The new era of Federal Reserve policy allowing an overshoot of its 2% inflation target for an extended time launched Wednesday with two Federal Open Market Committee dissents after a “robust discussion.”
There were, however, few expectations expressed that even reaching the 2% target would be possible for at least two more years and exceeding it remained a largely theoretical possibility.
The two-day FOMC meeting appeared to have been livelier than most even though raising rates was never on the agenda in this period “of great uncertainty,” in Chair Jay Powell’s words. The dissents were for largely opposite reasons, with Minneapolis Fed’s Neel Kashkari wanting an inflexible rule to keep policy tied to a “sustained” 2% core inflation rate and the Dallas Fed’s Robert Kaplan wanting to preserve policy flexibility after full recovery, not a prolonged inflation overshoot. In any event, everyone seemed to agree full recovery in a long way off.
Referring to the new policy framework, which excised the fear of accelerating inflation during full employment, Powell said in his post-meeting news conference, “We have to support it with our actions.” And the policy statement issued in the afternoon, aiming to achieve “inflation moderately above 2% for some time” was, in his view, exactly that. “I think today is a very good first step,” Powell said. “It is strong powerful guidance, it ties in” and, “We had quite a robust discussion, there are different ideas how to do that. That’s just the way it is when you have a diverse group of highly thoughtful and effective people so I’m pleased with where it came out.”
The quarterly “dot plot” of the assumptions of the 17 FOMC participants, Board members and District bank presidents, saw everyone keeping to the zero to quarter-point lower bound of the overnight rate through 2021, and only one contemplating a rate hike in 2022. Only four of the 17 saw rates higher in 2023.
Their outlook for GDP was for diminishing growth ahead, with the median bouncing from this year’s 3.7% contraction to a 4.0% acceleration next year. That’s a full percentage point lower than their June outlook. Then the GDP slows to 3.0% in 2022, a half point lower than June, and to 2.5% in 2023. The median personal consumption expenditure inflation rate, either overall or core items, didn’t reach 2.0% until 2023.
So how long will this recovery in employment and inflation take, Powell was asked in a number of ways. He answered basically, don’t hold your breath. “We think looking at everything we know about inflation dynamics and the United States and around the world over recent decades, we expect it will take some time,” Powell answered at one point. “We expect that the economy will recover quickly now but that that pace will slow as people go back to work and we’ll still have an area of the economy, a big area of the economy, that struggles.
“There will be slack in the economy,” he added. “The economy will be – maximum employment below full demand and that will tend to wear, put downward pressure on inflation.”
When the economy gets closer to maximum employment – which can’t be quantified exactly, “We think inflation will come back generally and that’s sort of what happened during the last long expansion.”
In view of the uncertainty, “There is no template here. There’s no experience with this,” Powell said. “For the last 60 days or so, the economy’s recovered faster than expected. Did (that) continue? Or not? We just need to get those things under control to make sure we can recover as quickly as possible.”
Recovery will be tied to success against the virus, he repeated. “The main thing is wearing a mask and keeping your distance while you’re in the workforce. That’s something we can all do that will limit spread, let people go back to work.”
What more can the Fed do? More asset purchases, stronger forward guidance, expanded and extended relief programs. Yet forward guidance is already “strong” and “powerful,” Powell repeated. “We believe that particularly, this very strong forward guidance, very powerful forward guidance that we’ve announced today, will provide strong support for the economy,” he said. “Effectively, we’re saying that rates will remain highly accommodative until the economy is far along in its recovery and that should be a very powerful statement in supporting economic stability.”
As far as Congress goes, Powell emphasised that more action seems necessary. “Direct fiscal support may be needed,” he said. “Elected officials have the power to tax and spend and to make decisions about where we as a society should direct our collective resources.”
So far, so good, he continued. “The fiscal policy actions that have been taken thus far have made a critical difference to families, businesses, and communities across the country.”
Powell’s warning? “The current economic downturn is the most severe in our lifetimes. It will take a while to get back to the levels of economic activity and employment that prevailed at the beginning of this year, and it may take continued support from both monetary and fiscal policy to achieve that.”