Did pandemic central banking work? Fed review to eye inflation, jobs
tradeoffs
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[December 01, 2023] By
Howard Schneider
ATLANTA (Reuters) - The U.S. Federal Reserve's pledge in 2020 to sustain
"broad-based and inclusive" employment through loose monetary policy was
considered a bold response to the pandemic, putting its muscle behind
the idea that low unemployment and low inflation could coexist.
The ensuing inflation surge has put that view under a spotlight, with
scrutiny likely to intensify over the next year as Fed officials prepare
for a broad policymaking review that Chair Jerome Powell has said will
commence in late 2024.
There's been no suggestion the Fed will drop language added to its
policy framework three years ago nodding implicitly to the gains
disadvantaged groups get from tight labor markets and showing a
willingness to take risks with higher inflation in order to let the
jobless rate fall as low as possible.
Noting the unemployment rate gap between Blacks and whites tends to
narrow as the job market tightens, the Fed's strategy does seem on track
to produce more equitable outcomes, said Miesha Williams, an associate
professor of economics at Spelman College in Atlanta, where Powell is to
appear Friday.
"There's this goal to be inclusive and while it may be new, it is going
to take some ironing out," she said.
But the experience of the last three years already has led some Fed
veterans to call for a renewed focus on preempting inflation before it
accelerates and others to say it may be time to consider redefining the
inflation target itself, all while Powell points to a deep discussion
over shaping central bank policy for the post-pandemic world.
After inflation's breakout and the scramble to contain it, even strong
advocates of aggressive Fed attention to joblessness agree changes may
be needed so future officials aren't constrained by the current
framework's commitment to loose policy as prices take off.
In an essay to be published next year shared with Reuters, former
Chicago Fed President Charles Evans, who helped lay the groundwork for
the current framework, argues the rise of inflation, driven by
stronger-than-expected demand and lingering pandemic supply shocks, show
the Fed needs "additional guard rails," perhaps even an inflation
"escape threshold" to allow rate hikes to begin regardless of pledges
made about employment.
After cutting rates to near zero to combat the fallout from the
pandemic, the Fed in September 2020 said it would not raise them until
maximum employment was restored and inflation was above 2% - an effort
to achieve its 2% target on an average basis over time after a long
period of weak price increases.
Central bankers are loathe to break such outright commitments for fear
of losing credibility, and the conditions set for a rate hike are widely
seen as slowing the Fed's response as inflation rose throughout 2021:
Its first rate hike did not occur until March 2022.
"My guess is they will have discussions about how quickly and abruptly
you can shift gears" when unexpected developments spur prices higher,
Evans said.
WHAT HAS CHANGED?
Powell recently pointed to some of the complications flagged by Evans,
noting pandemic supply shocks seemed long-lived and perhaps require
higher interest rates than would usually be the case for something
officials expect to adjust on its own.
Fed policy affects consumer and business demand by influencing the cost
of credit through interest rate changes, but the economy's supply side
is regarded as mostly self-correcting as businesses adapt output to
demand, a principle challenged by lengthy pandemic disruptions.
[to top of second column] |
Federal Reserve Board Chair Jerome Powell answers a question during
a press conference following a two-day meeting of the Federal Open
Market Committee on interest rate policy in Washington, U.S.,
November 1, 2023. REUTERS/Kevin Lamarque/File Photo
More broadly, Powell said the next review would have to tackle an
even more fundamental question.
The last one was framed around the experience of the 2007-to-2009
financial crisis and recession, the slow recovery that followed, and
the years the Fed kept rates pinned near zero with no conventional
way to further help the economy.
Hoping to avoid return trips to that "zero lower bound," the
framework shifted to aim for inflation that averaged 2% over time.
Periods of high inflation would offset those when inflation was low
as occurred between the financial crisis and the pandemic.
Those concerns may not matter anymore if the pandemic has driven
inflation and interest rates chronically higher.
"Among the questions we will consider is the degree to which the
structural features of the economy that led to low interest rates in
the pre-pandemic era will persist," Powell said last month.
The Fed has not provided further information about the coming review
process. The last one included "Fed Listens" events around the
country, allowing business owners, workers, elected officials and
others to talk about the economy and how monetary policy impacts
their lives. A major research conference at the Chicago Fed delved
into different policy approaches.
Whatever the process, the circumstances are radically changed: The
pandemic era's rapid growth and high inflation are a near complete
opposite of the decade preceding it.
A 'NOISY MEASURE'
Officials have begun flagging the issues they want to debate.
Cleveland Fed President Loretta Mester said this week she felt the
Fed needs to be more explicit about how financial stability factors
into policy, and Chicago Fed President Austan Goolsbee said it might
be time to consider relaxing an inflation target he feels is too
specific for a "noisy" variable.
"My thing about inflation targets is the false sense of precision to
say 2%. What about 2.1?" Goolsbee said in September. "Inflation is
an extremely noisy measure so I do think we have to think about
that."
Other policymakers have said they'd prefer a range instead of a
specific target for similar reasons.
To former Fed Vice Chair Donald Kohn, however, the lesson of the
last few years is different and calls for more old-fashioned
policymaking.
Speaking at a Boston Fed labor market conference in November, Kohn
said the new framework showed the risks of not keeping inflation at
bay to begin with.
"Probing" for maximum employment "can't ignore...inflation risks,"
Kohn said, calling for a return to a strategy disavowed in the last
review.
"I think preemptive tightening is best-practice central banking, and
I hope they return to allowing that."
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea
Ricci)
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