US Monetary Policy and Economic Outlook: Three Questions

US Monetary Policy and Economic Outlook: Three Questions GIC Conference in partnership with Universidad Del CEMA

The views expressed in this presentation do not represent those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or anyone other than the presenter. If you think you heard otherwise, you are mistaken.

Buenos Aries, Argentina March 8, 2018

The watch list • What effect will we see from non-monetary policies?

• Will inflation finally (b)reach the 2 percent longerrun target?

• What’s the deal with long-term interest rates?

2

The watch list • What effect will we see from non-monetary policies?

• Will inflation finally (b)reach the 2 percent longerrun target?

• What’s the deal with long-term interest rates?

3

The view from the FOMC as of December: Good, not spectacular growth.

Real GDP Growth Percent, Q4/Q4 3

Actual

Projected

2.5

2

1.5

1

2012

2013

2014

2015

2016

2017

2018

2019

2020

Note: The red line is the median projection; shaded bars represent the “central tendency� range of projections.

4

The question: If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018?

Results from the Survey of Business Executives: Nov. 13-24, 2017 Percent of total responses 100 90 80 70 60 50 40 30 20 10 0

Decrease by 10% or more

Decrease by less than 10%

No material change

Increase by Increase by less than 10% more than 10% 5

The new question: How has the recently enacted Tax Cuts and Jobs Act affect your capital expenditures in 2018?

Results from the Survey of Business Executives: Nov. 13-24 2017; Feb. 12-123, 2018 Percent of total responses 100 90 80 70 60 50 40 30 20 10 0

Decrease by Decrease by No material Increase by Increase by 10% or more less than 10% change less than 10% more than 10% 6

In November, smaller businesses were more inclined to say tax reform would result in higher investment expenditures‌ Results from the Survey of Business Executives: Nov. 13-24 2017; Feb. 12-123, 2018 Percent of responses indicating increases in planned capital spending 100 90 80 70 60 50 40 30 20 10 0

Small Firms (0 to 99 employees)

Medium-sized Firms (100 to 499 employees)

Large Firms (500 employees or more)

7

They (smaller businesses) have changed their minds.

Results from the Survey of Business Executives: Nov. 13-24 2017; Feb. 12-123, 2018 Percent of responses indicating increases in planned capital spending 100 90 80 70 60 50 40 30 20 10 0

Small Firms (0 to 99 employees)

Medium-sized Firms (100 to 499 employees)

Large Firms (500 employees or more)

8

The explanation? Traditional corporations expect to be the biggest beneficiaries of tax reform.

Firm-identified Business Structure and Expectation of a Reduction in their Tax Bill as a Result of the Tax Cuts and Jobs Act

100% 90%

25%

80% 53% Yes

70% 60%

53% Yes 25% No

76%

50% 40%

19% No

30% 20% 10%

28% No

13% 11%

28% Unsure

50% Unsure

19% Unsure

0% C-Corp

S-Corp

Limited Liablity Company

Sole proprietorship 9

The new supply-side economics? To be continued.

“The [supply-side] theory of the 1980s focused mainly on individuals, and lowering the tax rates they faced on labor income and capital gains...

The idea today is that the real power of mobilization comes through corporate associations. Assuming the tax bill passes, that theory is about to get a major test.�

10

Planned increases in capital expenditures are no more apparent for 2019 (in purple) than for 2018 (in green).

Results from the Survey of Business Executives: Feb. 12-123, 2018 Percent of total responses 100 90 80 70 60 50 40 30 20 10 0

Decrease by 10% or more

Decrease by less than 10%

No material change

Increase by Increase by less than 10% more than 10% 11

What’s not in these projections: The Bipartisan Budget Act of 2018.

•

Raised spending caps imposed by the Budget Control Act of 2011.

•

Suspended debt ceiling until March 2019.

•

Funds the government via continuing resolution through March 23 (2018).

•

Provides budget authority for additional 2018-2019 spending of $165 billion, $131 billion, and $89 billion for defense, non-defense discretionary, and disaster relief (respectively).

•

Mechanically, the spending increases would add something like 0.3 to 0.4 percent to GDP growth in 2018 and 2019.

12

The watch list • What effect will we see from non-monetary policies?

• Will inflation finally (b)reach the 2 percent longerrun target?

• What’s the deal with long-term interest rates?

13

You gotta have faith – The SEP projections bring us to the inflation target by 2019.

PCE Chained Price Index Q4/Q4 Growth sa, 2009=100 2.5

2

1.5

1

0.5

0 2012

2013

2014

2015

2016

2017

2018

2019

2020

Note: The red line is the median projection; shaded bars represent the “central tendency” range of projections.

