The Federal Reserve is adjusting its overall policy formulation framework
On May 15, local time, Federal Reserve Chairman Powell delivered a speech at the 2nd Thomas Laubach Research Conference.
In his speech, Powell focused on the central bank's last policy framework review in the summer of 2020. He pointed out that major changes have taken place in the past five years.
During this period, the Federal Reserve experienced a period of soaring inflation, which forced it to take historically aggressive interest rate hikes. Powell said that even if long-term inflation expectations are basically in line with the Federal Reserve's 2% target, the era of close to zero interest rates is unlikely to return in the short term.
He said that higher interest rates adjusted for inflation may reflect a possibility that future inflation may be more unstable than during the intermittent crisis in the 2010s.
Powell said that future inflation may be more volatile, and the US may be entering a period where supply shocks are more frequent and last longer. This is a tough challenge for both the economy and central banks.
Powell pointed out that although the Federal Reserve's benchmark policy interest rate is currently far above zero (currently in the 4.25% to 4.5% range), in recent decades, when the economy falls into recession, the Federal Reserve usually cut interest rates by about 500 basis points.
Powell emphasized the importance of maintaining inflation expectations at 2%, which was the core point of past assessments.
Powell said that the Federal Reserve will re-examine some aspects of the strategic framework based on the experience of the past five years, and will also consider improving the Committee's policy communication tools for predicting uncertainty and risk. In the current review, the Commission is discussing lessons learned from the past five years and plans to complete consideration of specific revisions to the consensus statement within the next few months.
Although the central bank governor did not mention President Trump's tariffs in his Thursday speech, he has indicated in recent days that tariffs may slow economic growth and drive up inflation. However, the extent of the impact of both measures is difficult to measure, particularly when Trump recently announced that he would drop the imposition of more aggressive tariffs before the 90-day negotiation window.
Below is the full text of Powell's speech (translated below by AI):
Good morning. I am very happy to welcome you all today. Thomas Laubach rightFederal Open Market Committee(FOMC) research and support has helped us better understand monetary policy, so it is very appropriate to continue this work under his name today. Thanks to the paper's authors, reviewers, and panelists, and special thanks to Trevor and his team for organizing this conference. It really took a lot of effort to get us together.
As we did in our previous assessment, the 2025 assessment also included three key elements: this meeting, Fed Listens events held at Federal Reserve Banks around the country, and discussions and deliberations among policymakers at a series of FOMC meetings supported by staff analysis. In the current assessment, we will re-examine several aspects of our strategic framework based on the experience of the past five years.
We will also consider possible enhancements to the Commission's policy communication tools, involving anticipation, uncertainty, and risk. The FOMC first systematically established our monetary policy framework in a document entitled “Statement of Long-term Objectives and Monetary Policy Strategy” in 2012, which we call the “Statement of Consensus.”
The opening wording of the statement has not changed, clearly expresses our commitment to fulfill the duties assigned to it by Congress, and clearly explains what we are doing and why we are doing it. Clear communication reduces uncertainty, increases the effectiveness of policies, and enhances transparency and accountability.
Under Ben Bernanke's presidency, the Leadership Council developed this initial consensus statement, established a 2% inflation target, and spelled out how we can fulfill the dual responsibilities assigned to us by Congress. The framework is broadly consistent with the best practices of flexible inflation-targeting central banks.
The structure of the economy evolves over time, and the strategies, tools, and communication methods of monetary policy makers must evolve with it. The challenges brought about by the Great Depression are different from those during the period of high inflation and the “Great Easing” period; these are all different from the challenges we face today.
A good framework should be able to adapt to various economic conditions, and it also needs to be updated regularly as the economy and our understanding of the economy changes. From 2012 to 2018, the FOMC voted to reconfirm the consensus statement at its January meeting in most years, but there were few substantive changes. In 2019, we changed this approach and conducted our first public assessment, and said we conduct such assessments approximately every five years.
Every five years is not for some magical reason; rather, we think this frequency is appropriate to re-evaluate the structural characteristics of the economy and communicate with the public, practitioners, and academia about the performance of our framework. Some of our global peers have adopted similar framework review mechanisms.
At the time of the last assessment, we had been living in a “new normal” for about ten years, characterized by low interest rates close to the effective lower limit, low growth, low inflation, and a very flat Phillips curve. If one statistics were to be used to summarize that period, it is that since the 2008 global financial crisis began, policy interest rates remained at the lower limit for a full seven years.
After starting the rate hike in December 2015, we slowly raised interest rates to a peak of 2.4% in just three years. After just seven months, we began cutting interest rates again, and by the end of 2019, the policy interest rate had dropped to 1.6%. This level continued until the COVID-19 pandemic broke out a few months later. Policy interest rates in other major developed economies were even lower at the time, and in many cases negative, and inflation rates in all of these economies were often below target levels.
The consensus at the time was that even if the economy experienced a slight recession, we would soon fall back into the lower interest rate limit, and probably continue for many more years. The decade after the financial crisis has shown how painful this situation can be. When the economy is weak, inflation often falls, and nominal interest rates are close to zero, which can push up real interest rates, further inhibit employment growth, and increase downward pressure on inflation and expectations.
Given the downside risks to employment and inflation posed by being close to the lower limit, and the need to keep inflation expectations anchored at 2%, we adopted a policy at the time to make up for the shortfall below the inflation target for a long time. This practice is very common in the literature on lower limit risk.
