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Jan 31 2018

January FOMC Review

January 31, 2018

FOMC Review Snapshot

  • The Fed left its interest on excess reserves (IOER) rate, its key monetary policy rate, unchanged at 1.50%.
  • Inflation continues to undershoot the Fed’s 2% target.
  • This was Chair Yellen’s final FOMC meeting; there will be 4 vacancies on the Fed’s Board going forward.


Monetary Indicators


The Federal Open Market Committee (FOMC) decided to keep its interest on excess reserves (IOER) rate at 1.50%. The fed funds rate will continue to trade between 1.50% and 1.25%, the Fed’s overnight reverse repurchase (ON-RRP) rate (see Box 2 below).

Before the 2008-09 recession, the fed funds rate target was 5.25% and the monetary base (a large portion of the Fed’s balance sheet) was $0.8 trillion (Fig. 1). The Fed’s current normalization plans include raising its IOER rate, which fell as low as 0.25% at year-end 2008, and gradually reducing the size of its balance sheet. Details of the latter can be found in the JEC July FOMC Review’s “Noteworthy” section. The Fed started raising the IOER rate in December 2015 and reducing its balance sheet in October 2017. Nevertheless, the monetary base remains enlarged at $3.9 trillion.

The inflation rate, as measured by the year-over-year percentage change in the core personal consumption expenditures (PCE) price index, trended upward recently, but remains below the Fed’s 2% inflation target (Fig. 2). Market-based measures of expected inflation1 have ticked up recently but continue to indicate inflation will undershoot the Fed’s target over the next 10 years. The FOMC continues to project that inflation will eventually rise to the target. The fed funds futures market anticipates a Fed IOER rate hike will occur at the next FOMC meeting on March 20-21.

Box 1: The Federal Open Market Committee (FOMC)

The FOMC schedules to meet 8 times per year. It consists of the 7 governors from the Fed’s Board of Governors in D.C. (there will be 4 vacancies going forward), and 12 regional Fed bank presidents.

While all Fed governors have a vote on the FOMC, only 5 Fed bank presidents can vote. The New York Fed president is a permanent voting member, and 4 others can vote on a rotating basis.

FOMC meeting minutes are released 3 weeks after meetings.

Box 2: IOER and ON-RRP

In 2008, the administratively determined interest on excess reserves (IOER) supplanted a market-determined fed funds rate as the Fed’s key policy rate. The fed funds rate is the rate banks charge each other for overnight loans when they do not hold large excess reserves at the Fed. The Fed would make small interventions in the fed funds market to influence that rate. The Fed pays IOER on the funds banks deposit with the Fed rather than lend to consumers, businesses, etc. A higher IOER rate portends a tighter monetary policy because it encourages banks to hold reserves rather than to make more loans.

A much-reduced level of trading still occurs in the fed funds market as government-sponsored enterprises (e.g., Fannie Mae and Freddie Mac), which are ineligible to earn IOER, lend their idle cash to banks at the fed funds rate. Banks then deposit the cash with the Fed to earn a higher IOER rate. To prop up the fed funds rate as the Fed raises the IOER rate, the Fed withdraws cash from the market by temporarily selling some of its securities for cash at its overnight reverse repurchase (ON-RRP) rate, which sets a floor for the fed funds rate.

The continued existence of the fed funds market and the ON-RRP facility should not distract from the fact that the Fed now uses IOER as the key rate to conduct monetary policy


Although a low unemployment rate (Fig. 3) and closed output gap imply the economy is at full employment, persistent below-target inflation, a low employment-to-population ratio, and improved real GDP growth in 2017 indicate the economy’s potential may be greater than currently estimated. 


The exhibit below shows the 2018 members of the FOMC after Janet Yellen’s departure on February 3. Last year, President Trump nominated Marvin Goodfriend to serve as a Federal Reserve governor, pending Senate confirmation. The FOMC’s vice chair, New York Fed President William Dudley, plans to retire sometime this year.

FOMC Composition


[1] The 10-year “TIPS spread” measures expected inflation by taking the difference between the market yields on 10-year U.S. Treasury notes and 10-year Treasury Inflation Protected Securities. “TIPS” compensate holders for changes in money’s purchasing power as measured by the consumer price index, CPI. Historical data and the Congressional Budget Office’s average projections of 2.4% CPI inflation and 2.0% personal consumption expenditures (PCE) inflation over the next 10 years indicate that CPI overstates inflation by 0.4 percentage point on average. JEC adjusted the TIPS spread by subtracting 0.4 percentage point to make the measures comparable to the Fed’s preferred inflation indicator (PCE).