Nick Timiraos stated that in a world where it is no longer certain whether there will be ultra-low interest rates, Powell is guiding a new Global Strategy. The Federal Reserve is about to adjust its framework for setting interest rates, which is unlikely to affect current policy decisions, but acknowledges that the era of 'long-term low rates' may have ended. This review by the Federal Reserve reflects on the shortcomings of the framework established in 2020—especially its failure to adapt to a wide range of economic scenarios, even when those scenarios seemed unlikely to occur at the time. This review is expected to retain the core concepts of the Federal Reserve's framework, including the 2% inflation target, and ensuring that the public believes the Federal Reserve will maintain low and stable inflation as a key mission.
On Thursday, Federal Reserve Chairman Jerome Powell stated that given the significant changes in the inflation and interest rate outlook following the COVID-19 pandemic, the Fed is working to adjust its overall policy-making framework. "Since 2020, the economic environment has changed significantly, and our review will reflect our assessment of these changes."
Nick Timiraos, a well-known financial journalist referred to as the "new Federal Reserve press agency," wrote that in the face of uncertainty about whether there will still be ultra-low interest rates, Powell is guiding a new strategy. The Federal Reserve is about to adjust its interest rate formulation framework, and while it is unlikely to affect current policy decisions, it acknowledges that the "era of long-term low interest rates" may have ended.
Timiraos explains that the "framework" referred to by Powell pertains to the overall strategy of the Federal Reserve for setting interest rate policy:
The responsibility given to the Federal Reserve by the USA Congress is to maintain low and stable inflation while promoting a healthy labor market. The means by which these goals are achieved are mainly decided by the Federal Reserve itself. Since 2012, the Federal Reserve has articulated its approach to achieving these goals through a framework statement.
The current policy framework of the Federal Reserve was adopted five years ago, and a review of this framework began this year. This review is not expected to affect the Fed's current interest rate decisions. Powell had previously stated that the review process could be completed in August or September, with results announced.
In his speech on Thursday, Powell hinted that the Federal Reserve would retract some key changes made five years ago.
Powell made these remarks at a research meeting held at the Federal Reserve's headquarters in Washington. Timiraos noted that during the meeting, officials would hear recommendations from leading policy theorists and discuss potential adjustments to the Fed's policy framework and communication tools.
Timiraos referenced Powell's speech of the day and outlined some key points.
Powell pointed out that the higher real interest rates (i.e., inflation-adjusted rates) that emerged after the 2020 pandemic may render certain elements of the current framework meaningless.
Higher real interest rates may reflect a future inflation that could be more volatile than during the crisis periods of the 2010s. We may be entering a period where supply shocks are more frequent and potentially more lasting, which poses a difficult challenge for both the economy and the central bank.
At last week's meeting, officials (of the Federal Reserve) suggested that the 'average inflation targeting' adopted five years ago should be revised. The idea of intentionally allowing inflation to exceed targets moderately has become irrelevant in policy discussions and remains so up to this day.
If the public does not believe that inflation will return to pre-pandemic levels, it will not be possible to achieve the recent decline in inflation without a surge in unemployment.
Timiraos wrote in the article:
The Federal Reserve meets every six to eight weeks to vote on whether to adjust interest rates and issues a policy statement explaining the reasoning behind decisions. This framework review focuses on another document that is typically reissued each January, outlining the fundamental way the Federal Reserve sets interest rates.
The Federal Reserve officially set a 2% inflation target in 2012. However, the global long-term low interest rate environment following the 2007–2009 financial crisis raised concerns among officials regarding the viability of this target: with rates often close to zero, the Federal Reserve may lack tools to stimulate growth during economic downturns.
Therefore, the Federal Reserve can more easily curb economic overheating through interest rate hikes in many situations, while stimulating the economy during economic weakness becomes more difficult. Six years ago, the Federal Reserve launched its first 'framework review', lasting one year, aimed at addressing this asymmetry.
Under Powell's leadership, the Federal Reserve adopted a new policy framework in 2020, making a seemingly minor but important change. At that time, even in a very low-interest-rate environment, inflation was below the 2% target. Therefore, the Federal Reserve adopted a 'compensatory' strategy: even if models suggested higher interest rates, they would keep rates low, allowing inflation to slightly exceed the 2% target. Officials agreed to revisit the framework every five years.
The economic restart after the pandemic in 2021 rendered the main changes of the 2020 framework inapplicable. In November 2021, inflation in the USA reached 6%. This 'exceeding' was driven by strong demand and disrupted supply chains, situations that were not anticipated when the framework was established.
This review by the Federal Reserve is a reflection on the shortcomings of the 2020 framework—particularly its failure to adapt to a range of broad economic scenarios, even if those scenarios seemed unlikely at the time.
However, this review is expected to retain the core concepts of the Federal Reserve framework, including the 2% inflation target and ensuring public confidence that the Federal Reserve will maintain low and stable inflation as a key task. Officials believe this inflation expectation has self-fulfilling characteristics and is the main reason for achieving inflation decline over the past two years without significantly increasing unemployment.
Editor/lambor
