Participants' Views on Current Conditions and the Economic Outlook
In conjunction with this FOMC meeting, members of the Board of Governors and Federal Reserve Bank presidents submitted their projections of the most likely outcomes for real GDP growth, the unemployment rate, inflation, and the federal funds rate for each year from 2016 through 2018 and over the longer run [One participant did not submit longer-run projections in conjunction with the June 2016 FOMC meeting]. Each participant's projections were conditioned on his or her judgment of appropriate monetary policy. The longer-run projections represented each participant's assessment of the rate to which each variable would be expected to converge, over time, under appropriate monetary policy and in the absence of further shocks to the economy. These projections and policy assessments are described in the Summary of Economic Projections, which is an addendum to these minutes. [the projections are in the meeting statement].
In their discussion of the economic situation and the outlook, meeting participants agreed that information received over the intermeeting period indicated that the pace of improvement in the labor market had slowed while growth in economic activity appeared to have picked up. Although the unemployment rate had declined, job gains had diminished. Growth in household spending had strengthened. Since the beginning of the year, the housing sector had continued to improve and the drag from net exports appeared to have lessened, but business fixed investment had been soft. Inflation had continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations were little changed, on balance, in recent months.
Participants generally expected that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor market indicators would strengthen. Inflation was expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipated and the labor market strengthened further. Participants generally agreed that the Committee should continue to closely monitor inflation indicators and global economic and financial developments.
Growth of consumer spending appeared to have picked up from its slow pace in the first quarter. Retail sales posted strong gains in April and May, and sales of light motor vehicles moved back up. At the time of the April meeting, most participants had anticipated a rebound in consumer spending in light of the still-solid fundamental determinants of household spending. Some participants indicated that consumption was likely to continue being supported by these factors, which included ongoing gains in income, robust household balance sheets, and the positive assessment of current economic conditions that was evident in recent surveys of consumers. However, a few participants expressed caution about the outlook for consumer expenditures, noting that slower increases in employment and higher energy prices could restrain spending.
The housing sector continued to improve since the beginning of the year. Reports from a number of participants indicated that single-family construction was strengthening and house prices were rising in most parts of their Districts. However, some areas that were affected by the slowdown in the energy sector experienced house price declines or increases in mortgage delinquency rates.
Participants summarized survey readings and anecdotal reports on business conditions in their Districts. Those indicators were mixed regarding the pace of economic activity within the manufacturing sector. Some of the weakness in manufacturing activity was linked to the effects of earlier declines in oil prices on firms in the energy sector and to previous increases in the exchange value of the dollar, which had adversely affected exporters. But manufacturing activity was judged to have stabilized in a couple of Districts, and contacts there were optimistic about further improvement in the months ahead. It was noted that the recent increase in crude oil prices had improved the outlook for the energy sector. However, a couple of participants observed that financial strains caused by previous declines in energy prices had continued for firms or financial institutions in their Districts, and such difficulties were seen as likely to persist absent further increases in energy prices. Regarding the service sector, a few participants commented that activity and hiring continued to expand in their Districts. The near-term outlook for farm income remained weak despite recent increases in the futures prices of some agricultural commodities.
Available indicators suggested that the softness in business fixed investment since late last year persisted early in the second quarter. While weakness in the drilling and mining sector was attributable to the earlier declines in oil prices, participants identified a variety of potential causes of the broader weakness in investment spending, including a slowdown in corporate profits, concern about prospects for economic growth, heightened uncertainty regarding the future course of domestic regulatory and fiscal policies, and a persistent reluctance on the part of firms to undertake new projects in the wake of the financial crisis. Some participants mentioned that the sluggishness in business investment could portend a broader economic slowdown. A couple of participants also noted that elevated inventory levels could be a drag on economic growth in the near term. However, participants also cited factors that could lead to a pickup in business spending, including the recent turnaround in energy prices and the greater optimism on the part of firms indicated by surveys of businesses and anecdotal reports in some Districts.
The employment report for May showed considerably weaker growth in payrolls than had been expected, and gains in previous months were revised down. Although the unemployment rate fell in May, a drop in labor force participation accounted for the decline. Participants discussed a range of interpretations of these data. Many participants observed that, because of transitory factors, such as statistical noise and the effects of a strike in the telecommunications industry, the reported rate of payroll job growth likely understated its underlying pace; however, many participants thought that the underlying pace had slowed some from that of previous months. Some noted that other indicators did not corroborate a material weakening of labor market conditions. These indicators included a number of regional surveys of labor market conditions, relatively low levels of initial claims for unemployment insurance, surveys of business hiring plans, and positive views of labor market conditions in recent consumer surveys. In addition, a few participants commented that the movements in labor force participation in recent months were, on balance, consistent with its secular downtrend. In contrast, some noted that the lower rate of payroll gains could instead be indicative of a broader slowdown in growth of economic activity that was also evidenced by other downbeat labor market indicators, such as a decline in the diffusion indexes of industry payrolls, an increase in the number of workers reporting that they were working part time for economic reasons, or the recent sharp drop in labor force participation. Finally, a few participants suggested that the weak employment growth may instead reflect supply constraints associated with a general tightening of labor market conditions. These participants saw the rising trend in wages, business reports of reduced worker availability, and high rate of job openings as supporting this interpretation. Others thought it unlikely that such constraints would have become evident so abruptly.
Almost all participants judged that the surprisingly weak May employment report increased their uncertainty about the outlook for the labor market. Even so, many remarked that they were reluctant to change their outlook materially based on one economic data release. Participants generally expected to see a resumption of monthly gains in payroll employment that would be sufficient to promote continued strengthening of the labor market. However, some noted that with labor market conditions at or near those consistent with maximum employment, it would be reasonable to anticipate that gains in payroll employment would soon moderate from the pace seen over the past few years.
