The first Monetary Policy Report of 2018, released earlier today, doesn’t change our expectation for Powell’s message at his testimony next week. It included only a minimal amount of discussion of the recent tax and spending bills. Likewise, the recent decline in equity prices received little attention; rather, the emphasis with respect to financial conditions was that they remain highly accommodative. Below we go over a few of the areas touched on in the report.
There was noticeably little discussion of the impact of fiscal policy. Perhaps this is partly because the massive spending bill was passed just a couple of weeks ago. The most that was written about the expected impact on the outlook was that “Under currently enacted legislation, which includes the Tax Cuts and Jobs Act (TCJA) and the Bipartisan Budget Act, federal fiscal policy will likely provide a moderate boost to GDP growth this year.” The tax bill featured more than the spending bill but mostly came up indirectly. For example, “Equity prices were reportedly supported in part by an increase in investors’ confidence that changes to the federal tax law will boost corporate earnings.”
Throughout the report, the theme was that overall financial conditions have become more accommodative since mid-2017 and that valuations are high: “Valuation pressures continue to be elevated across a range of asset classes even after taking into account the current level of Treasury yields and the expectation that the reduction in corporate tax rates should generate an increase in after-tax earnings.”
The report did not place much import on the recent decline in equity prices, alluding to it only in passing. The emphasis was that, notwithstanding the recent decline, valuations are at high levels: “Over the second half of 2017, valuation pressures edged up from already elevated levels. In general, valuations are higher than would be expected based solely on the current level of longer-term Treasury yields. In part reflecting growing anticipation of the boost to future (after-tax) earnings from a corporate tax rate cut, price-to-earnings ratios for U.S. stocks rose through January and we’re close to their highest levels outside of the late 1990s (figure A); ratios dropped back somewhat in early February.” There was also an acknowledgment, without much discussion, of the rise in Treasury yields: “The nominal Treasury yield curve has shifted upon net since the middle of 2017, owing to greater optimism about the global growth outlook and investors’ perceptions of higher odds for the removal of monetary policy accommodation.”
Inflation and the Labor Market
There was a special box on “Low Inflation in the Advanced Economies,” but much like the minutes of the January FOMC meeting, it didn’t give away anything. It noted that “The low core U.S. inflation in 2017 has been more of a puzzle (albeit modest in magnitude) and harder to associate with an identifiable cause.” It said that FOMC participants (pointing to the December 2017 SEP) expected the slowdown to be transitory, as did “many private forecasters.” It then included a laundry list of the usual “other, possibly more persistent, factors [that] may be at work.” It noted that the inflation process is not well understood and that there is not strong evidence for these other factors. The conclusion was what we’ve heard many times before: “Even as most policymakers expect inflation in their economies to move back to their targets over time, they remain attentive
to the possibility that factors not included in those models, such as those described here, may keep inflation low.” It was of course noted that policymakers are attentive to upside risks as well.
As there was for inflation, there was a special box for the labor market (“How Tight Is the Labor Market?”). Again, the conclusion was unsurprising: “While the uncertainty around the ‘normal’ trends in all of these variables is substantial, the labor market in early 2018 appears to be near or a little beyond full employment.” That said, the labor market doesn’t appear to be overly tight: “while wage gains have likely been held down by the sluggish pace of productivity growth in recent years, serious labor shortages would probably bring about larger increases than have been observed thus far.”
Price-Level Targeting Rule
The section discussing monetary policy rules included a price-level targeting rule. The report noted that, like the adjusted Taylor (1993) rule, “price-level rules may prescribe more appropriate policy settings than the other rules following a period when the policy rate falls below zero.” That was followed with the qualification that “all of the rules shown are highly simplified and do not capture the substantial complexity of the U.S. economy.” This will raise some eyebrows, as some have wondered about the prospect of the Fed moving toward such a framework. However, we don’t see any signal here in that regard. It had already been known that the staff has featured a price-level rule among a range of other rules for internal analyses.