Merry Christmas at the Federal Reserve

The US Federal Reserve held their December FOMC meeting yesterday. They voted unanimously to continue the current accommmodative stance, keeping interest rates at zero and asset purchases at $120 billion a month.

The decision is unsurprising given the impact of Covid in the US, and the ongoing fight in Congress over more fiscal stimulus.

The FOMC meets eight times a year, but every second meeting they release a Summary of Economic Projections. Each member of the committee forecasts the path of GDP, unemployment, and inflation and they are aggregated. The public gets to see the median, central tendency, and range, but not the projections of individual members.

The figures reveal the diversity of opinion on the FOMC, especially when it comes to the path of unemployment. Since September, forecasts have improved, but there is still quite a gap between the optimists and pessimists. Of particular interest is the longer run estimate, which likely reflects participant’s views on the “natural rate of unemployment.”

Source

Where the FOMC thinks the “natural rate” is matters because, up until this year, the Fed would tighten policy preemptively when unemployment neared the “natural rate.” If the estimate was wrong, and there was still slack, the effect would be to unnecessarily throw people out of work.

The experience after 2015, where unemployment dropped below estimates of the natural rate (at that time, ~5%), down to the unprecedented level of 3%, without stoking any inflation, led the Fed to change tact. Under the Fed’s new strategy, policy will not be tightened preemptively, it will instead wait for inflation to pick up sustainably.

Still, estimates of the “natural rate” continue to be an important guide for central bankers around the world. They have real consequences for the stance of monetary and fiscal policy, and are important to keep track of.

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