In Janet Yellen’s final meeting as Chair, the Federal Open Markets Committee (FOMC or Committee) voted unanimously to maintain the federal funds rate, its short-term policy rate, at a range of 1.25 percent and 1.50 percent, a level it deems “accommodative”. According to estimates of financial markets expectations, this decision was widely expected. Calculations of the appropriate level for the federal funds rate by the Federal Reserve Bank of Atlanta suggest that the current rate remains below the level estimated by their version of the Taylor Rule.
In its statement, the Committee cited “gains in employment, household spending, and business fixed investment” that have been “solid”. At the same time, the unemployment rate remains “low”. However, inflation, both headline and “core”, remain below the Committee’s target rate of 2 percent. The FOMC prefers prices associated with the estimation of nominal personal consumption expenditures in the calculation of GDP but NAHB analysis of the consumer price index reaches a similar conclusion for core prices.
The Committee noted that “market-based measures of inflation compensation have increased in recent months but remain low”. This language is similar to what was used by the Committee when longer-term rates were rising at the end of 2016. Previous analysis has demonstrated that inflation compensation is a key component of the 10-Year Treasury Note and that it has returned to being reasonably consistent with survey-based estimates of inflation expectations.
Inflation expectations are important because rational expectations theory posits that consumer inflation is equal to expectations of future inflation unless some unforeseen shock such as oil prices emerges. In addition, an expectations-augmented Phillips Curve extends rational expectations by including an explicit role for labor market conditions. Price stability, quantified as two percent inflation, is apart of the Committee’s statutory mandate, along with maximum employment.
Going forward, the Committee expects the federal funds rate to “remain below levels that are expected to prevail in the longer-run”. According to the December 2017 iteration of the Summary of Economic Projections, the median estimate of the longer-run federal funds rate is 2.8 percent. These most recent projections also suggest that the median expectation among Federal Reserve Board members and Federal Reserve Bank presidents is for the federal funds rate to rise by 70 basis points in 2018, or about three 25 basis point increases.
At the same time, this meeting marks Janet Yellen’s final one as Chair of the FOMC and Jay Powell will become the new chairman of the Federal Reserve Board of Governors and the Federal Open Market Committee. Janet Yellen has also indicated that she plans to step down from her position as a Member of the Board of Governors. Despite having the background of a practitioner, as opposed to an academic, monetary policy is not expected to deviate significantly from its current path.
However, the departure of Chair Yellen would expand the number of vacant seats on the Board of Governors to four of the seven total seats. At the same time, four of the five bank presidents that served on the Committee in 2017 rotated off the Committee following the expiration of their one-year term as a Committee member. These four Bank presidents were replaced by four new bank presidents among the 12 total Bank presidents. In addition, although the Federal Reserve Bank of New York President holds a permanent seat on the Committee, reports indicate that its current President, William C. Dudley, will retire. These personnel changes will inform the policy discussion as well.