ECONOMIC REPORT OF THE PRESIDENT

The size of the Federal Reserve’s balance sheet at the end of November
2016 was $4.45 trillion—over five times its size at the end of 2006, largely
reflecting several large-scale asset purchase programs (quantitative easing)
from 2008 to 2014, which are estimated to have lowered long-term interest
rates by about a percentage point (Ihrig et al. 2012; D’Amico et al. 2012;
Engen, Laubach, and Reifschneider 2015).4 Since the conclusion of its largescale
asset purchase program in 2014, however, the Federal Reserve’s asset
holdings have remained at $4.4 trillion as maturing bonds were replaced
with purchases of new issues.
In recent years, FOMC participants have tended to lower their estimates
of the longer-run level for the federal funds rate. As of September, the
median of FOMC participants’ projections of the long-run federal funds rate
was 2.9 percent, down from 3.5 percent in December 2015. The downward
revisions are consistent with downward trends in long-term interest rates in
U.S. and global financial markets.
The natural rate of interest is the real interest rate that should prevail
when the economy is producing at its long-run potential level and has
attained full employment. Both cyclical factors (such as unconventional
monetary policies, fiscal austerity measures, and private sector deleveraging)
and structural factors (such as slowing productivity growth, changing
demographics) could be contributing to the decline in the natural rate of
interest.5 An interest-rate decline implies that monetary policy may now
have less room to provide accommodation during recessions than in the past
because it has less room to lower rates.6 In light of this, some have argued
that stabilization policy could benefit from greater use of countercyclical fiscal
policy and perhaps changes in the approach to monetary policy such as
targeting nominal GDP or adopting a higher inflation target.7
4 See Ihrig et al. (2012) for a discussion of how interest rates paid on excess reserves and
overnight reverse repurchase agreement have replaced open market operations—the buying
and selling of Treasury securities—as the way in which the Federal Reserve achieves its target
policy rate.
5 See CEA 2015d for a survey on the nature and sources of the decline in long-term interest
rates.
6 Yellen (2016b) has argued that a low equilibrium federal funds rate does not mean that the
Federal Reserve’s current toolkit will be ineffective. She points out that a recent paper using
simulations from a Federal Reserve model finds that forward guidance and asset purchases
should be sufficient to combat most recessions “even if the average level of the federal funds
rate in the future is only 3 percent.”
7 See Williams (2016), Summers (2014), Yellen (2016b), Fischer (2016), Bernanke (2013),
Goodfriend (2016).
The Year in Review and the Years Ahead | 75