Monetary Policy Report: Using Rules for Benchmarking, March 2017

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

The U.S. economy continues to grow at a near-trend rate, with nowcasts of real GDP growth in the current quarter largely in the 1.0 percent to 2.0 percent range. Much of the recent and projected growth is due to healthy increases in consumption, although we are seeing signs of a modest recovery in manufacturing activity and some indications that business fixed investment will contribute as well. The labor market continues to generate new jobs at a healthy rate, and wage rates have been slowly trending upward. Economic conditions in the rest of the world appear to be improving, and there is substantial optimism among domestic consumers and firms alike. That optimism has yet to fully translate into hard data, so it is important not to place undue weight on it yet. Inflation continues to move slowly toward the Federal Open Market Committee’s target, and the risks to the economy appear largely balanced. These factors have given the FOMC members a bit more confidence in the ongoing stability of the expansion, and they raised the federal funds rate by 25 basis points at their March meeting. The rate is intended to trade in the 75 to 100 basis points range, and the move was well anticipated. Market reaction has been positive, with both stock and bond prices rising following the move.

^[1]The views expressed in this report 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.