February 2025 Monetary Policy Report: Full Text
Summary
Inflation moderated a little further last year after having slowed notably in 2023, but it remains somewhat above the Federal Open Market Committee's (FOMC) objective of 2 percent. The labor market appears to have stabilized following a period of easing, with the unemployment rate flattening out at a relatively low level over the second half of last year. Real gross domestic product (GDP) increased solidly last year, supported by strength in consumer spending.
As labor market tightness continued to ease and inflation moderated a bit further, the FOMC lowered the target range for the policy rate by a cumulative 100 basis points over its September, November, and December meetings, bringing it to the current range of 4-1/4 to 4-1/2 percent. The Federal Reserve has also continued to reduce its holdings of Treasury and agency mortgage-backed securities. The FOMC is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective, and it remains attentive to the risks to both sides of its dual mandate. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.
Recent Economic and Financial Developments
Inflation. Inflation. After stepping down notably in 2023, consumer price inflation eased a bit more last year, although recent progress has been bumpy and inflation remains somewhat above 2 percent. The price index for personal consumption expenditures (PCE) rose 2.6 percent over the 12 months ending in December, down from a peak of 7.2 percent in 2022. The core PCE price index—which excludes often-volatile food and energy prices and is generally considered a better guide to the future of inflation—rose 2.8 percent last year, only a little less than its increase in 2023, as core services price inflation remained elevated. However, some other approaches to removing the influence of volatile components of inflation, such as the trimmed mean PCE measure produced by the Federal Reserve Bank of Dallas, showed more marked deceleration in prices last year. Measures of longer-term inflation expectations are within the range of values seen in the decade before the pandemic and continue to be broadly consistent with the FOMC's longer-run objective of 2 percent inflation.
The labor market. The labor market. The labor market remains solid and appears to have stabilized after a period of easing. The unemployment rate moved up over the first half of last year but was mostly flat thereafter, ending the year at 4.1 percent—still low by historical standards—while job vacancies, which had been trending down, also flattened out over the second half at a solid level. As labor demand cooled somewhat further last year, monthly job gains slowed to a moderate pace on average. Labor supply likely increased less robustly than in previous years, with immigration appearing to have slowed over the second half of last year. Given the further rebalancing of labor demand and supply last year, the labor market no longer appears especially tight. Reflecting this further balancing, nominal wage gains continued to slow in 2024 and are now closer to the pace consistent with 2 percent inflation over the longer term.
Economic activity. Economic activity. Real GDP is reported to have increased last year by 2.5 percent, a little slower than in 2023. Consumer spending continued to grow robustly, supported by a solid labor market and rising real wages, while real business fixed investment increased moderately. In the housing market, new home construction was solid but existing home sales remained depressed, with mortgage rates still elevated. In contrast to GDP, manufacturing output was little changed, in part reflecting weak production in interest-sensitive sectors.
Financial conditions. Financial conditions. Financial conditions continue to appear to be somewhat restrictive on balance. Short-term Treasury yields declined, in line with the easing of monetary policy since September; however, the market-implied path for the federal funds rate over the next year shifted up notably, and long-term Treasury yields increased markedly in the fourth quarter. Broad equity prices continued to increase despite the rise in longer-term Treasury yields, and yields on corporate bonds were little changed, as spreads narrowed. Credit continued to be broadly available to large-to-midsize businesses, most households, and municipalities but remained relatively tight for small businesses and households with lower credit scores. Bank lending to households and businesses continued to decelerate in the second half of 2024, likely reflecting still-elevated interest rates and tight lending standards.
Financial stability. Financial stability. The financial system remains sound and resilient. Valuations remained high relative to fundamentals in a range of markets, including those for equity, corporate debt, and residential real estate. Total debt of households and nonfinancial businesses as a fraction of GDP continued to trend down to a level that is very low relative to that in the past two decades. Most banks continued to report capital levels well above regulatory requirements and have reduced their reliance on uninsured deposits, but fair value losses on fixed-rate assets were still sizable for some banks. In terms of funding risks, while the 2023–24 Securities and Exchange Commission reforms on money market funds (MMFs) have partially mitigated vulnerabilities of prime MMFs, other less regulated short-term investment vehicles remain vulnerable and somewhat opaque, and their assets have been growing. Meanwhile, hedge fund leverage appears to be high and concentrated. (See the box "Developments Related to Financial Stability".)
International developments. International developments. Foreign growth remained modest in the second half of 2024. Foreign manufacturing in general was weak, as the cumulative effects of restrictive monetary policy weighed on the sector and, in Europe, energy-intensive industries continued to grapple with elevated energy costs. That said, high-tech manufacturing and exports remained strong in Asia on robust U.S. artificial intelligence (AI) and data center demand. In China, while exports were strong, domestic demand remained sluggish despite stimulus measures to shore up the ailing property sector. Meanwhile, foreign headline inflation continued to decline, but progress on inflation reduction was uneven across economies.
Many foreign central banks cut policy rates further since mid-2024, citing declining inflationary pressures, easing labor markets, and concerns about economic growth. Policymakers generally stressed the importance of maintaining vigilance amid persistent geopolitical risks and, in some economies, still-somewhat-elevated services inflation and wage pressures. Since mid-2024, the trade-weighted exchange value of the U.S. dollar has increased significantly, on net, reflecting widening gaps of U.S. interest rates over those of major advanced foreign economies, the relative strength of the U.S. economy, and political and fiscal developments in some foreign economies.
Monetary Policy
Interest rate policy. Interest rate policy. After having held the target range for the policy rate at 5-1/4 to 5-1/2 percent between late July 2023 and mid-September 2024, the FOMC lowered the target range for the policy rate by a cumulative 100 basis points over its September, November, and December meetings, bringing it to the current range of 4-1/4 to 4-1/2 percent. The FOMC's decision to begin reducing the degree of policy restraint reflected the FOMC's greater confidence in inflation moving sustainably toward 2 percent and the judgment that it was appropriate to recalibrate the policy stance. The FOMC remains attentive to the risks to both sides of its dual mandate. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.
Balance sheet policy. Balance sheet policy. The Federal Reserve has continued the process of significantly reducing its holdings of Treasury and agency securities in a predictable manner. Beginning in June 2022, principal payments from securities held in the System Open Market Account have been reinvested only to the extent that they exceeded monthly caps. Under this policy, the Federal Reserve has reduced its securities holdings by $297 billion since June 2024, bringing the total reduction in securities holdings since the start of balance sheet reduction to about $2 trillion. The FOMC has stated that it intends to maintain securities holdings at amounts consistent with implementing monetary policy efficiently and effectively in its ample-reserves regime. To ensure a smooth transition, the FOMC slowed the pace of decline of its securities holdings in June 2024 and intends to stop reductions in its securities holdings when reserve balances are somewhat above the level that the FOMC judges to be consistent with ample reserves.
Special Topics
Employment and earnings across groups. Employment and earnings across groups. The tight labor market in recent years has been especially beneficial for historically disadvantaged groups of workers, and many of the disparities in employment and wages by sex, race, ethnicity, education, and geography have narrowed. Over the past year, even as labor market conditions have eased, employment disparities continue to be near their recent lows, while wage growth has remained solid across many groups despite slowing a bit from post-pandemic highs. Even so, in absolute levels, significant disparities in groups remain. (See the box "Employment and Earnings across Demographic Groups".)
Strong productivity growth. Strong productivity growth. Labor productivity in the business sector increased 1.9 percent per year, on average, since the fourth quarter of 2019, stronger than its 1.5 percent average annual pace over the previous expansion. Should this faster pace of productivity growth persist, it can support stronger GDP growth without adding inflationary pressure. Some factors that have boosted productivity growth recently may continue providing support, such as new business formation, which surged early into the pandemic and has remained strong. Other factors may have had more short-lived influences on productivity growth, including a temporary burst in worker reallocation across jobs earlier in the pandemic. Any measured productivity gains from integration of AI technologies into production processes have likely been small so far, but productivity gains may grow as AI use becomes more widespread. (See the box "Labor Productivity since the Start of the Pandemic".)
Federal Reserve's balance sheet and money markets. Federal Reserve's balance sheet and money markets. The size of the Federal Reserve's balance sheet has declined since June as the FOMC has continued to reduce its securities holdings. Usage of the overnight reverse repurchase agreement facility decreased further, while reserve balances were little changed. Conditions in money markets remained stable. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets".)
Framework review. Framework review. The Federal Reserve has begun its periodic public review of the monetary policy framework it uses to pursue its dual-mandate goals of maximum employment and price stability. The review is focused on the FOMC's Statement on Longer-Run Goals and Monetary Policy Strategy, which articulates the Committee's approach to monetary policy, and the Committee's policy communications tools. Like the Federal Reserve's 2019–20 review of its monetary policy framework, the current review will include outreach and public events attended by policymakers, community leaders, experts from outside the Federal Reserve System, and other members of the public. (See the box "Periodic Review of Monetary Policy Strategy, Tools, and Communications".)
Monetary policy rules. Monetary policy rules. Simple monetary policy rules, which prescribe a setting for the policy interest rate in response to the behavior of a small number of economic variables, can provide useful guidance to policymakers. With inflation easing and the unemployment rate having increased somewhat, the policy rate prescriptions of most simple monetary policy rules have generally declined since 2023. Currently, most of the rules call for levels of the federal funds rate that are within the current target range. (See the box "Monetary Policy Rules in the Current Environment".)
Domestic Developments
Inflation eased a little further last year
After stepping down notably in 2023, inflation moderated a little further last year, although it remains somewhat elevated. The price index for personal consumption expenditures (PCE) rose 2.6 percent over the 12 months ending in December, down slightly from its 2.7 percent pace the previous year and well below its peak of 7.2 percent in mid-2022. Thus, inflation has moved closer to—although still somewhat above—the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent (figure 1). Progress on disinflation last year was bumpy, with both total PCE prices and core PCE prices—which exclude often-volatile food and energy prices and are generally considered a better guide to the future of inflation—showing firmer monthly price increases over the first quarter of last year and more moderate price gains thereafter. For 2024 as a whole, core PCE prices rose 2.8 percent—a little less than the 3.0 percent gain over the previous year. However, some alternative measures that attempt to reduce the influence of idiosyncratic price movements showed more marked disinflation. For example, the trimmed mean measure of PCE prices constructed by the Federal Reserve Bank of Dallas increased 2.8 percent over the 12 months ending in December, a noticeable step-down from its 3.3 percent increase in 2023.
Personal consumption expenditures price indexes
The horizontal line indicates the Federal Open Market Committee's objective of 2 percent.
Source: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Bureau of Economic Analysis; all via Haver Analytics.
Consumer energy prices declined last year, while food prices increased modestly
PCE energy prices fell a modest 1.1 percent over the 12 months ending in December, as oil prices moved a little lower over 2024 (figure 2, left panel). The decline in oil prices was partially due to tepid oil demand from China and rising production in the U.S. and other non-OPEC (Organization of the Petroleum Exporting Countries) members; the effect of these factors more than offset upward price pressure from sustained geopolitical tension, including conflicts in the Middle East (figure 3). More recently, however, oil prices increased amid colder-than-expected weather and news of stricter sanctions on Russian oil exports. Continuing geopolitical tensions remain an upside risk to energy prices.
Price indexes for subcomponents of personal consumption expenditures
Percent change is from year earlier.
Source: Bureau of Economic Analysis via Haver Analytics.
Spot and futures prices for crude oil
The data are monthly averages of daily data and extend through January 31, 2025.
Source: ICE Brent Futures via Bloomberg.
Series: Brent spot price and 24-month-ahead futures contracts Horizon: January 1, 2019, to January 31, 2025 Description: A line chart with two curves over January 1, 2019, to January 31, 2025. Units are dollars per barrel. The data are monthly averages of daily data. The Brent spot price series starts at around 60 and fluctuates between about 60 and 75 through 2019 until it falls sharply to nearly 25 by mid-2020. The series climbs steadily to and peaks at about 120 in mid-2022 and then slides to about 85 by the start of 2023, ending at about 80 in January 2025, with two smaller peaks a bit above and below 90 in September 2023 and April 2024, respectively. The 24-month-ahead futures contracts series, while a bit less volatile in its movements, largely follows the Brent spot price series. The series starts at and hovers around 60 in 2019. It drops to about 40 by mid-2020 before rising steadily to about 90 in mid-2022 and declining to and hovering between about 70 and 80 through late 2024, ending at around 70 in January 2025.
PCE food prices increased a modest 1.6 percent last year, a second year of low increases following the much larger increases in 2021 and 2022. Since the middle of 2024, egg prices surged in response to bird flu-related supply disruptions, while price increases across other agricultural commodities have been more modest (figure 4).
Spot prices for commodities
The data are monthly averages of daily data and extend through January 31, 2025.
