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Guest contribution: “Federal Funds Rate: FOMC Forecasts, Policy Rules, and Futures Markets”


Today we publish an article by David Papel and Ruksandra Prodan-BullProfessor of Economics at the University of Houston and Lecturer in Economics at Stanford University.


The Federal Open Market Committee (FOMC) maintained the target range for the federal funds rate (FFR) at 5.25% – 5.5% at its January 2024 meeting.As inflation falls, December 2023 Economic Forecast Summary The Federal Reserve (SEP) expects the FFR to range from 4.5% to 4.75% by the end of 2024. At a press conference after the January 2024 meeting, Federal Reserve Chairman Jerome Powell said that the Federal Open Market Committee (FOMC) is unlikely to cut interest rates in March.In contrast, the futures market summarizes CME Group Fed Watch Tool The second day of the conference predicted that by the end of 2024, FFR would range between 3.75% and 4.00%.

The Fed is widely seen as “behind the curve” by not raising interest rates in 2021 when inflation rose, forcing it to “catch up” in 2022. However, without measuring “on the curve.” In the latest version of our paper, “Policy rules and forward guidance following the Covid-19 recession”, we compare policy rule provisions to actual and FOMC forecasts of FFR using SEP data from September 2020 to December 2023. This provides a precise definition of “behind the curve,” that is, policy rule provision of FFR versus actual or The difference between expected FFR. In our article, we analyze four policy rules related to the future path of FFR:

this Taylor(1993) The rules for unemployment gap are as follows,

Where rightt is the level of the short-term federal funds rate specified by the rules, PIt is the inflation rate, PILR is the 2% inflation target level, ULRt The long-term unemployment rate is 4%. Ut is the current unemployment rate, and rLRt is the current SEP neutral real interest rate of 0.5%.

Yellen (2012) The balancing law rule is analyzed, in which the inflation gap coefficient is 0.5, but the unemployment gap coefficient is increased to 2.0.

After the Great Recession, the balancing act received widespread attention and became a standard policy rule used by the Federal Reserve.

These rules are non-inertial in that whenever the target FFR changes, the FFR will adjust completely. This is inconsistent with the FOMC's approach of steadily raising interest rates when inflation rises.We specify the inertial version of the rule based on Clarida, Galli and Gertler (1999),

Where p is the degree of inertia and is the target level of the federal funds rate specified in equations (1) and (2).We set p like Bernanke, Kelly and Roberts (2019). rightt-1 If positive, it is equal to the ratio specified by the rule; if the specified ratio is negative, it is equal to zero.

Figure 1 depicts the midpoint of the September 2020 to December 2023 FFR target range and the March 2024 to December 2026 FFR forecast based on the December 2023 SEP. After exiting the ELB to 0.375 in March 2022, FFR rose to 5.375 in September 2023 and is expected to fall to 4.625 in December 2024, 3.625 in December 2025, and 2.875 in December 2026. Based on Jerome Powell's responses to questions in the press conference following the January 2024 meeting, the FOMC is unlikely to cut the FFR in March, and we assume June, September, and December 2024 Interest rates will be cut by 25 basis points. Figure 1 also depicts the policy rule prescription. We use immediate inflation and unemployment data available at FOMC meetings between September 2020 and September 2023. For the period from December 2023 to December 2026, we use inflation and unemployment forecasts from the September 2023 SEP. The difference between the prescribed FFRs between inertial and non-inertial rules is much greater than the difference between the Taylor rule and the balanced approach rule.

figure 1. Federal funds rate and policy rule regulations. Panel A. non-inertial rules

Panel A reports policy rule prescriptions for non-inertial Taylor and equilibrium approach rules. They are inconsistent with the Federal Open Market Committee's approach to smoothing rate increases when inflation rises. As of March 2021, the ELB's provisions for both rules are identical. The Federal Open Market Committee (FOMC) has been behind the curve starting in June 2021, when the stated FFR increased from 0.125 for the ELB's Taylor rule to 2.625 for the balanced approach rule to 0.375 for the ELB, while the actual FFR remained at the ELB middle. Policy rule provisions increased significantly in 2021, peaking in March 2022 at 7.875 for the Taylor Rule and 8.125 for the Balancing Act rule, when FFR first rose above the ELB to above 0.375. The gap also peaked in March 2022, at 750 basis points for the Taylor rule and 775 basis points for the balancing act rule. Between March 2022 and September 2023, the gap narrowed significantly, with the FFR rising from 0.375 to 5.375, while the Taylor Rule prescription fell to 6.125 and the Balancing Rule prescription fell to 6.625. Looking forward, the gap between FFR forecasts and policy rule provisions will reverse in December 2023, and by December 2026, FFR forecasts will be higher than policy rule provisions.

figure 1. Federal funds rate and policy rule regulations. Panel B. rule of inertia

Panel B reports results for inertial Taylor and equilibrium method rules. They are more consistent with the FOMC's approach of slowly raising FFR as inflation rises. As of March 2021, the ELB's provisions for both rules are the same. The Federal Open Market Committee (FOMC) has been behind the curve since September 2021, when the stated FFR of the Taylor rule increased to 0.875 and the balanced approach rule increased to 0.625, while the actual FFR remained at the ELB. The gap between policy rule provisions and FFR peaked at 200 basis points in March 2022, when the FFR under both rules was 2.325 and the FFR rose above the ELB for the first time, reaching 0.375.

The inertia rule stipulates that the path of interest rate increases from September 2021 to September 2023 is much smoother than the path of interest rate increases taken by the FOMC. Had the Fed followed inertial Taylor or balancing rules rather than the FOMC's forward guidance, it could have avoided the backward curve, turnaround, and back-on-track pattern that characterized Fed policy in 2021 and 2022. The SEP's FFR forecast for December 2023 is very close to the policy rule provisions through December 2026. Current and projected FFR are consistent with the provisions of the inertia policy rules.

It has been widely reported that market participants predict that the FFR will decline more sharply than the SEP. Figure 2 plots the median futures market forecast for the period from February 1, 2024, the day after the January 2024 FOMC meeting, to the end of the forecast horizon in December 2024, as depicted in the CME FedWatch tool. FFR is expected to decrease from 5.375 in December 2020. 4.875 from March to June 2024, 4.375 from September 2024, and 3.875 from December 2024. The futures market forecast is equal to the December 2023 SEP forecast for the March 2024 FFR, which is lower than the forecast FFR from June 2024 to December 2024.

figure 2: Federal funds rate, CME FedWatch tool and policy rule provisions. Panel A. Taylor's rule

figure 2: Federal funds rate, CME FedWatch tool and policy rule provisions. Panel B. balancing method rules

We supplement this discussion by including provisions in policy rules. For both the Taylor Law rule and the Balancing Law rule, the futures market forecast is equal to FFR and is lower than the provisions of the inertia policy rule from June 2024 to December 2024. In contrast, futures market forecasts are higher than the prescribed rule for non-inertial policy rules from December 2023 to December 2024. The comparison between futures market forecasts and policy rule provisions depends on the choice between inertia rules and non-inertia rules, not on the choice between Taylor law rules and balancing law rules.


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The author of this article is David Papel and Ruksandra Prodan-Bull.



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