Monetary Policy Report: Using Rules for Benchmarking, September 2016

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

For the most part, economic fundamentals appear to be solid. Economic growth in the third quarter appears to have accelerated from its tepid pace of slightly less than 1.0 percent over the first half of the year. Nowcasts of the current quarter generally indicate that growth is solidly above trend. Buoyed by robust growth in jobs and modest growth in wages, consumption has been the largest contributor to overall growth during the year and is expected to continue along that trend. Additionally, the economy has benefited from steady if unspectacular growth in housing. The stock market has risen steadily of late, financial volatility is low, and oil prices and the dollar appear to have stabilized. Brexit does not seem to be having any large effect on the U.S. economy, nor is it expected to. However, inflation as measured by year-over-year core personal consumption expenditures (PCE) inflation remains below target. And not all sectors of the economy are looking strong. Business fixed investment is exceptionally weak, and although manufacturing appears to be showing some signs of improvement, the ISM manufacturing index edged back into negative territory after expansionary readings in the previous four months.

^[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.