Edmonton Journal

Fed’s strategy shift allows for higher employment, inflation

- CRAIG TORRES, CHRISTOPHE­R CONDON and STEVE MATTHEWS

Federal Reserve chairman Jerome Powell unveiled a new approach to setting U.S. monetary policy, letting inflation and employment run higher in a shift that will likely keep interest rates low for years to come.

Following a more than year-long review, Powell said the Fed will seek inflation that averages two per cent over time, a step that implies allowing for price pressures to overshoot after periods of weakness. It also adjusted its view of full employment to permit labour-market gains to reach more workers.

“Maximum employment is a broad-based and inclusive goal,” Powell said Thursday in a speech delivered virtually for the central bank’s annual policy symposium traditiona­lly held in Jackson Hole, Wyo. “This change reflects our appreciati­on for the benefits of a strong labour market, particular­ly for many in low- and moderate-income communitie­s.”

During the longest U.S. economic expansion on record until the pandemic hit earlier this year, many groups benefited — including minorities and women. With millions out of work and unrest flaring up across the U.S. over racial inequality, questions about how the Fed’s policy helps diverse communitie­s have been raised.

While the new strategy doesn’t target a specific rate of unemployme­nt broadly or for certain demographi­c groups, it does give the central bank flexibilit­y to let the job market run hotter and inflation float higher before taking action.

“They really, really, really are not going to be raising interest rates any time soon,” said James Knightley, chief internatio­nal economist at ING Financial Markets.

“The Fed is saying rates will be lower for longer, but don’t worry inflation is not going to be picking up.”

Achieving an overshoot of inflation in the near term will be difficult. Unemployme­nt is above 10 per cent, and the economy is still recovering from the shock of virus shutdowns that inflicted the steepest recession on record.

Powell’s speech left the matter of how tactically they would aim for higher inflation for future Federal Open Market Committee meetings.

With the new strategy in place, Goldman Sachs chief economist Jan Hatzius said he now expects “changes to the forward guidance and asset purchase program to come at the September” policy meeting.

St. Louis Fed chief James Bullard later said in an interview on Bloomberg Television with Michael Mckee that “we’re going to try to make up for past misses,” but judgments about how to do so were for policy-makers and there are different opinions around the table.

“If you wanted to stay on the price-level path that was establishe­d from 1995 to 2012 you could run 2.5 per cent inflation for quite a while,” he said. In the new statement on longer-run goals, the Fed said its decisions would be informed by its assessment of “shortfalls of employment from its maximum level.” The previous version had referred to “deviations from its maximum level.” The change de-emphasizes previous concerns that low unemployme­nt can cause excess inflation.

While expected, the announceme­nt of the strategy shift came sooner than some thought. After first fluctuatin­g on the news, U.S. stocks resumed their record-breaking rally and the Treasury yield curve steepened to the widest in two months as traders bet policy rates will remain locked near zero for even longer.

Calling the revised strategy “a robust updating,” Powell said that after periods when inflation has been running below two per cent, monetary policy will likely aim to achieve inflation moderately above two per cent for some time.

The shift he announced is a product of an unpreceden­ted review of the Fed’s strategies, tools and approach to communicat­ions that began in early 2019. Fed officials said they will now conduct such reviews about every five years.

Since the central bank officially set its inflation target at two per cent in 2012, the Fed’s preferred measure of price increases has consistent­ly fallen short of that objective, averaging just 1.4 per cent .

That challenge was part of the impetus for the strategy review. Low inflation contribute­s to low interest rates, which reduces the Fed’s ability to fight off economic downturns — potentiall­y making them deeper and longer. Indeed, the strategy document pointed out that this limitation on their policy rate means “downward risks to employment and inflation have increased.”

“Powell is not only saying that they will be more patient in removing the punch bowl in the future, he has changed the recipe for the punch,” said Mark Vitner, senior economist at Wells Fargo & Co. “While the timing comes slightly earlier than had been expected, the Fed is far better served to under-promise and over-deliver, or deliver earlier in this case.”

Even so, the document leaves the Fed ample room to fight a run up in inflation.

Powell noted the risk, saying that “if excessive inflationa­ry pressures were to build or inflation expectatio­ns were to ratchet above levels consistent with our goal,” the central bank wouldn’t hesitate to act.

Fed officials also altered the strategy document to include a section acknowledg­ing that financial stability can also affect their ability to reach their longer-run goals.

“Sustainabl­y achieving maximum employment and price stability depends on a stable financial system,” it said. “Therefore, the committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessment­s of the balance of risks, including risks to the financial system that could impede the attainment of the committee’s goals.”

Powell has emerged an unexpected change agent in the role of chairman.

While he isn’t a PHD economist, his first speech at Jackson Hole in 2018 discussed the risks and uncertaint­ies around the basic parameters of policy-making.

As U.S. President Donald Trump’s pick to helm the central bank, he engaged the Fed in a dialogue with moderate- and low-income communitie­s across the U.S. and steered the economy toward lower rates of unemployme­nt that benefited Black and Hispanic communitie­s.

 ?? DANIEL ACKER/BLOOMBERG ?? Fed chairman Jerome Powell speaks during the central bank’s virtual annual policy symposium on Thursday.
DANIEL ACKER/BLOOMBERG Fed chairman Jerome Powell speaks during the central bank’s virtual annual policy symposium on Thursday.

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