We then employ this model to explore the expected behavior of economic variables, including the policy rate, under alternative policy rules. The policy rules help to benchmark not only the current stance of the federal funds rate but also guidance on how the path of policy is likely to evolve in the context of the model. Such an exercise as part of a more comprehensive quarterly monetary policy report would enhance communication and promote a more systematic approach to monetary policy.

We begin with an overview of the economy and then discuss the benchmark model we use to generate our forecasts with different policy rules. The remainder of the report highlights the outcomes of different robust policy rules and discusses why policymakers might choose to deviate from the rules.

Economic Overview

Economic growth in the second quarter has accelerated largely due to a healthy pickup in consumption and continued steady growth in housing. Financial volatility, which was prevalent last quarter, has waned, and oil prices have recovered somewhat. The recent rise in oil prices is contributing to the gradual return of inflation to the target rate, although year-over-year core PCE (personal consumption expenditures) inflation remains below target. For the most part, economic fundamentals appear to be solid. After a weak first quarter in which GDP grew at a mere 0.8 percent, nowcasts of the current quarter generally indicate that growth is now above trend. GDPplus indicates that some of the weakness in the first quarter GDP report may be due to seasonal adjustment problems in GDP, as GDPplus grew at 2.3 percent in the first quarter. But not all is rosy: Employment grew by a scant 38,000 net new jobs in May, and April’s employment was revised down significantly. Thus, the robust first quarter growth in employment has attenuated markedly. In addition, manufacturing and investment remain quite weak.

[1]The views expressed here are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. We thank Brie Coellner for her assistance.