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Powell talks down the economy as often as he can: Economist on Jackson Hole

Federal Reserve Chairman Jerome Powell announced a major policy shift to "average inflation targeting" on Thursday. Vincent Reinhart, Mellon Chief Economist and Macro Strategist joins Yahoo Finance's On The Move panel to discuss.

Video Transcript

JULIE HYMAN: Let's talk more now about the change at the Federal Reserve in terms of inflation targeting. Vincent Reinhart is joining us now. He's Mellon chief economist and macro strategist. He is joining us from Florida. He also is a former Federal Reserve official.

So we have talked a lot today about how this wasn't necessarily a shock, right? That the Fed is sort of following on a number of years where it wasn't seeing 2% inflation. That said, as someone who was previously inside the Fed, can you give us some insight here as to how big of a change it is from that perspective. Even if it's not a huge surprise, is this a big change for the Fed?

VINCENT REINHART: Yeah, it's an incremental change. And I think it's important to work backwards. What do monetary policy makers worry the most about at this point in the business cycle? And that is investors getting ahead of themselves.

We're looking at improving data and coming to believe the Fed would tighten too soon. So you want to control that risk. One way Jay Powell does it is he talks down the economy as often as he can about the long-run headwinds on activity and the like.

The other way is he just says he's not thinking about thinking about raising rates. Still another way is to rewrite your goals in a way that will tolerate some overshoot of inflation. That's what they did today by targeting average inflation.

BRIAN CHEUNG: Vincent, it's Brian Cheung here. I wanted to ask more specifically about maybe if there's anything to be gleaned backwards looking from the announcement today. It seemed like there were certain changes to the long-run policy statement that might hint that the Federal Reserve regrets the interest rate hikes that it made in 2015, and then again in 2018. Wondering what your interpretation is of that.

VINCENT REINHART: Generally, you never say you're sorry, because it only invites more criticism. I think the main message to take away is that Jay Powell's buying himself a little bit more flexibility. His two immediate predecessors were all about the science of monetary policy. Let's be specific about the role.

But what he told us is, well, you really can't measure maximum employment. You're gonna have to look at a wide range of indicators. And the Fed would be willing to tolerate inflation going above its goal, just so as long as on average, it's 2%.

But did he explain what the average is? How much they'd be willing to tolerate inflation going above goal? How long he'd be willing to tolerate inflation above goal? Buying himself a little space. And in that sense, it's more back to the future.

JULIE HYMAN: Vince, I also want to come at this from another angle, which is potential moral hazard of leaving rates as low as they are for as long as they have been and potentially boundlessly into the future. We talked yesterday to Bill Campbell of DoubleLine Capital. And one of his theses is that what the Fed is doing-- not just the Fed, but central banks around the globe-- is not helping-- it's not flowing to small and medium businesses, for example.

We know it's flowing into the markets. We have seen equities certainly benefit. But that the income gap and wealth gap might actually be widening as a result of what the Fed is doing. Do you think that the Fed is cognizant enough of this? And is there anything they can do about it?

VINCENT REINHART: Well, the bad news is in the traditional transmission mechanism. It all goes through financial markets. That is the lever the Federal Reserve has. And it can be summarized kind of cruelly by saying the Fed's policy tool is to make the wealthy wealthier-- i.e. you stimulate markets.

They're uncomfortable with that, obviously. You wouldn't put that on the side of a building. So they're emphasize-- they emphasize really two things.

One is they're going to be at the effective lower bound more often than previously thought. And that is essentially trend growth slower. People are uncertain. That's the time you should save more and invest less. And the market outcome, more saving and less investment, is lower market rates. That's where we are.

If that's the case, then the Fed needs to be willing to use its other policy tools. So I think they would say yes, the traditional transmission of monetary policy can worsen inequities, can worsen income distribution. However, they can use other tools as well to provide some support, i.e. the 11 facilities they have going.

And then the last point I think Jay Powell would make is to say yeah, but Janet Yellen showed that when you run an overheated labor market, it benefits everybody. And so that's how the Fed is going to do it-- make its most progress toward income inequality, making sure the economy is firing all cylinders.

BRIAN CHEUNG: Vincent, I want to ask about communication. So there's an argument to be made that all this is all about inflation expectations, managing inflation expectations in the future, not necessarily right now. There was nothing about the announcement this morning that's at an actual policy decision. So from that aspirational standpoint, how is inflation targeting or flexible average inflation targeting, as they announced this morning, an easier thing to communicate to the average person than prior to that, which was we have an inflation target of 2% and it's symmetric?

VINCENT REINHART: Or it may have been even easier when it was Volcker and Greenspan saying price stability is when people are not worried about changing price-- changeable prices. I think average inflation is a more difficult concept. You're exactly right. And that's why I meant earlier he's buying himself more space to be flexible. He's buying some discretion.

Also notice that back in 2012 when they first wrote this statement, the expectation was it would be written in stone. This is the longer-run strategy for monetary policy. Every year, the committee will endorse it. But they wouldn't be tinkering with it every year.

This version is very situational. It talks about where they are right now, effective lower bound. They talk about average inflation targeting. But they only give the example from below. Given an average and now that we're below average, we'll tolerate an overshoot.

There's two ways to take that. One is OK, it's the situ-- it's the problem in the moment. The other is they're showing what is the credibility problem of an average inflation targeter. You're willing to overshoot when you were below.

But do you think the Fed, if inflation were above 2% and it got down to 2%, it would continue to tighten monetary policy to get on average inflation at 2%? Probably not. It's not a symmetrical.

JULIE HYMAN: Vincent, thank you so much. It's great to see you, as always. Vincent Reinhart is Mellon chief economist and macro strategist. Thanks.

VINCENT REINHART: Thanks for having me.