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 2023 by providing excerpts and select figures from the Monetary Policy Report published in March 2024 and June 2023.¹ The report, submitted semiannually to the Congress, is delivered concurrently with testimony from the Federal Reserve Board Chair.²

March 2024 Summary

While inflation remains above the Federal Open Market Committee's (FOMC) objective of 2 percent, it has eased substantially over the past year, and the slowing in inflation has occurred without a significant increase in unemployment. The labor market remains relatively tight, with the unemployment rate near historically low levels and job vacancies still elevated. Real gross domestic product (GDP) growth has also been strong, supported by solid increases in consumer spending.

The FOMC has maintained the target range for the federal funds rate at 5-1/4 to 5-1/2 percent since its July 2023 meeting. The Committee views the policy rate as likely at its peak for this tightening cycle, which began in early 2022. The Federal Reserve has also continued to reduce its holdings of Treasury and agency mortgage-backed securities.

As labor market tightness has eased and progress on inflation has continued, the risks to achieving the Committee's employment and inflation goals have been moving into better balance. Even so, the Committee remains highly attentive to inflation risks and is acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials.

The FOMC is strongly committed to returning inflation to its 2 percent objective. In considering any 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. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

Recent Economic and Financial Developments

Inflation. Consumer price inflation has slowed notably but remains above 2 percent. The price index for personal consumption expenditures (PCE) rose 2.4 percent over the 12 months ending in January, down from a peak of 7.1 percent in 2022. The core PCE price index—which excludes volatile food and energy prices and is generally considered a better guide to the direction of future inflation—rose 2.8 percent in the 12 months ending in January, and the slowing in inflation was widespread across both goods and services prices (figure 2.1). More recently, core PCE prices increased at an annual rate of 2.5 percent over the six months ending in January, though measuring inflation over relatively short periods risks exaggerating the influence of idiosyncratic or temporary factors. 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.

The labor market. The labor market has remained relatively tight, with job gains averaging 239,000 per month since June and the unemployment rate near historical lows (figure 2.2). Labor demand has eased—as job openings have declined in many sectors of the economy—but continues to exceed the supply of available workers (figure 2.3). Labor supply has trended higher over the past year, reflecting a continued strong pace of immigration and increases in the labor force participation rate, particularly among prime-age workers. Reflecting the improved balance between labor demand and supply, nominal wage gains slowed in 2023, but they remain above a pace consistent with 2 percent inflation over the longer term, given prevailing trends in productivity growth.

Economic activity. Real GDP increased 3.1 percent last year, notably faster than in 2022 despite tighter financial conditions, including elevated longer-term interest rates. Consumer spending grew at a solid pace, and housing market activity started to turn back up in the second half of last year after having declined since early 2021. However, real business fixed investment growth slowed, likely reflecting tighter financial conditions and downbeat business sentiment. In contrast to GDP, manufacturing output was little changed, on net, last year, a downshift following two years of robust post-pandemic gains.

Financial conditions. Conditions in financial markets tightened considerably further over the summer and early fall before reversing course toward the end of the year. The FOMC raised the target range for the federal funds rate a further 25 basis points at its meeting last July, bringing the overall increase in the target range for this tightening cycle to 525 basis points. The market-implied expected path of the federal funds rate has moved up, on net, since the middle of 2023, and yields on longer-term nominal Treasury securities are notably higher on balance. Credit remains generally available to most households and businesses but at elevated interest rates, which have weighed on financing activity. Lending by banks to households and businesses slowed notably since June as banks continued to tighten standards and demand for loans softened.

Financial stability. Overall, the banking system remains sound and resilient; although acute stress in the banking system has receded since last March, a few areas of risk warrant continued monitoring. Upward pressure on asset valuations continued, with real estate prices elevated relative to rents and high price-to-earnings ratios in equity markets. Borrowing from nonfinancial businesses and households continued to increase at a pace slower than that of nominal GDP, and the combined debt-to-GDP ratio now sits close to its 20-year low. Vulnerabilities from financial-sector leverage remain notable. While risk-based bank capital ratios stayed solid and increased broadly, declines in the fair values of fixed-rate assets have been sizable relative to the regulatory capital at some banks. Meanwhile, leverage at hedge funds has stabilized at high levels, and leverage at life insurers increased to values close to the historical averages but with a liability composition that has become more reliant on nontraditional sources of funding. Most banks maintained high liquidity and stable funding, while bank funding costs continue to increase. (See the box "Developments Related to Financial Stability" on pages 27–28 of the March 2024 Monetary Policy Report.)

