Today, we present a guest post written by David Papell<\/a> and Ruxandra Prodan-Boul<\/a>, Professor of Economics at the University of Houston and Economics Lecturer at Stanford University.<\/em><\/p>\n The Federal Open Market Committee (FOMC) maintained the target range for the federal funds rate (FFR) at 5.25 \u2013 5.5 percent in its June 2024 meeting and, in the Summary of Economic Projections<\/a> (SEP), projected one \u00bc percent rate cut with a range for the FFR between 5.0 and 5.25 percent by the end of 2024. Futures markets summarized by the CME FedWatch Tool<\/a> after the meeting predicted two rate cuts with a range for the FFR between 4.75 \u2013 5.0 percent by the end of 2024. Comparing prescriptions of inertial policy rules where the FOMC smooths rate increases when inflation rises to projections from the SEP, the FOMC went from \u201con track\u201d in March to \u201chigher for longer\u201d in June.<\/p>\n There is widespread agreement that the Fed fell \u201cbehind the curve\u201d by not raising rates when inflation rose in 2021, forcing it to play \u201ccatch-up\u201d in 2022. \u201cBehind the curve,\u201d however, is meaningless without a measure of \u201con the curve.\u201d In our paper, \u201cPolicy Rules and Forward Guidance Following the Covid-19 Recession<\/a>,\u201d we use data from the SEP\u2019s from September 2020 to December 2023 to compare policy rule prescriptions with actual and FOMC projections of the FFR. This provides a precise definition of \u201cbehind the curve\u201d as the difference between the FFR prescribed by the policy rule and the actual or projected FFR. In this post, we analyze four policy rules that are relevant for the future path of the FFR, update the policy rule prescriptions through the June 2024 SEP, and include futures market predictions.<\/p>\n The\u00a0Taylor (1993)<\/a>\u00a0rule with an unemployment gap is as follows,<\/p>\n where \u00a0is the level of the short-term federal funds interest rate prescribed by the rule, \u00a0is the inflation rate, is the 2 percent target level of inflation, \u00a0is the 4 percent rate of unemployment in the longer run, is the current unemployment rate, and \u00a0is the \u00bd percent neutral real interest rate from the current SEP.<\/p>\n Yellen (2012)<\/a>\u00a0analyzed the balanced approach rule where the coefficient on the inflation gap is 0.5 but the coefficient on the unemployment gap is raised to 2.0.<\/p>\n The balanced approach rule received considerable attention following the Great Recession and became the standard policy rule used by the Fed.<\/p>\n These rules are non-inertial because the FFR fully adjusts whenever the target FFR changes. This is not in accord with FOMC practice to smooth rate increases when inflation rises. We specify inertial versions of the rules based on\u00a0Clarida, Gali, and Gertler (1999)<\/a>,<\/p>\n where \u00a0is the degree of inertia and \u00a0is the target level of the federal funds rate prescribed by Equations (1) and (2). We set \u00a0as in\u00a0Bernanke, Kiley, and Roberts (2019)<\/a>. \u00a0equals the rate prescribed by the rule if it is positive and zero if the prescribed rate is negative.<\/p>\n Figure 1 depicts the midpoint for the target range of the FFR for September 2020 to June 2024 and the projected FFR for September 2024 to December 2026 from the June 2024 SEP. Figure 1 also depicts policy rule prescriptions. Between September 2020 and June 2024, we use real-time inflation and unemployment data that was available at the time of the FOMC meetings. Between September 2024 and December 2026, we use inflation and unemployment projections from the June 2024 SEP. The differences in the prescribed FFR\u2019s between the inertial and non-inertial rules are much larger than those between the Taylor and balanced approach rules.<\/p>\n Policy rule prescriptions are reported in Panel A for the non-inertial Taylor and balanced approach rules. They are much higher than the FFR in 2022 and 2023 and are not in accord with the FOMC\u2019s practice of smoothing rate increases when inflation rises. In contrast, the policy rule prescriptions for 2024 through 2026 from the June 2024 SEP are consistently lower than the FFR projections. The inertial rules in Panel B prescribe a much smoother path of rate increases from September 2021 through September 2023 than that adopted by the FOMC. If the Fed had followed the inertial Taylor or balanced approach rule instead of the FOMC\u2019s forward guidance, it could have avoided the pattern of falling behind the curve, pivot, and getting back on track that characterized Fed policy during 2021 and 2022.<\/p>\n Looking forward, the policy rule prescriptions from the June 2024 SEP are below the FFR projections through September 2025 and are close to the FFR projections through December 2026. While the current and projected FFR is generally in accord with prescriptions from inertial policy rules, the gaps are larger for 2024 than in the March SEP because the FOMC projected three \u00bc percent rate cuts in March and one \u00bc percent rate cut in June. The results for the March 2024 SEP in this and the following two paragraphs are shown in our Econbrowser post<\/a>.<\/p>\n Figure 2 depicts the median predictions from futures markets described in the CME FedWatch Tool following the June 2024 FOMC Meeting through the end of the CME prediction horizon in September 2025. The futures market predictions are \u00bc percent below the FOMC projections before converging at the end because futures markets predict two rate cuts while the FOMC projects one rate cut in 2014. The pattern of lower futures market predictions than FOMC projections is consistent with December 2023 but not with March 2024, where the predictions and projections were identical.<\/p>\n![](\"https:\/\/econbrowser.com\/wp-content\/uploads\/2023\/05\/pp_eqn1-1.png\"\/)
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