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The Fed's Inconsistent Numbers



As was widely expected, the Federal Open Market Committee (FOMC) raised its short-term interest rate target one-quarter of a percentage point on December 13 to a range of 1.25 to 1.50 percent. The statement accompanying this decision was little changed from the November meeting. The FOMC also released updated projections, which it provides after every other meeting. But the projections for growth, inflation, and unemployment seem to be inconsistent with each other.

The FOMC's projections for growth, inflation, and unemployment seem to be inconsistent with each other.

The most notable change in the projections is higher economic growth. The median projected GDP growth rate is now higher by an average of 0.2 percentage points for each year from 2017 through 2020. The unemployment rate was also marked down 0.2 percentage point throughout the forecast. There was no change to the projection for core inflation through 2020 and only a tiny 0.1 percentage point increase in 2017 headline inflation with no change in 2018–20. There was no change to the projected policy rate path in 2017–19 and a small 0.2 percentage point increase in the projection for 2020.

In her final press conference, outgoing Chair Janet Yellen attributed most of the increase in projected growth to the fact that a majority of FOMC participants now include the effects of a likely tax cut in their forecasts. New York Times reporter Binyamin Appelbaum asked Yellen whether the upgraded growth forecast is consistent with no change in the inflation and policy rate forecasts. Yellen responded that the median forecast does not necessarily reflect the forecast of any individual participant and that some of the changes in the outlook may reflect changes in the people who participate in the meetings. She also said that the unexpected weakness in inflation earlier this year may be weighing against the tendency of participants to see higher growth as raising future inflation.

Yet there remains a fundamental inconsistency within the projections that grew wider this week. The rationale for tightening monetary policy now and in the projections is that unemployment is below its long-run sustainable level and that this places upward pressure on inflation, which needs to be contained to prevent inflation from overshooting its target of 2 percent. The problem is that core inflation is currently 1.9 percent on a three-month annualized basis and is projected to remain at 1.9 percent next year and edge up only slightly to 2.0 percent in 2019 and 2020.[1] Given that the unemployment rate is projected to remain significantly below its long-run level for at least the next three years, the projections should show a more noticeable increase in core inflation.

It is possible that an unemployment rate of 4 percent is sustainable indefinitely with no pressure on inflation and that the current and projected rate hikes are just sufficient to bring employment growth down to potential and achieve a perfect soft landing. In that case, the long-run projection for the unemployment rate is too high. Alternatively, there may be no reliable connection between the unemployment rate and inflation, in which case the FOMC has no reason to raise rates until inflation exceeds its target by a significant and sustained amount.

The bottom line is that a projection over the next three years of (1) inflation constant at 2 percent, (2) unemployment constant at 4 percent, (3) a long-run unemployment rate of 4.6 percent, and (4) a policy interest rate that rises slowly toward its long-run level does not seem to be internally consistent. My own hunch is that inflation is likely to exceed the 2 percent target by 2019.


1 Core personal consumption expenditure (PCE) inflation is projected at only 1.5 percent for 2017, but this reflects a temporary dip early in the year. The latest three-month inflation rate refers to the change from July to October. An alternative measure of inflation based on the consumer price index (CPI) for November was released on the morning of the FOMC decision, almost certainly too late to have been incorporated into these projections. The November core CPI inflation rate on a three-month basis dropped to 1.9 percent from 2.4 percent in October. CPI inflation has generally been slightly higher than PCE inflation. Data are from the Bureau of Economic Analysis and the Bureau of Labor Statistics.

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