Fed's expansive experiment in strategy to get a reboot at Jackson Hole

Zawya

14 hours ago

The U.S. Federal Reserve's pivot toward the labor market in 2020 will get a reboot on Friday when Fed Chair Jerome Powell is expected to release a new framework for the central bank that accounts for a half-decade in which inflation surged, jobs were plentiful, and uncertainty became the watchword.
The new document may not completely discard the language rolled out when the Fed, in the midst of the pandemic and a burgeoning social justice movement, pledged not to short-circuit labor market gains on the mere threat of inflation in hopes of achieving "broad-based and inclusive" levels of employment.
But Powell has flagged that a recalibration is coming, potentially emphasizing stable inflation as a foundation for the best labor market results, and relegating some ideas to times when the economy is abnormally weak or inflation is abnormally low, as occurred in the decade before the pandemic.
In those years, as the Fed organized a nationwide series of community listening tours, staffers would ask about inflation and "people would look at us like we had two heads. It was not the topic" when employment and growth concerns were more paramount, said Duke University professor Ellen Meade, who helped organize the 2020 framework review as a top Fed adviser. "The world looks very different today."
Powell has already acknowledged that the language adopted in 2020 had been overtaken by the surge of inflation during the COVID-19 pandemic and was likely on its way out. He is expected to detail the new strategy document when he addresses an annual Fed research conference on Friday.
Minutes of the Fed's July 29-30 meeting released on Wednesday said the committee was close to finalizing changes to its statement of principles and reiterated that it "would be designed to be robust across a wide range of economic conditions."
The current approach has been criticized for introducing complexities that may have slowed the Fed's response to emerging inflation in 2021 and proved irrelevant to how the economy evolved during the pandemic.
Much of what was introduced in 2020, especially a controversial promise to allow periods of high inflation to offset low ones so it averages 2% over time, grew out of the Fed's experience trying to lift interest rates from near-zero where they had been mired after the 2007-to-2009 recession.
That approach may remain appropriate during prolonged economic weakness, said former Fed Vice Chair Richard Clarida, who helped oversee the last framework revisions. But the approach for normal times may revert to the more straightforward inflation-targeting the Fed previously used.
"A verbatim reading of the 2020 statement holds up pretty well operating in the environment the Fed had been operating in for a dozen years. Inflation below target. Secular stagnation," said Clarida, now global economic adviser for Pimco. But "2025 is not 2020. We have policy space."
The Fed's current benchmark rate is set between 4.25% and 4.50%, but had been a full percentage point higher last year, a level more in line with prior decades. From around March 2008 to September 2022 it was never above 2.5%.
RETHINKING TRADEOFFS
The challenge for Powell and the Fed now will be to avoid the appearance of giving up on the labor market in favor of an inflation-first approach.
The job market recovered slowly from the 2007-to-2009 crisis, but the unemployment rate eventually fell well below the level Fed officials regard as consistent with stable inflation.
Yet inflation remained tame, sparking a small revolution in thinking. Rather than seeing an inevitable tradeoff between inflation and jobs, policymakers decided they no longer needed to view a low unemployment rate as a sign of inflation to come. Job gains could continue until there were more obvious signs of rising prices.
As the pandemic threw millions out of work, Powell at the Jackson Hole forum in 2020 spoke about the Fed's "appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities," and described a new strategy that "reflects our view that a robust job market can be sustained without causing an outbreak of inflation."
The approach added to an emerging Republican critique of a "woke" Fed that downgraded price control to address income inequality. But it also was true to what the data suggested in the 2010s, and again more recently when the unemployment rate fell to very low levels even as inflation declined, defying many mainstream economists' predictions that high unemployment would be needed to lower inflation from its peak in 2022.
Though the Fed's two congressionally mandated goals of stable inflation and maximum employment are considered equally important, Powell has begun using a formulation in which stable inflation is described as necessary for the job market to reach its potential - an approach that would let the Fed justify steps to fight inflation as still consistent with its employment goals.
"Without price stability, we cannot achieve the long periods of strong labor market conditions that benefit all Americans," Powell said at the press conference following the Fed's July meeting.
Meade said that harkens back to an approach former Fed Chair Alan Greenspan used to try to balance the two sometimes conflicting priorities, even if the understanding of how low unemployment does or does not influence inflation has changed.
"You achieve price stability and that lays the groundwork for maximum employment...I do think Powell found his way back to that framing," Meade said. "You have to get to price stability first and that is in the front part of their brains."
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)