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Fed gets a grip on 2022, still optimistic on 2023



The big news from the March 16 meeting of the Federal Open Market Committee (FOMC or Fed) was the release of new economic projections that showed the Fed's key policy interest rate rising to 2.8 percent by sometime next year. That is modestly above the estimated neutral rate of 2.4 percent and much higher than the previously projected peak of 2.1 percent in 2024. Given the persistence of elevated inflation and the strength of the US labor market, the Fed is right to aim for a rate above neutral, but it may need to go even further if it wants to get inflation all the way back to 2 percent.[1] As expected, the Fed started on the tightening path with a hike of 0.25 percentage point at this meeting.

The Fed also caught up with the reality of inflation, the core measure of which reached 4.6 percent[2] in 2021. It now projects inflation to decline to 4.1 percent this year, compared to the previous projection of 2.7 percent. The new forecast for this year is reasonable, but the Fed remains somewhat optimistic in its projection of further steps down in core inflation to 2.6 percent in 2023 and 2.3 percent in 2024. It is more likely that inflation will be around or above 3 percent next year.

Another optimistic, indeed confusing, aspect of the Fed's projections is that the unemployment rate is projected to be constant at 3.5 percent over the next three years despite the tightening of monetary policy.[3] It is not clear why inflation should drop as fast as the Fed projects if unemployment remains steadily about 0.5 percentage point below the level projected by the Fed as the equilibrium rate.

The Fed will have plenty of opportunities to adjust its views and resolve these issues going forward. For now, it is on the right path.


1. In a recent blog post, I argued that the Fed should raise its inflation target to 3 percent.

2. Inflation data refer to the percent change in prices of personal consumption expenditures excluding food and energy on a Q4/Q4 basis.

3. The median projection shows a tiny uptick to 3.6 percent in 2024.

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