Source: For industrial metals, S&P GSCI Industrial Metals Spot Index; for agriculture and livestock, S&P GSCI Agriculture & Livestock Spot Index; both via Haver Analytics.
Prices of both energy and food products are of particular importance for lower-income households, for whom such necessities account for a large share of expenditures. Reflecting the sharp increases seen in 2021 and 2022, these price indexes remain around 25 percent higher than before the pandemic.
Core goods prices have been declining slightly, close to pre-pandemic declines...
In assessing the outlook for inflation, it remains helpful to consider three separate components of core prices: core goods, housing services, and core nonhousing services (figure 2, right panel). Price changes for core goods appear to have nearly normalized, with core goods prices declining slightly last year at a pace that was just a little slower than the average annual decline that prevailed in the years before the pandemic. The movement toward pre-pandemic conditions for this category of inflation in part reflects the resolution of supply chain issues and other supply constraints that had boosted goods prices earlier, and supply–demand conditions in goods markets now appear to be relatively balanced. As one indication, the shares of respondents to the Quarterly Survey of Plant Capacity Utilization who cite insufficient labor or materials as reasons for operating below capacity have returned close to their pre-pandemic levels (figure 5). Core goods inflation received a small boost last year from price gains in nonfuel import prices, which rose 2.4 percent over the year (figure 6).
Reasons for operating below full capacity
The series are the share of firms selecting each reason for operating below full capacity. The data extend through 2024:Q3.
Source: U.S. Census Bureau: Quarterly Survey of Plant Capacity Utilization.
...while housing services price inflation moved lower last year but remains elevated...
Housing services price inflation continued moderating last year, with prices rising 4.7 percent over the 12 months ending in December, down from 6.3 percent in 2023 and 7.7 percent in 2022. Despite this moderation, housing services inflation remains notably above its pre-pandemic level. Housing services inflation tends to respond with a lag to movements in rents for new leases to new tenants ("market rents"), and as these market rents have largely returned to pre-pandemic rates of increase, housing services inflation will likely continue to move lower as well (figure 7).2
Measures of rental price inflation
Zillow data start in January 2016, and Apartment List data start in January 2018. CoreLogic data extend through November 2024. Apartment List, Zillow, RealPage, and CoreLogic measure market-rate rents—that is, rents for a new lease by a new tenant. PCE is personal consumption expenditures.
Source: Bureau of Economic Analysis, PCE, via Haver Analytics; Apartment List, Inc., via Haver Analytics; Zillow, Inc.; RealPage, Inc.; CoreLogic, Inc.; Federal Reserve Board staff calculations.
...and core nonhousing services price inflation has flattened out at a somewhat elevated level
Finally, prices for core nonhousing services—a broad group that includes services such as medical, travel and dining, and financial services—increased 3.5 percent last year, a bit above their increase in 2023 and their pre-pandemic pace. However, the lack of further progress in this category masks important heterogeneity within its components. For the "market-based" category of core services, which account for roughly three-fourths of core nonhousing services, prices increased 2.9 percent last year—similar to its pre-pandemic pace and slower than its 3.5 percent increase in 2023. Market-based core services include components such as food service and lodging that are more directly influenced by supply–demand conditions, so easing in the labor market has likely contributed to the ongoing deceleration in this category of prices. In contrast, price inflation for the "non-market-based" category, where prices are imputed and which includes some volatile categories such as portfolio management that tend to be heavily influenced by idiosyncratic factors, jumped last year.3
Measures of longer-term inflation expectations have been stable, while shorter-term expectations generally moved down a bit last year
A generally held view among economists is that inflation expectations influence actual inflation by affecting wage- and price-setting decisions. Measures of inflation expectations over a longer horizon from surveys of households (such as the University of Michigan Surveys of Consumers) and professional forecasters have remained broadly consistent with the FOMC's longer-run 2 percent inflation objective (figure 8). Over the past year, these measures have been little changed and within the range seen in the decade before the pandemic. For example, the median forecaster in the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, continued to expect inflation to average 2 percent over the five years beginning five years from now.
Measures of inflation expectations
The data for the Michigan survey are monthly and extend through January 2025. The data for the Survey of Professional Forecasters (SPF) are quarterly.
Source: University of Michigan Surveys of Consumers; Federal Reserve Bank of Philadelphia, SPF.
Similarly, market-based measures of longer-term inflation compensation, which are based on financial instruments linked to inflation such as Treasury Inflation-Protected Securities, are also broadly in line with readings seen in the years before the pandemic and consistent with PCE inflation returning to 2 percent (figure 9).
Inflation compensation implied by Treasury Inflation-Protected Securities
The data are at a business-day frequency and are estimated from smoothed nominal and inflation-indexed Treasury yield curves.
Source: Federal Reserve Bank of New York; Federal Reserve Board staff calculations.
Series: 5-to-10-year and 5-year Horizon: January 4, 2016, to February 4, 2025 Description: A line chart with two curves over January 4, 2016, to February 4, 2025. Units are percent, and the data are daily. The 5-to-10-year series begins around 1.7 in January 2016. It then steps down gradually to a bit below 1.5 in June 2016, rises to 2 in January 2017, and drops again to 1.8 in June 2017. The series then grows to about 2 in January 2018, moderates to about 1.5 by the end of February 2020, and then falls below 1 in March 2020 before returning to about 1.5 in April 2020. The series steadily climbs to about 2.5 by May 2021 and fluctuates between approximately 2 and 2.5 through mid-April 2022 before briefly hitting close to 2.8 in late April. The series then drops to just above 2 in late May 2022 and fluctuates between just below 2 and about 2.5 through May 2023 before increasing to above 2.5 in September 2023 and remaining there through November 2023. It then dips to about 2.1 in December 2023, climbs to around 2.4 by February 2024, and fluctuates between 2.2 and 2.5 until August, when it dips to between 2.1 and 2.2 until October 2024. The series swings up to nearly 2.5 in early November and then ticks down, fluctuating around 2.3 through December 2024. In January 2025, the series edges up, finishing just above 2.4 in early February 2025. From early 2016 through February 2020, both series are nearly identical. The 5-year series subsequently falls to just above 0 by mid-March 2020 before jumping to over 2.7 in May 2021, surpassing the 5-to-10-year series. From there, the series fluctuates slightly, ramping up to more than 3 in November 2021, retreating slightly to about 2.8 by December 2021, and remaining around there through most of February 2022. In late February 2022, the series begins to rise, peaking around 3.5 in late March 2022. It drops briefly to below 3.3 in early April before increasing again to nearly 3.5 in late April 2022. From there, the series decreases to just below 3 in mid-May and remains roughly between 2.8 and just above 3 through mid-June 2022. The series then falls to slightly above 2 by the end of September 2022 before rebounding to over 2.5 in late October 2022. The series then follows the 5-to-10-year series closely until early March 2023, when it rises to nearly 2.8. Over the next three months, the series declines slowly past the 5-to-10-year series to just above 2 by mid-June 2023. The series increases and peaks around 2.4 by mid-October 2023. It fluctuates between just above 2 and nearly 2.5 until late July 2024, when it falls to around 2. The series rises to around 2.3 in October 2024 and crests around 2.4 in early November. It then fluctuates around 2.3 for the rest of 2024 before hovering just below 2.5 in January 2025. The series then inches up, finishing just above 2.5 in early February 2025.
Survey-based inflation expectations over a shorter horizon—which tend to follow observed inflation more closely—rose along with inflation in 2020 and 2021 but then moved back down through the end of 2024. More recently, the median value for expected inflation over the next year from the University of Michigan survey moved up some in December and January. Even so, both this measure and a similar measure from the Federal Reserve Bank of New York's Survey of Consumer Expectations are in line with pre-pandemic levels.
The labor market remains solid...
The labor market remains in solid shape. At the end of the year, the unemployment rate was low relative to historical experience, the labor force participation rate (LFPR) among workers aged 25 to 54 remained above its high from the years just before the pandemic, and job vacancies were at a strong level. For the year, employment rose moderately, layoffs remained low, and wage gains were solid.
...with labor market conditions appearing to stabilize over the second half of last year after a period of easing
After gradually increasing over much of 2023, the unemployment rate rose somewhat further in the first half of last year, from 3.8 percent in December 2023 to 4.1 percent in June 2024. However, it was mostly unchanged thereafter, ending the year at 4.1 percent—still low by historical standards (figure 10). Among most age, educational attainment, sex, and racial and ethnic groups, unemployment rates moved up, on net, last year, but to still relatively low levels (figure 11). (The box "Employment and Earnings across Demographic Groups" provides further details.)
Civilian unemployment rate
Source: Bureau of Labor Statistics via Haver Analytics.
Unemployment rate, by race and ethnicity
All data displayed are 3-month moving averages. Unemployment rate measures total unemployed as a percentage of the labor force. Persons whose ethnicity is identified as Hispanic or Latino may be of any race. Small sample sizes preclude reliable estimates for Native Americans and other groups for which monthly data are not reported by the Bureau of Labor Statistics.
Source: Bureau of Labor Statistics via Haver Analytics.
Similar to the unemployment rate, measures of job vacancies—which had been gradually moving lower since mid-2022—also appear to have stabilized over the second half of last year. For example, job openings as measured in the Job Openings and Labor Turnover Survey (JOLTS), as well as an alternative measure using job postings data from the large online job board Indeed, edged down, on net, over the first half of last year and flattened out more recently. In December, both measures were a bit above their 2019 average levels.4
Job gains eased some last year, slowing from a strong average monthly pace of 267,000 in the first quarter to a more moderate 159,000 average pace over the rest of the year (figure 12).5 Job growth remained relatively strong in health care and state and local governments (where employment levels have been normalizing toward pre-pandemic trends after earlier staffing shortages), but employment declined in manufacturing.
Nonfarm payroll employment
The data shown are a 3-month moving average of the change in nonfarm payroll employment.
Source: Bureau of Labor Statistics via Haver Analytics.
Much of the additional easing in labor demand last year manifested as a slowdown in hiring rather than an increase in layoffs. Indeed, many hiring indicators, such as the hiring rate from the JOLTS and the rate at which unemployed individuals became employed each month from the Current Population Survey, moved lower last year. In contrast, layoffs indicators, such as initial claims for unemployment insurance and the layoffs rate from JOLTS, were mostly little changed and have remained low (figure 13).
Indicators of layoffs
The data for initial claims are reported as a 4-week moving average and extend through January 18, 2025. The data for the Job Openings and Labor Turnover Survey (JOLTS) layoff rate are monthly. Series are truncated at the top of the figure in 2020 and 2021.
Source: Bureau of Labor Statistics via Haver Analytics; U.S. Department of Labor, Employment and Training Administration.
Employment and Earnings across Demographic Groups
Economic expansions have tended to narrow long-standing disparities in employment and earnings across demographic groups, which can help make up for disproportionate losses experienced during downturns. These benefits have been evident during the expansion in recent years as an exceptionally tight labor market has allowed gaps between groups to narrow significantly. Over the past year, even as labor market conditions have eased, employment disparities continue to be near their recent lows, while wage growth has remained solid across many groups despite slowing a bit from post-pandemic highs. However, despite the progress in recent years, significant disparities in absolute levels across groups remain.
Among prime-age people (aged 25 to 54), employment for Black or African American workers remains relatively high. The employment-to-population (EPOP) ratio for this group increased from mid-2020 until 2023 and has been mostly flat, on net, near its historical peak since then (figure A, left panel). This movement, combined with relatively smaller increases in the EPOP ratio for white workers over the same period, led the gap between the EPOP ratios for Blacks and whites to fall to its lowest point in 50 years. Over the past year, as the labor market has eased, this gap appears to have widened slightly but remains near its historical low.1 Employment for Hispanic or Latino workers has also remained quite strong, with an EPOP ratio close to its historical high. As a result, the gap between the EPOP ratios between this group and white workers is also near its narrowest point. The EPOP ratio for prime-age Asian workers remains high as well, sitting slightly below its historical peak.2
Prime-age employment-to-population ratios compared with the 2019 average ratio, by group
The data are 3-month moving averages. Prime age is 25 to 54. All series are seasonally adjusted by Federal Reserve Board staff.
Source: Bureau of Labor Statistics; U.S. Census Bureau, Current Population Survey; Federal Reserve Board staff calculations.
Similarly, the EPOP ratio for prime-age women of all levels of education grew strongly in the post-pandemic recovery, surpassing its pre-pandemic level, and peaked last year. The increase in the EPOP ratio among this group most likely reflects both the continuation of the pre-pandemic trend of rising female labor force participation—some of which is likely attributable to increased educational attainment—and the continuing availability of remote work.3 In contrast, the EPOP ratio for prime-age men has remained mostly flat near 2019 levels over the past several years, and, as a result, the male–female EPOP ratio gap narrowed significantly to a record low. That said, the EPOP ratios for women by education level diverged a bit in the latter half of 2024 (figure A, right panel). While the EPOP ratio for college-educated women remained well above 2019 levels through the second half of last year, that for non-college-educated women moved closer to 2019 levels, reflecting both a small decline in labor force participation and a small increase in unemployment.
