MNI: Powell - Fed Framework To Address Volatile Inflation Era

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May-15 12:40By: Jean Yung
Federal Reserve

The Federal Reserve will reconsider the average inflation targeting regime it adopted in 2020 and update its policymaking framework now that the economy has entered an era of higher long term interest rates and potentially more volatile inflation, Chair Jerome Powell said Thursday. 

As the pandemic swept the world, up-ending supply chains and causing prices to spike, the idea of an intentional, moderate overshoot on a 2% inflation target proved "irrelevant" to the Fed's policy discussions and remains so now, Powell said. 

"Longer-term interest rates are a good deal higher now, driven largely by real rates given the stability of longer-term inflation
expectations. Many estimates of the longer-run level of the policy rate have risen, including those in the Summary of Economic Projections," he said in remarks prepared for a two-day conference on the Fed's framework in Washington. 

"Higher real rates may also reflect the possibility that inflation could be more volatile going forward than in the inter-crisis period of the 2010s. We may be entering a period of more frequent, and potentially more persistent, supply shocks — a difficult challenge for the economy and for central banks."

UNCERTAINTY

The framework should be "robust to a wide range of economic environments and developments," Powell said. The 2020 changes reflected the post-financial-crisis economic conditions that kept rates close to zero lower bound. 

"Although getting stuck at the lower bound is no longer the base case, it is only prudent that the framework continue to address that risk," Powell said. 

In 2020, the FOMC said it would assess “shortfalls” rather than “deviations” from maximum employment, signaling that labor market tightness would not alone be enough to trigger a policy response. That language will also be reconsidered, Powell said. 

The FOMC will also look at ways to foster a broader understanding of the uncertainty that the economy faces, Powell said. Some have suggested central banks discuss alternate scenarios in addition to baseline forecasts. (See: MNI: Fed To Examine If Framework Robust To Any Scenario)