Federal Reserve Chair Jerome Powell said policymakers are weighing changes to key parts of the framework that guides their monetary policy decisions, including how they think about shortfalls in US employment and approach their inflation target.
Officials “have indicated that they thought it would be appropriate to reconsider the language around shortfalls. And at our meeting last week, we had a similar take on average inflation targeting,” Powell said Thursday in remarks prepared for a research conference on the Fed’s monetary policy framework.
Powell acknowledged the current framework was designed at a time of persistently low interest rates and low inflation.
“We will ensure that our new consensus statement is robust to a wide range of economic environments and developments,” he said.
Fed officials this year began a periodic review of the central bank’s longer-run strategy — or framework — for implementing monetary policy and its communication tools. The framework serves as a guide for officials on the rate-setting Federal Open Market Committee as they aim to meet the broad goals assigned to them by Congress of fostering stable prices and maximum employment. Fed officials target 2% inflation.
Following the last review, which concluded in 2020, the Fed adopted a new framework that aimed to achieve inflation moderately above 2% for “some time” after periods when inflation ran persistently below that level — an approach known as flexible average inflation targeting.
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Critics have since said the new framework was overly-tailored to the low-rate, low-inflation environment of the time and wasn’t applicable following the onset of the Covid-19 pandemic.
Powell said a major consideration in 2020 was keeping Americans’ long-term expectations for inflation close to 2%.
“Anchored expectations are critical to everything we do, and we remain fully committed to the 2% target today,” he said.
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Still, he said the economic environment had changed significantly since 2020, and the current framework review will reflect policymakers’ assessment of those changes.
Powell said the idea of policymakers being constrained by the so-called zero lower bound — a situation where already-low interest rates offer officials little room to slash borrowing costs to support the economy when needed — “is no longer the base case.” But, he added, “it is only prudent that the framework continue to address that risk.”
Shortfalls
The 2020 framework review also reworked the central bank’s employment goal to focus on so-called “shortfalls” — or periods when the unemployment rate is too high. Previously, the Fed worried equally about situations in which unemployment was deemed too high or too low.
The change effectively moderated a practice in which the Fed would pre-emptively lift interest rates to cool the labor market and protect against inflationary pressures before they materialized.
Powell said Thursday the tweak was not a commitment to permanently forswear pre-emptive policy moves or to ignore labor market tightness, when job openings far exceed the number of available workers.
“It signaled that apparent labor market tightness would not, in isolation, be enough to trigger a policy response, unless the committee believed that, if left unchecked, it would lead to unwelcome inflationary pressure,” he said.
Some Fed watchers have pointed to this change as the reason the central bank was late to hike interest rates in response to the inflation that followed the pandemic, arguing that officials were overly attentive to the employment goal. By the time the Fed began aggressively raising interest rates in early 2022, inflation was well on its way to its highest levels in roughly four decades.
Powell has pushed back against the idea the framework was responsible for the delayed response. He has instead pointed to officials’ judgment at the time — which later proved erroneous — that pandemic inflation would be transitory.
Powell has said the central bank intends to conclude its current framework review by the end of the summer.
