing monetary policy. In light of the effects of COVID-19 on economic activity and on risks to the outlook, the Federal Open Market Committee (FOMC) rapidly lowered the target range for the federal funds rate. Specifically, at two meetings in March, the FOMC lowered the target range for the federal funds rate by a total of 1-1/2 percentage points, bringing it to the current range of 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum-employment and price-stability goals. The Committee noted that it would continue to monitor the implications of incoming information for the economic outlook, including information related to public health, as well as global developments and muted inflation pressures, and that it would use its tools and act as appropriate to support the economy.

Safeguarding market functioning. Market functioning deteriorated in many markets in late February and much of March, including the critical Treasury and agency MBS markets. The Federal Reserve swiftly took a series of policy actions to address these developments. The FOMC announced it would purchase Treasury securities and agency MBS in the amounts needed to ensure smooth market functioning and the effective transmission of monetary policy to broader financial conditions. The Open Market Desk began offering large-scale overnight and term repurchase agreement operations. The Federal Reserve coordinated with other central banks to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements and announced the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with additional central banks. The Federal Reserve also established a temporary repurchase agreement facility for foreign and international monetary authorities. (Separately, the Board introduced several facilities with the backing of the U.S. Treasury to more directly support the flow of credit to the economy.) Since these policy actions were announced, the functioning of Treasury and MBS markets has gradually improved. (See the box "Federal Reserve Actions to Ensure Smooth Functioning of Treasury and MBS Markets" on pages 45–47 of the June 2020 Monetary Policy Report.) Reflecting these policy responses, the size of the Federal Reserve's balance sheet increased significantly. (See the box "Developments on the Federal Reserve's Balance Sheet" on pages 50–52 of the June 2020 Monetary Policy Report.)

Fed Listens. The Federal Reserve has released a report on its Fed Listens initiative. This initiative is part of a broad review of the monetary policy strategy, tools, and communication practices the Federal Reserve uses to pursue its statutory dual-mandate goals of maximum employment and price stability. A key component of the review was a series of public Fed Listens events aimed at consulting with a broad range of stakeholders in the U.S. economy on issues pertaining to the dual-mandate objectives.

Special Topics

Disparities in job loss during the pandemic. The deterioration in labor market conditions since February has been sudden, severe, and widespread. At the same time, workers in some industries, occupations, demographic groups, and locations have experienced more significant employment declines than others. Although disparities in labor market outcomes often arise during recessions, factors unique to this episode have also contributed to the recent divergence. Job losses have been especially severe for those with lower earnings and for the socioeconomic groups that are disproportionately represented among low-wage jobs. (See the box "Disparities in Job Loss during the Pandemic" on pages 8–9 of the June 2020 Monetary Policy Report.)

Small businesses during the COVID-19 crisis. Small businesses make up nearly half of U.S. private-sector employment and play key roles in local communities. The pandemic poses acute risks to the survival of many small businesses. Their widespread failure would adversely alter the economic landscape of local communities and potentially slow the economic recovery and future labor productivity growth. The Congress, the Federal Reserve, and other federal agencies are making aggressive efforts to support small businesses. (See the box "Small Businesses during the COVID-19 Crisis" on pages 24–26 of the June 2020 Monetary Policy Report.)

Federal fiscal policy response to COVID-19. While the economic consequences resulting from the pandemic have been historically large, the amount of fiscal support that has been enacted constitutes the fastest and largest fiscal response to any postwar economic downturn. The pieces of legislation enacted since the arrival of the pandemic that have composed this response are expected to raise government outlays and reduce tax revenues by nearly $2 trillion in the current fiscal year. (See the box "Federal Fiscal Policy Response to COVID-19" on pages 20–21 of the June 2020 Monetary Policy Report.)

Policy response to COVID-19 in foreign economies. Authorities in many foreign economies have implemented fiscal, monetary, and regulatory measures to mitigate disruptions caused by the COVID-19 pandemic. Sizable fiscal packages targeted the sudden loss of income by firms and households. Actions by central banks, including purchases of sovereign and private bonds, have aimed to restore market functioning, sustain the provision of credit to businesses and households during the pandemic, and support the economic recovery. Regulatory changes have focused on ensuring that banks sustain their capacity to absorb pandemic-related losses while continuing to lend to households and firms. (See the box "Policy Response to COVID-19 in Foreign Economies" on pages 38–39 of the June 2020 Monetary Policy Report.)

Footnotes