Fed Eases into New Policy

Federal Reserve Chairman Jay Powell provided a summary of the Fed’s policy review framework for the Kansas City Fed’s symposium in Jackson Hole, Wyoming this year. The Federal Open Market Committee (FOMC) is going to adopt an “average inflation target,” whereby officials allow a modest overshoot of inflation in an effort to trigger more “inclusive” employment and wage gains. The ultimate goal is to boost wages instead of profits as a share of the economy and level the playing field between Main Street and Wall Street. But don’t hold your breath for a complete shift in the Fed’s stance at the next meeting scheduled for September 15-16.

Since Powell spoke, comments made by Fed governors and presidents reveal that members of the FOMC have yet to come to a consensus as to what an overshoot on inflation would actually look like. They have not agreed on how high or how long an overshoot of the 2% target the Fed should actually tolerate. We expect it to eventually accept a modest overshoot of 2-¼% to 2-½% for at least a year before raising rates.

The trajectory of inflation is as important as the level because an unwanted flare would erode purchasing power for the very workers the Fed hopes to help with its new strategy. The goal is to lift wages and lower unemployment for low-wage workers, including underrepresented populations.

The regional Federal Reserve Banks are working on training programs and ways to reduce the barriers to entry for workers but are limited in what they can accomplish. Much of the systemic bias we see in the economy is linked to legal hurdles that undermine workers’ access to the basics of education, health care and housing; redlining, for example, is real and undermines potential growth.

In the interim, the Fed is expected to ease its stance on inflation without fully defining what that new stance means. The statement from the September meeting will reflect the concern that the economy is losing momentum after the initial surge that followed lockdowns. Powell will underscore that additional aid from Congress is needed to ensure that the economy heals from the damage triggered by the pandemic, which is ongoing. The Fed has been consistent in its assessment that the course of the virus determines the course of the economy. Additional aid is needed to support households, states and institutions that are suffering the economic consequences of the virus “through no fault of their own.”

The FOMC is scheduled to update its forecasts for the economy at its September meeting. That will include a forecast for 2023 as well as 2022. The biggest news for 2023 is the outlook for the fed funds rate, which is expected to stay at 0.125% to acknowledge the commitment to overshoot on inflation. Unemployment could come down in the medium term and long term outlook. That would underline the commitment to actually overshoot. It is probably too soon to see an uptick in the forecast for inflation, although it would be useful to underscore the Fed’s resolve to seed a catch-up in economic conditions.

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