International developments. Following a rebound in early 2023, growth in foreign economic activity was subdued in the second half of last year. Economic growth was particularly weak in advanced foreign economies (AFEs) as monetary policy tightening weighed on activity and high inflation eroded real household incomes. Structural adjustment to higher energy prices in Europe continued to hinder economic performance, while property-sector weakness and sluggish domestic demand restrained Chinese economic activity. Foreign headline inflation has fallen further, reflecting declines in core and food inflation. However, the pace of disinflation has varied across countries and sectors, with the moderation in goods inflation generally outpacing that in services inflation.

Most foreign central banks paused policy interest rate hikes in the second half of last year and have since held rates steady. Policy rate paths implied by financial market pricing suggest that central banks in many AFEs are expected to begin lowering their policy rates in 2024. Several central banks in emerging market economies have already begun easing monetary policy. The trade-weighted exchange value of the U.S. dollar has increased slightly, on net, since the middle of last year.

Monetary Policy

Interest rate policy. After significantly tightening the stance of monetary policy since early 2022, the FOMC has maintained the target range for the policy rate at 5-1/4 to 5-1/2 percent since its meeting last July (figure 2.4). Although the FOMC judges that the risks to achieving its employment and inflation goals are moving into better balance, the Committee remains highly attentive to inflation risks. The Committee has indicated that it does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In considering any 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, contributing to the tightening of financial conditions.³ 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 about $640 billion since mid-June 2023, bringing the total reduction in securities holdings since the start of balance sheet runoff to about $1.4 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 intends to slow and then 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. An exceptionally tight labor market over the past two years has been especially beneficial for historically disadvantaged groups of workers. As a result, many of the long-standing disparities in employment and wages by sex, race, ethnicity, and education have narrowed, and some gaps reached historical lows in 2023. However, despite this narrowing, significant disparities in absolute levels across groups remain. (See the box "Employment and Earnings across Demographic Groups" on pages 10–12 of the March 2024 Monetary Policy Report.)

Housing sector. The rise in mortgage rates over the past two years has reduced housing demand, resulting in a steep drop in housing activity in 2022 and a marked slowing in house price growth from its historically high pace. Offsetting factors boosting housing demand, such as the robust job market and the increased prevalence of remote work, have prevented significant price declines. High mortgage rates have also discouraged some potential sellers with low rates on their current mortgages from moving, which has kept the existing home market unusually thin. The shortage of available existing homes has pushed some remaining homebuyers toward new homes and supported a modest rebound in construction of single-family homes later in 2023. In contrast, multifamily starts rose to historically high levels in 2022 but have more recently fallen back because of builders' concerns about the effect of the significant amount of new multifamily supply on rents and property prices. (See the box "Recent Housing Market Developments" on pages 19–21 of the March 2024 Monetary Policy Report.)

Federal Reserve's balance sheet and money markets. The size of the Federal Reserve's balance sheet has decreased since June as the FOMC continued to reduce its securities holdings. Despite ongoing balance sheet runoff, reserve balances—the largest liability on the Federal Reserve's balance sheet—edged up as declines in the usage of the overnight reverse repurchase agreement facility—another Federal Reserve liability—more than matched the decline in assets. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets" on pages 38–40 of the March 2024 Monetary Policy Report.)

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 supply and demand conditions in labor markets coming into better balance, the policy rate prescriptions of most simple monetary policy rules have decreased recently and now call for levels of the federal funds rate that are close to the current target range for the federal funds rate. (See the box "Monetary Policy Rules in the Current Environment" on pages 41–43 of the March 2024 Monetary Policy Report.)

June 2023 Summary

Although inflation has moderated somewhat since the middle of last year, it remains well above the Federal Open Market Committee's (FOMC) objective of 2 percent. The labor market continues to be very tight, with robust job gains and the unemployment rate near historically low levels, though nominal wage growth has shown some signs of easing and job vacancies have declined. Real gross domestic product (GDP) growth was modest in the first quarter, despite a pickup in consumer spending. Bringing inflation back to 2 percent will likely require a period of below-trend growth and some softening of labor market conditions.

