Wall Street is still weighing the implications of the Federal Reserve’s most substantive shift in the way it thinks about monetary policy in years.
In essence, Fed Chairman Jerome Powell on Thursday emphasized the primacy of the labor market in its mandate, even if it means that inflation rises above an annual 2% target that the central bank has traditionally deemed as indicative of a healthy, well-functioning economy.
Powell’s new policy framework comes after 18 months of review by the interest rate setting Federal Open Market Committee and marks a subtle tweak from targeting 2% inflation to now allowing for undershoots and overshoots that would see inflation average 2% over time.
“This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation,” Powell said in his webcast speech as a part of the annual Jackson Hole symposium on Thursday.
Indeed, the shift is a big deal experts say, and not just because of the defenestration of decades of central-bank orthodoxy centered on the relationship between the labor market and price pressures, but because it expresses policy that may be far removed from a policy such as advocated by Stanford University economist John Taylor, who has championed a mathematical approach to setting interest rates.
The Fed’s new approach, instead, may raise more questions than answers about implementation and crucially how it achieves inflation targets that have thus far remained elusive over the past decade.
“How much inflation is the Fed comfortable with?” asked Aneta Markowska, chief economist at Jefferies in a Friday research note.
“The FOMC was surprisingly vague with respect to its inflation averaging framework, saying merely that it will aim to achieve inflation ‘moderately above 2 percent for some time’ following periods of undershoots. What does that mean in practical terms? We simply don’t know,” the economist wrote.
After Powell’s Jackson Hole speech, some Fed officials did attempt to provide some sense of the degree to which inflation might be allowed to rise above the central bank’s target before raising alarms.
“To me, it’s not so much the number, whether it’s 2.5% or 3%,” Philadelphia Fed President Patrick Harker, a voting member of the FOMC, told CNBC in a Friday interview. “It’s whether it’s reaching 2%, creeping up to 2.5% or shooting past 2.5%,” he said.
