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 2019 and over the longer run.  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.
In their discussion of the economic situation and the outlook, participants agreed that information received over the intermeeting period suggested that the labor market had continued to strengthen and growth of economic activity had picked up from the modest pace seen in the first half of the year. Although the unemployment rate was little changed in recent months, job gains had been solid, on average. Household spending had been growing strongly but business fixed investment had remained 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 remained low; most survey-based measures of longer-term inflation expectations were little changed, on balance, in recent months. Volatility in domestic and global asset markets was relatively low over most of the intermeeting period, and U.S. financial conditions were broadly accommodative.
Participants generally expected that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor market conditions would strengthen somewhat further. 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. A number of participants indicated that there had been little change in their economic outlooks over recent months. A substantial majority now viewed the near-term risks to the economic outlook as roughly balanced, with several of them indicating the risks from Brexit had receded. However, a few still judged that overall risks were weighted to the downside, citing various factors that included the possibility of weaker-than-expected growth in foreign economies, continued uncertainty associated with Brexit, the proximity of policy interest rates to the effective lower bound, or persistent headwinds to economic growth. Participants agreed that the Committee should continue to closely monitor inflation indicators and global economic and financial developments.
Growth in consumer spending appeared to have moderated somewhat in the third quarter from its rapid second-quarter pace, reflecting a softening in retail sales since June. District contacts provided mixed reports, consistent with some easing in growth of sales. Nevertheless, incoming data pointed to still-solid growth in consumption expenditures overall. Many participants noted that they expected household spending to be a primary contributor to economic growth going forward. They saw consumer spending as likely to be supported by a number of factors, including ongoing job gains, rising household income and wealth, improved household balance sheets, and buoyant consumer sentiment.
Economic activity in the second half of the year was expected to be buoyed in part by a pickup in business fixed investment and some rebuilding of inventories. A recent increase in oil drilling rigs in operation was seen as a positive sign for business investment, although the continued low level of oil prices was still weighing on capital investment in the energy industry. Contacts in some Districts suggested that businesses were taking a cautious approach to capital spending even outside of the energy sector--for instance, preferring to modernize existing manufacturing facilities rather than increase capacity by investing in new facilities--in light of continuing sluggish global demand, shorter investment time horizons for businesses, and uncertainty about prospects for government policy and regulation. Nonresidential construction was reported to be strong in a few Districts. However, the sluggishness in the housing sector appeared to have continued into the third quarter. A couple of participants pointed to limited availability of lots and a shortage of skilled labor as restraining residential construction activity in their Districts; in one District, constraints on the supply of new homes for sale were expected to boost spending on home improvements and offset some of the drag from the slowing in new construction.
Participants' reports on the manufacturing sector indicated varying conditions across Districts, but, on the whole, manufacturing activity remained flat. The most recent survey evidence was downbeat, although smoothing through the past several months provided a more neutral signal. A couple of participants noted that the firming in crude oil prices had led to a stabilization in drilling activity. In the agricultural sector, lower crop prices continued to weigh on profit margins, farm income was expected to fall, and loan repayment rates had declined.
Global financial conditions had improved somewhat in recent months. However, participants noted that economic growth in many foreign economies remained subdued, and inflation rates abroad generally continued to be quite low. Some participants continued to see important downside risks from abroad.
Participants generally agreed that labor market conditions had improved appreciably over the course of the year, with monthly payroll gains averaging about 180,000. Reports from several Districts indicated widespread increases in employment over the intermeeting period. Although job gains had slowed from their pace in 2015, average monthly increases so far this year had exceeded most estimates discussed by participants of monthly payroll increases that could be expected to prevail with economic growth proceeding at its longer-run trend rate. In addition, several participants cited the rise in the labor force participation rate since late 2015 or the increase in the employment-to-population ratio--series with downward structural trends--as welcome developments. However, it was noted that the unemployment rate and broader measures of unemployment had changed little since the beginning of the year. Participants generally expected the unemployment rate to run somewhat below their estimates of its longer-run normal rate over the next couple of years, but they offered differing views about the extent of slack that currently remained in the labor market. Some participants pointed to the slowing in payroll gains and modest pickup in wages this year and judged that the labor market had little or no remaining slack. Some others noted that still-muted wage growth, a level of involuntary part-time employment that remained elevated, and recent increases in labor force participation indicated that slack remained in resource utilization, or expressed the view that the longer-run normal rate of unemployment was uncertain and could be lower than current estimates. Participants commented on a staff analysis showing differential patterns of unemployment across racial and ethnic groups that remained after taking education into account; it was suggested that it might be worthwhile to examine such issues further.
