U.S. Federal Reserve Chairman Jerome Powell announced on Thursday that the central bank will seek to achieve inflation that averages 2 percent over time, a new policy strategy that will likely keep short-term interest rates near zero for years.
“Following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time,” Powell said in remarks to the Kansas City Fed’s annual Jackson Hole research conference, which is held virtually this year because of the pandemic.
“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,” he said.
The new approach came after the Federal Open Market Committee (FOMC), the Fed’s policy-making committee, on Thursday formally approved a revamp of the central bank’s statement on longer-run goals and monetary policy strategy following a yearlong review of its monetary policy framework.
The revised statement also shows that the Fed’s policy decision will be informed by the “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level” in the previous statement, Powell noted.
“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 said.
“Average inflation targeting signals that the Fed will tolerate inflation moderately above 2% to make up for past undershoots, resulting in lower real interest rates and more accommodative monetary policy, all else equal,” Sam Bullard and Michael Pugliese, economists at Wells Fargo Securities, wrote Thursday in an analysis.
“In practice, however, the move is less monumental than meets the eye: for more than three years, the FOMC has stressed the ‘symmetric’ nature of its 2% target in its statements,” they wrote, adding they view the Fed’s shift to average inflation targeting as the codification of a policy the central bank had already de facto adopted.
“One thing does seem fairly certain amid these changes: the Fed seems unlikely to tighten monetary policy for quite a long time,” they noted.
While this may seem a small technical adjustment to policy, it carries significant long-run consequences for the American economy, said Joseph Brusuelas, chief economist at accounting and consulting firm RSM US LLP.
“It gives the central bank a tremendous amount of flexibility to respond to exigent circumstances such as a massive second wave of the pandemic next winter or to address another policy fail by the fiscal authority if the current policy polarization in Washington, D.C. endures,” Brusuelas said.
While the extra federal unemployment benefits for roughly 30 million Americans expired at the end of July, congressional lawmakers and the Trump administration remain deadlocked over the next COVID-19 relief package.
“The longer it takes to convince lawmakers that the economy is not experiencing a V-shape recovery and that without their support a W-shape is likely, the more likely it will suffer a W,” said Mark Zandi, chief economist of Moody’s Analytics, referring to a double-dip recession.
The U.S. economy contracted at a revised annual rate of 31.7 percent in the second quarter amid mounting COVID-19 fallout, the U.S. Commerce Department reported Thursday.
The Fed last month kept its benchmark interest rate unchanged at the record-low level of near zero while warning that a recent resurgence in COVID-19 cases nationwide started to weigh on economic recovery.
The Fed cut interest rates to near zero at two unscheduled meetings in March and began purchasing massive quantities of U.S. treasuries and agency mortgage-backed securities to repair financial markets. It also unveiled new lending programs to provide up to 2.3 trillion U.S. dollars to support the economy in response to the coronavirus outbreak.