Federal Reserve Chairman Jerome Powell has lifted the veil on a new thinking framework for the Central Bank that will allow an inflation tolerance above its 2% target (moderately). The policy will also be reviewed every five years.
Jerome Powell acknowledged the lessons learned from the runaway inflation days of the 1970s during a speech on Thursday morning. He went on to warn about the possibility of new economic difficulties as a result of the low inflation over the last eight years.
As per Powell, “Many find it counterintuitive that the Fed would want to push up inflation.” However, low inflation can have the effect of “diminishing our capacity to stabilize the economy through cutting interest rates,” Powell said.
The Fed’s target for inflation is 2%. It is always measured as core personal consumption expenditures (which do not include volatile sectors like energy and food & beverages). Since the Fed set that goal in its 2012 Statement on Longer-Run Goals and Monetary Policy Strategy, the Fed has only touched the target value of 2% briefly in 2018. The average inflation has only been 1.6%.
The Fed had launched a nationwide listening tour to see if it could tweak its statement with the goal of pushing inflation closer to the target number of 2%.
On Thursday morning, Powell announced the conclusion of that review and said the policy-setting Federal Open Market Committee had reached a consensus and approved of a new language that would allow for inflation to stay moderately above 2% “for some time”, especially after periods during which the inflation was consistently lower than the target.
This strategy is also referred to as flexible average inflation targeting. The main reason behind that is the Fed deciding to drop the usage of a particular mathematical formula to define a time horizon over which 2% inflation is achieved.
Powell added, “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 also emphasized that the Fed will prioritize its dual mandate of maximum employment, aside from the major changes addressed in its Congressional mandate on price stability.
The revised statement reads that the Fed’s policy decisions will be guided by assessments of “the shortfalls of employment from its maximum level.”
Powell’s remarks were delivered virtually during the Fed’s annual Jackson Hole meeting. He described the change as a reflection of “our view that a robust job market can be sustained without causing an outbreak of inflation.”
The Fed has also added language which has committed the FOMC to “use its full range of tools to achieve its maximum employment and price stability goals.” The statement also requires the Fed to undertake a “thorough” review of the statement every five years.
The next round of the FOMC is scheduled for September 15th and 16th.