Recent readings on headline and core PCE price inflation had come in about as expected, and participants continued to anticipate that headline inflation would rise over the medium term to the Committee's 2 percent objective. It was noted, however, that 12-month core PCE price inflation had been running at a steady rate below 2 percent, and several participants commented on factors that might be expected to restrain increases in inflation. Such factors included the limited evidence of rising cost or price pressures, the apparent low responsiveness of inflation to the rate of labor utilization, a possible downward shift in inflation expectations, and remaining economic slack. The median expectation for inflation over the next 5 to 10 years from the Michigan survey dropped to its historical low of 2.5 percent in August and held steady in September. However, a couple of participants indicated that the drop in some survey-based measures of inflation expectations could be explained by a decline in the number of respondents who had previously expected relatively high inflation outcomes. Overall, survey-based measures of longer-term expectations were judged to have been reasonably stable in recent months. Many participants observed that core CPI inflation had been running appreciably above core PCE inflation; it was noted that different weights on rents and medical prices as well as different measurement of health-care inflation in the two indexes largely accounted for the disparity.
In their discussion of the outlook, participants considered the likelihood of, and the potential benefits and costs associated with, a more pronounced undershooting of the longer-run normal rate of unemployment than envisioned in their modal forecasts. A number of participants noted that they expected the unemployment rate to run somewhat below its longer-run normal rate and saw a firming of monetary policy over the next few years as likely to be appropriate. A few participants referred to historical episodes when the unemployment rate appeared to have fallen well below its estimated longer-run normal level. They observed that monetary tightening in those episodes typically had been followed by recession and a large increase in the unemployment rate. Several participants viewed this historical experience as relevant for the Committee's current decisionmaking and saw it as providing evidence that waiting too long to resume the process of policy firming could pose risks to the economic expansion, or noted that a significant increase in unemployment would have disproportionate effects on low-skilled workers and minority groups. Some others judged this historical experience to be of limited applicability in the present environment because the economy was growing only modestly above trend, inflation was below the Committee's 2 percent objective, and inflation expectations were low--circumstances that differed markedly from those earlier episodes. Moreover, the increase in labor force participation over the past year suggested that there could be greater scope for economic growth without putting undue pressure on labor markets; it was also noted that the longer-run normal rate of unemployment could be lower than previously thought, with a similar implication. Participants agreed that it would be useful to continue to analyze and discuss the dynamics of the adjustment of the economy and labor markets in circumstances when unemployment falls well below its estimated longer-run normal rate.
With regard to recent financial developments, it was noted that regulatory changes and impending MMF reforms likely had led to an increase in certain short-term interest rates, but these developments were expected to have only a small effect on the borrowing costs of nonfinancial corporations and little adverse influence on overall financial market conditions. A few participants expressed concern that the protracted period of very low interest rates might be encouraging excessive borrowing and increased leverage in the nonfinancial corporate sector. Finally, one participant expressed the view that prolonged periods of low interest rates could encourage pension funds, endowments, and investors with fixed future payout obligations to save more, depressing economic growth and adding to downward pressure on the neutral real interest rate.
Participants discussed reasons for the apparent fall over recent years in the neutral real rate of interest--or r*--including lower productivity growth, demographic shifts, and an excess of saving around the world. Although several participants indicated that there was uncertainty as to how long the low level of r* would persist, one pointed to a growing consensus that the long period of slow productivity growth and recent evidence that the neutral rate had fallen across countries suggested that r* was likely to remain low for some time. A number of participants noted that they had revised down their estimates of longer-run r* in their contributions to the Summary of Economic Projections for this meeting. Participants discussed the implications of a fall in longer-run r* for monetary policy, including the possibility that policy interest rates might be closer to the effective lower bound more frequently and for a long period, or that monetary policy was ill equipped to address structural factors such as the decline in productivity growth. A couple of participants noted that a lower estimated value for r* over the near term implied that monetary policy was providing less accommodation than previously thought.
Against the backdrop of their economic projections, participants discussed whether available information warranted taking another step to reduce policy accommodation at this meeting. Participants generally agreed that the case for increasing the target range for the federal funds rate had strengthened in recent months. Many of them, however, expressed the view that recent evidence suggested that some slack remained in the labor market. With inflation continuing to run below the Committee's 2 percent objective and few signs of increased pressure on wages and prices, most of these participants thought it would be appropriate to await further evidence of continued progress toward the Committee's statutory objectives. In contrast, some other participants believed that the economy was at or near full employment and inflation was moving toward 2 percent. They maintained that a further delay in raising the target range would unduly increase the risk of the unemployment rate falling markedly below its longer-run normal level, necessitating a more rapid removal of monetary policy accommodation that could shorten the economic expansion. In addition, several participants expressed concern that continuing to delay an increase in the target range implied a further divergence from policy benchmarks based on the Committee's past behavior or risked eroding its credibility, especially given that recent economic data had largely corroborated the Committee's economic outlook.
Among the participants who supported awaiting further evidence of continued progress toward the Committee's objectives, several stated that the decision at this meeting was a close call. Some participants believed that it would be appropriate to raise the target range for the federal funds rate relatively soon if the labor market continued to improve and economic activity strengthened, while some others preferred to wait for more convincing evidence that inflation was moving toward the Committee's 2 percent objective. Some participants noted the importance of clearly communicating to the public the conditions that would warrant an increase in the policy rate