Like the experiences of women and minority workers, employment for prime-age people living outside of large metropolitan areas also especially benefited from the economic expansion of recent years. While the EPOP ratios for workers in all areas increased over this period, those for rural areas ("nonmetros") and smaller cities have been particularly strong (figure B, top panel).4 As a result, and given that EPOP ratios are relatively low in rural areas, the gap between EPOP ratios for workers in larger cities and those for workers in rural areas has declined over the past several years and now sits 1 percentage point below its 2019 average. The EPOP ratio gap between smaller and larger cities also dropped below its pre-pandemic level during this period; however, as the labor market has rebalanced over the past year, this gap appears to have widened back to its 2019 level. Interestingly, the employment gains for workers in rural areas and smaller cities differed significantly by education level. In rural areas, employment for non-college-educated workers increased by more than for similarly educated workers in cities (figure B, bottom-left panel). In contrast, employment for college-educated workers increased relatively more in smaller cities than in either of the other areas (figure B, bottom-right panel).
Prime-age employment-to-population ratios compared with the 2019 average ratio, by metropolitan status and education
The data are 3-month moving averages. Prime age is 25 to 54. Larger metropolitan statistical areas (MSAs) consist of 500,000 people or more, and smaller MSAs consist of 100,000 to 500,000 people. All series are seasonally adjusted by Federal Reserve Board staff.
Source: Bureau of Labor Statistics via Haver Analytics; U.S. Census Bureau, Current Population Survey; Federal Reserve Board staff calculations.
While employment disparities across many demographic groups are within range of historical lows reached during the post-pandemic recovery period, substantial gender, racial, ethnic, and geographic gaps remain, underscoring long-standing structural factors. Currently, prime-age women are employed at a rate 11 percentage points less than men, while prime-age Black and Hispanic workers are employed at a rate 3 to 4 percentage points less than white workers. Further, workers in rural areas are employed at a rate 1 to 3 percentage points below workers in cities.
Similar to employment, a solid but cooling labor market has supported nominal wage growth over the past year—albeit at a slower pace than that during the exceptionally tight labor market in the previous two years. Even so, with headline inflation declining, these wage gains imply continued solid increases in real wages across many groups. In recent years, real wage growth was particularly robust for lower-wage workers and for many historically disadvantaged groups; however, by the end of 2024, wage growth for these groups had moderated. As shown in the top-left panel of figure C, real wage growth—as measured by the Federal Reserve Bank of Atlanta's Wage Growth Tracker and deflated by the personal consumption expenditures price index—was relatively strong for workers in the bottom half of the income distribution during the post-pandemic recovery through the first half of 2024; however, by the end of the year, wage growth had edged down for this group, and growth had become similar across all quartiles.5
Median real wage growth, by group
Series show 12-month moving averages of the median percent change in the hourly wage of individuals observed 12 months apart, deflated by the 12-month moving average of the 12-month percent change in the personal consumption expenditures price index. In the top-left panel, workers are assigned to wage quartiles based on the average of their wage reports in both Current Population Survey outgoing rotation group interviews; workers in the lowest 25 percent of the average wage distribution are assigned to the 1st quartile, and those in the top 25 percent are assigned to the 4th quartile.
Source: Federal Reserve Bank of Atlanta, Wage Growth Tracker; Bureau of Labor Statistics; U.S. Census Bureau, Current Population Survey.
This pattern in wage growth across the income distribution is reflected in the experiences of different demographic groups. Wage growth for nonwhite workers had been a bit stronger than that for white workers since 2022 but, by mid-2024, had fallen to a similar rate of growth (figure C, top-right panel). Similarly, wage growth for workers with a high school diploma or less was strong relative to other groups in the post-pandemic tight labor market; however, as labor market conditions softened in 2024, wage growth for this group tapered and fell below that for college-educated workers (figure C, bottom-left panel). In contrast, wages for men and women largely grew in tandem until the middle of last year, but real wage growth for women outpaced a bit that for men by the end of 2024 (figure C, bottom-right panel).
Increases in labor supply appear to have slowed
At the same time, the supply of labor—determined by both the LFPR (the share of the population either working or seeking work) and population growth—appears to have increased more slowly over the second half of last year, after substantial increases over the past several years.
After having rebounded notably from its pandemic lows, the LFPR has been little changed since mid-2023 and was 62.5 percent in December (figure 14). Although population aging has continued to put downward pressure on the LFPR, this influence has been offset by increasing participation among some age groups. In particular, the LFPR among those aged 25 to 54 has increased substantially over the past few years (especially among women) and, despite declining a bit, on net, over the second half of last year, has remained at a high level.
Labor force participation rate
Values before January 2024 are estimated by Federal Reserve Board staff to eliminate discontinuities in the published history.
Source: Bureau of Labor Statistics via Haver Analytics.
Series: Labor force participation rate Horizon: January 2005 to December 2024 Description: A line chart with one curve over January 2005 to December 2024. Units are percent, and the data are monthly. The series begins just below 66 in January 2005, fluctuates between about 65 and 66 through July 2009, and decreases to just below 63 in April 2014, with the series dipping to just above 64 in December 2009 and just below 63 in October 2013 during the decline. The series then increases slowly, peaking above 63 in February 2020. It then decreases rapidly to just above 60 in April 2020 before rising quickly to nearly 62 in October 2020. The series then climbs at a slower pace, growing to above 62 in mid-2022 and fluctuating between 62 and 63 through December 2024, when it ends a bit above 62.
Regarding population growth, the Census Bureau now estimates that immigration increased strongly from 2022 through June 2024, contributing to strong annual population growth over this period.6 While official Census Bureau immigration estimates are unavailable after June, more recent indicators point to a sharp slowdown in immigration and population growth since the middle of last year.7
The labor market no longer appears especially tight
As labor demand has slowed further, labor demand and supply have continued to move into closer alignment. By many measures, the labor market appears somewhat less tight than just before the pandemic; for example, the gap between the number of total available jobs (measured by employed workers plus job openings) and the number of available workers (measured by the size of the labor force) averaged 0.8 million in the fourth quarter of last year—well below its 2022 peak of 6.0 million and somewhat below its 2019 average (figure 15). Additionally, the share of respondents to the Conference Board Consumer Confidence Survey who say that jobs are plentiful, and the monthly percentage of the workforce that has quit their job as measured in JOLTS (an indicator of the availability of attractive job prospects), are also somewhat below 2019 levels (but above their ranges that prevailed over much of the previous expansion). Similarly, the unemployment rate in December was about 1/2 percentage point higher than its 2019 average (but still low relative to its range over the past 50 years).
Available jobs versus available workers
Available jobs are employment plus job openings as of the end of the previous month. Available workers are the labor force. Data for employment and labor force before January 2024 are estimated by Federal Reserve Board staff to eliminate discontinuities in the published history.
Source: Bureau of Labor Statistics via Haver Analytics; Federal Reserve Board staff calculations.
Labor productivity increased solidly in 2024
Labor productivity in the business sector increased 1.97 percent in 2024 (figure 16). Productivity growth has swung wildly since the onset of the pandemic, but looking through this volatility, average labor productivity since the fourth quarter of 2019 is estimated to have increased 1.8 percent, 0.3 percentage point faster than the average pace that prevailed over the previous expansion.8 (For some potential explanations for this faster productivity growth, see the box "Labor Productivity since the Start of the Pandemic.")
U.S. labor productivity
The data are output per hour in the business sector.
Source: Bureau of Labor Statistics via Haver Analytics.
Labor Productivity since the Start of the Pandemic
While labor productivity in the business sector has been volatile since the start of the pandemic, smoothing through these swings, productivity has increased at an average annual rate of 1.8 percent from 2019:Q4 to 2024:Q4—stronger than its 1.5 percent annual average pace over the previous business cycle, 2007:Q4 to 2019:Q4 (figure A). This relatively strong growth rate has put the level of productivity more than 1-1/2 percent above where it would have been had it increased at its pre-pandemic pace. Should stronger productivity growth be maintained, it would have important economic consequences, because stronger productivity growth can support stronger growth in gross domestic product and real wages without additional inflationary pressure.
Business-sector productivity
The data are output per hour in the business sector. The blue line plots output per hour, assuming a constant growth rate equal to its average from 2007:Q4 to 2019:Q4. The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: December 2007 to June 2009 and February 2020 to April 2020.
Source: Bureau of Labor Statistics via Haver Analytics; Federal Reserve Board staff calculations.
Why has productivity growth been stronger than its pre-pandemic pace? One key contributing factor has likely been new business formation, which surged early in the pandemic and remains strong (figure B). This strength has likely supported productivity growth because newer firms are more likely to adopt new technologies or production processes, use existing processes more efficiently, or create new products themselves.1 Moreover, the surge in business formation has been disproportionately concentrated in high-tech industries, which historically have been important drivers of productivity gains.2 As some of the more productive businesses started over the past few years grow further, they may continue to support strong productivity growth, even if the rate of business formation slows. That said, much is still unknown about the nature and growth prospects of these pandemic-era new businesses, so there is considerable uncertainty around how much these businesses have contributed to recent productivity growth and how consequential they will be to productivity going forward.
Establishment births and new business applications
Quarterly new business applications are the sum of high-propensity applications over the month. The Business Employment Dynamics (BED) data extend through 2024:Q2. The shaded bar with a top cap indicates a period of business recession as defined by the National Bureau of Economic Research: February 2020 to April 2020.
Source: Bureau of Labor Statistics, BED via Haver Analytics; Federal Reserve Board staff calculations and U.S. Census Bureau, Business Formation Statistics.
Other contributing factors may have provided a more short-lived boost to productivity growth. For example, some firms facing severe labor shortages early in the pandemic likely expanded their use of labor-saving technologies and more efficiently restructured aspects of production, which enhanced their workers' productivity and reduced some firms' need for pre-pandemic levels of labor. However, as labor supply has gradually returned, firms' need for further expansion of labor-saving technologies may have diminished.
Another temporary factor has likely been worker reallocation across jobs (figure C). Measures of worker reallocation, such as the rate of transitions between jobs (black line) and quits (blue line), jumped early in the pandemic and may have resulted in more productive matches between some workers and jobs.3 However, these measures have returned to pre-pandemic levels (or lower), so worker reallocation is unlikely to still be providing much support to productivity growth.
Measures of worker reallocation
The data are seasonally adjusted quarterly averages. The black line applies only to persons aged 16 or older. JOLTS is the Job Openings and Labor Turnover Survey.
Source: Federal Reserve Bank of Philadelphia, Fujita, Moscarini, and Postel-Vinay Employer-to-Employer Transition Probability; Bureau of Labor Statistics via Haver Analytics.
Finally, integration of artificial intelligence (AI) into production processes may already be contributing to productivity gains. However, any effects on measured productivity so far have probably been small, since it will likely take many firms some time to figure out how to effectively integrate AI into the workplace.4 As AI becomes more widely adopted and more efficiently used, it may contribute more substantially to productivity, although there are conflicting views about any potential economic implications.5
It seems possible that all of the aforementioned factors have contributed, at least to some degree, to the strength in productivity since the start of the pandemic, although it is difficult to separate out their relative contributions. Going forward, whether productivity growth can remain above its pre-pandemic pace depends in part on how persistent the influence of some of these factors proves to be and whether these or other factors become even more consequential (for example, how much further AI technologies develop and how widespread their usage becomes).
Wage growth has slowed but remains solid
As labor market tightness eased somewhat further last year, nominal wage growth has also continued to slow, although to a still-solid pace (figure 17). Total hourly compensation, as measured by the employment cost index (ECI), increased 3.6 percent over the 12 months ending in December and has gradually slowed from its peak increase of 5.5 percent in mid-2022. Other measures also slowed some last year, with the Federal Reserve Bank of Atlanta's Wage Growth Tracker (which reports the median 12-month wage growth of individuals responding to the Current Population Survey) slowing in line with the ECI and growth in average hourly earnings (a less comprehensive measure) slowing in the first half but flattening out over the second half.
Measures of change in hourly compensation
For the private-sector employment cost index, change is over the 12 months ending in the last month of each quarter; for private-sector average hourly earnings, the data are 12-month percent changes; for the Atlanta Fed's Wage Growth Tracker, the data are shown as a 3-month moving average of the 12-month percent change.
Source: Bureau of Labor Statistics; Federal Reserve Bank of Atlanta, Wage Growth Tracker; all via Haver Analytics.
Despite this slowing, wage growth remains somewhat above its 2019 pace. This contrasts with the normalization in other labor market tightness indicators cited earlier and might reflect persistence in the adjustment process of wages to earlier shocks as well as support from strong productivity growth. Nominal wage growth may still remain somewhat too high to be consistent with 2 percent inflation over time, although this depends in part on how persistent the recent strength in productivity proves to be.
