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 output growth, the unemployment rate, and inflation for each year from 2016 through 2019 and over the longer run, based on their individual assessments of the appropriate path for the federal funds rate. 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. [click here to read - they are in the meeting statement post].
In their discussion of the economic situation and the outlook, participants agreed that information received over the intermeeting period indicated that the labor market had continued to strengthen and that economic activity had been expanding at a moderate pace since midyear. Job gains had been solid in recent months, and the unemployment rate had declined. Household spending had been rising moderately, but business fixed investment remained soft. Inflation had increased since earlier in the year but was still 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 had moved up considerably but still were low; most survey‑based measures of longer‑term inflation expectations were little changed, on balance, in recent months.
Participants 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 rise to 2 percent over the medium term as the transitory effects of past declines in energy prices and non-energy import prices dissipated and the labor market strengthened further. Participants indicated that recently available economic data had been broadly in line with their expectations, and they judged that near‑term risks to the economic outlook appeared roughly balanced. Moreover, participants generally made only modest changes to their forecasts for real GDP growth, the unemployment rate, and inflation. About half of the participants incorporated an assumption of more expansionary fiscal policy in their forecasts.
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. However, almost all also indicated that the upside risks to their forecasts for economic growth had increased as a result of prospects for more expansionary fiscal policies in coming years. Many participants underscored the need to continue to weigh other risks and uncertainties attending the economic outlook. In that regard, several noted upside risks to U.S. economic activity from the potential for better-than-expected economic growth abroad or an acceleration of domestic business investment. Among the downside risks cited were the possibility of additional appreciation of the foreign exchange value of the dollar, financial vulnerabilities in some foreign economies, and the proximity of the federal funds rate to the effective lower bound. Several participants also commented on the uncertainty about the outlook for productivity growth or about the potential effects of tight labor markets on labor supply and inflation. For some participants, the greater upside risks to economic growth, the upward movement in inflation compensation over recent months, or the possibility of further increases in oil prices had increased the upside risks to their inflation forecasts. However, several others pointed out that a further rise in the dollar might continue to hold down inflation. Participants generally agreed that they should continue to closely monitor inflation indicators and global economic and financial developments.
Regarding the household sector, the available information indicated that consumer spending had been rising at a moderate rate, on balance, since midyear. Participants cited a number of factors likely to support continued moderate gains in consumer spending. Consumer confidence remained positive. The outlook was for further solid gains in jobs and income, and household balance sheets had improved. The personal saving rate was still relatively high, and household wealth had been boosted by ongoing gains in housing and equity prices. In the housing market, recent data on starts and permits for new residential construction suggested a firming in residential investment after two quarters of decline. Several participants commented that housing activity appeared to be gaining momentum in their Districts, and it was noted that the rate of new construction still appeared to be low relative to levels that would be expected based on the longer-run rate of household formation.
The outlook for the business sector improved over the intermeeting period. Although nonresidential investment was still weak and equipment spending had been flat in the third quarter, orders for nondefense capital goods and the number of drilling rigs in operation had both turned up recently. A couple of participants reported plans for a pickup in capital spending by businesses in their Districts, driven by stronger demand and increasing revenues. Surveys and information gathered from contacts in several Districts indicated an improvement in manufacturing activity as well as expectations for further gains in factory production in the near term. And the recent firming in oil prices, if sustained, was anticipated to boost domestic energy production. In contrast, conditions in the agricultural sector remained depressed, and a couple of reports highlighted softer activity in some service-sector industries. More generally, participants reported that many of their District business contacts expressed greater optimism about the economic outlook, and several participants commented that the improved sentiment could spur stronger investment spending. Some contacts thought that their businesses could benefit from possible changes in federal spending, tax, and regulatory policies, while others were uncertain about the outlook for significant government policy changes or were concerned that their businesses might be adversely affected by some of the proposals under discussion.
Labor market conditions continued to improve over the intermeeting period. Monthly increases in nonfarm payroll employment averaged nearly 180,000 over the three months ending in November, in line with the average pace of job creation over the past year. The unemployment rate dropped markedly to 4.6 percent in November; a few participants suggested that part of the decline might be reversed in coming months. Most participants viewed the cumulative progress in the labor market as having brought labor market conditions to or close to those consistent with the Committee's maximum-employment objective. Over the past year, broad measures of labor underutilization that include both the unemployed and workers marginally attached to the labor force had trended lower, the labor force participation rate had been relatively steady despite downward pressure from demographic trends, and layoffs had fallen to low levels. National surveys reported that job availability was high and that firms were increasingly finding their job openings hard to fill. Some participants commented that some businesses in their Districts were experiencing shortages of skilled workers in some occupations or were needing to offer higher wages to fill positions. However, some others noted that aggregate measures of wages were still rising at a subdued pace, suggesting that upward pressure on wages had not become widespread.
