Vice chair offers view of how new framework for Fed’s dual mandate will work

The new framework for achieving price stability and maximum employment that will be used by the Federal Reserve in determining monetary policy was outlined Monday by the vice chair of the agency board, as he noted it has “important implications” for policy decisions in the future.

In remarks delivered remotely to a group meeting at the Brookings Institution in Washington, D.C., Federal Reserve Vice Chair Richard H. Clarida separately outlined the framework provisions for the two portions of the Fed’s dual mandate: price stability and maximum employment.

On the price-stability mandate, Clarida listed five features of the new framework:

  • The agency’s Federal Open Market Committee (FOMC) expects to delay liftoff from the effective lower bound (ELB) until personal consumption expenditures (PCE) inflation rises to 2% annually, and other complementary conditions are met.
  • With inflation having run persistently below 2%, the FOMC will aim to achieve inflation moderately above 2% for some time with the aim of an average 2% inflation rate over time and with “longer-term inflation expectations well anchored at the 2% longer-run goal.”
  • The FOMC expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met.
  • Policy will aim over time to return inflation to its longer-run goal, which remains 2%, but not below, once the conditions to commence policy normalization have been met.
  • Inflation that averages 2% over time “represents an ex ante aspiration of the FOMC, but not a time-inconsistent ex post commitment.”

“I believe that a useful way to summarize the framework defined by these five features is temporary price-level targeting (TPLT, at the ELB) that reverts to flexible inflation targeting (once the conditions for liftoff have been reached),” the Fed vice chair said.

On the maximum employment mandate, Clarida said that the framework now defines it as “the highest level of employment that does not generate sustained pressures that put the price-stability mandate at risk.” He said that means to him that “monetary policy should, as before, continue to be calibrated to eliminate such employment shortfalls as long as doing so does not put the price-stability mandate at risk.”

“In our new framework, when in a business cycle expansion labor market indicators return to a range that, in the Committee’s judgment, is broadly consistent with its maximum-employment mandate, it will be data on inflation itself that policy will react to, but going forward, policy will not tighten solely because the unemployment rate has fallen below any particular econometric estimate of its long-run natural level,” he said.

The Federal Reserve’s New Framework: Context and Consequences