In response to high inflation, the FOMC continued to increase interest rates and reduce its securities holdings. The FOMC has raised the target range for the federal funds rate a further 75 basis points since the start of the year, bringing the range to 5 to 5-1/4 percent. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the FOMC indicated that it will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. The Federal Reserve also continued to reduce its holdings of Treasury and agency mortgage-backed securities; these holdings have declined by about $420 billion since January, further tightening financial conditions.

The Federal Reserve is acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials. The FOMC is strongly committed to returning inflation to its 2 percent objective.

Recent Economic and Financial Developments

Inflation. Consumer price inflation, as measured by the 12-month change in the price index for personal consumption expenditures (PCE), was 4.4 percent in April, down from its peak of 7.0 percent last June but still well above the FOMC's 2 percent objective. Core PCE price inflation—which excludes volatile food and energy prices and is generally considered a better guide to the direction of future inflation—is also off its peak but was still 4.7 percent over the 12 months ending in April. As supply chain bottlenecks have eased and demand has stabilized, increases in core goods prices slowed considerably over the past year. Within core services prices, housing services inflation has been high, but the monthly changes have started to ease in recent months, consistent with the slower increases in rents for new tenants that have been observed since the second half of last year. For other core services, price inflation remains elevated and has not shown signs of easing, and prospects for slowing inflation may depend in part on a further easing of tight labor market conditions. 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, suggesting that high inflation is not becoming entrenched.

The labor market. The labor market has remained very tight, with job gains averaging 314,000 per month during the first five months of the year and the unemployment rate remaining near historical lows. Labor demand has eased in many sectors of the economy but continues to exceed the supply of available workers, with job vacancies still elevated. Labor supply has improved, with a pickup in immigration and an improvement in the labor force participation rate, particularly among prime-age workers. Nominal wage gains continued to slow in the first half of 2023, but they remain above the pace consistent with 2 percent inflation over the longer term, given prevailing trends in productivity growth.

Economic activity. After the strong rebound in 2021 from the pandemic-induced recession, economic activity lost momentum last year, and growth in the first quarter of this year was modest as financial conditions continued to tighten. Real consumer spending grew at a solid pace in the first quarter but appears to be moderating as consumer financing conditions have tightened and consumer confidence has remained low. Real business fixed investment growth continued to slow in the first quarter, likely reflecting tighter financial conditions and weaker output growth, while manufacturing output has been roughly unchanged so far this year after having declined in the fourth quarter. Activity in the housing sector continued to contract in response to elevated mortgage rates, but several indicators appear to have bottomed out.

Financial conditions. Financial conditions have tightened further since January. The FOMC has raised the target range for the federal funds rate a further 75 basis points since January, and the market-implied expected path of the federal funds rate over the next year shifted up. Though yields on longer-term nominal Treasury securities were little changed, on net, over this period, the relatively high level of interest rates has weighed on financing activity. Business loans at banks grew since the start of 2023, but the pace of growth continued to slow as banks tightened standards and average borrowing costs rose. Investment-grade corporate bond issuance rebounded to a brisk pace in May, following a slowdown in March and April. Speculative-grade issuance rebounded as well but was still subdued by historical standards. While business credit quality remains strong, some indicators of future business defaults are somewhat elevated. For households, mortgage originations remained weak, although consumer loans (such as auto loans and credit cards) grew further. After having risen last year, delinquency rates leveled off in the first quarter for auto loans and continued to increase for credit card loans.

Financial stability. Despite concerns about profitability at some banks, the banking system remains sound and resilient. Most measures of valuation pressures in corporate securities markets remained near the middle of their historical distributions. By contrast, valuation pressures in commercial and residential real estate markets continued to be elevated. Borrowing by households and businesses grew a bit more slowly than GDP, leaving vulnerabilities arising from household and business debt largely unchanged at moderate levels. In the banking sector, heavy reliance on uninsured deposits, declining fair values of long-duration fixed-rate assets associated with higher interest rates, and poor risk management led to the failure of three domestic banks. Broad bank equity prices fell sharply as market participants reassessed the strength of some banks with similar risk profiles to those that failed. However, the broader banking sector maintained substantial loss-absorbing capacity and ample liquidity. In the nonbank financial sector, leverage at hedge funds remained elevated, and structural vulnerabilities associated with funding risk persisted at some money market funds and certain mutual funds. (See the box "Developments Related to Financial Stability" on pages 31–32 of the June 2023 Monetary Policy Report.)