With PCE prices having risen 2.6 percent last year, these wage measures suggest that most workers saw increases in the purchasing power of their wages in 2024. That said, the extent of these increases depends in part on workers' individual circumstances—because nominal wage changes vary significantly across industry and occupation and because households consume different baskets of goods than the one represented in the aggregate PCE price index. (For details on how real wage gains have differed across demographic groups, see the box "Employment and Earnings across Demographic Groups.")
Gross domestic product rose solidly last year
Real gross domestic product (GDP) is reported to have increased at a solid annual rate of 2.7 percent over the second half of last year, a little stronger than its pace over the first half (figure 18). GDP growth last year was importantly supported by strength in consumer spending. Meanwhile, business investment grew moderately, while activity in the housing market was lackluster. For the year, GDP increased 2.5 percent—somewhat slower than its 3.2 percent pace from 2023, primarily because of moderation in both state and local government spending and nonresidential structures investment (which surged in 2023 from booming construction of manufacturing facilities), and more of a drag from net exports (as imports grew faster than exports).
Change in real gross domestic product and gross domestic income
The key identifies bars in order from left to right. The data for gross domestic income extend through 2024:H1.
Source: Bureau of Economic Analysis via Haver Analytics.
In contrast to GDP, manufacturing output was little changed last year. In part, weakness in manufacturing production reflects tight financing conditions, as manufacturing output was weaker, on average, in sectors that tend to be more responsive to interest rates. Moreover, recent growth in domestic goods spending has largely been accommodated by increased imports. Special factors also held down production in some key industries like aircraft, where a labor dispute held down output. In all, manufacturing output has been fairly flat in recent years and remains below its recent peak from 2018.
Consumer spending has been resilient despite some headwinds
Despite headwinds from high interest rates, consumer spending adjusted for inflation grew a strong 3.2 percent last year, a little above its pace in 2023 (figure 19). Consumer spending has been supported by a still-solid labor market, high levels of household wealth relative to income, and rising real wages—indeed, real disposable personal income increased at an average pace of 3.6 percent over the past two years. However, consumers continued to spend more of their income than was typical before the pandemic, and the saving rate—the difference between current income and spending, as a share of income—has remained somewhat below its pre-pandemic level for much of the past two years (figure 20). Consumers maintained this pace of spending in part by drawing down their stock of liquid assets (such as checking and savings accounts) that had accumulated to elevated levels during and after the pandemic and by relying more on credit. Even so, households' stock of liquid assets appears to have stabilized at a solid level somewhat above its pre-pandemic trend, suggesting that households, in the aggregate, may have a larger-than-usual buffer to weather economic shocks.
Change in real personal consumption expenditures
Source: Bureau of Economic Analysis via Haver Analytics.
: Personal saving rate
Source: Bureau of Economic Analysis via Haver Analytics.
Consumer spending has been more robust than measures of consumer sentiment would suggest (figure 21). Although sentiment in the University of Michigan survey has improved notably since 2022, it remains well below its pre-pandemic level. A similar measure from the Conference Board also remains somewhat low—though stronger than the University of Michigan survey measure, as it puts more weight on labor market conditions.
Indexes of consumer sentiment
The data extend through January 2025.
Source: University of Michigan Surveys of Consumers; Conference Board.
Consumer financing conditions remain somewhat restrictive
Despite a tick down in interest rates over the second half of the year in many categories of consumer loans, consumer financing conditions have remained restrictive, reflecting still-high borrowing costs and tight bank lending standards. According to the October 2024 and January 2025 Senior Loan Officer Opinion Surveys on Bank Lending Practices (SLOOS), conducted by the Federal Reserve Board, over the second half of last year banks reported tightening lending standards further for credit cards but loosening them somewhat for auto loans, albeit from tight levels.9 For credit cards, the relatively tight consumer lending standards likely reflect, in part, delinquency rates that have remained somewhat elevated relative to the pre-pandemic period.
Even so, financing has generally remained available to support spending for most households, other than those with low credit scores, and consumer credit expanded moderately through the third quarter of last year (figure 22).
Consumer credit flows
Credit card balances were little changed in 2011 and 2012.
Source: Federal Reserve Board, Statistical Release G.19, "Consumer Credit."
Residential investment increased modestly last year
After steep declines in 2022, residential investment turned around in the middle of 2023 and increased modestly, on net, last year, supported by solid income growth and mortgage rates—which moved down a bit through the fall of last year, although to levels still far above pre-pandemic mortgage rates (figure 23). More recently, however, mortgage rates have moved back up again.
Mortgage interest rates
The data are contract rates on 30-year, fixed-rate conventional home mortgage commitments and extend through January 30, 2025.
Source: Freddie Mac Primary Mortgage Market Survey via Haver Analytics.
The markets for new and existing homes have evolved differently over the past few years (figure 24). Existing home sales remain depressed, as many homeowners who purchased or refinanced homes when fixed mortgage rates were lower appear unwilling to move and take out a new mortgage with a much higher rate. Indeed, the majority of outstanding mortgages still have interest rates below 4 percent, well below the prevailing 30-year fixed interest rate of 7.0 percent at the end of January (figure 25).
New and existing home sales
New and existing home sales include only single-family sales.
Source: For new home sales, U.S. Census Bureau; for existing home sales, National Association of Realtors; all via Haver Analytics.
Distribution of interest rates on outstanding mortgages
The sample only includes outstanding mortgages current on their payments.
Source: ICE, McDash®.
Series: Below 6 percent, below 5 percent, and below 4 percent Horizon: January 2010 to December 2024 Description: A line chart with three curves over January 2010 to December 2024. Units are percent, and the data are monthly. The below 6 percent series begins just above 60 and rises over the time horizon until 2022, increasing the fastest between January 2010 and December 2014. The series is around 85 in January 2014 and continues to gradually increase before reaching its peak of around 95 in May 2022. It then decreases steadily and ends just above 85 in December 2024. The below 5 percent series stays under the below 6 percent series and above the below 4 percent series over the entire horizon. The series begins around 20 in January 2010 and increases at a steady rate, reaching about 68 in December 2014. It then increases at a less substantial rate until September 2018, when it hits 82 before dipping to around 80 in early 2019. From there, the series increases to a peak of about 90 in April 2022 and then begins to decrease, ending a bit above 76 in December 2024. The below 4 percent series begins just under 4 in January 2010 and increases to about 35 by January 2014. From there, it moves up at a slower rate until hitting about 48 in late 2016 and fluctuating there through early 2018. The series then dips to around 43 in June 2019 before increasing again to a peak of about 71 in March 2022. It then begins to decrease again and ends just below 60 in December 2024.
In contrast, sales of new homes bounced back to pre-pandemic levels in early 2023 and remained around these levels throughout last year. The new home market has likely been supported by demand from buyers who are unable to find homes in the existing home market. The rebound in demand for new homes encouraged builders to increase housing construction, and starts for single-family housing generally maintained solid levels last year (figure 26). Reflecting some additional rebalancing in the housing market, in part from supply improvements, house prices increased moderately last year, well below the pace seen in 2021 and 2022 (figure 27).
Growth rate in house prices
S&P/Case-Shiller and CoreLogic data extend through November 2024.
Source: CoreLogic, Inc., Home Price Index; Zillow, Inc., Real Estate Data; S&P/Case-Shiller U.S. National Home Price Index. The S&P/Case-Shiller index is a product of S&P Dow Jones Indices LLC and/or its affiliates. (For Dow Jones Indices licensing information, see the Data Notes page.)
Meanwhile, starts of multifamily units—which are predominantly rental units—continued to trend lower last year because of weaker rent growth, increasing vacancies, and as a large backlog of new units have entered the market following a wave of multifamily construction from 2021 through mid-2023.
Capital spending grew moderately last year
After increasing solidly in 2023, business investment spending rose moderately last year despite high interest rates, supported by strong sales growth and improving business sentiment (figure 28). The sources of strength in business investment have shifted over the past year. Investment in structures, which surged in 2023 largely from a boom in manufacturing construction (especially for factories that produce semiconductors or electric vehicle batteries), has flattened out, albeit at a high level. Meanwhile, growth in business investment in equipment and intellectual property (which includes software and research and development) has picked up a bit, in part as businesses have been outfitting new manufacturing structures and data centers with high-tech equipment, as well as from continued investment related to artificial intelligence technologies.
Change in real business fixed investment
Business fixed investment is known as "private nonresidential fixed investment" in the national income and product accounts. The key identifies bars in order from left to right.
Source: Bureau of Economic Analysis via Haver Analytics.
Business financing conditions remained somewhat restrictive, but credit remains generally available
While businesses have still faced somewhat restrictive financing conditions as interest rates have stayed elevated, credit has remained generally available to most nonfinancial corporations. Over the second half of last year, banks reported leaving lending standards for business loans basically unchanged, after tightening them since the middle of 2022. Issuance of corporate bonds remained solid across credit categories, although below the levels that prevailed at the start of the tightening cycle.
For small businesses, which are more reliant on bank financing than large businesses are, credit conditions were little changed over the second half of last year. Surveys indicate that credit supply for small businesses remained relatively tight, while interest rates on loans to small businesses decreased some late in the year but remained near the top of the range observed since 2008. Loan default rates and delinquency rates, which had risen since mid-2022, moved down somewhat starting in the fall but still stand above their pre-pandemic rates. Finally, loan originations trended down slowly since the summer but are in the range observed before the pandemic, suggesting that credit continues to be available for small businesses with sound financial positions.
Exports and imports grew moderately in the second half of 2024
After lackluster growth in the first half of last year, real exports of goods and services picked up in the second half, led by exports of capital goods (figure 29). Meanwhile, real imports were robust throughout much of the year, supported by imports of high-tech capital goods. Combined, net exports subtracted 0.2 percentage point from U.S. GDP growth in the second half and subtracted 0.5 percentage point from overall 2024 GDP growth. The current account deficit as a share of GDP widened somewhat in the third quarter to roughly twice as wide as it was before the pandemic.
Change in real imports and exports of goods and services
The key identifies bars in order from left to right.
Source: Bureau of Economic Analysis via Haver Analytics.
Federal fiscal policy actions provided a modest boost to GDP growth last year
Last year, federal purchases grew moderately, and some policies enacted after the pandemic continued to boost private investment and consumption. This support to economic activity was offset somewhat by the fading effects of earlier pandemic-related fiscal policy support. All told, the contribution of discretionary changes in federal fiscal policy was a modest boost to real GDP growth in 2024.
The budget deficit and federal debt remain elevated
After surging to about 15 percent of GDP in fiscal year 2020, the federal budget deficit—the difference between federal expenditures and receipts—declined through fiscal 2022 as the imprint of the pandemic faded, but it has been fairly flat since then (figure 30). In fiscal 2024, the budget deficit was 6.4 percent of GDP—notably larger than in the years before the pandemic—as noninterest outlays continued to outpace receipts and as the cost of debt service increased as a result of higher interest rates and a higher level of debt.
Federal receipts and expenditures
The receipts and expenditures data are on a unified-budget basis and are for fiscal years (October through September); gross domestic product (GDP) data are on a 4-quarter basis ending in Q3.
Source: Department of the Treasury, Financial Management Service; Office of Management and Budget and Bureau of Economic Analysis via Haver Analytics.
As a result of the fiscal support enacted early in the pandemic, federal debt held by the public jumped during the pandemic, reaching nearly 100 percent of GDP in early 2021—the highest debt-to-GDP ratio since 1946—and has only edged lower since then (figure 31). The debt-to-GDP ratio has been about flat since then, as the large primary deficits have occurred along with strong nominal GDP growth, but the Congressional Budget Office projects that debt-to-GDP will resume rising in the coming years as deficits remain elevated.
Federal government debt and net interest outlays
The data for net interest outlays are annual, begin in 1948, and extend through 2024. Net interest outlays are the cost of servicing the debt held by the public, offset by certain types of interest income the government receives. Federal debt held by the public equals federal debt excluding most intragovernmental debt, evaluated at the end of the quarter. The data for federal debt are annual from 1900 to 1951 and a 4-quarter moving average thereafter and extend through 2024:Q3. GDP is gross domestic product.
Source: For GDP, Bureau of Economic Analysis via Haver Analytics; for federal debt, Congressional Budget Office and Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States."
The fiscal position of most state and local governments remains in good shape, as tax revenue growth has normalized...
Federal policymakers provided a historically high level of fiscal support to state and local governments during the pandemic, which—together with robust state tax collections in 2021 and 2022—left the sector in a strong budget position overall (figure 32). After falling somewhat in 2023, state tax revenues grew modestly in 2024, and taxes as a percentage of GDP remain somewhat above historical norms. According to the National Association of State Budget Officers, states' total balances—that is, including rainy day fund balances and previous-year surplus funds—declined in 2024 from their all-time high in 2023 but remained well above pre-pandemic levels. At the local level, overall property tax receipts rose at a solid pace in 2024, and the typically long lags between changes in the market value of real estate and changes in taxable assessments suggest that—given past house price appreciation—property tax revenues will continue to rise going forward.
