Watch FOMC Rewind Live—Conversations Breaking Down Fed Policy Announcements

Good afternoon, everyone, and welcome to the first installment of FOMC Rewind Live, a new conversation to provide a bit of context about FOMC decisions, and also about the tradeoffs and challenges that policymakers are facing. So I wanted to have this series for a few reasons. First, we know monetary policy is important. It impacts all Americans. It impacts the global economy. And so it’s important to know about it. So during this whole process, I’ll try to be as transparent and as clear as I can be. That’s really our goal in Economic Research, we do cutting-edge research, but we try to really reach a broad audience.

And this is a goal in central banking these days, but it hasn’t always been the case. And in fact, some policymakers, very prominent ones, kind of cultivated this sense of not being transparent. So if you think about Alan Greenspan famously said, “If I seem unduly clear to you, you must have misunderstood what I said.” So, again, like we kind of play on this sense of not being transparent.

Since then things have changed a fair amount, as you all know. The central bank here, the Fed, and other central banks around the world are putting a whole lot of information out there to be more transparent, Either the forecast, economic analysis on policy or the economy in general. So that if you’re interested in policy, in economics, you’ll get a whole lot of information.

Over the past 30 years, the FOMC now puts FOMC statements out to explain the context of its decisions, to explain the reasoning for its decisions. And in the past, it wasn’t the case. So like the public was a bit in the dark. They didn’t quite know that the Fed tightened policy or not. And then the experts had to look at the tea leaves to infer what the decisions were.

You know, we had the FOMC statement being released on Wednesday [March 16, 2022], relatively short, 274 words. But it’s still, when you look at the test scoring for these, for how accessible the statements are, it’s still the case that you need a college degree to fully understand the statement.

The FOMC basically says, first, they raised rates a quarter of a percentage point. Why? The economy, the labor market is doing well, but inflation is high. So as you know, the Federal Reserve has a dual mandate of maximum employment and price stability, and we try to achieve both. At this point, the first part of the mandate, maximum employment, seems to be there, but inflation is very high, way too high compared to our goal of 2% inflation on average.

Let’s dig into this a little bit. Okay, so a little bit more context in terms of the unemployment rate. That’s one indicator of the labor market that we often look at. So the number of people who are out of a job, but are looking for a job.

I’m looking at the unemployment rate here since 2010, so 2010 to 2024. Every time you see a little gray bar here, it means that it’s a recession. This is the pandemic hitting right here. So let’s go right before the pandemic. We had the longest expansion on record at the time following the Great Recession of 2008 and 2009. The unemployment rate just started declining steadily down, reaching here like 3.5% right before the recession.

And then the pandemic hits, we go into shutdown, like the economy shuts down basically. Unemployment rate jumps nearly to 15%. Nearly to 15%. What’s remarkable with this after that is that the unemployment rate started declining really quickly. Now we’re back, just after a year and a half, we’re back to more or less where we were. A little bit higher, but more or less where we were right on the eve of the pandemic. The unemployment rate is back to about 3.8%.

It’s an amazing amount of progress, and I think you get the feel of it. You see the “Help Wanted” ads out there. People are moving jobs because it’s easy to get a new job. Wages are going up. There’s a sense that the labor market is doing very well, and the FOMC is noting that in this decision.

The flip side of that though is that if you look at inflation, inflation has just shot up over the recent period. So now like we’re above 5%. So you see this big movement up. That’s what you’re feeling when you go to the grocery store, when you try to put gas in your car. You just feel that things are just way more expensive than they were just a year ago.

And that’s the case. The index that we’re looking at for inflation is indeed showing that there’s a big increase in inflation. So if you go back, so I’m plotting the inflation rate here from the 1960s all the way to today, and there’s a lot of comparisons. I’m sure if you hear about this, are we back to the 1970s? Are we going to live again through those periods of very high inflation rate. So this is the ’70s here and you see like how our inflation was way higher in that decade, reaching above 10%, compared to today. So we’re certainly not there yet.

What’s happening also is the FOMC compared to then is reacting faster. So it’s very well aware of what happened in the ’70s. We don’t want to go back there. And you see policymakers here being way more concerned. We thought this would go down last year. You’ve heard it, that this is going to be transitory. A lot of it is supply-side disruption. We’re going to see supply repair. Inflation’s going to come back down.

It hasn’t come back down, and the Fed is on top of it, is really reacting now and saying, okay, we have good employment, inflation is too high, we have to raise rates. And this is what you’re seeing.

This is the target for the federal funds rate. So this is an overnight rate between banks that the Federal Reserve controls. And you see it fluctuating. I’m plotting it here between the year 2000 and today, and you’re seeing it going up, down, up, down. So when the economy does well, the rate tends to go up. When the economy enters a recession, you see the federal funds rate going down. The Federal Reserve then provides stimulus to the economy to mitigate the impact of the recession. And so you’re seeing it going back up. And so you could see following the Great Recession in 2008 and 2010, the Federal Reserve brought the fed funds rate really low to close to 0%, kept it there for a long time because the economy took time to get back on its feet, and then it started raising the rate around 2015 until the pandemic, and then we brought the fed funds rate back down basically to zero. And now you see the little, little, tiny blip in the fed funds rate, increased by a quarter of a percentage point.

