“In their discussion of their economic forecasts, participants emphasized their considerable uncertainty about the timing, size, and composition of any future fiscal and other economic policy initiatives as well as about how those polices might affect aggregate demand and supply. Several participants pointed out that, depending on the mix of tax, spending, regulatory, and other possible policy changes, economic growth might turn out to be faster or slower than they currently anticipated.”
The minutes from the December meeting of the Federal Reserve’s monetary policy setting arm, the Federal Open Market Committee (FOMC) were released today. A dominant factor in the deliberations surrounding charting a future course for monetary policy normalization was the 66 basis point increase in the yield on 10-year Treasury securities between the November election and the December meeting. The increase is assumed to be based largely on market expectations of more expansionary fiscal policy from the incoming administration. The economic intuition is that fiscal stimulus will lead to higher rates of economic growth and in turn inflation and interest rates.
Those market expectations had little effect on the economic projections prepared by meeting participants for the December meeting, compared to the projections in September. Projections for real GDP growth, the unemployment rate and inflation moved at most 0.1 percentage point for some but not all projections for 2017, 2018, 2019 and the longer run. However, uncertainty about fiscal and other policy initiatives has raised the uncertainty about the projections “considerably,” with most participants agreeing on heightened upside risk to economic growth based on more expansionary fiscal policy.
Downside risks to the forecast from more expansionary fiscal policy include a further appreciation of the dollar, financial vulnerabilities in some foreign economies, and potentially undershooting target unemployment and overshooting target inflation. And while committee members generally reported on increased optimism among business contacts in their districts, some reported uncertainty or concern about adverse effects from some proposals among business contacts.
With limited information about the specifics of policies, both proposed and ultimately adopted, uncertainty is increased, and there are concerns about policies that might impede economic growth as well as those that may increase economic growth, and maybe too much. The timing, size and composition of future policies will have significant implications: the devil is in the details.