Participants expected the labor market to strengthen somewhat further over the medium run, with almost all anticipating that the unemployment rate over the next couple of years would run below their estimates of its longer-run normal level. Some participants saw the possibility that an extended period during which labor markets remained relatively tight could continue to shrink remaining margins of underutilization, including the still-high level of prime-age workers outside the labor force and elevated levels of involuntary part-time employment and long-duration unemployment. A few added that continued gradual strengthening in labor markets would help return inflation to the Committee's 2 percent objective. But some other participants were uncertain that a period of tight labor utilization would yield lasting labor market benefits or were concerned that it risked a buildup of inflationary pressures. Most participants expected that if economic growth remained moderate, as they projected, the unemployment rate would be only modestly below their estimates of the longer-run normal rate of unemployment over the next few years, but several anticipated a more substantial undershoot. A few participants noted the uncertainty surrounding real‑time estimates of the longer-run normal rate of unemployment, and it was pointed out that geographic variation in labor market conditions contributed to that uncertainty. In discussing the possible implications of a more significant undershooting of the longer-run normal rate, many participants emphasized that, as the economic outlook evolved, timely adjustments to monetary policy could be required to achieve and maintain both the Committee's maximum-employment and inflation objectives.
Participants generally viewed the information on inflation received over the intermeeting period as reinforcing their expectation that inflation would rise to the Committee's 2 percent objective over the medium term. The 12‑month change in the headline PCE price index moved up further to 1.4 percent in October, as the rise in energy prices since the spring offset much of the decline earlier in the year. Although the headline measure was still below 2 percent, it had increased more than 1 percentage point over the past year. Core PCE price inflation had also moved up moderately over the past year, and, over the 12 months ending in October, it was 1.7 percent for a third consecutive month. Median 5‑ to-10-year inflation expectations in the Michigan survey were, on balance, stable in November and early December, just above the low recorded in October. Market-based measures of inflation compensation had moved up considerably over the intermeeting period. A few participants added that other readings from financial markets, such as implied probabilities of various inflation outcomes derived from inflation derivatives, pricing in the inflation swaps market, and the apparent upward shift of the estimated term premium in the 10-year Treasury yield, suggested that the risks to the inflation outlook had become more balanced around the Committee's 2 percent inflation objective. A couple of participants noted that the recent firming in oil prices might have contributed to the changes in these market-based measures. Several, however, pointed out that market-based measures of inflation compensation were still low or that downside risks to inflation remained, given the recent further appreciation of the dollar.
Most participants attributed the substantial changes in financial market conditions over the intermeeting period--including the increase in longer-term interest rates, the strengthening of the dollar, the rise in equity prices, and the narrowing of credit spreads--to expectations for more expansionary fiscal policies in coming years or to possible reductions in corporate tax rates. Many participants expressed the need for caution in evaluating the implications of recent financial market developments for the economic outlook, in light of the uncertainty about how federal spending, tax, and regulatory policies might unfold and how global economic and financial conditions will evolve.
In their consideration of economic conditions and monetary policy, participants agreed that sufficient evidence had accumulated of continued progress toward the Committee's objectives of maximum employment and 2 percent inflation to warrant an increase of 25 basis points in the target range for the federal funds rate at this meeting. Participants judged that, even after the increase in the target range, the stance of policy would remain accommodative, consistent with some further strengthening in labor market conditions and a return of inflation to 2 percent over the medium term.
Participants discussed the implications of the economic outlook for the likely future path of the target range for the federal funds rate. Most participants judged that a gradual pace of rate increases was likely to be appropriate to promote the Committee's objectives of maximum employment and 2 percent inflation. A gradual pace was also viewed by some participants as likely to be warranted because the proximity of the federal funds rate to the effective lower bound placed constraints on the ability of monetary policy to respond to adverse shocks to the aggregate demand for goods and services. In addition, the neutral real rate--defined as the real interest rate that is neither expansionary nor contractionary when the economy is operating at or near its potential--still appeared to be low by historical standards, and it was noted that gradual increases in the federal funds rate over the next few years probably would be sufficient to return to a neutral policy stance.
While viewing a gradual approach to policy firming as likely to be appropriate, participants emphasized the need to adjust the policy path as economic conditions evolved. They pointed to a number of risks that, if realized, might call for a different path of policy than they currently expected. Moreover, uncertainty regarding fiscal and other economic policies had increased. Participants agreed that it was too early to know what changes in these policies would be implemented and how such changes might alter the economic outlook. It was also noted that fiscal and other policies were only some of the many factors that could influence the economic outlook and thus the appropriate course of monetary policy. Moreover, many participants emphasized that the greater uncertainty about these policies made it more challenging to communicate to the public about the likely path of the federal funds rate. Participants noted that, in the circumstances of heightened uncertainty, it was especially important that the Committee continue to underscore in its communications that monetary policy would continue to be set to promote attainment of the Committee's statutory objectives of maximum employment and price stability.
Many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures. However, with inflation still below the Committee's 2 percent objective, it was noted that downside risks to inflation remained and that a moderate undershooting of the longer-run normal unemployment rate could help return inflation to 2 percent. A couple of participants expressed concern that the Committee's communications about a gradual pace of policy firming might be misunderstood as a commitment to only one or two rate hikes per year; participants agreed that policy would need to respond appropriately to the evolving outlook. Several participants noted circumstances that might warrant changes to the path for the federal funds rate could also have implications for the reinvestment of proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities.