The Fed is reluctant to project good times
In its meeting on March 17, the Federal Open Market Committee (FOMC or Fed) made no change to its policy stance, but it did release the first revision to its economic projections since the passage of two major fiscal stimulus packages in December and March. The Fed raised its outlook for growth and inflation this year and next, as have most private forecasters. But the Fed’s upward revision is notably muted in relation to the massive fiscal packages, and it made no change to the projection of its future policy stance. The Fed is determined to keep monetary policy, and projections of monetary policy, very supportive of growth until it judges that maximum employment and price stability have been achieved.
The median forecast by FOMC participants of GDP growth in 2021 (Q4/Q4) jumped to 6.5 percent, modestly above the latest Consensus Forecasts projection of 6.0 percent. The median FOMC projection for core personal consumption expenditures (PCE) inflation in 2021 (Q4/Q4) is 2.2 percent, a tad above the Fed’s target of 2 percent, but inflation is projected to drop back to 2.0 percent in 2022.
Despite these upward revisions to its economic projections, which remain slightly above the consensus of private forecasters, the median FOMC projection for the federal funds rate remains at 0.1 percent through the end of 2023. The FOMC also did not change its assertion that long-term asset purchases will continue “at least” at their current pace until “substantial further progress” is made toward achieving the committee’s goals. Bond yields ticked down slightly. Apparently, the FOMC’s signal of policy on hold was taken as more important than the upward revision to the economic outlook.
Given the recent passage of fiscal stimulus measures worth 13 percent of GDP, a bulge in household savings last year worth 7 percent of GDP, and the prospect of reopening important sectors of the economy over the summer as COVID-19 vaccines are distributed (see this post), it may be surprising that the Fed projects GDP growth of only 6 percentage points above trend in 2021 and 2022 combined. That would imply a historically low fiscal multiplier.
The answer appears to be that the Fed is reluctant to count on a vaccine-driven economic reopening. Chair Jerome Powell said during the press conference after the meeting that the economic effects of the virus are likely to linger, particularly those related to social distancing. People reluctant to engage in a wide range of customary activities are likely to continue to save an unusually large portion of the government’s fiscal largesse, as they did in 2020.
Moreover, the Fed likely sees little advantage in projecting a much faster recovery than private forecasters, as that would complicate its message of policy patience and exacerbate the recent runup in bond yields. Powell stated repeatedly that the Fed is determined to stand pat until well after the economy has recovered and not move on the basis of projections, no matter how positive.
If vaccinations do enable closed sectors to reopen by summer, we are likely to see further upward revisions in the FOMC economic projections this year. The tension between the rising economic projections and the flat policy projections may well increase.
1. Consensus Forecasts (March 8, 2021) does not provide a core PCE inflation projection on a Q4/Q4 basis, but the projected annual average core PCE inflation rates in 2021 and 2022 are 1.9 and 2.0 percent, respectively.