Source: FOMC Summary of Economic Projections, December 2017, Bureau of Economic Analysis, Haver Analytics

14

Headline inflation over the past 12 months noticeably below the FOMC’s 2-percent target…

PCE Price Index year-over-year percent change, monthly

4.0

3.0

FOMC’s inflation target

2.0

1.0

0.0

PCE

-1.0

-2.0 10

11

12

13

14

15

16

17

18 15

‌ but the 6-month rate has accelerated dramatically.

PCE Price Index year-over-year percent change, monthly

4.0

3.0

FOMC’s inflation target

2.0

1.0

PCE

0.0

PCE (6 month annualized rate) -1.0

-2.0 10

11

12

13

14

15

16

17

18 16

Core measures tell the same story – recent data suggests some inflationary momentum.

Dallas Fed Trimmed-Mean PCE Price Index annualized percent change, monthly

4.0

3.0

FOMC’s inflation target

2.0

1.0

Year-over-year

6-month

0.0

-1.0

-2.0 10

11

12

13

14

15

16

17

18 17

Decomposing the recovery’s soft inflation numbers: Expectations, slack, import prices, and we just don’t know.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

18

Why was inflation below target in 2017: “We just don’t know.”

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

19

The contribution of ‘slack� (the red areas)inflation so, which was a big part of the inflation story has disappeared.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

20

Both the narrow (U3) unemployment rate and the broader (U6) underemployment rate suggest that labor utilization is about “normal”…

Unemployment (U-3) and Underemployment (U-6) Rates percent 18 17 16 15

Un(under)employment rate (U6). Includes PTER and marginally attached workers

14 13 12 11

Unemployment rate (U3)

10 9 8 7 6 5 4

FOMC participants’ median unemployment rate estimate (from Dec. ’17 SEPs)

3 2 05

06

07

08

09

10

11

12

13

14

15

16

17

18

data through January 2018

21

Notable: The contribution of import prices (the green areas) has been negative for nearly 5 years – substantially so as the dollar was appreciating.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

22

The watch list • What effect will we see from non-monetary policies?

• Will inflation finally (b)reach the 2 percent longerrun target?

• What’s the deal with long-term interest rates?

23

Longer-term interest rates have shifted with the funds rate target, and have accelerated since the end of last year.

5.00

Effective Federal Funds Rate (% p.a.)

4.00

10-Year Treasury Note Yield at Constant Maturity (Avg, % p.a.)

3.00

As of 7:00 AM: 2.9%

2.00

1.00

0.00 2015

2016

2017

2018 24

The recent rise did occur after the Fed began to implement its balance sheet reduction policy in the fourth quarter.

5.00

Effective Federal Funds Rate (% p.a.)

4.00

10-Year Treasury Note Yield at Constant Maturity (Avg, % p.a.)

3.00

Balance sheet “normalization� begins

2.00

1.00

0.00 2015

2016

2017

2018 25

And the same goes for balance sheet normalization.

The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account.

Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.

FOMC Addendum to Policy Normalization Principles and Plans, June 14, 2017 26

Easing in slowly.

Monthly Caps on Security Redemptions Billions of Dollars

2017

U.S. Treasuries Agency Debt and MBS

Oct-Dec 6 4

2018

Jan-Mar 12 8

Apr-June 18 12

Jul-Sep 24 16

Final cap 30 20

27

The caps will be binding with respect to the Treasury part of the portfolio.

SOMA Treasury Securities Maturity Profile billions of dollars

80

Redemptions 60

40

20

0

2017

2018

2018

2019

2019

28

The caps on MBS pay-downs will only bind in the transition part of the program.

SOMA Agency Debt and MBS Pay-Down Profile billions of dollars

40

Redemptions Reinvestments Monthly Cap

20

0

2017

2018

2018

2019

2019 29

Will the ramp-down look like the ramp-up? Reasons to think not.

• Effects of policies likely more powerful when markets are fragile • Pace is slow – if flows matter, we are starting with a relative trickle • The footprint of the Fed’s activities have grown smaller as the economy has expanded • Everyone knows the scheme (and have likely already embedded the policy in market prices) 30

Reverse-QE or fiscal policy?

5.00

Effective Federal Funds Rate (% p.a.)

4.00

10-Year Treasury Note Yield at Constant Maturity (Avg, % p.a.)

3.00

Balance sheet “normalization� begins

President signs TCJA

2.00

1.00

0.00 2015

2016

2017

2018 31

US Monetary Policy and Economic Outlook: Three Questions