Tag Archives: federal funds rate

(Revised) Fed Officials Expect Overshooting in 2016

Following the Fed’s March 18-19 meeting, the policy making committee provided a collection of charts showing the projections of macro economic main variables in the coming years. Before discussing the projections, I should note here a little bit of confusion I have. In the projection file, it states that these projections are “based on FOMC participants’ individual assessments of appropriate monetary policy.” Therefore, these number’s aren’t actually projections as done by someone outside of the Fed, but these are the expected values of these economic variables that could be seen according to Fed officials’ own appropriate policies. 

In other words, when looking at these projections, we should take into consideration that these projections are influenced by each committee member’s policy recommendation.

The recent post on the WSJ touches on how this projection could be misleading the market into expecting that interest rate rise will come sooner than expected. According to the article, some Fed’s policy committee members raised their expectation of interest rates in 2015 and 2016. This could signal market that the Fed policy makers are looking at possible rate increase which is sooner than expected prior to March meeting.

ProjectionFed_March

From the above chart we could see what rate Fed officials are expecting fed funds rate target to be in 2014, 2015, 2016 and long-run. In 2014, according to the chart, we see that the policymakers almost unanimously expect the fed funds rate target be at the current level of 0 to 0.25 percent target. In 2015 and 2016, the averages of the Fed officials’ expected fed funds rate are around 1 percent and 2.5 percent, respectively. The policy makers expect the rate to be around 4 percent in the long-run. This rate is slightly lower than the historical average of the fed funds rate target since 1990, which is 4.2 percent. In general, the committee members expect to have similar fed funds rate target that it has had since 1990.

Note that, the expected fed funds rate target is still lower than long-run expected rate of 4 percent at around 2.5 percent in 2016. Hence, it is plausible that somewhat easy monetary policy will be taking place until 2016. But we should always remember that low interest rate doesn’t always mean expansionary monetary policy as Milton Friedman put it, “After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”

The surprise of the projection comes when we look at another chart which was included in the same projection report. The following chart shows how the committee members expect the unemployment rate to be under appropriate policy in coming years and in the long-run.

ProjectionFed_MarchUn

 The central tendency among the policy makers regarding the expected unemployment rate in 2016 is along with the long-run projection: at 5.2-5.6 percent.

So, what can we conclude about the Fed’s future policy from these two charts?

The Fed policy makers are believing (or seems to be) that under appropriate policy, the Fed will be pursuing expansionary policy even after the unemployment rate reaches the long-waited long-run average. In other words, the Fed policy makers think overshooting the unemployment rate is a viable option for the Fed policy in coming years. This is along the line with the worry about low inflation in coming years. Another chart in the projection shows how the policy makers expect inflation to be in coming years.FedINflation

 As we see from the chart that central tendency among the officials regarding the expected inflation in 2016 is below the Fed’s target of 2 percent inflation. It is kinda counter-intuitive; they target 2 percent, but expect it to be below it. Or are they really targeting 2 percent?

Then, given the the below target inflation rate, the Fed officials shouldn’t be worried about their fed funds rate target expectation below the long-run expectation.

From the Fed officials’ projection, we can conclude that the Fed will be still operating somewhat stimulus policy in 2016 relative to their long-run policy. if we assume these projections are made with rational expectation

Federal Funds Rate

Recently, the QE program and its prospects on how it may influence the economy has been one of the most media covered news on economics. Upon reading Professor Kimball’s blog post on QE, I had also written a very short blog on the magnitude of its influence around the world. As a continuation of our discussion about the QE today and the Federal Open Market Committee’s meeting just around the corner (Jan 28-29), I thought I might write a blog post on the federal funds rate.

On my last blog ( and also in Professor Kimball’s blog), there were explanations on the state of US economy as of today. In order to revive the US economy after the housing bubble in 2008 and somewhat adverse situations at global scale such as eurozone crisis, the federal reserve has lowered the interest rate down to zero, making it a more viable environment for more borrowing and spending. So far, the scoreboard says the results are not bad. There has been a slow but steady recovery.

If and when the consensus reaches that the US economy has reached a comfortable level of output and economic activity, the interest rate will rise. The question, then, would this might be? According to a recent article on Wall Street Journal, the market may move in a direction to adjust for the higher federal funds rate even before the trigger is pulled. The treasury bonds futures market is trading solely based on the belief that the interest may shoot up half year earlier than expected (Dec. 2014). This is somewhat counter-productive to Federal Reserve’s aim because they have been carefully working to convey their message that the interest rate will not rise until they deem the economy stable.

What are some ramification that we may see due to actual rise in federal funds rate? Rise in Federal funds rate– which is simply the central bank’s target for overnight loans between banks– will make borrowing more costly, seeing some hesitations among borrowers. According to a Bloomberg article, however, the actual expectation that the federal funds rate rising before 2015 is only 18%. Chief Executive of Pacific Investment Management company, which is one of the largest investor in bonds, is also very doubtful that we will see any immediate changes in the interest rate.

To prove some of these points, the economic activity may have been leveling off as seen with the chart below.

NA-BW986_Busine_G_20130626165405
Some of more charts and statistics on the state of US economy can be found here.

The article includes to say that the leveling pattern is the proof that it may be long before Fed completely tapers QE program and start raising the federal funds rate, but I guess we need to wait less than 10 days to see what FOMC has to say about the 2014 outlooks for US economy