Federal Reserve chief to outline plans for inflation, economy
Federal Reserve Chairman Jerome Powell is set to preview a significant shift in the bank’s approach to price and wage increases as the Fed faces intense political pressure.
In a Thursday speech, Powell is expected to lay out how the Fed plans to fight years of low inflation that the bank fears could weaken the U.S. economy’s long-term growth potential.
Fed watchers expect Powell to explain how the Fed will aim for an average of 2 percent annual inflation, its target for nearly a decade, instead of constantly trying to push inflation toward that specific level. The new approach means the Fed may allow inflation to run above 2 percent for longer periods of time instead of raising rates to prevent inflation from exceeding its target.
The Fed’s shift has been in the works for nearly two years. Powell and top Fed officials have acknowledged that long-held views about the connection between low unemployment and high inflation cannot explain why price and wage increases failed to meet the Fed’s target despite a 50-year low in joblessness.
The Fed’s new approach is intended to maximize the economy’s ability to add jobs and boost wages while giving the Fed more room to fight future downturns.
“What they’re really striving for is not higher cost of living per se,” said Skanda Amarnath, director of research and analysis at Employ America, a nonprofit that advocates for Fed policies to maximize job growth.
“It’s really that in the event that we have slightly higher inflation, we’re also going to see higher wage growth, higher nominal [gross domestic product] growth, and it’ll also be associated with slightly better outcomes across the board.”
But following through on that plan will be a daunting challenge for the Fed as it already faces heightened scrutiny over its response to the coronavirus recession.
The Fed’s swift rate cuts and emergency lending programs have helped foster a much quicker recovery for the financial sector than struggling small businesses and local governments, irritating Democrats. Conservatives have also grown alarmed about the inflationary risks of the Fed’s response, making the Fed’s new approach a risky political gamble with Republicans who are also facing the prospect of a brutal 2020 election.
“I don’t think Powell and the Fed can count on that continuing political support,” said Sarah Binder, a political science professor at George Washington University.
“It remains to be seen how strong Republican support for Powell’s approach will be should Republicans find that they’ve lost the White House come November,” she added.
Powell is expected to outline the broad strokes of the Fed’s new strategy during the virtual adaptation of the central bank’s annual summit in Jackson Hole, Wyo. Hosted by the Federal Reserve of Kansas City, the summit traditionally gathers leading central bankers and monetary policy experts for economic seminars set against stunning Rocky Mountain scenery.
Due to the pandemic, the summit will be conducted virtually, giving the general public its first chance to watch the gathering typically convened out of the eye of broadcast cameras and out of reach of the political news cycle.
“Jackson Hole, whether it’s virtual or real, is about monetary policy, and how best to make it,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research consultancy that analyzes Fed policy.
“The [Federal Open Market Committee] makes it,” she continued, referring to the Fed’s policymaking arm. “Jackson Hole is about how to do that better.”
Powell’s decision to lay out the Fed’s new approach to price and wage increases at the adapted Jackson Hole summit has, perhaps ironically, inflated expectations about the chairman’s remarks. But Fed experts caution that Powell is unlikely to do more than formalize a shift in the Fed’s thinking that has been in the works for several years.
The Fed has long approached its dual mandate of price stability and maximum employment as a tradeoff between inflation and joblessness. Times of low unemployment and low interest rates were seen as threats to price stability, prompting the Fed to raise interest rates to avoid spikes in inflation.
That view was largely shaped by the legacy of former Fed Chairman Paul Volcker’s crusade against staggering inflation during the early 1980s, which topped 10 percent annually. The Fed under his watch hiked rates to induce a recession that slowed the economy but also the pace of price increases.
Several of Volcker’s successors sought to avoid the need to deploy another round of shock therapy and favored raising interest rates to get ahead of inflation spikes. Even Powell and former Fed Chair Janet Yellen, each of whom supported keeping interest rates near zero for nearly eight years after the 2008 recession began, raised rates nine times between 2015 and 2018 as unemployment dipped below the Fed’s target of 5 percent.
Even so, the connection between falling unemployment and rising prices and wages did not materialize. Annual wage growth for all nonfarm employees lingered near a meager 2.5 percent during former President Obama’s second term and rose to a respectable 3 percent during President Trump’s first term as unemployment hit a 50-year low of 3.5 percent.
“They’re still kind of dealing with a fundamentally difficult problem of trying to motivate more spending in the economy purely through nominal interest rate changes, and they don’t have that much space to do that in a way that they did during the days of Volker,” Amarnath said.
Fed experts say if the new approach is successfully employed, it will allow periods of strong growth to make up for lost wage increases that would have happened had the bank not raised rates to prevent prices from rising too quickly. Doing so would also increase inflation expectations, which could encourage spending and give the Fed more room to respond to future crises.
But experts also warn that the uncertain future for the U.S. economy and the Fed’s historic troubles with keeping prices and wages growing at a stable rate will complicate efforts to deploy and explain the new approach.
“It’s a good idea in principle to acknowledge the need to allow the inflation rate sometimes to rise above its long-run target, said George Selgin, director of the Center for Monetary and Financial Alternatives at the libertarian Cato Institute.
“But on the other hand, it should be recognized that it seems easier said than done,” he continued. “Merely announcing their willingness to let the inflation rate rise above target is not itself necessarily a formula for actually getting it to do so.”
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