State and local tax receipts
Receipts shown are year-over-year percent changes of 4-quarter moving averages, begin in 2012:Q4, and extend through 2024:Q3. Property taxes are primarily collected by local governments.
Source: U.S. Census Bureau, Quarterly Summary of State and Local Government Tax Revenue.
...contributing to above-average growth in employment and construction spending last year
Against the backdrop of continued strong budget positions, state and local government employment has moved up sharply over the past two years, after hiring and retention difficulties earlier in the pandemic faded, in part because wages have become more competitive with those in other sectors (figure 33). As employment has approached its pre-pandemic trend, growth slowed somewhat last year, although to a still-strong pace. Similarly, real construction outlays—which grew at a historically high pace in 2023 owing to support from federal grants and easing bottlenecks—increased last year at a more moderate (though still-strong) pace as support from these factors faded.
State and local government payroll employment
Source: Bureau of Labor Statistics via Haver Analytics.
Financial Developments
The expected level of the federal funds rate over the next year shifted up notably...
Market-based measures of the expected path of the federal funds rate declined over the summer and early fall as the Federal Reserve eased monetary policy beginning at its September meeting. Subsequently, these measures moved up in the fourth quarter as market participants scaled back their expectations of the extent of further easing. On net, the market-implied path for the federal funds rate in 2025 is little changed since last July, and the path for 2026 is notably higher (figure 34). Financial market prices now imply that the federal funds rate will decline a further 40 basis points from current levels to 3.9 percent by year-end 2025 and remain near that level through the end of 2026. Consistent with current market prices, respondents to the January Blue Chip Financial Forecasts survey expected the federal funds rate to average 3.8 percent in the fourth quarter of 2025.
Market-implied federal funds rate path
The federal funds rate path is implied by quotes on overnight index swaps—a derivative contract tied to the effective federal funds rate. The implied path as of July 9, 2024, is compared with that as of February 4, 2025. The path is estimated with a spline approach, assuming a term premium of 0 basis points. The July 9, 2024, path extends through 2028:Q3 and the February 4, 2025, path through 2029:Q1.
Source: Bloomberg; Federal Reserve Board staff estimates.
...and yields on long-term U.S. nominal Treasury securities are higher on net
While short-term Treasury yields declined somewhat, on net, since last July, yields on long-term nominal Treasury securities increased markedly on balance. After declining from early summer to mid-September to a level just above 3.6 percent, the 10-year Treasury yield rose notably, reaching a level of 4.6 percent by early February (figure 35). The rise in long-term nominal yields since mid-September largely reflected an increase in real yields, as measured by yields on Treasury Inflation-Protected Securities.
Yields on nominal Treasury securities
Source: Department of the Treasury via Haver Analytics.
Yields on other long-term debt were little changed on net
Amid the easing of monetary policy and improved market sentiment since September, spreads on corporate bonds over comparable-maturity Treasury securities narrowed, particularly for speculative-grade bonds, and are now very low relative to their respective historical distributions. As the decline in spreads largely offset the increase in Treasury yields, corporate bond yields were little changed, on net, across credit categories and remained elevated (figure 36). Similarly, municipal bond spreads over comparable-maturity Treasury securities narrowed somewhat, on net, and stand near the bottom of the historical distribution. Meanwhile, municipal bond yields increased slightly since July. Yields on agency mortgage-backed securities (MBS)—an important factor for home mortgage interest rates—were little changed, on net, and currently stand at similar levels to those observed in June (figure 37). The MBS spreads narrowed notably but remained elevated by historical standards, at least partly due to high interest rate volatility, which increases prepayment risk and reduces the value of holding MBS.
Corporate bond yields, by securities rating, and municipal bond yield
High-yield corporate reflects the effective yield of the ICE Bank of America Merrill Lynch (BofAML) High Yield Index (H0A0). Investment-grade corporate reflects the effective yield of the ICE BofAML triple-B U.S. Corporate Index (C0A4). Municipal reflects the yield to worst of the ICE BofAML U.S. Municipal Securities Index (U0A0).
Source: ICE Data Indices, LLC, used with permission.
Series: Investment-grade corporate, municipal, and high-yield corporate Horizon: January 1, 2017, to February 4, 2025 Description: A line chart with three curves over January 1, 2017, to February 4, 2025. Units are percent, and the data are daily. The investment-grade corporate series starts slightly below 4, increases to about 5 by the end of 2018, and declines to around 3 by the beginning of 2020. The series sharply increases to a bit above 5 in early 2020, decreases to around 2 by early 2021, rises to about 6 by the end of 2022, fluctuates between 5 and 7 through late 2024, and ends just below 6 in early 2025. The municipal series, following a similar pattern, starts a bit below 3 and fluctuates between 2 and 3 before declining in late 2018 and dropping to a bit below 2 by the beginning of 2020. The series then increases sharply to about 3 in early 2020, decreases to about 1 by late 2021, moves up to about 4 by late 2023, and then declines slightly, ending at above 3 in early 2025. The high-yield corporate series starts at around 6 and increases to about 8 by the beginning of 2019. The series decreases to around 5 by the beginning of 2020, jumps to about 11 in early 2020, drops to around 4 by mid-2021, climbs to around 9 by late 2022, and fluctuates between about 7 and 10 through early 2025, ending at around 7.
Yield and spread on agency mortgage-backed securities
Yield shown is for the uniform mortgage-backed securities 30-year current coupon, the coupon rate at which new mortgage-backed securities would be priced at par, or face, value for dates after May 31, 2019; for earlier dates, the yield shown is for the Fannie Mae 30-year current coupon. Spread shown is to the average of the 5-year and 10-year nominal Treasury yields.
Source: Department of the Treasury; J.P. Morgan. Courtesy of J.P. Morgan Chase & Co., Copyright 2025.
Broad equity price indexes increased further
Amid elevated expectations of long-term earnings growth and broad-based optimism about the corporate outlook, the S&P 500 index increased further since June (figure 38). Similarly, equity prices for small market capitalization firms rose during this period. Bank equity prices increased during the second half of the year. One-month option-implied volatility on the S&P 500 index—the VIX—increased moderately since July amid higher uncertainty about the strength of the economy and the corresponding monetary policy path (figure 39). Currently, the level of the VIX is below the median of its historical distribution since 1990. (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability.")
Equity prices
Source: S&P Dow Jones Indices LLC via Bloomberg. (For Dow Jones Indices licensing information, see the Data Notes page.)
Series: Dow Jones bank index and S&P 500 index Horizon: January 1, 2017, to February 4, 2025 Description: A line chart with two curves over January 1, 2017, to February 4, 2025. Units for both series have been indexed to 100 based on their respective values on December 31, 2019, and the data are daily. The Dow Jones bank index series starts at around 75 and rises to about 100 by early 2018. The series fluctuates between about 75 and 100 until early 2020, when it plummets to about 50. The series rebounds to slightly below 125 by mid-2021, fluctuates between about 100 and 125 through early 2022, and then falls to a bit above 75 in mid-2022. It fluctuates between around 75 and 100 through late 2023 before rising steadily to its ending value of around 140. The S&P 500 index series follows a similar trajectory until early 2020, when the gap between the two series sharply increases to and persists at about 25 until early 2023, widening to and remaining at around 50 through early 2025. The series finishes slightly below 200.
S&P 500 volatility
The VIX is an option-implied volatility measure that represents the expected annualized variability of the S&P 500 index over the following 30 days. The expected volatility series shows a forecast of 1-month realized volatility, using a heterogeneous autoregressive model based on 5-minute S&P 500 returns.
Source: Cboe Volatility Index® (VIX®) via Bloomberg; Refinitiv DataScope; Federal Reserve Board staff estimates.
Series: VIX and expected volatility Horizon: January 5, 2015, to February 4, 2025 Description: A line chart with two curves over January 5, 2015, to February 4, 2025. Units are percent, and the data are daily. The VIX series starts at around 20 in 2015, spikes to about 40 in late 2015, and fluctuates between about 10 and 30 in 2016 and 2017. The series generally increases during 2018 aside from spikes to nearly 40 in February 2018 and December 2018 and declines to about 15 by the beginning of 2020. The series sharply increases to about 85 in early 2020 and quickly decreases to about 20 by early 2021, where it then stays relatively constant throughout 2021 before gradually increasing to around 30 in mid-2022. It continues fluctuating between about 20 and 35 through early 2023 and decreases to around 15 in mid-2023. After jumping to a bit above 20 in late 2023, the series decreases to and stays at around 15 through mid-2024. It spikes to just below 40 in late 2024 and then fluctuates between about 15 and 30, finishing a touch below 20. The expected volatility series follows a similar trajectory but with a magnitude about 5 to 10 points lower.
Developments Related to Financial Stability
This discussion reviews vulnerabilities in the U.S. financial system. The framework used by the Federal Reserve Board for assessing the resilience of the U.S. financial system focuses on financial vulnerabilities in four broad areas: asset valuations, business and household debt, leverage in the financial sector, and funding risks. All told, the financial system remains sound and resilient. Valuations remained high relative to fundamentals in a range of markets, including those for equity, corporate debt, and residential real estate. Total debt of households and nonfinancial businesses as a fraction of gross domestic product (GDP) continued to trend down to a level that is very low relative to that in the past two decades. Most banks continued to report capital levels well above regulatory requirements, but fair value losses on fixed-rate assets were still sizable for some banks. In addition, the trend of reduced reliance by banks on uninsured deposits continued, and recent Securities and Exchange Commission (SEC) reforms mitigated some vulnerabilities associated with prime money market funds (MMFs). Meanwhile, hedge fund leverage appears to be high and concentrated.
Valuation pressures increased somewhat from already high levels. The ratio of equity prices to 12-month forward earnings is close to the high end of its historical range, driven to a substantial extent by the largest companies. Spreads between yields on corporate bonds and those on comparable-maturity Treasury securities were very low compared with their history. In residential property markets, the ratio of house prices to rents rose to near the highest levels on record, though high house prices do not appear to have been supported by excessive borrower leverage. Meanwhile, conditions in commercial real estate (CRE) markets have recently showed signs of stabilization after a sustained period of deterioration. Nominal long-term Treasury yields increased moderately and Treasury market depth remained low, suggesting market liquidity remained low by historical standards.
Vulnerabilities from nonfinancial business and household debt remained moderate. The combined debt of both sectors as a share of GDP continued to trend down and is at its lowest level in the past 20 years (figure A). Household debt as a share of GDP is especially subdued relative to recent history and is owed primarily by prime-rated borrowers (figure B). However, delinquency rates on credit cards and auto loans among borrowers with nonprime credit ratings remained above pre-pandemic levels. Business debt as a share of GDP has declined significantly from the post-COVID-19 peak and stands near the bottom of its range over the past decade (as shown in figure B); however, business debt as a share of business assets was high by historical standards, and private credit arrangements have also been growing rapidly. That said, measures of the ability of businesses to service their debt have been stable within typical ranges, in part reflecting robust corporate earnings.
Private nonfinancial-sector credit-to-GDP ratio
The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: January 1980 to July 1980, July 1981 to November 1982, July 1990 to March 1991, March 2001 to November 2001, December 2007 to June 2009, and February 2020 to April 2020. GDP is gross domestic product. The data extend through 2024:Q3.
Source: Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; Bureau of Economic Analysis, national income and product accounts; Federal Reserve Board staff calculations.
Nonfinancial business and household debt-to-GDP ratios
The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: July 1981 to November 1982, July 1990 to March 1991, March 2001 to November 2001, December 2007 to June 2009, and February 2020 to April 2020. GDP is gross domestic product. The data extend through 2024:Q3.
Source: Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; Bureau of Economic Analysis, national income and product accounts; Federal Reserve Board staff calculations.
Vulnerabilities associated with financial leverage remained notable. The banking sector remained sound and resilient overall, and most banks continued to report capital levels well above regulatory requirements. Although fair value losses on fixed-rate assets have moderated, they were still sizable for some banks and remained sensitive to changes in long-term interest rates. The overall credit quality of banks' assets was sound, with the aggregate bank loan delinquency rate remaining at historically low levels. However, some banks, insurers, and securitization vehicles continued to have concentrated exposures to CRE. Indicators suggest that hedge fund leverage was at or near the highest level in the past decade while broker-dealer leverage stayed near historical lows. Hedge funds' Treasury cash–futures basis trade, which is highly leveraged and involves shorting a Treasury futures contract and purchasing a Treasury note deliverable into that contract, remained elevated through the second half of 2024. Separately, some highly leveraged hedge funds may also have contributed to the spike in volatility that hit equity markets in early August, as they had to quickly deleverage positions, largely to meet internal volatility targets.
