September 26, 2020

The Fed will allow inflation to exceed the 2% target on time


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The United States Federal Reserve (Fed) has announced a series of changes in the framework of action of its policies to adapt to changes in economic reality, including a more flexible definition of the entity’s 2% inflation target, which will become a long-term average, which will allow a greater margin of action for the monetary policy of the US central bank in its search for full employment, as announced by the president of the entity, Jerome powell.

The changes introduced, which the Fed chairman defined in his opening speech at the Jackson Hole symposium as “a robust update of the monetary policy framework,” contemplate that the entity’s long-term inflation target of 2% will pass to be ‘an average over time’, so that after periods in which inflation has been persistently below 2%, monetary policy may allow for inflation ‘moderately above that’ for some time. two%».

The Fed’s Open Market Committee (FOMC) has also approved modifying the definition of the central bank’s mandate with respect to maximum employment, considering it a broad and inclusive objective and noting that its decisions in this regard will take into account “deficiency assessments employment from its maximum level ”when previously he referred to “Deviations from its maximum level”.

Monetary policy challenges

In addition, the US central bank has underlined that the update of its policy framework explicitly recognizes the challenges for monetary policy posed by an environment of persistently low interest rates both in the United States and around the world, and it has warned that monetary policy interest rates are more likely to be capped by their effective lower bound than in the past.

«The economy is always evolving and the strategy of the FOMC To achieve its objectives, it must adapt to meet the new challenges that arise, “said Powell.

In this sense, the president of the Fed pointed out during his speech at the Jackson Hole conclave of central bankers, which this edition is held virtually due to the pandemic, that other advanced economies have also had difficulties meeting their inflation targets in the last decade and has recognized that persistent low inflation “is cause for concern.”

“Many find it contradictory that the Fed wants to boost inflation,” admitted Powell, noting that low and stable inflation is essential for the proper functioning of the economy, although he warned that “persistently too low inflation can pose serious risks to the economy ”, causing an unwanted drop in longer-term inflation expectations, which, in turn, can cause real inflation to decline further, resulting in an adverse inflation cycle and lower and lower expectations.

“This dynamic is a problem because expected inflation directly influences the general level of interest rates,” pointed out the US central banker, who pointed out that if inflation expectations fall below the 2% objective, the entity would have less margin to cut rates to boost employment during an economic downturn, further reducing its ability to stabilize the economy.

The adoption of these changes in inflation targeting and labor market developments “largely codifies the ‘dovish’ strategy that the Fed was already following,” said Kathy Bostjancic, chief economist for U.S from the Oxford Economics consultancy, for whom the announced formal changes and Powell’s caution “underscore that the Fed will keep rates close to zero for a long time.”

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