Fed Chair Sets Stage for Longer Periods of Lower Rates

Jerome H. Powell, the chair of the Federal Reserve, announced a major shift in how the central bank guides the economy, signaling it will make job growth pre-eminent and will not raise interest rates to guard against coming inflation just because the unemployment rate is low.

In emphasizing the importance of a strong labor market and saying the Fed will tolerate slightly faster price gains, Mr. Powell and his colleagues laid the groundwork for years of low interest rates. That could translate into long periods of cheap mortgages and business loans that foster strong demand and a solid job market.

The changes, which Mr. Powell detailed at the Kansas City Fed’s annual Jackson Hole policy symposium, follows a year-and-a-half long review of the central bank’s monetary policy strategy. In conjunction with his remarks, the Fed released an outline of its long-run policy plan.

“Our revised statement emphasizes that maximum employment is a broad-based and inclusive goal,” Mr. Powell said in the remarks. “This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities.”

Market reaction to Mr. Powell’s announcement was mixed. Investors had already penciled in years of rock-bottom interest rates and analysts will be watching for more concrete rate guidance at the Fed’s upcoming meetings.

Still, Mr. Powell’s announcement could mark a defining moment in his tenure as chair, which began in early 2018 in the midst of the longest economic expansion on record and has run straight into the sharpest downturn since the Great Depression. The Fed raised rates nine times between 2015 and late 2018, with four of those increases under Mr. Powell’s watch, as it tried to guard against inflation. Price increases instead stagnated, making the Fed’s moves seem like overkill and helping to inspire and inform the policy review.

The central bank is facing major long run challenges as price gains prove tepid and as interest rates have slipped lower across advanced economies including the United States, leaving Fed officials with less room to cut borrowing costs and coax higher growth following recessions. Those slow-burn problems are what prompted Mr. Powell and his colleagues to revamp their policy framework. At the same time, the coronavirus pandemic has created a significant short-run threat, shuttering businesses and costing millions of people their jobs.

Mr. Powell’s announcement codifies a critical change in how the central bank tries to achieve its twin goals of maximum employment and stable inflation — one that could inform how the Fed sets monetary policy in the wake of the pandemic-induced recession.

The Fed had long raised rates as joblessness fell to avoid an economic overheating that might result in breakaway inflation — the boogeyman that has haunted monetary policy ever since price gains hit double-digit levels in the 1970s. But the Fed’s updated framework recognizes that too low inflation is now the problem, rather than too high.

“It seems like a pretty subtle shift to most normal human beings,” said Janet L. Yellen, the former Fed Chair. But “most of the Fed’s history has revolved around keeping inflation under control. This really does reflect a decisive recognition that we’re in a very different environment.”

[Read more about how the Fed’s view on inflation has been shifting.]

The Fed’s revised statement says that its policies will be informed by “shortfalls” of employment from its maximum level, rather than by “deviations” — suggesting that the central bank is no longer planning to raise rates to cool off the economy simply because unemployment has dipped to low levels.

The central bank is also formally shifting its inflation approach, aiming to average 2 percent inflation over time, rather than as an absolute goal. In doing so, the Fed is trying to convince the public and investors that it will allow prices to rise a little bit faster. If public inflation expectations slip, it can lock in slow increases. Those feed directly into the level of interest rates, and leave the central bank with even less room to cut them during times of crisis.

“If inflation expectations fall below our 2 percent objective, interest rates would decline in tandem,” Mr. Powell said. “In turn, we would have less scope to cut interest rates to boost employment during an economic downturn.”

Higher inflation may seem like an odd goal to anyone who buys milk or pays rent, but excessively weak price gains can actually have damaging effects on the economy. A circle of stagnation has played out in countries including Japan, in which lower price gains leave less room to cut rates, limiting policymakers’ ability to stimulate the economy and resurrect inflation.

“We are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes,” Mr. Powell said. “However, inflation that is persistently too low can pose serious risks to the economy.”

In a question-and-answer session after the speech, Mr. Powell said the Fed was “talking about inflation moving moderately.”

If the Fed can achieve slightly higher price gains, it will translate into more room for future rate cuts — and buying that extra headroom is a crucial goal in 2020. Long-running economic changes, such as an aging population with different saving habits and weaker productivity gains, have weighed on the interest rate setting that neither stokes nor slows the economy. That has left the central bank with less recession-fighting wiggle room.

Still, Mr. Powell pointed out that he and his colleagues “are not tying ourselves to a particular mathematical formula that defines the average.”

Some economists questioned whether the Fed will actually manage to achieve its new inflation target.

“The Fed is announcing this policy framework in part to push up inflation expectations,” said Seth Carpenter, a former Fed research official now at UBS. “In practice, however, getting above 2 percent is a long way off.”

Many of the changes the Fed announced Thursday formalize an approach it has edged toward over the past decade. The Fed was patient in beginning to lift interest rates following the recession from 2007 to 2009, even as unemployment fell.

When it did start to raise borrowing costs in late 2015, under Ms. Yellen, it did so slowly.

Under Mr. Powell’s leadership, the Fed has increasingly emphasized the benefits of that strong labor market, which pulled long-sidelined workers into jobs and helped to foster strong wage growth for those who earn the least.

Ms. Yellen, who has long argued that a strong labor market could boost marginalized groups, said the Fed’s shift is “great” and “a recognition that tight labor markets are beneficial.”

The long-run document promises that the central bank will continue to hold reviews, roughly every five years, and will continue to consult the public as it has done over the past year through its “Fed Listens” events.

“Public faith in large institutions around the world is under pressure,” Mr. Powell said in a question-and-answer session following his speech. “Institutions like the Fed have to aggressively seek transparency and accountability to preserve our democratic legitimacy.”

The Fed also explicitly noted in its statement that financial stability ranks among its key goals. In recent decades, expansions have ended when asset price bubbles — like the mid-2000s housing boom — got out of control, rather than at the hands of too-high inflation.

“Sustainably achieving maximum employment and price stability depends on a stable financial system,” the Fed said in its statement. “Therefore, the committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the committee’s goals.”

Mr. Powell’s remarks, and the Fed’s shift, are set against an unhappy backdrop that has highlighted the central bank’s limits.

Fed officials have taken action to support the economy as the pandemic-induced downturn drags on — cutting interest rates to near-zero, buying government-backed bonds in vast sums, and rolling out emergency lending programs. Still, more than one million people filed initial state jobless claims last week, data released Thursday morning showed.

The Fed has repeatedly emphasized that a strong job market and economy is an imperative goal, but that Congress will need to help achieve it.

“It is hard to overstate the benefits of sustaining a strong labor market, a key national goal that will require a range of policies in addition to supportive monetary policy,” Mr. Powell said.

He added that there was a strong economy under the surface of the ongoing weakness.

“We will get through this period, maybe with some starts and stops,” he said. Still, “we’re looking at a long tail” as people who work in industries heavily impacted, like travel and service, struggle to find new work in a process that could take years.

“We need to support them,” Mr. Powell said.

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