Liquidity at most domestic banks remained sound. Many banks have significantly reduced the fraction of assets funded with uninsured deposits. This funding was replaced, in part, by increased use of brokered and reciprocal deposits and, at large banks, short-term wholesale funding. Some open-end bond mutual funds remained vulnerable to significant withdrawals, as they are required to permit daily redemptions despite holding assets that can suffer losses and become illiquid under stress. While the 2023–24 SEC reforms on MMFs have mitigated some vulnerabilities associated with prime MMFs, structural vulnerabilities remained in certain other short-term investment vehicles. Moreover, assets in these alternative vehicles, including prime-like offshore MMFs, as well as stablecoins which are also vulnerable to runs, grew notably in the second half of 2024. Bond and loan funds remained susceptible to redemptions during periods of stress, with more severe pressures possible if assets become more illiquid or redemptions become unusually large. In addition, life insurers continued to rely on a higher-than-average share of nontraditional liabilities.
Major asset markets functioned in an orderly manner, but liquidity remained low
Treasury securities market functioning continued to be orderly, but a number of indicators suggest that liquidity remained low by historical standards. The persistence of low liquidity is broadly in line with the continued high level of interest rate volatility. Liquidity in equity markets continued to be low, at levels comparable with those observed last July. Meanwhile, corporate and municipal bond markets continued to function well amid stable liquidity and trading conditions.
Short-term funding market conditions remained stable
Conditions in overnight bank funding and repurchase agreement markets continued to be stable. The reduction in the target range for the federal funds rate in the September, November, and December FOMC meetings fully passed through to overnight money market rates. Since June, the effective federal funds rate has remained 7 basis points below the interest rate on reserve balances. The Secured Overnight Financing Rate has been slightly above the offering rate on the overnight reverse repurchase agreement (ON RRP) facility, except for short-lived periods of upward pressure on quarter-ends. Take-up at the ON RRP facility continued to decline amid an increase in net Treasury bill issuance and more favorable rates on private investments.
The implementation of new rules for institutional prime money market funds (MMFs) in October by the SEC passed in an orderly manner. In anticipation of the rules, there were multiple conversions from prime to government MMFs and closures of prime MMFs. Assets under management of MMFs reached historical highs in January as MMFs continued to offer favorable yields relative to bank deposits. Meanwhile, MMFs extended the maturity profile of their portfolios somewhat, on net, in the second half of 2024.
Bank credit continued to decelerate
Banks' core loan holdings continued to decelerate in the second half of 2024, growing at a 1.3 percent annualized rate, down from 1.9 percent during the first half of last year (figure 40). The subdued loan growth likely reflects still-elevated interest rates and tight lending standards. Delinquency rates remained relatively stable in the second half of 2024 following several quarters of deterioration. Even so, delinquencies for commercial real estate loans and credit cards remained elevated relative to the pre-pandemic period. In contrast, delinquency rates for commercial and industrial loans remained in line with their pre-pandemic levels. Measures of bank profitability edged down during the second half of last year amid a decline in net interest margins and remain below the levels that prevailed before the pandemic (figure 41).
Ratio of total commercial bank credit to nominal gross domestic product
Source: Federal Reserve Board, Statistical Release H.8, "Assets and Liabilities of Commercial Banks in the United States"; Bureau of Economic Analysis via Haver Analytics.
Profitability of bank holding companies
The data extend through 2024:Q3.
Source: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies.
International Developments
Foreign economic growth has remained modest in the second half of 2024
Foreign growth remained modest in the second half of last year, as the cumulative effects of restrictive monetary policy became more pronounced, curbing both private investment and consumer spending. Additionally, in Europe, energy-intensive sectors continued to grapple with elevated energy costs that resulted from Russia's war on Ukraine. By contrast, growth in Asian economies stepped up somewhat in the second half of the year, bolstered by strong export activity in the high-tech sector associated with robust U.S. artificial intelligence and data center demand. In China, growth was also supported by a slew of government stimulus measures, including monetary easing, support for the property sector and stock market, and a program to boost consumer purchases of automobiles and large appliances. These economic stimulus measures have been enacted both to stabilize the property market, which has experienced large declines in activity and prices in recent years, and to restore confidence in the broader economy.
Inflation abroad slowed but remains uneven across economies
After mostly moving sideways in the first half of last year, foreign headline inflation slowed in the second half, largely driven by declines in core inflation (figures 42 and 43). However, progress on inflation reduction remains uneven across economies and sectors, with services inflation and wage growth still running above levels consistent with central banks' inflation objectives in several economies. China stood out with near-zero inflation, reflecting weak domestic demand and falling housing prices despite government stimulus measures. Global risks to inflation include upside risk from potential disruptions to energy supplies driven by geopolitical events and downside risk from the possibility that deflationary forces in China could become entrenched.
Consumer price inflation in foreign economies
The advanced foreign economy (AFE) aggregate is the average of Canada, the euro area, Japan, and the U.K., weighted by shares of U.S. non-oil goods imports. The emerging market economy (EME) aggregate is the average of Argentina, Brazil, Chile, Colombia, Hong Kong, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Russia, Saudi Arabia, Singapore, South Korea, Taiwan, Thailand, and Vietnam, weighted by shares of U.S. non-oil goods imports. The foreign aggregate is the import-weighted average of all aforementioned economies. The inflation measure is the Harmonised Index of Consumer Prices for the euro area and the consumer price index for the other economies.
Source: Federal Reserve Board staff calculations; Haver Analytics.
Components of foreign consumer price inflation
The advanced foreign economy aggregate is the average of Canada, the euro area, Japan, and the U.K., weighted by shares of U.S. non-oil goods imports. The emerging market economy (EME) aggregate is the average of Argentina, Brazil, Chile, Colombia, Hong Kong, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Russia, Saudi Arabia, Singapore, South Korea, Taiwan, Thailand, and Vietnam, weighted by shares of U.S. non-oil goods imports, and begins in May 2017. The inflation measure is the Harmonised Index of Consumer Prices for the euro area and the consumer price index for other economies. The stacked bars measure the percentage point contribution of each component to 12-month headline inflation in each referenced period. For each of these periods, the values shown are averages over all monthly 12-month changes ending in that period. The energy component of inflation for the EMEs was little changed in 2023.
Source: Federal Reserve Board staff calculations; Haver Analytics.
Many foreign central banks continued to ease monetary policy
Many foreign central banks, including the European Central Bank and the Bank of Canada as well as several central banks in Latin America and Southeast Asia, continued to cut policy rates since mid-2024, citing declining inflationary pressures, easing labor markets, and concerns about economic growth. Policymakers generally emphasized that they are following a data-dependent approach and underscored the importance of maintaining vigilance amid persistent geopolitical risks as well as still-elevated services inflation and wage pressures in some economies.
In contrast, the Bank of Japan raised its policy rates last summer and again this January and has continued to emphasize its commitment to achieving its inflation target after more than two decades of low-inflation outcomes. Brazil was also a notable exception, as a resurgence of inflation amid tight labor markets and large depreciation of the currency has prompted the Central Bank of Brazil to raise its policy rates forcefully since early September and to signal that further hiking is likely.
Financial conditions abroad are little changed on balance...
Since mid-2024, short-term sovereign yields declined notably in many advanced foreign economies (AFEs) as many AFE central banks cut policy rates. By contrast, short-term yields rose in Japan, where market-based measures of policy expectations suggest further policy rate hikes by the Bank of Japan in 2025. Meanwhile, AFE longer-term sovereign yields rose moderately in some countries, with declines in expected policy rates being more than offset by increases in term premiums on market expectations of large bond issuance due to persistently large government deficits (figure 44). Relatedly, most AFE equity indexes were moderately higher, on net, since mid-2024.
Nominal 10-year government bond yields in selected advanced foreign economies
The data are weekly averages of daily benchmark yields and extend through January 31, 2025.
Source: Bloomberg.
Series: Germany, U.K., Canada, and Japan Horizon: January 4, 2019, to January 31, 2025 Description: A line chart with four curves over January 4, 2019, to January 31, 2025. The units are percent, and the data are weekly averages of daily benchmark yields. The curves for Germany, the U.K., Canada, and Japan all vary significantly at short time scales. The Germany series begins just above 0, decreases to around negative 0.5 by mid-2019, stays between 0 and negative 1 through 2021, and slowly rises to just over 0 in early 2022. The series then climbs to more than 2.5 by early 2023, approaching 3 before declining to around 2 at the end of 2023 and then rebounding to and ending at around 2.5 in January 2025. The U.K. series begins slightly above 1, slumps to just above 0 by mid-2020, climbs steadily to about 2.5 by mid-2022, and then sharply increases to over 4 in late 2022. The series declines to about 3 in early 2023, rises to around 4.5 before decreasing to about 3.5 by the end of 2023, and climbs to and finishes a bit above 4.5. The Canada series begins around 2, slides to about 0.5 by mid-2020, increases to about 1.5 by early 2021, and stays between 1 and 2 until early 2022, when it rises quickly and fluctuates between about 2.5 and 3.5 until mid-2023, increasing to around 4 before falling to just above 3 by year-end. The series rises to around 3.5 by mid-2024 and ends a bit above 3. The Japan series begins around 0 and stays slightly below 0 in 2019 and slightly above 0 from 2020 to 2021 before rising gradually to about 0.5 by the beginning of 2023. The series stays at around 0.5 for the first half of 2023 before following a slightly bumpy rise to about 1 in mid-2024 and finishing a bit above 1 in January 2025.
Chinese equity prices increased sharply in late September, and China-focused investment funds recorded large inflows in response to announcements by Chinese authorities of economic stimulus measures and policies to support equity markets. These movements were later partially reversed, however, as investors expressed disappointment at the size and scope of the stimulus when details of the measures became clearer. More broadly, while aggregate emerging market economy (EME) funds recorded strong inflows last September, these turned to large outflows in the fourth quarter as investors reacted to the deterioration in the economic outlook for China, rising U.S. longer-term interest rates, and the prospect of new U.S. tariffs on EME exports to the U.S. (figure 45). Nevertheless, EME sovereign spreads narrowed significantly amid a broad narrowing in dollar-denominated credit spreads.
Emerging market mutual fund flows and spreads
The bond and equity fund flows data are semiannual sums of weekly data from December 28, 2006, to December 25, 2024, and exclude domestically focused funds in emerging market economies. Weekly data span Thursday through Wednesday, and the semiannual values are sums over weekly data for weeks ending in that half year. The J.P. Morgan Emerging Markets Bond Index Plus (EMBI+) data are weekly averages of daily data, extend through January 31, 2025, and exclude Venezuela.
Source: For bond and equity fund flows, Federal Reserve Board staff calculations and EPFR Global; for EMBI+, J.P. Morgan Emerging Markets Bond Index Plus via Bloomberg.
Series: EMBI+, equity fund flows, and bond fund flows Horizon: December 28, 2006, to January 31, 2025 Description: A line chart with one curve overlaid on a stacked bar chart with two series. The EMBI+ curve data are weekly averages of daily data from January 1, 2007, to January 31, 2025, and the units are basis points. The stacked bar chart comprises a series for equity fund flows and a series for bond fund flows, which are semiannual sums from December 28, 2006, to December 25, 2024. The units are billions of dollars. The EMBI+ series begins around 200, rises sharply to nearly 750 in late 2008, drops to about 300 in mid-2009, and fluctuates between 150 and about 300 until early 2020, when it spikes to about 500 before declining back to 300 by late 2021. The series jumps to nearly 500 in early 2022 and then slowly steps down, ending below 250 in January 2025. The equity fund flows begin at about 35 in late 2007, fall to about negative 25 by late 2008, rise to about 35 in 2009, increase sharply to nearly 70 in late 2010, drop to about negative 30 in 2011, rise to about 35 in 2012, fluctuate between just above 0 and about negative 25 through early 2015, fall sharply to about negative 60 in late 2015, rise to fluctuate between about 15 and 35 through early 2018, decrease to fluctuate between just above 0 and about negative 15 through 2019, slide sharply to about negative 40 in early 2020, rebound to about 50 in late 2020, increase to about 85 in early 2021, and decrease to about 10 in late 2021 and then further to negative 20 in late 2022. The series increases to about 45 in early 2023 before going negative and ending around negative 20 in December 2024. The bond fund flows follow a similar pattern with about one-third to one-half the magnitude of the equity fund flows through 2016. The bond fund flows increase to just above 40 in early 2017, fall to about negative 10 by the end of 2018, increase to about 30 in 2019, slide to about negative 35 in early 2020, rebound to slightly above 40 in late 2020, move down to about 30 in early 2021, decline to about negative 5 in late 2021, and drop even further to negative 45 in early 2022. The series fluctuates between about negative 40 and negative 10 until December 2024, when it ends at around negative 20.
