The Federal Reserve’s new push for higher inflation means crafting new tactics that convince Americans it won’t clamp down on rising prices.
For four decades, the Federal Reserve kept up its guard on inflation, beating it back even when it whispered a threat. Such vigilance won the battle but price pressures have since become too weak, depressing interest rates and making it harder for officials to fight recessions.
To fix the problem, Chair Jerome Powell now says the Fed will let inflation overshoot its 2% target and not tighten rates when unemployment falls.
But the new approach “won’t have any practical impact unless Federal Open Market Committee members consciously avoid talking about inflation risk in the coming years,” said Jason Thomas, head of global research at The Carlyle Group in Washington. “Until inflation is sustainably above target, the Fed needs to project perfect calm about price developments.”
Powell can expect questions on how the Fed will go about delivering higher inflation at his press conference at 2:30 p.m. Washington time Wednesday, 30 minutes after officials release a policy statement at the conclusion of the rate-setting FOMC’s two-day meeting.
Preemptive Action
Unlearning the habits of a generation of central bankers is a big cultural shift and could take a long time to refine. Ever since its then-chief Paul Volcker defeated inflation in the 1980s, his successors have generally hiked rates and publicly sounded the alarm as price pressures built.
Businesses and households took note, effectively defining the central bank’s inflation goal as slightly below 2%, researchers find.
Now the Fed has committed to achieving 2% inflation on average -- by overshooting the goal if that’s what it takes -- and, importantly, it has the consensus of all 17 policy makers that this is the right thing to do. Despite the historic shift, announced Aug. 27 at the Fed’s annual Jackson Hole policy conference, they have left a lot of work undone, including a description of how they will use their limited tools to get there.
“Changing people’s mindsets about what monetary regime you are under, what levels of inflation will be tolerated and will occur, is a long process,” said Adam Posen, president of the Peterson Institute for International Economics. “There is nothing in the strategy so far that generates inflation unless you believe that the statement of the strategy alone is credible and somehow immaculately moves prices and wages without any action.”
Raising inflation will be especially hard amid the steep recession caused by the coronavirus pandemic, which has sent unemployment soaring in the U.S. and depressed price pressures across advanced economies.