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- The Federal Reserve updated its monetary policy framework on Thursday to better guide the US inflation rate, reach maximum employment, and pad against future economic downturns.
- The central bank will now target an inflation rate that averages 2% over time, Chairman Jerome Powell said in a keynote speech at the Fed’s annual conference in Jackson Hole, Wyoming. The previous policy set a stricter target of 2% inflation.
- The new framework reflects the Fed’s hope to drive “a strong labor market” and to sustain low unemployment “without causing an unwelcome increase in inflation,” Powell said.
- Allowing the inflation rate to run above 2% for periods of time should grant the Fed more leeway to cut its interest rate in the event of an economic shock.
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Federal Reserve Chairman Jerome Powell revamped the central bank’s policy framework on Thursday to better handle the US inflation rate and achieve maximum employment.
The Fed will now target an inflation rate that averages 2% over time, differing from its previous goal of maintaining inflation at 2%, Powell said during the Fed’s annual conference in Jackson Hole, Wyoming.
The new strategy is a significant change from the central bank’s previous target and signals that the Fed will actively combat inflation that runs too low, as opposed to its previous concerns of prices increasing too quickly.
Under the new approach, the Fed accepts that a robust labor market can exist without unwanted spikes in inflation; the past rulebook viewed the two as somewhat mutually exclusive. The central bank’s new statement indicates that it will be more lenient in guiding inflation to allow for a healthier labor market.
“Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation,” Powell said.
The US inflation rate trended below the Fed’s 2% goal for several quarters as the unemployment rate sat at historic lows. The central bank’s new framework means policymakers would allow inflation to trend above 2% for some time to balance out periods of weaker price growth.
The framework also aims to better equip the Fed to combat future downturns. Powell said that under the Fed’s previous guidelines, targeting a flat 2% rate without allowing for overshoots left the bank with little monetary policy ammunition for economic crises. With inflation below its goal before the pandemic, the central bank had less room to cut its benchmark interest rate before reaching zero.
The central bank established an unprecedented lineup of lending facilities and undertook historic asset purchases to further pad against the pandemic’s fallout. But economists fear that the unwinding of such efforts could introduce volatility to markets. The hefty monetary relief efforts also spiked government borrowing and frightened federal budget hawks.
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Thursday announcement came nearly two years after the Fed announced a comprehensive review of its monetary policy strategy. The central bank conducted several town-hall-type events to judge how monetary policy was affecting workers and business owners. The framework updates account for goals established before the pandemic and for those that emerged in the pandemic’s wake, Powell said.
The Fed also announced that it would undertake a public review of its policy tools and strategy every five years.
“Time is going to tell, and what we do going forward is really going to decide the effectiveness of the changes we’ve made,” Powell said in a follow-up conversation after his keynote speech.
He continued: “It’s a very promising set of changes to deal with, what with a reality of a quite difficult macroeconomic context of low interest rates, low inflation, relatively low productivity, slow growth, and those kinds of things.”
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