The Marriner S. Eccles Federal Reserve Building in Washington, DC, USA, on August 18th.
Photographer: Erin Scott / Bloomberg
Photographer: Erin Scott / Bloomberg
The Federal Reserve’s new plan to boost the economy looks easier said than done, as the central bank confronts multiple forces holding inflation.
“The Fed needs to articulate very clearly how they plan to achieve the new goal,” Aneta Markowska, chief economist at Jefferies, wrote in a report to clients. “Otherwise, these are just words on paper that really mean nothing.”
Chairman Jerome Powell outlines Thursday a new approach to establishing US monetary policy. The Fed, he said, will sometimes allow inflation to run above the 2% target to compensate for previous undershoots, and allow unemployment to run lower than officials previously tolerated.
The move confirmed to investors that the Fed is likely to keep interest rates close to zero in the coming years, as it tries to reach its inflation target decisively, adopted in 2012. Inflation has since averaged only 1.4% amid headwinds affecting the US and other major economies. , including weak productivity growth, globalization, population decline and technological change.
Fed policymakers meet again Sept. 15-16 when they have a chance to express how the new strategy will shape their policies to pull the U.S. economy out of the worst downturn since the Great Depression.
Economists at Deutsche Bank AG said officials could clarify their guidance on the path of tariffs by linking future hurdles to reaching certain thresholds for inflation and employment. Minutes of their meeting in July showed that they debated this approach.
Powell’s announcement, though not entirely unexpected, marked the completion of a historic shift for the world’s most powerful central bank. Instead of worrying that very low unemployment would provoke inflation, they have now shifted their focus almost completely to too low inflation.
To justify this, he made the point to explain why persistent low inflation is a problem for central bankers, especially in combination with low economic growth. It results in very low interest rates, even with economic expansions. This means that policymakers do not have much room to cut borrowing costs in the event of a downturn.
Federal Reserve Chairman Jerome Powell says the Fed will take a more relaxed stance on inflation. He is speaking during remarks that are being made voluntarily for the central bank’s annual policy symposium, which was traditionally held in Jackson Hole, Wyoming.
“The result may be less economic outcomes in terms of both employment and price stability, with the cost of such outcomes likely to fall most heavily on those who can bear the least,” Powell said.
On the other side of the argument, there is a camp of investors convinced that the ultra-easy monetary policy of the Fed and the massive government spending run the risk of re-igniting the escaped inflation of the 1970s.
However, many observers saw the Fed’s ability to lift inflation with skepticism, especially considering that much of the world has just tumbled into a new recession – caused by the coronavrus pandemic – that is polluted demand and sent U.S. unemployment north 10%. Both of these factors conspire to put more downward pressure on inflation.
The Fed could also be hindered in delivering if Congress does not provide extra significant fiscal support. Lawmakers have approved $ 3 trillion in aid for workers, struggling businesses and the economy as a whole. But they failed to reach an agreement on a new package, even when provisions of the previous round expired.
What Bloomberg Economics says …
“This approach underscores previous concerns that low unemployment could lead to excessive inflation. This means that the first increase in interest rates may often not be visible for many years.”
– Yelena Shulyatyeva and Eliza Winger
Click here for the full report
“It is doubtful that they will soon be able to overcome inflation, and it is mostly out of their hands, in my view, if they are to get it even in the medium term,” Adam Posen, president of the Peterson Institute for International Economics, said reporters following Powell’s speech.
Ryan Sweet, head of monetary policy research at Moody’s Analytics, sounded equally dubious, and not just because of the pandemic.
“The Fed can say it wants inflation to surpass, but that does not mean it will happen,” he said. “Demographics and technology will push against inflation.”
Other economists remarked that Powell was silent about exactly what makes inflation above the 2% target. Unemployment hit 3.5%, half a century low, in 2019, and still inflation, measured by the Fed’s favorite, never rose above 1.6% that year.
“What is not obvious is exactly how the Fed intends to achieve sustained higher inflation” as opposed to promising to use the same tools as the Fed used in the recent downturn, Roberto Perli, a former Fed economist and now partner at Cornerstone Macro wrote in a note to clients.
“Those tools took us out of the Great Recession, but did not generate inflation,” Perli wrote. “It is possible that the Fed intends to use this tool in stronger doses, but there is also reason to believe that the power of this tool may be lower today than it was years ago.”
In their framework review, Fed officials have rejected, at least for now, alternative tools that other central banks have used, including negative interest rates and limiting the yields of certain government bonds.
James Bullard, president of the St. Louis Fed, offered a defense of the new strategy and its potential for success in an interview Thursday on Bloomberg Radio with Michael McKee. He said the approach could help raise inflation expectations among investors, a factor economists believe has a strong impact on inflation results.
“There was an observation both in markets, and perhaps also in the policy-making community, that 2% inflation was a kind of ceiling,” he said. “Inflation expectations should now be slightly raised in markets in response to this.”
Powell sounded a little more cautious when projecting the results.
“It is a very promising set of changes to deal with what is the reality of a very difficult macroeconomic context,” he said in an interview after his speech. “Time will tell, and our actions will finally tell it.”
– Assisted by Rich Miller, and Craig Torres
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