Change unlikely in balance sheet normalisation plan

Good afternoon. At our meeting that concluded earlier today, my colleagues and I on the Federal Open Market Committee (FOMC) decided to maintain the target range for the federal funds rate at 1 to 1.25 per cent. This accommodative policy should support some further strengthening in the job market and return to two percent inflation consistent with our statutory objectives.

We also decided that in October, we will begin the balance sheet normalisation programme that we outlined in June. This programme will reduce our securities holdings in a gradual and predictable manner. As we expected, and smoothing through some variation from quarter to quarter, economic activity has been rising moderately so far this year.

Household spending has been supported by ongoing strength in the job market. Business investment has picked up and exports have shown greater strength this year, in part reflecting improved economic conditions abroad. Overall, we expect the economy will continue to expand at a moderate pace over the next few years.

In the third quarter, however, economic growth will be held down by the severe disruptions caused by hurricanes Harvey, Irma and Maria. Once activity resumes and rebuilding gets under way, growth likely will bounce back. Based on experience, these effects are likely to materially alter the course of the national economy beyond the next couple of quarters. Of course, for the families and communities that have been devastated by the storms, recovery will take time, and on behalf of the Federal Reserve, let me express my sympathy for all those who have suffered losses.

In the labour market, job gains averaged 185,000 per month over the three months ending in August, a solid rate of growth that remained well above estimates of the pace necessary to absorb new entrants into the labour force. We know from some timely indicators such as initial claims for unemployment insurance that the hurricane severely disrupted the labour market in the affected areas, and payroll employment may be substantially affected in September. However, such effects should unwind relatively quickly.

Meanwhile, the unemployment rate has stayed low in recent months, and at 4.4 per cent in August was modestly below the median of FOMC participants’ estimates of its longer-run normal level. Given the underlying downward trend in participation stemming largely from the ageing of the US population, a relatively steady participation rate is a further sign of improving conditions in the labour market.

Turning to inflation, the 12-month change in the price index for personal consumption expenditures was 1.4 per cent in July, down noticeably from earlier in the year. Core inflation, which excludes the volatile food and energy categories, has also moved lower. For quite some time, inflation has been running below the committee’s two per cent longerrun objective. However, we believe this year’s shortfall in inflation primarily reflects developments that are largely unrelated to broader economic conditions. For example, one-off reductions earlier this year in certain categories of prices such as wireless telephone services are currently holding down inflation, but these effects should be transitory.

More broadly, with employment near assessments of the maximum sustainable level and the labour market continuing to strengthen, the committee continues to expect inflation to move up and stabilise around two per cent over the next couple of years in line with our longer-run objective. Nonetheless, our understanding of the forces driving inflation isn’t perfect. And in light of the unexpected lower inflation readings this year, the Committee is monitoring inflation developments closely.

The Committee is prepared to adjust monetary policy as needed to achieve its inflation and employment objectives over the medium term. Let me turn to the economic projections that Committee participants submitted for this meeting, which now extend through 2020.

The median projection for growth of inflation-adjusted gross domestic, or real GDP, is 2.4 per cent this year and about two per cent in 2018 and 2019. By 2020, the median growth projection moderates to 1.8 per cent, in line with its estimated longer-run rate. The median projection for the unemployment rate stands at 4.3 per cent in the fourth quarter of this year and runs a little above four per cent over the next three years, modestly below the median estimate of its longer run normal rate. Finally, the median inflation projection is 1.6 per cent this year, 1.9 per cent next year and two per cent in 2019 and 2020. Compared with the projections made in June, real GDP growth is a touch stronger this year, and inflation — particularly core inflation — is slightly softer this year and the next.

The median projection for the federal funds rate is 1.4 per cent at the end of this year, 2.1 per cent at the end of next year, 2.7 per cent at the end of 2019, and 2.9 per cent in 2020. Compared with the projections made in June, the median path for the federal funds rate is essentially unchanged, although the median estimate of the longer run normal value edged down to 2.8 per cent.

As always, the economic outlook is highly uncertain and participants will adjust their assessments of the appropriate path for the federal funds rate in response to changes to their economic outlooks and views of the risks of their outlooks. Policy is not on a preset course.

As I noted, the Committee announced today that it will begin its balance sheet normalisation programme in October. This programme, which was described in the June addendum to our policy normalisation principles and plans, will gradually decrease our reinvestments of proceeds for maturing treasury securities and principal payments for agency securities. As a result, our balance sheet will decline gradually and predictably. For October through December, the decline in our securities holdings will be capped at $6 billion per month for treasuries and $4 billion per month for agencies.

By limiting the volume of securities that private investors will have to absorb as we reduce our holdings, the caps should guard against the outsized moves in interest rates and other potential market strains. Finally, changing the target range for the federal funds rate is our primary means of adjusting the stance of monetary policy.

Our balance sheet is not intended to be an active tool for monetary policy in normal times. We, therefore, do not plan on making adjustments to our balance sheet normalisation programme. But of course, as we stated in June, the Committee would be prepared to resume reinvestments if a material deterioration in the economic outlook would warrant a sizeable reduction in the federal funds rate.