Considering this risk, we said that after a long period of inflation below 2%, we may target inflation slightly above 2% for a period of time.
We also decided that policy decisions would be based on an assessment of “below maximum employment” rather than an assessment of “deviating from maximum employment.” This change in expression does not mean permanently abandoning preventative interest rate hikes or ignoring labor market tension; rather, it suggests that the labor market alone is not sufficient to trigger policy responses alone.
Unless the Commission believes that unchecked inflationary pressure will cause worrying inflationary pressures, it will not adjust policy as a result. This change reflects our experience during a long period of economic expansion: even if the unemployment rate is at a historically low level, as long as inflation remains low and stable, we can continue to maximize employment without worrying about price stability being damaged.
For example, in the years before the pandemic, the unemployment rate had fallen to a decades-low level, while inflation was still below 2%. By December 2019, estimates of the long-term natural unemployment rate had been significantly lowered. This focus on “shortfalls” (shortfalls) reflects the reality that a combination of low inflation and low unemployment does not necessarily create an unfavorable trade-off for monetary policy.
The economic conditions that brought us closer to the lower limit and the reasons driving us to adjust the consensus statement were originally thought to be global factors that slowly evolved over a long period of time, and are expected to continue until the next five-year review. Had it not been for the outbreak, this situation is likely to continue as predicted.
The idea of “intent to moderately exceed goals” has failed to play a role in policy discussions in reality, and this has been the case since then. Shortly after we announced this framework change in 2020, there was a sharp rise in global inflation, which was neither “intentional” nor “moderate.” I publicly acknowledged this in December 2021.
We are once again relying on another part of the framework, the traditional inflation targeting system. Until the end of 2021, FOMC participants are still predicting a rapid decline in inflation in 2022, and our policy interest rate will rise only moderately. This forecast is consistent with other central banks and the vast majority of economic forecasting agencies with different policy frameworks.
And when the facts showed that this was not the case, we raised the policy interest rate by 525 basis points within 16 months. Recent data shows that the PCE inflation rate for the 12th month of April was 2.2%, far below the peak of 7.2% in 2022. This is a welcome and extremely rare result in history — as everyone here knows — that this fall in inflation has not been accompanied by a sharp rise in unemployment, which in the past was usually characteristic of austerity cycles.
The economic environment has changed significantly since 2020, and this assessment will reflect our understanding of those changes. Long-term interest rates have now risen markedly, mainly driven by rising real interest rates, while long-term inflation expectations are relatively stable. Estimates of the long-term neutral level of policy interest rates have generally increased, and this is also reflected in the summary of economic forecasts.
Higher real interest rates may also reflect the possibility that future inflation may be more volatile than the period between the two crises of the 2010s. We may be entering a period where supply shocks are more frequent and more persistent, and this will be a difficult challenge for the economy and central banks.
Although the current policy interest rate is far above the lower limit, in the past few decades, every time the economy recedes, we have cut interest rates by an average of about 500 basis points. Therefore, although being limited to a lower limit is no longer a basic scenario, it is still necessary for us to maintain mechanisms to deal with this risk in the framework.
Although the framework requires constant evolution, some of its elements are timeless. After experiencing “big inflation,” policymakers are keenly aware of the importance of keeping inflation expectations at an appropriately low level. During the “Great Easing” period, stable inflation expectations enabled us to provide policy support for employment without causing the risk of inflation getting out of control.
Since the “Great Inflation,” the US economy has experienced three of the four longest periods of expansion in history. Anchored inflation expectations played a key role. One step closer, without this anchoring, we wouldn't be able to reduce inflation by about 5 percent without triggering a surge in unemployment.
Keeping long-term inflation expectations anchored was an important driver when we set our 2% target in 2012. Maintaining this anchoring is still one of the main considerations in the 2020 framework change.
Anchored inflation expectations are critical to all of our policy work, and we remain firmly committed to achieving the 2% inflation target today. In the current assessment, the Commission is discussing lessons learned over the past five years. We plan to complete the review of specific changes to the consensus statement in the next few months. We are paying particular attention to the changes in 2020 and will consider how to make important and definitive updates to the consensus statement based on changes in our understanding of the economy and the public's understanding of these changes.
In discussions so far, participants generally agreed that the expression “shortfalls” (shortfalls) should be reconsidered. At last week's meeting, we had a similar discussion on “average inflation targeting” (average inflation targeting). We will ensure that the new consensus statement remains resilient in the face of various economic environments and developments.
In addition to revising the consensus statement, we will also consider potential improvements in formal policy communication, particularly in terms of predictive and uncertain expressions. In evaluating the 2020 Framework and recent policy decisions, a common view is that as complex events evolve, more clear communication is needed.
While academics and market participants generally agree that FOMC communication is generally effective, there is always room for improvement. In fact, even in times of relative calm, clear communication is still essential. One key question is how to make the public better understand the uncertainty facing the economy.
In times of greater impact, more frequent, and more complex, effective communication requires us to clearly communicate the uncertainty in our perception of economic conditions and prospects. We will be looking for further improvements in this area.
Finally, allow me once again to thank everyone for coming. We are very much looking forward to this meeting and to the discussions that will take place over the next two days. These discussions will help broaden and deepen our thinking on these issues, which is critical to the success of our assessment work. Thank you all so much.