International developments.Following a slowdown at the end of 2022, foreign activity rebounded early this year. This rebound was driven in part by strong growth in China, as the lifting of COVID-19 restrictions unleashed pent-up demand, though recent indicators suggest that momentum is slowing. Europe showed resilience to the energy price shock stemming from Russia's war against Ukraine. Foreign headline inflation continued to fall, driven by declines in retail energy prices. However, while energy inflation has moderated in many foreign economies, both food and core inflation remain elevated.

Since January, several major foreign central banks continued tightening their monetary policies, communicating concerns about elevated inflation and tight labor markets. That said, some central banks also emphasized the need to be cautious in their approach, given the lags of monetary policy and the uncertainty about the outlook for growth and inflation. The trade-weighted exchange value of the U.S. dollar is a touch lower.

Monetary Policy

In response to high inflation, the FOMC continued to increase the target range for the federal funds rate and reduce its securities holdings this year. Adjustments to both interest rates and the balance sheet are playing a role in firming the stance of monetary policy in support of the Federal Reserve's maximum-employment and price-stability goals.

Interest rate policy. The FOMC continued to increase the target range for the federal funds rate, bringing it to the current range of 5 to 5-1/4 percent. In light of the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation, the FOMC slowed the pace of policy tightening relative to last year. The FOMC will determine meeting by meeting the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, based on the totality of incoming data and their implications for the outlook for economic activity and inflation.

Balance sheet policy. The Federal Reserve has continued the process of significantly reducing its holdings of Treasury and agency securities in a predictable manner.⁴ Beginning in June of last year, principal payments from securities held in the System Open Market Account (SOMA) have been reinvested only to the extent that they exceeded monthly caps. The Federal Reserve has reduced its securities holdings by about $420 billion since January. This decrease in assets was partially offset by liquidity provisions to the banking system following the banking-sector stresses in March.

 

Special Topics

Employment and earnings across groups. Strong labor demand over the past two years has particularly benefited historically more disadvantaged workers. As a result, many of the disparities in employment and wages across racial, ethnic, sex, and education groups, which had been exacerbated by the pandemic, have narrowed—in some cases to historically narrow ranges. Despite this narrowing, there remain significant disparities in absolute levels of employment and wages across groups. (See the box "Developments in Employment and Earnings across Demographic Groups" on pages 11–13 of the June 2023 Monetary Policy Report.)

Bank stress and lending. Bank lending conditions have tightened notably over the past year, and bank loan growth has slowed, following the tightening of monetary policy that started in early 2022. Banking-sector strains in March 2023 reportedly led to further tightening in lending conditions at some banks. Results from the April 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices show that banks expect to further tighten their lending standards over the remainder of 2023, with some banks reporting concerns about their liquidity positions, deposit outflows, and funding costs. Economic research suggests that tighter credit conditions at banks can have adverse effects on economic activity, but different studies find effects that vary in scope, magnitude, and timing. In terms of scope, the effects are also likely to differ across borrowers, economic sectors, and geographic areas, and they may be larger for sectors that depend more heavily on bank credit, such as the commercial real estate and the small business sectors. (See the box "Recent Developments in Bank Lending Conditions" on pages 21–23 of the June 2023 Monetary Policy Report.)

Federal Reserve's balance sheet and money markets. The Federal Reserve continued to reduce the size of its SOMA portfolio. However, in March, amid banking-sector developments, borrowing from the discount window increased, and the Federal Reserve implemented a new facility, the Bank Term Funding Program (BTFP), to make additional funding available to eligible depository institutions. As a result of Federal Reserve lending through the BTFP, the discount window, and other credit extensions, the Federal Reserve's total assets have increased since March. Take-up in the overnight reverse repurchase agreement (ON RRP) facility remained elevated, as low rates on repurchase agreements persisted amid still abundant liquidity and limited Treasury bill supply. The ON RRP facility continued to serve its intended purpose of helping to provide a floor under short-term interest rates and supporting effective implementation of monetary policy. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets" on pages 42–43 of the June 2023 Monetary Policy Report.)

Monetary policy rules. Simple monetary policy rules, which prescribe a setting for the policy interest rate based on a small number of other economic variables, can provide useful guidance to policymakers. Since 2021, inflation has run well above the FOMC's 2 percent longer-run objective, and labor market conditions have been very tight over the past year. As a result, simple monetary policy rules have called for elevated levels of the federal funds rate. (See the box "Monetary Policy Rules in the Current Environment" on pages 44–46 of the June 2023 Monetary Policy Report.)

Footnotes