The other thing that the Fed has done, because the rate fell to zero and it can’t quite go below zero, so then the Fed thought maybe there’s other ways to provide accommodation. And so what it did is that it started buying long-term assets. It bought Treasury securities. It bought mortgage-backed securities to try to lower their interest rates. And so what happened is that the Fed’s balance sheet, so it bought assets so the size of the Federal Reserve balance sheet as a ratio to GDP increased. So it went from about 20% to more than 30%, 35% now. You see it ballooning very, very quickly. And so what the Federal Reserve now has indicated is that it’s not only going to raise interest rates, but it’s also going to shrink the balance sheet over time at ongoing meetings. This hasn’t been decided yet, but it’s likely to come, to come soon.

So these are the two policy instruments that you’re going to see the Federal Reserve acting on over the next meetings.

The first question we got is, “Russia’s war on Ukraine has caused global uncertainty to the global economy and baseline security. How does the FOMC make decisions in such an environment?”

This is a great question. One thing we know from the current situation is that oil prices have really increased because market participants have concerns about the supply of oil from Russia, potential disruptions, the impact of sanctions. And so what you saw is the price of oil per barrel just kept rising and then just shot up, from around $90, $80 to more than $130 at some point. And then it became much more volatile also. There’s just a lot of uncertainty. People are not exactly sure what’s going to happen. There’s a lot of downside, of course. If the supply of oil is disrupted from Russia, you could see oil prices going back up a lot. Of course, that would impact the price of gas at the pump and feed into inflation. And because the cost to companies of transport and other costs would rise, it would tend to curtail economic activity. So there’s just a lot of risk on top of that.

What does the FOMC do when that happens? Well, they certainly take that into account. You see that they make forecasts of the economy, but they understand that often the forecasts are wrong, and there’s a lot of risks on both sides. And so you’ll hear often policymakers—Mary C. Daly will mention it—we do risk management. You’re in the business of doing risk management, assessing the risk, and then trying to set a course for monetary policy that balances the risk as much as possible.

Okay, let’s go to the next question. “I always hear that monetary policy has a delayed effect. How does the Fed take decisive action for inflation without knowing the full impact right away?”

Great question. So what do we do? We make forecasts. Policymakers are asked four times a year to make forecasts, but the Board also, every time, every meeting, the Board of Governors does a forecast of the economy. We do the same here to some extent. But basically the idea is that we need to know where the economy is heading because of that delayed impact of policy on the economy. Here’s a forecast, for instance, from the Summary of Economic Projections. Those are the policymakers’ forecasts four times a year. This is the median of that forecast. So you can see in terms of inflation, they’re expecting inflation, which is very high right now, to decline steadily over the coming years. Part of it is a reaction of policy, but also the fact that supply disruption will ease. But this is really important. You need to kind of get the forecasts right if you want to calibrate policy correctly. If you miss on the forecasts, you’ll have to make rapid adjustment because you’re not going in the right direction. So this is a great question. It’s extremely important. And the challenge with this is that, I’m showing here inflation, but, of course, our forecasts of the unemployment rate and all the other variables and so it’s a pretty challenging exercise, particularly now during a pandemic where everything is relatively, of course, relatively new.

Let me close here with one final question. “We had seen the impact of stimulus, unemployment, and various relief measures fairly early in the pandemic. Why did the Fed not react to this inflation earlier?”

Of course, we hear this often in the press, that the Fed is behind the curve, it’s asleep at the switch. Larry Summers, a very prominent economist at Harvard, has been a huge critic last year and this year about this. And so, what basically happened?

I would say one thing that happened is that the pandemic lasted way longer than we anticipated. I’m showing here, we have a lot of data we look at in Economic Research. This is just a number of COVID-19 deaths, the number of cases since the pandemic started. And you see the different waves. I want you to go back in June 2020. I think that’s a really important month. All during the spring we had this second wave. Cases were coming back down. Things looked up in June. You’ll remember that year, mask mandates went away, the economy was reopening. You felt like a sense of (exhales) finally. Vaccination rates were going up. And then what happened? And then the Delta variant hit right here. It started growing in the summer of 2021 and then it started peaking in the fall. And that, again, delayed the adjustment that we were thinking about seeing that year. And we have to remember that this is global also. There are waves happening in China, in East Asia, around the world in Europe, and that’s delaying their own adjustment.

So it delays the whole progress that we were thinking we would see sooner, and let alone now with the Omicron variant. And so back then, I think, in the summer, we thought we would see more. We knew the demand was there. Fiscal policy had provided a lot of support. Monetary policy had provided a lot of support to the economy. And we thought at that time that it’d be more of an increase in the supply side of the economy. And the fact that the pandemic lasted way longer than we anticipated, particularly in the spring and summer of 2021, in part delayed this whole adjustment. I think policymakers, again, because of this uncertainty, were maybe a little bit more reluctant to raise rates very rapidly.

This is what I have for you today. I hope this was useful. We’re hoping to do this a few times a year after FOMC meetings to try again to provide a little bit of context about the decision and some of the challenges that policymakers are facing. So thanks for joining us, and we hope to see you next time.