Are we there yet? Conundrum warrants poise.

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“For every complex problem there is an answer that is clear, simple, and wrong.” – H.L. Mencken. So while there is no substitute for considering a variety of theories, we offer a reasonable framework for timing consideration for reducing accommodative policies.

Output: Few Recent Concerns, But Dollar Strength May Slow Positive Momentum

Source: FRED.2

Output: Manufacturing-related Data Trends Likely More Volatile in 2015, but expect Consistent Rise in Post-Recession Household Formation

ISM

HO

US

EH

OL

D

FO

RM

AT

ION

Sources: Bloomberg and U.S. Census Bureau.3

Labor: Unemployment Improvement Since 2009; Quits Rate Rising Gradually, but Still Below Pre-Recession Level

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Labor: “Adjusted” U-3 as a key policy factor?

5Sources: F.O.M.C. and estimates (see Slide 14).

Adjusted U-3 could provide a more stable NAIRU indicator for policy discussions, decisions and communications.

One current data set suggests a baseline NAIRU achievement timeframe of mid-2016, with expansionary upside of late-2015, and global economic downside risk of early-2017.

Labor: Upward Wage Trajectory, Below Pre-Recession Levels, Controlled by LFPR Level

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Currency: Net Exports likely suppressing real GDP growth by 0.25%-0.75%

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Given the roughly 10-15% weighting of international trade in the the U.S. economy according to the Chamber of Commerce, the recent roughly 15% strength in the U.S. dollar may depress real GDP growth by 0.25%-0.75%. See slide 14 for calculation.

Source: N.Y. Times.

PCE: Core Lagging 2% target; LFPR and strong dollar partly to blame.

8Source: Barron’s, March 30, 2015.

Inflation: Subdued expectations likely until ‘adjusted’ U-3 NAIRU in mid- or late-2016; expect inflation ‘wiggles’ with dollar weakness.

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Balance Sheet: Despite “Tantrum,” Tapering Has Been Right F.O.M.C. Adjustment; Strong U.S. asset demand may offer opportunities for securities sales in later stages of policy normalization process

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Preferred Sequence of Normalization Actions

1. Cease reinvestment of maturing bonds.

2. Fed Funds Rate target increases as ‘adjusted’ U-3 approaches NAIRU.

• Consistent with Taylor Rule principles (see Appendix III on Slide 15)• Implemented with scheduled communications and Interest-On-Excess-

Reserves and Over-Night-Reverse-Repurchase-Agreements

3. Controlled, opportunistic, limited, periodic Treasury bond sales during peak financial markets demand periods for U.S. Dollar-denominated assets – initial sales should favor shorter maturities to keep mortgage rates attractive.

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Recommendation: Data-Driven “When” on FFR

Summary: (1) consistent U.S. output recovery, albeit below historical trend; (2) ‘adjusted U-3” suggests little urgency to FFR change; (3) global economies and currencies weakness limiting U.S. inflation expectations; (4) domestic wages and loan growth controlled, but upwardly biased; and (5) FFR target increases historically problematic when USD demand high

Key Tools: (1) “Opportunistic Overheating” in absence of target PCE data and when LFPR below historical norms; (2) Employment and output trends solid, with wage trends controlled due to LFPR; and (3) focus on global economic stability, not currency fluctuations. 12

Appendix I: Calculation of ‘adjusted U-3” at 65% LFPR

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Appendix II: Estimated Impact of U.S. Dollar Strength on Reported Real G.D.P.

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Appendix III: Synthesis of Taylor Rule principles, ‘adjusted U-3’ and Okun’s Law

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