...and the exchange value of the dollar has increased significantly
Since mid-2024, the broad dollar index—a measure of the exchange value of the dollar against a trade-weighted basket of foreign currencies—increased significantly, on net, continuing its notable rise seen in the first half of 2024 and reaching its highest level in decades (figure 46). The dollar index was, however, somewhat volatile since mid-2024; it decreased initially as U.S. yields declined in the third quarter of 2024, before increasing steadily afterward. Market participants attributed the recent increase in the dollar index to widening gaps of U.S. interest rates over those of major AFEs, the relative strength of the U.S. economy, and political and fiscal developments in some foreign economies. Some market participants also pointed to potential increases in U.S. tariffs on imports as a factor pushing the dollar higher in recent months.
U.S. dollar exchange rate index
The data, which are in foreign currency units per dollar, are weekly averages of daily values of the broad dollar index and extend through January 31, 2025. As indicated by the arrow, increases in the data reflect U.S. dollar appreciation and decreases reflect U.S. dollar depreciation.
Source: Federal Reserve Board, Statistical Release H.10, "Foreign Exchange Rates."
Footnotes
Monetary Policy
The Federal Open Market Committee lowered the target range for the federal funds rate
After having held the target range for the policy rate at 5-1/4 to 5-1/2 percent between late July 2023 and mid-September 2024, the Federal Open Market Committee (FOMC) lowered the target range for the policy rate by a cumulative 100 basis points over the last three meetings of 2024, bringing the range to 4-1/4 to 4-1/2 percent (figure 47). The FOMC's decision to begin reducing the degree of policy restraint reflected the FOMC's greater confidence in inflation moving sustainably toward 2 percent and the judgment that it was appropriate to recalibrate the policy stance. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the FOMC will carefully assess incoming data, the evolving outlook, and the balance of risks.
Selected interest rates
The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities.
Source: Department of the Treasury; Federal Reserve Board.
The FOMC has continued the process of significantly reducing its holdings of Treasury and agency securities
The FOMC began reducing its securities holdings in June 2022 and, since then, has continued to implement its plan for significantly reducing the size of the Federal Reserve's balance sheet in a predictable manner. Over the second half of last year, the FOMC reduced the size of the Federal Reserve's balance sheet with redemption caps of $25 billion per month on Treasury securities and $35 billion per month on agency debt and agency mortgage-backed securities (MBS). Any principal payments in excess of the agency debt and agency MBS caps are to be reinvested into Treasury securities, consistent with the FOMC's intention to hold primarily Treasury securities in the longer run.
The System Open Market Account holdings of Treasury and agency securities have declined about $2 trillion since the start of the balance sheet reduction and $297 billion since June 2024 to around $6.5 trillion, a level equivalent to 22 percent of U.S. nominal gross domestic product, down from a peak of 35 percent reached at the end of 2021 (figure 48). Reserve balances—the largest liability item on the Federal Reserve's balance sheet—have edged down $68 billion since late June 2024 to a level of around $3.2 trillion. Since the beginning of balance sheet runoff, reserves have been little changed because the reserve-draining effect of balance sheet runoff has been largely offset by a $1.8 trillion decline in balances at the overnight reverse repurchase agreement facility. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets.")
Federal Reserve assets and liabilities
"Other assets" includes repurchase agreements, FIMA (Foreign and International Monetary Authorities) repurchase agreements, and unamortized premiums and discounts on securities held outright. "Credit and liquidity facilities" consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns Companies, Inc., and AIG; and other credit and liquidity facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Term Asset-Backed Securities Loan Facility, the Primary and Secondary Market Corporate Credit Facilities, the Paycheck Protection Program Liquidity Facility, the Municipal Liquidity Facility, and the Main Street Lending Program. "Agency debt and mortgage-backed securities holdings" includes agency residential mortgage-backed securities and agency commercial mortgage-backed securities. "Capital and other liabilities" includes the U.S. Treasury General Account and the U.S. Treasury Supplementary Financing Account. The key identifies shaded areas in order from top to bottom. The data extend through January 29, 2025.
Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances."
The FOMC has stated that it intends to maintain securities holdings at amounts consistent with implementing monetary policy efficiently and effectively in its ample-reserves regime. To ensure a smooth transition to ample reserve balances, the FOMC slowed the pace of decline of its securities holdings in June 2024 and intends to stop reductions in its securities holdings when reserve balances are somewhat above the level that the FOMC judges to be consistent with ample reserves. Once balance sheet runoff has ceased, reserve balances will likely continue to decline at a slower pace—reflecting growth in other Federal Reserve liabilities—until the FOMC judges that reserve balances are at an ample level. Thereafter, the FOMC will manage securities holdings as needed to maintain ample reserves over time.
Developments in the Federal Reserve's Balance Sheet and Money Markets
The Federal Open Market Committee (FOMC) continued to reduce the size of the Federal Reserve's System Open Market Account (SOMA) portfolio. Loans extended under the Bank Term Funding Program—which made longer-term funding and liquidity available to eligible depository institutions amid the banking-sector developments of spring 2023 to help ensure the stability of the banking system and the ongoing provision of money and credit to the economy—have also decreased $106 billion to a level of $213 million since late June 2024.1 Since the previous report, total Federal Reserve assets have decreased $413 billion, leaving the total size of the balance sheet at $6.8 trillion, $2.1 trillion smaller since the reduction in the size of the SOMA portfolio began in June 2022 (table A and figure A).2
Table A. Balance sheet comparison
Billions of dollars
Federal Reserve assets
MBS is mortgage-backed securities. The key identifies shaded areas in order from top to bottom. The data are weekly and extend through January 29, 2025.
Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances."
Reserves, the largest liability item on the Federal Reserve's balance sheet, have edged down $68 billion since late June 2024 to a level of about $3.2 trillion.3 Since the beginning of balance sheet runoff, reserves have been little changed because the reserve-draining effect of balance sheet runoff was largely offset by a $1.8 trillion decline in balances at the overnight reverse repurchase agreement (ON RRP) facility. Since June 2024, usage of the ON RRP facility has continued to decline to levels below $200 billion (figure B). Reduced usage of the ON RRP facility largely reflects money market mutual funds shifting their portfolios toward higher-yielding investments, including Treasury bills and private-market repurchase agreements.
Federal Reserve liabilities
"Capital and other liabilities" includes the liability for earnings remittances due to the U.S. Treasury and contributions from the U.S. Treasury; the sum is negative from June 2023 onward because of the deferred asset that the Federal Reserve reports. The key identifies shaded areas in order from top to bottom. The data are weekly and extend through January 29, 2025.
Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances."
Conditions in overnight money markets remained stable. The ON RRP facility continued to serve its intended purpose of supporting the control of the effective federal funds rate (EFFR), and the Federal Reserve's administered rates—the interest rate on reserve balances and the ON RRP offering rate—remained highly effective at maintaining the EFFR within the target range. Following the December 2024 FOMC meeting, the Federal Reserve made a technical adjustment to lower the ON RRP offering rate 5 basis points. The technical adjustment aligned the ON RRP offering rate with the bottom of the target range for the federal funds rate.
The Federal Reserve's deferred asset has increased $43 billion since late June to a level of around $221 billion.4 Negative net income and the associated deferred asset do not affect the Federal Reserve's conduct of monetary policy or its ability to meet its financial obligations.5
The FOMC will continue to monitor the implications of incoming information for the economic outlook
The FOMC is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the FOMC will carefully assess incoming data, the evolving outlook, and the balance of risks. Its assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
In addition to considering a wide range of economic and financial data, the FOMC gathers information from business contacts and other informed parties around the country, as summarized in the Beige Book. The Federal Reserve has regular arrangements under which it hears from a broad range of participants in the U.S. economy about how monetary policy affects people's daily lives and livelihoods. In particular, the Federal Reserve has continued to gather insights into these matters through the Fed Listens initiative and the Federal Reserve System's community development outreach. Additionally, this year the Federal Reserve has begun a public review of its monetary policy framework. (See the box "Periodic Review of Monetary Policy Strategy, Tools, and Communications.")
Policymakers also routinely consult prescriptions for the policy interest rate provided by various monetary policy rules. These rule prescriptions can provide useful benchmarks for the consideration of monetary policy. However, simple rules cannot capture all of the complex considerations that go into the formation of appropriate monetary policy, and many practical considerations make it undesirable for the FOMC to adhere strictly to the prescriptions of any specific rule. Nevertheless, some principles of good monetary policy can be brought out by examining these simple rules. (See the box "Monetary Policy Rules in the Current Environment.")
Periodic Review of Monetary Policy Strategy, Tools, and Communications
The Federal Reserve has begun its periodic public review of its monetary policy strategy, tools, and communication practices—the framework it uses to pursue its dual-mandate goals of maximum employment and price stability. Routine self-evaluation is healthy for any organization, and it is essential that the Federal Open Market Committee's (FOMC) monetary policy framework evolves as needed to best support the dual mandate amid an ever-changing economy. Accordingly, following the review that concluded in 2020, the FOMC indicated that it would carry out a thorough public review roughly every five years.
The review is focused on two specific areas: the FOMC's Statement on Longer-Run Goals and Monetary Policy Strategy, which articulates the Committee's approach to monetary policy, and the Committee's policy communication tools. The Committee's 2 percent longer-run inflation goal is not a focus of the review.1
Like the Federal Reserve's 2019–20 review of its monetary policy framework, the ongoing review will include outreach and public events attended by policymakers, community leaders, experts from outside the System, and other members of the public. As part of the public outreach associated with the review, the Federal Reserve Board will host a conference featuring economists and other analysts from outside the Federal Reserve System, who will discuss topics central to the review.2
The 2025 review will include a set of events hosted by the Federal Reserve as part of the Fed Listens initiative, which began with the FOMC's 2019–20 framework review and has continued since then. At Fed Listens events, the Board and Reserve Banks have engaged with a wide range of organizations—employee groups and union members, small business owners, residents of low- and moderate-income communities, workforce development organizations and community colleges, retirees, and others—to hear about how monetary policy affects peoples' daily lives and livelihoods.
FOMC participants discussed topics related to the review at the January 28–29, 2025, FOMC meeting, and these discussions will continue at subsequent meetings. At the end of the process, information and perspectives gathered during the review will inform policymakers' judgments about appropriate changes to the FOMC's monetary policy framework to best serve the American people.
Monetary Policy Rules in the Current Environment
Simple interest rate rules relate a policy interest rate, such as the federal funds rate, to a small number of other economic variables—typically including the current deviation of inflation from its target value and a measure of resource slack in the economy. As part of their monetary policy deliberations, policymakers regularly consult the prescriptions of a variety of simple interest rate rules without mechanically following the prescriptions of any particular rule.
In 2024, the economy continued to make progress toward the Federal Open Market Committee's (FOMC) dual-mandate goals. Inflation moved a little closer to 2 percent in 2024 and ran well below its peak in 2022. While the labor market remains solid, labor market conditions generally eased. Accordingly, the simple policy rules considered here called for levels of the policy rate in 2024 that were, on average, lower than in the previous year. In support of its goals of maximum employment and inflation at the rate of 2 percent over the longer run, the FOMC has reduced the target range for the federal funds rate from 5-1/4 to 5-1/2 percent to 4-1/4 to 4-1/2 percent while continuing to reduce its holdings of Treasury securities and agency debt and agency mortgage-backed securities.
Selected Policy Rules: Descriptions
In many economic models, desirable economic outcomes can be achieved over time if monetary policy responds to changes in economic conditions in a manner that is predictable and adheres to some key design principles. In recognition of this idea, economists have analyzed many monetary policy rules, including the well-known Taylor (1993) rule, the "balanced approach" rule, the "adjusted Taylor (1993)" rule, and the "first difference" rule.1 Table A shows these rules, along with a "balanced approach (shortfalls)" rule, which responds to the unemployment rate only when it is higher than its estimated longer-run level. All of the simple rules shown embody key design principles of good monetary policy, including the requirement that the policy rate should be adjusted by enough over time to ensure a return of inflation to the central bank's longer-run objective and to anchor longer-term inflation expectations at levels consistent with that objective.
Table A. Monetary policy rules
All five rules feature the difference between inflation and the FOMC's longer-run objective of 2 percent.2 The five rules use the unemployment rate gap, measured as the difference between an estimate of the rate of unemployment in the longer run ($$ u_t^{LR}$$) and the current unemployment rate; the first-difference rule includes the change in the unemployment rate gap rather than its level.3 All but the first-difference rule include an estimate of the neutral real interest rate in the longer run ($$ r_t^{LR}$$).4
Unlike the other simple rules featured here, the adjusted Taylor (1993) rule recognizes that the federal funds rate cannot be reduced materially below the effective lower bound (ELB). By contrast, the standard Taylor (1993) rule prescribed policy rates that, during the pandemic-induced recession, were far below zero. To make up for the cumulative shortfall in policy accommodation following a recession during which the federal funds rate is constrained by its ELB, the adjusted Taylor (1993) rule prescribes delaying the return of the policy rate to the (positive) levels prescribed by the standard Taylor (1993) rule.