Inflation continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Core PCE price inflation registered an increase of 1.6 percent for the 12 months ending in April, while recent readings on retail energy prices moved up notably. Most participants expected to see continued progress toward the Committee's 2 percent inflation objective. They viewed the firming in some measures of core inflation, the evidence that wage growth was picking up, the ongoing tightening of resource utilization, the recent firming in oil prices, and the stabilization of the foreign exchange value of the dollar this year as factors likely to boost inflation over time. However, other participants were less confident that inflation would return to its target level over the medium term. They thought that progress could be very slow, particularly in light of the likelihood that tighter resource utilization may impart only modest upward pressure on prices. They also saw important downside risks, including persistent disinflationary pressures from very low inflation and weak economic growth abroad as well as the softening in some survey-based measures of longer-term inflation expectations and market-based measures of inflation compensation.
Global financial conditions had improved since earlier in the year, and recent data on net exports suggested that the drag on domestic economic activity from the external sector had abated somewhat. Still, participants generally agreed that global economic and financial developments should continue to be monitored closely. Some participants indicated that prospects for economic activity in many foreign economies appeared to be subdued, that global inflation and interest rates remained very low by historical standards, and that recurring bouts of global financial market instability remained a risk. Most participants noted that the upcoming British referendum on membership in the European Union could generate financial market turbulence that could adversely affect domestic economic performance. Some also noted that continued uncertainty regarding the outlook for China's foreign exchange policy and the relatively high levels of debt in China and some other EMEs represented appreciable risks to global financial stability and economic performance.
In light of participants' updates to their economic projections, they discussed their current assessments of the appropriate trajectory of monetary policy over the medium term. Most still expected that the appropriate target range for the federal funds rate associated with their projections of further progress toward the Committee's statutory objectives would rise gradually in coming years. However, some noted that their forecasts were now consistent with a shallower path than they had expected at the time of the March meeting. Many participants commented that the level of the federal funds rate consistent with maintaining trend economic growth--the so-called neutral rate--appeared to be lower currently or was likely to be lower in the longer run than they had estimated earlier. While recognizing that the longer-run neutral rate was highly uncertain, many judged that it would likely remain low relative to historical standards, held down by factors such as slow productivity growth and demographic trends. Several noted that in the prevailing circumstances of considerable uncertainty about the neutral federal funds rate, the Committee could better gauge the effects of increases in the federal funds rate on the economy if it proceeded gradually in adjusting policy.
Participants weighed a number of considerations in assessing the conditions under which it would be appropriate to increase the target range for the federal funds rate. Most participants indicated that they made only small changes to their forecasts for achieving and maintaining the Committee's objectives of maximum employment and 2 percent inflation over the medium term. Several noted that the fundamentals underlying their forecasts remained solid, with several mentioning, in particular, that financial conditions were accommodative and household balance sheets had improved. In evaluating recent economic information, participants generally agreed that it was advisable to avoid overreacting to one or two labor market reports; however, the implications of the recent data on labor market conditions for the economic outlook were uncertain. Most judged that they would need to accumulate additional information on the labor market, production, and spending to help clarify how the economy was evolving in order to evaluate whether the stance of monetary policy should be adjusted. In addition, participants generally thought that it would be prudent to wait for the outcome of the upcoming referendum in the United Kingdom on membership in the European Union in order to assess the consequences of the vote for global financial market conditions and the U.S. economic outlook.
Most participants judged that, in the absence of significant economic or financial shocks, raising the target range for the federal funds rate would be appropriate if incoming information confirmed that economic growth had picked up, that job gains were continuing at a pace sufficient to sustain progress toward the Committee's maximum-employment objective, and that inflation was likely to rise to 2 percent over the medium term. Some participants viewed a broad range of labor market indicators as well as the recent firming in wages as consistent with a high level of labor utilization. They also pointed out that core inflation had begun to move up and that the transitory factors that had been holding down headline inflation were receding. Several of these participants expressed concern that a delay in resuming further gradual increases in the federal funds rate would increase the risks to financial stability or would raise the potential for overshooting the Committee's objectives; such an overshooting might require a rapid removal of policy accommodation at some point in the future, which could entail significant risks for U.S. financial markets and the economy.
However, some other participants were uncertain whether economic conditions would soon warrant an increase in the target range for the federal funds rate. Several of them noted downside risks to the outlook for growth in economic activity and for further improvement in labor market conditions, including the possibility that the sharp slowdown in employment gains and the continued weakness in business fixed investment signaled a downshift in economic growth, as well as the potential for global economic or financial shocks. Moreover, several of them worried about the declines in measures of inflation compensation and in some survey-based measures of inflation expectations and suggested that monetary policy may need to remain accommodative for some time in order to move inflation closer to 2 percent on a sustained basis. A few pointed out that with inflation likely to remain low for some time and to rise only gradually, maintaining an accommodative stance of policy could extend the strengthening of the labor market. In addition, several participants observed that because short-term interest rates were still near zero, monetary policy could, if necessary, respond more effectively to surprisingly strong inflationary pressures in the future than to a weakening in the labor market and falling inflation.
A number of participants emphasized that the Committee's approach to policy-setting was necessarily data dependent given the uncertainties associated with medium-term forecasts of economic activity and, accordingly, with the appropriate policy path over the medium term. It was noted that their expectations for the federal funds rate did not represent a preset plan and could change as incoming information influenced their views of the economic outlook and the risks associated with it. Several participants expressed concern that the Committee's communications had not been fully effective in informing the public how incoming information affected the Committee's view of the economic outlook, its degree of confidence in the outlook, or the implications for the trajectory of monetary policy.