How to Read the Fed’s Interest Rate Projections

Federal Reserve officials will release both an interest-rate decision and a fresh set of economic projections on Wednesday — estimates that Wall Street is keenly awaiting as investors try to understand what the next phase of the central bank’s ongoing fight against inflation will look like.

Officials are widely expected to raise interest rates by half a point at this meeting, but what will be even more notable is what they forecast for interest rates in 2023 — and beyond. Central bankers have been shifting their focus away from how fast rates are rising and toward how high they will ultimately climb and how long they will remain elevated.

Here’s how to read the numbers released on Wednesday.

When the central bank releases its Summary of Economic Projections each quarter, Fed watchers focus obsessively on one part in particular: the so-called dot plot.

The dot plot shows the estimates by the Fed’s 19 policymakers for interest rates at the end of 2022, along with the next several years and over the longer run. The forecasts are represented by dots arranged along a vertical scale.

Economists closely watch how the range of estimates is shifting, because it can give a hint to where policy is heading. Even so, they fixate most intently on the middle dot (currently the 10th). That middle, or median, official is regularly quoted as the clearest estimate of where the central bank sees policy heading.

The Fed is trying to wrestle down rapid inflation, and to do that, officials believe that they need to lift interest rates enough to weigh down spending, crimp business investment and expansion, and cool off a hot job market. The central bank has moved rates up quickly in 2022, and expectations for future increases have also climbed.

In June, the median official expected interest rates to close out the year at a range of 3.25 to 3.5 percent — instead, they’ll be set to a range of 4.25 to 4.5 percent if policymakers lift rates as much as expected on Wednesday. The median official expected rates to climb to 4.6 percent in 2023 as of the last rate projections in September, but that projection is expected to tick up slightly in the new release.

Still, central bankers are likely to project that they are near the end of the road when it comes to raising interest rates. They have already done a lot to cool the economy, and they do not want to overdo it and crush growth and the labor market more than is necessary.

The most important trick for reading this dot plot? Pay attention to where the numbers fall in relation to the longer-run median projection. That number is sometimes called the natural rate, and it most recently stood at 2.5 percent. It represents the theoretical dividing line between easy and restrictive monetary policy.

The Fed can use the gap between the Fed funds rate and that so-called natural rate to signal how far they plan to go into economy-restricting territory — and also how long they will stay there. How long rates will stay elevated is a particularly important question at this moment.

Is the Fed expecting a much-higher jobless rate as it tries to counter rapid inflation? Page 2 of the economic projections will hold some answers.

The Fed has two jobs. It is supposed to achieve maximum employment and stable inflation. Unemployment has been very low, employers are hiring steadily, and wages have been rapid throughout 2022, so officials think that their full employment goal is more than satisfied. Inflation, on the other hand, is running at about three times their official target.

Given that, the central bankers are now single-mindedly focused on bringing price gains back under control. But once the job market slows, joblessness begins to rise and wage growth moderates — a series of events officials think is necessary to getting back to slow and steady price gains — the difficult phase of the Fed’s maneuvering will begin. Central bankers will have to decide how much joblessness they are willing to tolerate, and may have to judge how to balance two goals that are in conflict.

Jerome H. Powell, the Fed chair, has at times acknowledged that the adjustment process is likely to bring “pain” to businesses and households. The Fed’s updated unemployment rate projections will show how much he and his colleagues are prepared to tolerate.

The road toward higher unemployment is paved with slower growth. To force the job market to cool and inflation to moderate, Fed officials believe they have to drag economic growth below its potential level — and how much it is expected to drop can send a signal about how punishing the Fed thinks its policies will be.

Many experts think that the economy is capable of a certain level of growth in any given year, based on fundamental characteristics like the age of its population and productivity of its companies. Right now, the Fed estimates that longer-run sustainable level to be about 1.8 percent, after adjusting for inflation.

Last year, the economy was growing much more strongly than that — it began overheating. This year, growth was much weaker. The question is how tepid the Fed thinks it needs to be in 2023 to help policymakers achieve their inflation goal.

The inflation estimates in the Fed’s projections typically do not offer a lot of insight.

That’s because the Fed’s forecasts predict how the economy will shape up if central bankers set what they consider “appropriate” monetary policy. To qualify as “appropriate,” by definition, monetary policy must push price increases back toward the Fed’s 2 percent annual average goal over the course of a few years. That means Fed inflation forecasts always converge back toward the central bank’s goal in economic estimates.

If there is a glimmer of utility here, it is how long the central bank sees it taking to wrestle prices back to its target level. As of September, Fed officials thought that core inflation — the figure that strips out food and fuel costs to get a sense of underlying price patterns — would remain at 2.1 percent in 2025.

The upshot? It could be a long road back to normal, even in an ideal world.

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