Turning the page
Federal Reserve Chair Jerome Powell has tolled the bell for inflation-focused monetary policy. The world’s most powerful central bank on Thursday unveiled a new mission statement that targets labour markets more aggressively and will tolerate inflation overshoots. This spells ultra-easy policy more of the time.
The changes were the result of a review that lasted a year and a half and are underpinned by a belief that the big risk for the foreseeable future is not enough inflation, rather than too much. Crucially, the new mission statement, which was released as Powell delivered a speech at the Kansas City Fed’s annual economic conference, says a robust job market need not lead to galloping inflation.
The Fed’s policy decisions will now depend on its assessment of how much employment is falling short of maximum levels, rather than on deviations in either direction. That means the Fed will be quicker to react when joblessness is rising than when it’s falling.
This asymmetry recognises that some groups, such as the Black labour force, are generally the last to benefit when growth and employment rates pick up. Democratic politicians, among others, are increasingly asking the Fed to do what it can to reduce inequities like this, and Powell’s new direction is one way to attempt it with the fairly blunt tools at his disposal.
Granted, the Fed’s easy monetary policy since the financial crisis over a decade ago has failed to lift inflation sustainably even to the 2% target. And the central bank is hardly likely to raise interest rates during the ongoing global recession. But the new framework will outlast the pandemic. Moreover, other central banks will follow where the Fed leads.
For three decades, monetary policymakers have seen price stability, expressed as inflation targets, as their best contribution to economic prosperity. But as Powell pointed out in his speech, economic expansions have in recent decades been more likely to end with episodes of financial instability rather than runaway inflation.
That is, however, also the Achilles heel of the U.S. central bank’s new policy strategy. While the Fed acknowledges that the health of the labour market depends on a stable financial system, protracted periods of extremely low interest rates and easy money imply more financial-market booms and busts.