Federal Reserve Chair Jerome Powell said Thursday the Fed will be “flexible” in pursuing a new “average inflation targeting” regime and not use any set “mathematical formula”.
Powell, elaborating on what he called a “robust” new monetary policy strategy framework adopted earlier by the Fed’s policymaking Federal Open Market Committee, also noted the new policy framework will allow the Fed to maintain a more accommodative monetary stance when unemployment is running below estimates of the “natural” jobless rate, so long as inflation does not significantly exceed the average 2% inflation target and inflation expectations remain anchored.
At the same time, Powell vowed the Fed “will not hesitate to act” if it sees signs of accelerating inflation. The Fed chief was keynoting an online-based version of the Kansas City Federal Reserve Bank’s annual Jackson Hole symposium, whose 2020 theme is “Navigating the Decade Ahead: Implications for Monetary Policy”.
Without waiting for its September 15-16 meeting, the FOMC changed the Statement on Longer-Run Goals and Monetary Policy Strategy initially adopted in January 2012 in the aftermath of the financial crisis. Most notably, instead of an annual “symmetric” 2% inflation target, the FOMC stated that henceforth it will seek to “achieve inflation that averages 2% over time”.
“Following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time,” the revised statement adds.
In another key change to the statement, regarding the Fed’s maximum employment objective, the FOMC now says its policy decisions will be informed by its “assessments of the shortfalls of employment from its maximum level”. Formerly, the statement referred to “deviations from its maximum level”.
Explaining the change to the language on maximum employment, Powell told the symposium, “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,” he continued. “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.”
Powell said, “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 and job creation,” he added.
Regarding the new average inflation targeting framework, Powell said, “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 and price stability,” but said the shift to an average 2% inflation target had been necessitated by persistent undershooting of the 2% target.
He stressed, however, “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,” he went on. “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,” Powell added.
Elaborating in response to questions from conference host Kansas City Fed President Esther George, Powell emphasised the FOMC intends to permit only a “moderate” overshoot of 2% inflation.
“This is not a formulaic approach,” he said, adding that the FOMC “will continue to consider all the things it usually considers” as it “aspires to let inflation run above 2% after periods when it’s run below 2%”.
In the current situation, Powell said it is appropriate to pursue a “make-up strategy” and “make up” for past below-target inflation “in ways that allows us to consider all the other things that come into monetary policy unexpectedly without trying to follow a formula”.
He agreed with Fed Vice Chairman Richard Clarida’s observation that the new framework represents “more of an evolution than a revolution”.
Powell took pains to indicate that the Fed will not be wedded to any particular target or formula: “(W)e continue to believe that monetary policy must be forward looking, taking into account the expectations of households and businesses and 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.”
Powell said the framework review was necessitated by four basic changes in the global economic and financial environment:
- a slowdown in potential GDP growth, accompanied by a decline in productivity growth;
- a drop in interest rates in the US and around the world, including a decline in estimates of the
“real equilibrium interest rate” and hence the “neutral” policy rate;
- historic increases in employment, and
- the fact that lower levels of unemployment were not accompanied by acceleration in inflation, as central banks had traditionally grown to expect under “Phillips Curve” theory.
Powell put particular emphasis on the risks inherent in low inflation and inflation expectations: “The persistent undershoot of inflation from our 2% longer-run objective is a cause for concern…(I)nflation that is persistently too low can pose serious risks to the economy. Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations…”
“(I)f inflation expectations fall below our 2% objective, interest rates would decline in tandem,” he continued. “In turn, we would have less scope to cut interest rates to boost employment during an economic downturn, further diminishing our capacity to stabilise the economy through cutting interest rates. We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome…”
Powell had little to say about current economic developments or monetary policy intentions, but he made a point of differentiating the current recession from the Great Recession that followed the financial crisis. In contrast to the previous episode, he said the current crisis was not caused by financial imbalances or asset bubbles, but by “a natural disaster” (the coronavirus) and that the economy had been strong before the virus hit.
“It’s a very, very different situation…,” he said. “What happened here is that essentially people around the world withdrew from certain types of economic activity to protect themselves…”
By cutting the federal funds rate near zero, doing massive asset purchases and launching an array of special lending facilities in March, “we weren’t trying to stimulate the economy”, only to “provide a little bit of comfort and support the expansion”, he said.
Powell said the economy still “has strength”, but that some sectors are suffering from the pandemic, particularly travel-related industries. He said they could take a long time to recover.
As he and his fellow policymakers have often said, Powell vowed to use all the Fed’s tools to return to full employment.
In making his exposition of the new FOMC framework, Powell did not signal any further steps are forthcoming, although the committee has discussed making more far-reaching changes, eg, to monetary “forward guidance”.
Thus, at their July 28-29 meeting, FOMC participants agreed that “refining the statement could be helpful in increasing the transparency and accountability of monetary policy,” according to the minutes, which added that “a number of participants” believed “providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point.”
Those favouring revised policy communications “commented on outcome-based forward guidance – under which the committee would undertake to maintain the current target range for the federal funds rate at least until one or more specified economic outcomes was achieved..,” say the minutes. There was also discussion of calendar-based forward guidance.
“(V)arious participants mentioned using thresholds calibrated to inflation outcomes, unemployment rate outcomes, or combinations of the two, as well as combinations with calendar-based guidance,” the minutes went on. “In addition, many participants commented that it might become appropriate to frame communications regarding the committee’s ongoing asset purchases more in terms of their role in fostering accommodative financial conditions and supporting economic recovery.”
This year’s Jackson Hole theme is “Navigating The Decade Ahead: Implications for Monetary Policy.” The virtual symposium participants include Fed Vice Chairman Richard Clarida; Vice Chairman for Supervision Randal Quarles; Governors Michelle Bowman and Lael Brainard, and Federal Reserve Bank Presidents John Williams of New York, Thomas Barkin of Richmond, Charles Evans of Chicago, James Bullard of St Louis, Mary Daly of San Francisco, Neel Kashkari of Minneapolis, Raphael Bostic of Atlanta, Patrick Harker of Philadelphia, Loretta Mester of Cleveland, and host Esther George of Kansas City, as well as numerous foreign central bankers.
Steven K. Beckner