US Federal Reserve chair Jerome Powell issued a changed formula yesterday on how it will gauge economic shifts and the consequent moves in interest rates.
Essentially, it’s a quibble about achieving 2% inflation. The Powell formula enables the Fed to let things run longer, and shifts the emphasis on employment from deviations from the maximum to shortfalls.
The Fed policy has long favoured reducing interest rates across the economy, thus supporting a general rise in asset values. That doesn’t change.
The key components of his speech:
“Before addressing the key changes in our statement, let me highlight some areas of continuity. We continue to believe that specifying a numerical goal for employment is unwise, because the maximum level of employment is not directly measurable and changes over time for reasons unrelated to monetary policy. The significant shifts in estimates of the natural rate of unemployment over the past decade reinforce this point.
“In addition, we have not changed our view that a longer-run inflation rate of 2% is most consistent with our mandate to promote both maximum employment & price stability.
“Finally, we continue to believe that monetary policy must be forward looking, taking into account the expectations of households & businesses & the lags in monetary policy’s effect on the economy. Thus, our policy actions continue to depend on the economic outlook as well as the risks to the outlook, including potential risks to the financial system that could impede the attainment of our goals.
“Our new statement explicitly acknowledges the challenges posed by the proximity of interest rates to the effective lower bound. By reducing our scope to support the economy by cutting interest rates, the lower bound increases downward risks to employment & inflation. To counter these risks, we are prepared to use our full range of tools to support the economy.
“With regard to the employment side of our mandate, our revised statement emphasises that maximum employment is a broad-based & inclusive goal. This change reflects our appreciation for the benefits of a strong labour market, particularly for many in low- & moderate-income communities. In addition, our revised statement says that our policy decision will be informed by our ‘assessments of the shortfalls of employment from its maximum level’ rather than by ‘deviations from its maximum level’ as in our previous statement. This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.
“In earlier decades when the Phillips curve was steeper, inflation tended to rise noticeably in response to a strengthening labour market. It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation.
“The change to ‘shortfalls’ clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals. Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimise that shortfall by using our tools to support economic growth & job creation.
“We have also made important changes with regard to the price-stability side of our mandate. Our longer-run goal continues to be an inflation rate of 2%. Our statement emphasises that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2%. However, if inflation runs below 2% following economic downturns but never moves above 2% even when the economy is strong, then, over time, inflation will average less than 2%.
“Households & businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realised inflation down. To prevent this outcome & the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2%t over time. Therefore, following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.
“In seeking to achieve inflation that averages 2% over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting. Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula. Of course, if excessive inflationary pressures were to build or inflation expectations were to ratchet above levels consistent with our goal, we would not hesitate to act.
“The revisions to our statement add up to a robust updating of our monetary policy framework. To an extent, these revisions reflect the way we have been conducting policy in recent years. At the same time, however, there are some important new features.
“Overall, our new statement on longer-run goals & monetary policy strategy conveys our continued strong commitment to achieving our goals, given the difficult challenges presented by the proximity of interest rates to the effective lower bound. In conducting monetary policy, we will remain highly focused on fostering as strong a labour market as possible for the benefit of all Americans. And we will steadfastly seek to achieve a 2% inflation rate over time.”
Federal Open Market Committee announces approval of updates to its statement on longer-run goals & monetary policy strategy
Speech by US Federal Reserve chair Jerome Powell, 27 August 2020: New economic challenges & the Fed’s monetary policy review
Attribution: Fed release & speech.