Powell: The Federal Reserve is considering adjusting the monetary policy framework to re-examine the definition of “insufficient” employment and the path to achieving inflation targets

The Zhitong Finance App learned that Federal Reserve Chairman Jerome Powell (Jerome Powell) said that policymakers are considering adjustments to key parts of the framework guiding monetary policy decisions, including their views on underemployment in the US and ways to achieve inflation targets.

Powell said in a speech prepared for the Federal Reserve's monetary policy framework research meeting on Thursday that officials “have indicated that they think it is appropriate to re-examine the words relating to 'deficiency'. At last week's conference, we had a similar view on the average inflation target system.”

Powell acknowledged that the current framework was designed during a period of continued low interest rates and sluggish inflation. “We will ensure that the new consensus statement adapts to the broader economic environment and developments,” he said.

Federal Reserve officials this year began a regular review of the central bank's long-term strategy (or framework) for implementing monetary policy and its communication tools. The framework provides guidance to Federal Open Market Committee (FOMC) officials who set interest rates to help them achieve the broad goals set by Congress to promote price stability and maximum employment. The Federal Reserve has set an inflation target of 2%.

Following the last review, which was completed in 2020, the Federal Reserve adopted a new framework aimed at achieving inflation “moderately above 2% for a period of time” after a long period of less than 2% — an approach known as a flexible average inflation targeting system.

Since then, critics have said that the new framework was too targeted at the low interest rate and low inflation environment at the time, and was no longer applicable after the COVID-19 outbreak.

Powell said that one of the main considerations in 2020 is to bring Americans' long-term inflation expectations close to 2%. “Anchored expectations are critical to everything we do, and we're still fully committed to the 2% target today,” he said.

However, he pointed out that the economic environment has changed significantly since 2020, and the current framework review will reflect policymakers' assessments of these changes.

Powell said that the idea that policymakers are bound by the so-called zero interest rate floor “is no longer a basic assumption.” The zero interest rate floor indicates that interest rates are already low, leaving officials with little room to lower borrowing costs when needed to support the economy. But he added, “It is prudent for the framework to continue to address this risk.”

Adjusting the definition of “insufficient” employment

The 2020 Framework Review also adjusted the Federal Reserve's employment targets to focus on so-called “shortfalls” — that is, periods of excessive unemployment. Previously, the Federal Reserve paid equal attention to situations where the unemployment rate was too high or too low.

This change actually mitigates the Federal Reserve's practice of pre-emptively raising interest rates to cool down the labor market and prevent inflation before inflationary pressure becomes apparent.

Powell said on Thursday that this adjustment is not a promise to permanently abandon pre-emptive policy measures or ignore the tight labor market (job vacancies far exceed available labor).

“This shows that apparent labor market tension alone is not enough to trigger a policy response, unless the Commission believes that if left unchecked, it will lead to unwelcome inflationary pressures.”

Some Federal Reserve observers pointed out that this change was the reason the central bank failed to raise interest rates in a timely manner to deal with post-pandemic inflation, believing that officials paid too much attention to employment targets. By the time the Federal Reserve began to raise interest rates sharply in early 2022, inflation was close to the highest level in 40 years.

Powell has refuted claims that the policy framework has led to delays in response. Instead, he pointed out that officials at the time judged (later proved wrong) that the inflation caused by the pandemic was temporary.

Powell has stated that the Federal Reserve intends to complete the current framework review by the end of this summer.