Policy Rules: Limitations
As benchmarks for monetary policy, simple policy rules have important limitations. One of these limitations is that the simple policy rules mechanically respond to only a small set of economic variables and thus necessarily abstract from many of the factors that the FOMC considers when it assesses the appropriate setting of the policy rate. In addition, the structure of the economy and current economic conditions differ in important respects from those prevailing when the simple policy rules were originally devised and proposed. Relatedly, the prescriptions of the rules incorporate values of the unemployment rate in the longer run and the neutral real interest rate in the longer run, which are economic concepts that are not only difficult to measure, but can also change over time as the economy evolves. Finally, simple policy rules are not forward looking and do not allow for important risk-management considerations, associated with uncertainty about economic relationships and the evolution of the economy, that factor into FOMC decisions.
Selected Policy Rules: Prescriptions
Figure A shows historical prescriptions for the federal funds rate under the five simple rules considered. For each quarterly period, the figure reports the policy rates prescribed by the rules, taking as given the prevailing economic conditions and survey-based estimates of $$ u_t^{LR}$$ and $$ r_t^{LR}$$ at the time. All of the rules considered called for highly accommodative monetary policy in response to the pandemic-driven recession, followed by tighter policy as inflation picked up and labor market conditions strengthened. The policy rates prescribed by these rules have generally declined since 2023 because inflation moved closer to 2 percent and the unemployment rate increased somewhat. The current prescriptions from these rules are within the current target range for the federal funds rate of 4-1/4 to 4-1/2 percent except for the first-difference rule, which prescribes a somewhat higher policy rate. All the prescriptions remain higher than survey-based estimates of the longer-run value of the federal funds rate.
Historical federal funds rate prescriptions from simple policy rules
The rules use historical values of core personal consumption expenditures inflation, the unemployment rate, and, where applicable, historical values of the midpoint of the target range for the federal funds rate. Quarterly projections of longer-run values for the federal funds rate, the unemployment rate, and inflation used in the computation of the rules' prescriptions are interpolations to quarterly values of projections from the Survey of Primary Dealers. The rules' prescriptions are quarterly, and the federal funds rate data are the monthly average of the daily midpoint of the target range for the federal funds rate and extend through January 2025.
Source: Federal Reserve Bank of New York, Survey of Primary Dealers; Federal Reserve Bank of St. Louis, Federal Reserve Economic Data; Federal Reserve Board staff estimates.
Summary of Economic Projections
The following material was released after the conclusion of the December 17–18, 2024, meeting of the Federal Open Market Committee. The following material was released after the conclusion of the December 17–18, 2024, meeting of the Federal Open Market Committee.
In conjunction with the Federal Open Market Committee (FOMC) meeting held on December 17–18, 2024, meeting participants submitted their projections of the most likely outcomes for real gross domestic product (GDP) growth, the unemployment rate, and inflation for each year from 2024 to 2027 and over the longer run. Each participant's projections were based on information available at the time of the meeting, together with her or his assessment of appropriate monetary policy—including a path for the federal funds rate and its longer-run value—and assumptions about other factors likely to affect economic outcomes. The longer-run projections represent each participant's assessment of the value to which each variable would be expected to converge, over time, under appropriate monetary policy and in the absence of further shocks to the economy. "Appropriate monetary policy" is defined as the future path of policy that each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy his or her individual interpretation of the statutory mandate to promote maximum employment and price stability.
Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assumptions of projected appropriate monetary policy, December 2024
Percent
Medians, central tendencies, and ranges of economic projections, 2024–27 and over the longer run
Definitions of variables and other explanations are in the notes to table 1. The data for the actual values of the variables are annual.
FOMC participants' assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate
Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual participant's judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run.
Distribution of participants' projections for the change in real GDP, 2024–27 and over the longer run
Definitions of variables and other explanations are in the notes to table 1.
Distribution of participants' projections for the unemployment rate, 2024–27 and over the longer run
Definitions of variables and other explanations are in the notes to table 1.
Distribution of participants' projections for PCE inflation, 2024–27 and over the longer run
Definitions of variables and other explanations are in the notes to table 1.
Distribution of participants' projections for core PCE inflation, 2024–27
Definitions of variables and other explanations are in the notes to table 1.
Distribution of participants' judgments of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate, 2024–27 and over the longer run
Definitions of variables and other explanations are in the notes to table 1.
Uncertainty and risks in projections of GDP growth
The blue and red lines in the top panel show actual values and median projected values, respectively, of the percent change in real gross domestic product (GDP) from the fourth quarter of the previous year to the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants' current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as "broadly similar" to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as "broadly balanced" would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty."
Uncertainty and risks in projections of the unemployment rate
The blue and red lines in the top panel show actual values and median projected values, respectively, of the average civilian unemployment rate in the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants' current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as "broadly similar" to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as "broadly balanced" would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty."
Uncertainty and risks in projections of PCE inflation
The blue and red lines in the top panel show actual values and median projected values, respectively, of the percent change in the price index for personal consumption expenditures (PCE) from the fourth quarter of the previous year to the fourth quarter of the year indicated. The confidence interval around the median projected values is assumed to be symmetric and is based on root mean squared errors of various private and government forecasts made over the previous 20 years; more information about these data is available in table 2. Because current conditions may differ from those that prevailed, on average, over the previous 20 years, the width and shape of the confidence interval estimated on the basis of the historical forecast errors may not reflect FOMC participants' current assessments of the uncertainty and risks around their projections; these current assessments are summarized in the lower panels. Generally speaking, participants who judge the uncertainty about their projections as "broadly similar" to the average levels of the past 20 years would view the width of the confidence interval shown in the historical fan chart as largely consistent with their assessments of the uncertainty about their projections. Likewise, participants who judge the risks to their projections as "broadly balanced" would view the confidence interval around their projections as approximately symmetric. For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty."
Diffusion indexes of participants' uncertainty assessments
For each SEP, participants provided responses to the question "Please indicate your judgment of the uncertainty attached to your projections relative to the levels of uncertainty over the past 20 years." Each point in the diffusion indexes represents the number of participants who responded "Higher" minus the number who responded "Lower," divided by the total number of participants. Figure excludes March 2020 when no projections were submitted.
Diffusion indexes of participants' risk weightings
For each SEP, participants provided responses to the question "Please indicate your judgment of the risk weighting around your projections." Each point in the diffusion indexes represents the number of participants who responded "Weighted to the Upside" minus the number who responded "Weighted to the Downside," divided by the total number of participants. Figure excludes March 2020 when no projections were submitted.
Uncertainty and risks in projections of the federal funds rate
The blue and red lines are based on actual values and median projected values, respectively, of the Committee's target for the federal funds rate at the end of the year indicated. The actual values are the midpoint of the target range; the median projected values are based on either the midpoint of the target range or the target level. The confidence interval around the median projected values is based on root mean squared errors of various private and government forecasts made over the previous 20 years. The confidence interval is not strictly consistent with the projections for the federal funds rate, primarily because these projections are not forecasts of the likeliest outcomes for the federal funds rate, but rather projections of participants' individual assessments of appropriate monetary policy. Still, historical forecast errors provide a broad sense of the uncertainty around the future path of the federal funds rate generated by the uncertainty about the macroeconomic variables as well as additional adjustments to monetary policy that may be appropriate to offset the effects of shocks to the economy.
Table 2. Average Historical Projection Error Ranges
Percentage points
Forecast Uncertainty
The economic projections provided by the members of the Board of Governors and the presidents of the Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts are necessarily imperfect descriptions of the real world, and the future path of the economy can be affected by myriad unforeseen developments and events. Thus, in setting the stance of monetary policy, participants consider not only what appears to be the most likely economic outcome as embodied in their projections, but also the range of alternative possibilities, the likelihood of their occurring, and the potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy of a range of forecasts, including those reported in past Monetary Policy Reports and those prepared by the Federal Reserve Board's staff in advance of meetings of the Federal Open Market Committee (FOMC). The projection error ranges shown in the table illustrate the considerable uncertainty associated with economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP) and total consumer prices will rise steadily at annual rates of, respectively, 3 percent and 2 percent. If the uncertainty attending those projections is similar to that experienced in the past and the risks around the projections are broadly balanced, the numbers reported in table 2 would imply a probability of about 70 percent that actual GDP would expand within a range of 2.2 to 3.8 percent in the current year, 1.3 to 4.7 percent in the second year, 0.9 to 5.1 percent in the third year, and 0.7 to 5.3 percent in the fourth year. The corresponding 70 percent confidence intervals for overall inflation would be 1.7 to 2.3 percent in the current year, 0.4 to 3.6 percent in the second and third years, and 0.2 to 3.8 percent in the fourth year. Figures 4.A through 4.C illustrate these confidence bounds in "fan charts" that are symmetric and centered on the medians of FOMC participants' projections for GDP growth, the unemployment rate, and inflation. However, in some instances, the risks around the projections may not be symmetric. In particular, the unemployment rate cannot be negative; furthermore, the risks around a particular projection might be tilted to either the upside or the downside, in which case the corresponding fan chart would be asymmetrically positioned around the median projection.
Because current conditions may differ from those that prevailed, on average, over history, participants provide judgments as to whether the uncertainty attached to their projections of each economic variable is greater than, smaller than, or broadly similar to typical levels of forecast uncertainty seen in the past 20 years, as presented in table 2 and reflected in the widths of the confidence intervals shown in the top panels of figures 4.A through 4.C. Participants' current assessments of the uncertainty surrounding their projections are summarized in the bottom-left panels of those figures. Participants also provide judgments as to whether the risks to their projections are weighted to the upside, are weighted to the downside, or are broadly balanced. That is, while the symmetric historical fan charts shown in the top panels of figures 4.A through 4.C imply that the risks to participants' projections are balanced, participants may judge that there is a greater risk that a given variable will be above rather than below their projections. These judgments are summarized in the lower-right panels of figures 4.A through 4.C.
As with real activity and inflation, the outlook for the future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily because each participant's assessment of the appropriate stance of monetary policy depends importantly on the evolution of real activity and inflation over time. If economic conditions evolve in an unexpected manner, then assessments of the appropriate setting of the federal funds rate would change from that point forward. The final line in table 2 shows the error ranges for forecasts of short-term interest rates. They suggest that the historical confidence intervals associated with projections of the federal funds rate are quite wide. It should be noted, however, that these confidence intervals are not strictly consistent with the projections for the federal funds rate, as these projections are not forecasts of the most likely quarterly outcomes but rather are projections of participants' individual assessments of appropriate monetary policy and are on an end-of-year basis. However, the forecast errors should provide a sense of the uncertainty around the future path of the federal funds rate generated by the uncertainty about the macroeconomic variables as well as additional adjustments to monetary policy that would be appropriate to offset the effects of shocks to the economy.
If at some point in the future the confidence interval around the federal funds rate were to extend below zero, it would be truncated at zero for purposes of the fan chart shown in figure 5; zero is the bottom of the lowest target range for the federal funds rate that has been adopted by the Committee in the past. This approach to the construction of the federal funds rate fan chart would be merely a convention; it would not have any implications for possible future policy decisions regarding the use of negative interest rates to provide additional monetary policy accommodation if doing so were appropriate. In such situations, the Committee could also employ other tools, including forward guidance and asset purchases, to provide additional accommodation.
While figures 4.A through 4.C provide information on the uncertainty around the economic projections, figure 1 provides information on the range of views across FOMC participants. A comparison of figure 1 with figures 4.A through 4.C shows that the dispersion of the projections across participants is much smaller than the average forecast errors over the past 20 years.
Statement on Longer-Run Goals and Monetary Policy Strategy
The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.
Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Monetary policy plays an important role in stabilizing the economy in response to these disturbances. The Committee's primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate. The Committee judges that the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past. Owing in part to the proximity of interest rates to the effective lower bound, the Committee judges that downward risks to employment and inflation have increased. The Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals.
The maximum level of employment is a broad-based and inclusive goal that is not directly measurable and changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the shortfalls of employment from its maximum level, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments.
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.
Monetary policy actions tend to influence economic activity, employment, and prices with a lag. In setting monetary policy, the Committee seeks over time to mitigate shortfalls of employment from the Committee's assessment of its maximum level and deviations of inflation from its longer-run goal. Moreover, sustainably achieving maximum employment and price stability depends on a stable financial system. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.
The Committee's employment and inflation objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.
The Committee intends to review these principles and to make adjustments as appropriate at its annual organizational meeting each January, and to undertake roughly every 5 years a thorough public review of its monetary policy strategy, tools, and communication practices.