New Fed targets
Yesterday’s speech by Fed Chairman Powell was eagerly awaited, as he gave clues about the longer-term strategic direction of US monetary policy. On the market side, it was assumed that the Fed would explicitly allow the inflation target to be exceeded.
Inflation target has been missed in the past
Powell has fully met these expectations. The Fed will no longer be guided by the achievement of a specific inflation rate, but by an average inflation rate of 2% over time. The background to this adjustment is that achieving this target has already caused problems in previous years and inflation has been lower. As part of the strategic review of its monetary policy, which began in November 2018, the Fed examined this issue and has now adjusted its target system as a result.
Average inflation – but no precise timing
Powell announced at the Federal Reserve Symposium in Jackson Hole that the Fed will introduce what he called a „flexible form of the average inflation target“. However, as Powell did not specify a specific time frame for achieving average inflation or an exact method of measuring it, the statement is relatively flexible. The Fed also obviously does not want to be tied to a specific method of defining average inflation. The employment target for the labor market has also been changed. Thus, the monetary watchdogs emphasize that maximum employment should be a broad and comprehensive goal. The situation of low-income and minority workers is to be taken into account in the near future.
It will be difficult to achieve the new goals
The Fed’s preferred inflation measure, the core deflator of personal spending (PCE core rate), has not been above 2% since 2009. On a ten-year average, the PCE core rate was only 1.60%, a good 0.4 percentage points below the Fed’s target rate. This excessively low inflation rate is now to be „ironed out“ again by allowing values above 2%. In other words, the past plays a decisive role for future monetary policy. But Powell did not want to disclose how far and how long the Fed looks back into the past. Moreover, in our view it is more than questionable whether and how the Fed will manage to achieve an inflation rate of 2% at all, let alone permanently above this mark, after more than ten years of falling short of its target. One could even go so far as to say that the Fed will no longer abandon an expansive monetary policy because of the structural factors for low inflation. With its strategic labor market target, we believe that the Fed is embarking on a path that is difficult for it to achieve by monetary policy means. Powell has explicitly stated that the labor market would be run hot in order to integrate as many population groups as possible into the labor market. If one can allow higher inflation rates while the Phillips curve is flat, that may be possible. But this is actually a task for fiscal policy. The state would have a better chance than the Fed of ensuring greater equality of opportunity here through education policy.
No direct impact on future monetary policy
The Fed’s mandate will not be affected by the announcement of the new strategy, as the US Congress has by law given the Fed a dual mandate to ensure both price stability and full employment. The new regulations are only intended to sharpen the canon of targets set by Congress. Overall, we expect the impact on current monetary policy to be minimal. In any case, market participants assume that monetary policy will remain expansionary for the time being.