Monetary Policy Report: What Is It, What's In It?

The Report That's So Shocking It Only Comes Out Twice a Year

monetary policy report
Federal Reserve Board Chairwoman Janet Yellen looks over her papers during a House Financial Services Committee hearing on Capitol Hill, February 25, 2015 in Washington, DC. The committee heard testimony from Chairwomen Yellen on the Federal Reserves monetary policy and the state of the US economy. Photo by Mark Wilson/Getty Images

Definition: The Federal Reserve's Monetary Policy Report briefs Congress on the state of the U.S. economy. In it, the Federal Reserve Board summarizes U.S. monetary policy, how it affects the economy, and the Fed's outlook for the future.

The Fed Chair presents the report twice a year to Congress. He or she appears before the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services.

The report a must-read for anyone who wants an expert analysis of the U.S. economy. Unfortunately, it's so detailed and technical that it is often overlooked. Even the financial media pay attention to the Fed Chair's testimony instead. They focus on whether the policy is likely to change, and how it will affect the stock market. Sadly, the same is often true of the Fed's monthly report, the Beige Book.

Contents

Typically, the Report is divided into three broad sections: Part 1. Recent Economic and Financial Developments, Part 2. Monetary Policy and Part 3. Summary of Economic Projections.

Part 1. Recent Developments. Here, the Fed analyzes the events that are critical to its decision-making.

The first section in Part One is Domestic Developments. This include the following seven sections:

  • Productivity and wages.
  • Inflation, as the Fed has a target to meet of 2% annual core inflation. In other words, the Fed wants its policies to drive enough price increases so that consumers will prefer to buy now and avoid future higher prices. That works better in theory than in practice, because prices are so variable. Typically, even though inflation has been less than 2%, health care prices have risen 3%, while clothing prices have stayed flat. No one in their right mind would go in for surgery, get a physical, or have a baby now because they want to avoid a 3% increase in their hospital bill next year.
  • Economic growth, as measured by GDP. Fiscal policy (government spending and taxes). Consumer spending (including changes in household wealth and debt).
  • The strength of business investment. That is usually high when interest rates are low.
  • Exports and whether capital is moving into the country, or out of it.
  • Housing construction, mortgage availability, and the direction of home prices.

The next section is Financial Developments. In this section, the Fed summarizes these six areas.

  • Interest rates, including the Fed funds rate, Treasury yields, and money markets.
  • Stock and corporate bond rates
  • Leverage used in hedge funds, and bank capital ratios.
  • The strength of overall financial stability.
  • Municipal bond markets.
  • The money supply.

The third section is International Developments. Although the Fed focuses on the U.S. economy, it must acknowledge global influences. It consists of:

  • Foreign country bond yields. In 2015, this focused on economic vulnerabilities in emerging markets.
  • The dollar's value.
  • Global stock market volatility.
  • Changes in economic strength. In 2015, this focused on the recovery of Europe and other developed markets.

Part 2. Monetary Policy. That is where the Fed explains its decisions during the past year and its intentions for the coming year.

Monetary policy controls how much liquidity is available for bank loans. This part covers these four areas.

  • The Fed funds rate, which affects short-term interest rates.
  • Open market operations, which is how many Treasuries the Fed purchases. That can affect long-term interest rates.
  • Forward guidance, which is the Fed's stated intention of what it plans to do. The Fed is now so influential that merely stating its intentions has become a powerful tool. That means the Fed affects liquidity without actually doing anything
  • New tools that the Fed may develop.

Part 3. Economic Projections.  In this final section,  the Fed summarizes its outlook for the next several years. This includes:

  • The Fed's numerical forecast for GDP, unemployment, and inflation.
  • A detailed discussion that gives the basis for its forecasts.
  • A discussion of future monetary policy.
  • How certain the Fed is of its forecasts, and what could throw the forecasts off.