Academic journal article Economic Review (Kansas City, MO)

Monetary Policy at the Zero Lower Bound: Revelations from the FOMC's Summary of Economic Projections

Academic journal article Economic Review (Kansas City, MO)

Monetary Policy at the Zero Lower Bound: Revelations from the FOMC's Summary of Economic Projections

Article excerpt

In 2012, the Federal Open Market Committee (FOMC) added the federal funds rate to its quarterly Summary of Economic Projections (SEP). As a result, in addition to providing their individual projections of inflation, unemployment, and real GDP growth up to three years into the future, participants in FOMC meetings--including Federal Reserve Board governors and Bank presidents--also began providing their projections of the associated path for the target federal funds rate. These funds rate projections are not unconditional forecasts but rather reflect each participant's view of "appropriate" monetary policy. Thus, the projections reveal how participants expect the economy to evolve conditioned on their preferred future paths of the federal funds rate. While the federal funds rate remained at its effective lower bound from 2012 to 2015, FOMC participants repeatedly projected the funds rate would rise in conjunction with projected increases in inflation and declines in unemployment.

Although the SEP's various projections of liftoff from the zero lower bound did not materialize, the SEP still provides financial markets and the public valuable information about policymakers' outlook for the economy and their views about appropriate policy. In particular, the SEP can reveal information about Committee participants' policy reaction function. In this article, we use the SEP to evaluate the projected response of monetary policy to expected economic developments, compare this response to past policy actions, and assess why the actual policy path persistently differed from the projected path. We find that the relationship since 2012 between the FOMC's projections of the target funds rate and its projections of inflation and unemployment is data dependent and systematic, meaning the funds rate projections were not on a preset path. Moreover, we find that the relationship is generally consistent with the FOMC's actual policy responses prior to the onset of the zero lower bound. That the funds rate remained stuck at the effective lower bound after 2012 mainly reflects unexpectedly low inflation which was offset to some extent by a faster-than-expected decline in the unemployment rate.

Section I describes the SEP and shows how the projections of real GDP growth, unemployment, inflation, and the federal funds rate evolved over time. Section II estimates a policy reaction function relating FOMC participants' projections of the federal funds rate to their projections of inflation and unemployment and compares it to the Committee's actions before the onset of the zero lower bound. Section III decomposes the deviation of the projected funds rate from its realized level at the zero lower bound into three parts--projection "misses" for inflation and unemployment and an unexplained component.

I. Getting to Know the SEP

The SEP has its roots in the FOMC's semiannual economic reports to Congress that started in July 1979 after the Full Employment and Balanced Growth Act (commonly referred to as the Humphrey-Hawkins Act) took effect. These reports included projections of inflation, economic growth, and unemployment over various horizons, although many features of the projections--including the indicators used to measure inflation and growth--have evolved over time. (1)

The FOMC released the first SEP in the minutes of its October 2007 meeting and has since provided participants' economic projections in conjunction with four of the eight regularly scheduled FOMC meetings each year. A compilation and summary of these projections (without attribution) is circulated to participants of FOMC meetings, and a detailed summary of the economic projections is included as an addendum to the minutes released three weeks after each meeting. The summary includes the range of participants' projections of each variable and its central tendency--defined by excluding the top and bottom three projections. Since April 2011, an advance version of the SEP table presenting the range and central tendency of the participants' projections has been released in conjunction with the Federal Reserve Chair's post-meeting press conference. …

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