As expected, Jerome Powell used his address to this year’s virtual Jackson Hole symposium to set the stage for a shift in the Fed’s approach to inflation. In fact, he formally announced a new era.
In a hotly-anticipated speech that could echo for years, Powell expounded on the Fed’s policy framework review, which took on an extra sense of urgency when the pandemic ushered in a deflationary supernova, even as it introduced new upside risks for inflation down the road.
The Fed has notoriously failed to bring inflation sustainably to target. The market has long anticipated a shift to average inflation targeting and generally expects officials to countenance overshoots in the interest of avoiding the kind of disinflationary dynamics that have gripped Japan for years and now threaten to spill over into the rest of the developed world.
In essence, the market wants clarity. Whether Powell delivered in that regard will be the topic of vociferous debate for at least the next week, and very likely right up until the September FOMC.
“If inflation runs below 2% following economic downturns but never moves above 2% even when the economy is strong, then, over time, inflation will average less than 2%”, Powell said Thursday, adding that “households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down”.
That set the stage. Here is the big reveal, from Powell:
To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2% over time. Therefore, following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.
In seeking to achieve inflation that averages 2% over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting. Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula. 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.
Earlier this month, the market cringed at the July FOMC minutes which, according to some, were notable for what they didn’t contain. Specifically, disappointment centered around a perceived lack of commitment to rolling out new forward guidance or a tweaked bond-buying plan in September. That, combined with the apparent shelving of yield-curve control, raised questions about the Fed’s commitment to following through on promises, both explicit and implicit.
In revealing the full results of the policy review on Thursday, Powell could be seen as attempting to avoid “disappointing” the market.
“We describe this as codifying the ‘Powell Put'”, JonesTrading’s Mike O’Rourke wrote, in a Wednesday evening note, before posing a rhetorical question: “Over the past two decades, core PCE inflation has average 1.72% and been above 2% only 27% of the time — Does that mean the Fed does not need to raise interest rates for the next century?”
For his part, Kevin Muir, formerly head of equity derivatives at RBC Dominion, and better known for his exploits as “The Macro Tourist”, referenced Powell’s ill-fated 2018 hikes in a Wednesday note of his own.
“I said it then, and I will say it again – Powell’s 2018 rate hiking campaign will prove to be the last time (for a decade or two at least) a major central banker actively tries to raise real rates to a meaningfully positive level”, Kevin said. “A move to ‘average inflation targeting’ will merely put into formal policy what we all know has happened anyway”.
The figure (below) is just another way to visualize the undershoot using headline PCE.
“The history of Jackson Hole as the forum to roll out transitions in monetary policy is hard to ignore and expectations are in place for a grand reveal, making the prospects of disappointment also a concerning eventuality should Jay choose to play this one close to the vest”, BMO’s Ian Lyngen wrote, prior to Powell’s big “reveal”.
“Moreover, informing investors the Fed will keep rates very, very low for a very, very long time isn’t ‘news’ to a market pricing in nothing for several years”, Lyngen added.
Powell pushed back on the notion that the inauguration of average inflation targeting in the US doesn’t mark a meaningful shift, even as he acknowledged the Fed has followed some version of what one might call “pseudo-AIT” for years.
“The revisions to our statement add up to a robust updating of our monetary policy framework”, he said, noting that although “these revisions reflect the way we have been conducting policy in recent years to an extent… there are some important new features”.
You can judge that for yourself. The full statement is below.
On employment, the Fed is moving to a conceptually similar emphasis on overshooting when it comes to “running it hot” (so to speak) in what Powell characterized as a nod to “the benefits of a strong labor market, particularly for many in low- and moderate-income communities”. Specifically, the revised statement says the Fed will be informed by “assessments of the shortfalls of employment” as opposed to “deviations from its maximum level”.
Powell suggests you shouldn’t write that off as a mere semantic tweak. “This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation”, he emphasized, effectively acknowledging the broken Phillips curve.
Summing up, Powell notes that “overall, our new Statement on Longer-Run Goals and Monetary Policy Strategy conveys our continued strong commitment to achieving our goals, given the difficult challenges presented by the proximity of interest rates to the effective lower bound”.
Some will be skeptical, though. “While this market likes to rally in response to anything Fed-related, it is important to remember that none of this is really new”, JonesTrading’s O’Rourke remarked.
Federal Open Market Committee announces approval of updates to its Statement on Longer-Run Goals and Monetary Policy Strategy
Following an extensive review that included numerous public events across the country, the Federal Open Market Committee (FOMC) on Thursday announced the unanimous approval of updates to its Statement on Longer-Run Goals and Monetary Policy Strategy, which articulates its approach to monetary policy and serves as the foundation for its policy actions. The updates reflect changes in the economy over the past decade and how policymakers are taking these changes into account in conducting monetary policy. The updated statement is also intended to enhance the transparency, accountability and effectiveness of monetary policy.
“The economy is always evolving, and the FOMC’s strategy for achieving its goals must adapt to meet the new challenges that arise,” said Federal Reserve Chair Jerome H. Powell. “Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation.”
Among the more significant changes to the framework document are:
- 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 percent by noting that it “seeks to achieve inflation that averages 2 percent over time.” To this end, the revised statement states that “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent 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.
The Committee first adopted a framework statement in 2012.
This first public review of the FOMC framework was announced by Chair Powell in November 2018, and involved three distinct components. First, the Federal Reserve hosted a series of 15 Fed Listens events across the country to engage with employee groups and union members, small business owners, residents of low- and moderate-income communities, retirees, and others to hear a wide range of perspectives about how monetary policy decisions affect their communities. A report summarizing all of those events is available here: https://www.federalreserve.gov/publications/files/fedlistens-report-20200612.pdf.
Second, the Federal Reserve in June 2019 convened a research conference at which prominent academic experts addressed economic topics central to the review. That conference program, links to the conference papers and presentations, and links to session videos are available here: https://www.federalreserve.gov/conferences/conference-monetary-policy-strategy-tools-communications-20190605.htm.
Finally, the Committee explored the range of issues that were brought to light during the course of the review in five consecutive meetings beginning in July 2019. Analytical staff work put together by teams across the Federal Reserve System provided essential background for the Committee’s discussions. Minutes of those meetings are available here: https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm and a collection of those papers is available here: https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-system-analytical-work.htm.
The FOMC reported it would continue its practice of considering the Statement of Longer-Run Goals and Policy each January and that it intends to undertake a public review of its monetary policy strategy, tools, and communication practices roughly every 5 years.