December FOMC Meeting: Falling Further Through NAIRU, but Where is the Inflation?

13 Dec 2017

As was widely expected, the FOMC raised the target range for the federal funds rate by 25 basis points at its meeting today and made only modest changes to the post-meeting statement. Importantly, the Summary of Economic Projections (SEP) now more fully factor in fiscal stimulus, with the median growth projection for next year being revised up by four-tenths of a percent to 2.5 percent, and the 2019 and 2020 projections seeing more modest increases. With a stronger growth impetus, the unemployment rate projections for each of the next three years were revised lower by two-tenths of a percent. Despite the stronger assessment of the growth and labor market outlook, the core inflation projections were remarkably stable – not only did the median projections remain unchanged throughout the forecast horizon, but only in the full range of participant submissions in 2019 and 2020 do we see any evidence of a few participants marking up their inflation outlook, and then only modestly. Stronger growth but stable inflation projections could reflect a view that trend growth is higher, or NAIRU lower, than previously thought. But interestingly, these longer-run projections did not change from the September projection round. Another possibility is that a steeper projected policy rate path could bring growth back towards trend and limit inflation pressures. But the median projected rate path is unchanged through 2019 and there is just a modest 20 basis point upward revision to the 2020 median policy rate projection. Chair Yellen was asked about this seeming inconsistency in the projections in the press briefing, and her response suggests less confidence in a Phillips Curve framework, or that the framework remains valid but the curve is and will continue to remain quite flat: “inflation has run lower than we expect, and it could take a longer period of a very strong labor market in order to achieve the inflation objective.”


Chair Yellen was also cautious in her characterization of the inflation outlook at other points in the press briefing, even as she reiterated her view that inflation has been held down by transitory factors that are likely to fade over time. She noted that low inflation, “could end up being something that is more ingrained”, that assessments of NAIRU may need to come down further, and that inflation expectations may have slipped. These considerations may explain why the Committee remained hesitant to mark up its anticipated rate path despite further projected declines in the unemployment rate to well below their NAIRU estimate.


Overall, the Chair’s comments suggest that the Committee will remain quite cautious in continuing to raise rates next year absent clear evidence of inflation picking up, even if there are further declines in the unemployment rate. I continue to see 100 basis points of tightening next year, on the view that core PCE inflation will firm (but remain short of the inflation objective) while the unemployment rate declines to around 3.5 percent. But if the Committee’s concerns about lower trend inflation and inflation expectations are becoming more pronounced, the risks to my call are certainly skewed toward fewer rate increases.


Elsewhere in the press conference, Yellen elaborated on how the Committee assessed the impact of fiscal stimulus on the economy. Her comments suggest that the Committee remains somewhat skeptical that the tax package will meaningfully impact trend growth: “So, I think my colleagues and I mainly see the likely tax package as boosting aggregate demand, but also having some potential to boost aggregate supply… a stronger pace of investment could …raise productivity growth and potential GDP or output to some extent. Exactly how large those effects might be remain uncertain”. At this point, the Committee remains open to the possibility that the tax package could meaningfully change the supply picture, in which case the Committee might be less inclined to lean against strong growth with tighter policy. But at least judging by Yellen’s comments and the full range of projections for the economy’s longer-run growth rate, the majority of Committee participants are not yet making any revisions to their trend growth assumptions as a result of anticipated tax cuts.