Fed revises monetary policy framework to focus on inflation ‘over time’

The Federal Reserve on Thursday announced changes in how it manages its targets for maximum employment and price stability, a decision informed by trends following the global financial crisis and discussed in a speech by its chairman during the annual Jackson Hole, Wyo., economic symposium.

Fed Chair Jerome H. (“Jay”) Powell, speaking Thursday at the Jackson Hole symposium, said the revisions, which will have the Fed monitoring for longer-run inflation, reflect the fact that up until the current pandemic, inflation has consistently failed to reach projections amid a tightening employment market.

The Fed’s updated Statement on Longer-Run Goals and Monetary Policy Strategy, approved unanimously by the Federal Open Market Committee (FOMC), the Fed’s monetary policy setting arm, includes the following revisions:

  • On maximum employment, the FOMC emphasized that maximum employment is a broad-based and inclusive goal and reports that its policy decision will be informed by its “assessments of the shortfalls of employment from its maximum level.” The original document referred to “deviations from its maximum level.”
  • On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2% by noting that it “seeks to achieve inflation that averages 2% over time.” To this end, the revised statement states that “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 updates to the strategy statement explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past.

Noting lessons since the crisis, Powell said the “persistent undershoot of inflation from our 2% longer-run objective is a cause for concern.” He noted that while it may seem counterintuitive for the Fed to seek to push inflation upward, inflation that is persistently too low can pose serious economic risk. “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,” he said.

Powell said well-anchored inflation expectations “are critical” for giving the Fed room to support employment when necessary without destabilizing inflation. “But if inflation expectations fall below our 2% objective, interest rates would decline in tandem,” he said. “In turn, we would have less scope to cut interest rates to boost employment during an economic downturn, further diminishing our capacity to stabilize the economy through cutting interest rates.”

The Fed chair said this adverse dynamic has been seen in other major economies around the world, and “once it sets in, it can be very difficult to overcome. We want to do what we can to prevent such a dynamic from happening here.”

New Economic Challenges and the Fed’s Monetary Policy Review” – speech by Fed Chair Jerome H. Powell at “Navigating the Decade Ahead: Implications for Monetary Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming (via webcast)