Federal Reserve Chairman Jerome Powell unveiled a new framework of thinking for the central bank that will tolerate inflation “moderately” above its 2% target. The Fed also committed to reviewing this policy every five years.
In a speech on Thursday morning, Powell acknowledged the painful lessons of runaway inflation in the 1970’s, but warned that the persistence of low inflation over the last eight years risks new economic difficulties.
“Many find it counterintuitive that the Fed would want to push up inflation,” Powell said. But the Fed chief warned that low inflation leads to declining inflation expectations, which has the effect of “diminishing our capacity to stabilize the economy through cutting interest rates.”
The Fed’s target for inflation is 2%, measured as core personal consumption expenditures (which excludes volatile components like energy and food prices). But since establishing that goal in its 2012 Statement on Longer-Run Goals and Monetary Policy Strategy, the Fed has averaged inflation of only about 1.6%, touching 2% only briefly in 2018.
In 2019, the Fed launched a nationwide listening tour to see if it could tweak its statement with the objective of nudging inflation up toward its target.
On Thursday morning, Powell announced the conclusion of that review and said the policy-setting Federal Open Market Committee had unanimously approved new language that would allow for inflation moderately above 2% “for some time” following periods where inflation “has been running persistently” below that target.
The strategy is known as flexible average inflation targeting, in part because the Fed will not use a particular mathematical formula to define a time horizon over which 2% inflation is achieved.
“Of course, if excessive inflationary pressures were to build or inflation expectations were to ratchet above levels consistent with our goal, we would not hesitate to act,” Powell said.
Powell emphasized in his speech that although the major changes address its Congressional mandate on price stability, the Fed still places a heavy priority on its other dual mandate of maximum employment.
The revised statement now says the Fed’s policy decisions need to be guided by assessments of “the shortfalls of employment from its maximum level.”
Powell’s remarks, delivered virtually to the Fed’s annual Jackson Hole meeting, describe the change as a reflection of “our view that a robust job market can be sustained without causing an outbreak of inflation.”
The Fed also added language that commits the FOMC to “use its full range of tools to achieve its maximum employment and price stability goals.” The statement will now also require the Fed to undertake a “thorough” review of the statement every five years.
The next scheduled FOMC will take place September 15 and 16.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.