US: Federal Reserve Chairman Jerome Powell Speech

August 27, 2020 08:10 CDT

Federal Reserve Chairman Jerome Powell to deliver a speech entitled "Monetary Policy Framework Review" at the 44th annual Economic Policy Symposium - "Navigating the Decade Ahead:Implications for Monetary Policy". Held online instead of the traditional Jackson Hole venue, the event will be live-streamed.

In conjunction with Jerome Powell's address, the Federal Reserve released the text of revisions to its policy framework which, like many expected, mark a shift in how the FOMC targets inflation, that is moving from a set target to an average that allows inflation, following sustained periods of weakness such as now, to exceed the FOMC's 2 percent long-term goal.

Stressing the need for clarity of communications, the statement reasserts the primary role of the federal funds rate when adjusting policy noting, however, that the rate, currently targeted between zero and 0.125 percent, is now being constrained by its lower bound, in turn raising the risk, according to the Fed, that downward pressures on employment and inflation have increased.

The Fed will not be targeting employment levels in its policy moves, saying that, due to non-monetary factors, maximum employment is "not directly measurable", though it will look at shortfalls of employment however uncertain and subject to revision such assessments are.

In contrast to employment, the Fed argues that inflation over the longer run is primarily determined by monetary policy, giving the FOMC the ability to specify long-run goals. Today's statement reaffirms the policy board's long-term commitment to the 2 percent level (measured by personal consumption expenditures), a rate the Fed says promotes price stability, moderate long-term interest rates, and the ability of the FOMC to promote maximum employment including during times of significant economic disruption. In an effort to anchor long-term inflation expectations at the 2 percent mark, the Fed said it judges that following periods when inflation has been running persistently below 2 percent, monetary policy will "likely aim" to achieve inflation "moderately" above 2 percent for "some time".

In remarks echoing this statement, Powell said during long periods of sub-2 percent inflation, inflation expectations among households and businesses tend to move below the 2 percent goal, in turn pulling actual inflation lower. To offset this effect, Powell cited the need to allow inflation to moderately exceed 2 percent.

Details below of Powell's speech, written by Steven K. Beckner, are provided courtesy of Mace News:

Federal Reserve Chair Jerome Powell said Thursday the Fed will be "flexible" in pursuing a new "average inflation targeting" regime and not use any set "mathematical formula".

Powell, elaborating on what he called a "robust" new monetary policy strategy framework adopted earlier by the Fed's policy-making Federal Open Market Committee, also noted the new policy framework will allow the Fed to maintain a more accommodative monetary stance when unemployment is running below estimates of the "natural" jobless rate, so long as inflation does not significantly exceed the average 2% inflation target and inflation expectations remain anchored.

At the same time, Powell vowed the Fed "will not hesitate to act" if it sees signs of accelerating inflation. The Fed chief was keynoting an online-based version of the Kansas City Federal Reserve Bank's annual Jackson Hole symposium, whose 2020 theme is "Navigating The Decade Ahead: Implications for Monetary Policy".

Without waiting for its Sept. 15-16 meeting, the FOMC changed the Statement on Longer-Run Goals and Monetary Policy Strategy initially adopted in January 2012 in the aftermath of the financial crisis. Most notably, instead of an annual "symmetric" 2% inflation target, the FOMC stated that henceforth it will seek to "achieve inflation that averages 2 percent over time".

"Following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time," the revised statement adds.

In another key change to the statement, regarding the Fed's maximum employment objective, the FOMC now says its policy decisions will be informed by its "assessments of the shortfalls of employment from its maximum level". Formerly, the statement referred to "deviations from its maximum level".

Explaining the change to the language on maximum employment, Powell told the symposium, "This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation."

"In earlier decades when the Phillips Curve was steeper, inflation tended to rise noticeably in response to a strengthening labor market," he continued. "It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation."

Powell said "the change to 'shortfalls' clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals." "Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimize that shortfall by using our tools to support economic growth and job creation," he added.

Regarding the new average inflation targeting framework, Powell said "we have not changed our view that a longer-run inflation rate of 2 percent is most consistent with our mandate to promote both maximum employment and price stability," but said the shift to an average 2% inflation target had been necessitated by persistent undershooting of the 2% target.

He stressed, however, "In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average."

"Thus, our approach could be viewed as a flexible form of average inflation targeting," he went on. "Our decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula."

"Of course, if excessive inflationary pressures were to build or inflation expectations were to ratchet above levels consistent with our goal, we would not hesitate to act," Powell added.

Elaborating in response to questions from conference host Kansas City Fed President Esther George, Powell emphasized the FOMC intends to permit only a "moderate" overshoot of 2% inflation.

"This is not a formulaic approach," he said, adding that the FOMC "will continue to consider all the things it usually considers" as it "aspires to let inflation run above 2% after periods when it's run below 2%."

In the current situation, Powell said it is appropriate to pursue a "make-up strategy" and "make up" for past below-target inflation "in ways that allows us to consider all the other things that come into monetary policy unexpectedly without trying to follow a formula."

He agreed with Fed Vice Chairman Richard Clarida's observation that the new framework represents "more of an evolution than a revolution."

Powell took pains to indicate that the Fed will not be wedded to any particular target or formula: "(W)e continue to believe that monetary policy must be forward looking, taking into account the expectations of households and businesses and the lags in monetary policy's effect on the economy. Thus, our policy actions continue to depend on the economic outlook as well as the risks to the outlook, including potential risks to the financial system that could impede the attainment of our goals."

Powell said the framework review was necessitated by four basic changes in the global economic and financial environment: 1) a slowdown in potential GDP growth, accompanied by a decline in productivity growth; 2) a drop in interest rates in the U.S. and around the world, including a decline in estimates of the "real equilibrium interest rate" and hence the "neutral" policy rate. 3) historic increases in employment, and 4) the fact that lower levels of unemployment were not accompanied by acceleration in inflation, as central banks had traditionally grown to expect under "Phillips Curve" theory.

Powell put particular emphasis on the risks inherent in low inflation and inflation expectations: "The persistent undershoot of inflation from our 2 percent longer-run objective is a cause for concern ... Inflation that is persistently too low can pose serious risks to the economy. Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations ..."

"(I)f inflation expectations fall below our 2 percent objective, interest rates would decline in tandem," he continued. "In turn, we would have less scope to cut interest rates to boost employment during an economic downturn, further diminishing our capacity to stabilize the economy through cutting interest rates. We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome ..."

Powell had little to say about current economic developments or monetary policy intentions, but he made a point of differentiating the current recession from the Great Recession that followed the financial crisis. In contrast to the previous episode, he said the current crisis was not caused by financial imbalances or asset bubbles but by "a natural disaster" (the coronavirus) and that the economy had been strong before the virus hit. "It's a very very different situation," he said. "What happened here is that essentially people around the world withdrew from certain types of economic activity to protect themselves ..."

By cutting the federal funds rate near zero, doing massive asset purchases and launching an array of special lending facilities in March, "we weren't trying to stimulate the economy," only to "provide a little bit of comfort and support the expansion," he said.

Powell said the economy still "has strength," but that some sectors are suffering from the pandemic, particularly travel-related industries. He said they could take a long time to recover.