Fed Experts Say Powell Framework Needs Endgame, Inflation Reset
Federal Reserve chairs have frequently used the central bank’s annual Jackson Hole symposium at the base of the magnificent Teton mountain range in Wyoming to make major policy pronouncements. Last year was no exception — even though the conference was held virtually because of Covid-19.
After years in which the Fed fell short of hitting its 2% inflation goal, Jerome Powell unveiled a radical new operating strategy for monetary policy. The Fed was going to deliberately aim to lift inflation above its target for a while to make up for consistently undershooting it.
To help achieve that, the Fed also junked its past practice of raising interest rates when unemployment fell to levels it thought could lead to future inflation. Now it will wait for inflation to actually rise before acting to tighten credit. And it publicly described its maximum employment goal as broad-based and inclusive, after historically boosting borrowing costs when parts of the job market, such as for Black Americans, remained far from tight.
Here’s what some top economic thinkers have to say about the new framework one year after Powell presented it:
Former Fed chairman, now distinguished fellow at the Brookings Institution
“No strategy would have been perfect given the uncertainties created by the pandemic. And, at the time the strategy was introduced, few people anticipated the scale of the additional fiscal response or the bumpiness of the reopening process. Despite these complications, the policy strategy seems likely to achieve the Fed’s goals over time, including a strong labor market and inflation around target in the medium term.”
“I expect inflation to slow over the next year or two, consistent with the Fed’s goal of a moderate overshoot of the target. Getting inflation and inflation expectations sustainably near the target will give the Fed more flexibility and policy space going forward.”
“Judging when we have reached maximum employment is going to be challenging. In many ways, the labor market looks quite different today than before the pandemic struck. Whether (for example) participation rates return to pre-pandemic levels depends on how the last 18 months have affected the attitudes and expectations of both workers and employers.”
Former Fed vice chairman, now professor at Princeton University
“Generically it was a very positive step, though I was critical at the time, and still am, at the lack of specificity about what it means to ‘make up for past inflation errors.’”
“The greater emphasis on the employment objective is what we really needed when the pandemic struck.”
“Pretty soon the Fed is going to worry about inflation expectations going too high,” he said. “I don’t think the Fed is going to let inflation go persistently high.”
“Rates are going to go up before the dot plot is suggesting. I expect it to happen in 2022, especially if more fiscal stimulus comes in line.”
Director of The Hamilton Project at the Brookings Institution and former chief economist at the Congressional Budget Office
“When it comes to thinking about racial disparities, the Fed is of course right to be casting a wide net for information on how healthy the labor market is,” she said. “Before the pandemic, the labor market was considerably stronger than just about anyone thought was sustainable, without sparking inflation and wage pressure.”
“The only caution I want to offer is, if history is a guide in any sense, a hot labor market is not going to be enough to create racial equity in the unemployment rate, in the employment-population ratio. We are also going to have to do some hard work to make structural changes in the way our society works and the way our economy works. So we should not just be looking to the Fed to solve these problems.”
President of Queens’ College, Cambridge University, chief economic adviser at Allianz SE and an opinion columnist for Bloomberg
“They’re in a strait jacket,” he said. “There’s a window for an orderly normalization” of monetary policy. “I worry that window will close if inflation dynamics get out of control.”
“There are certain segments of the financial market that are in bubble territory,” he said. “If you tell people to continue partying, even before you shut down the party, you may end up having bad things happen.”
Former Fed vice chairman, now distinguished fellow at the Council on Foreign Relations
“Because the Fed had, for a long period, been unable to achieve the 2% target — for reasons that were not fully in their control — I am not surprised they decided to develop a more flexible approach and explicitly allow inflation to run somewhat above 2% to compensate for the undershooting.”
“While I am supportive of the new regime, one must recognize that it has both strengths and weaknesses: it seems to me that it is challenging to decide and communicate how much overshooting is allowable and for how long.”
Former Fed vice chairman, now senior fellow at the Brookings Institution
“There’s a risk that it isn’t suited for the time we find ourselves in. But I agree with the Fed that it’s too early to make that call,” he said. “The framework has yet to be tested.”
“The Fed’s basic outlook on inflation is the best forecast,” he said. “But there’s a huge amount of uncertainty and the risks are to the upside.”
“The endgame isn’t clear. How do you get from moderately above 2% inflation back to 2%?”
Incoming Bank of England policy maker, former chief economist for the Organization for Economic Cooperation and Development
“Interpreting the new monetary policy framework in the middle of the pandemic presents a quandary. In one interpretation, it gives the Fed the flexibility to evaluate incoming data fraught with extraordinary variation and wait to see sufficient progress towards objectives. In another interpretation, it offers too much leeway to make an unfortunate policy mistake, allow inflation to spiral, and so lose credibility and independence.”
“So far, inflation is testing the policy framework more than employment,” she said. “A key question going into 2022 and beyond is whether workers and firms generally will continue to exhibit the wage and pricing power that currently only some have. Given the increasing calls for fiscal and monetary policy discipline, both domestic and external growth moderation likely will check any macro wage-price spiral.”
Former Bank of England policy maker, now president of the Peterson Institute for International Economics
“It is still right that the risk of accelerating inflation is probably lower than the risk of undershooting on possible employment. It’s still right not to pre-empt” by tightening policy, he said.
“The inflation we’re going to get over the next year and a half is going to be higher and more persistent than they’ve been representing, given the nature of the recovery, given the very big front-loading of fiscal policy and given likely wage effects and other factors.”
“I worry about inflation being a problem in the U.S. because of a breakdown in fiscal credibility, an inability of our factionalized legislature to raise taxes when we need to.”
Former Treasury secretary, now Harvard University professor and paid Bloomberg News contributor
“I’m resistant to rigid frameworks. One can never know the set of contingencies that will come when one starts proposing frameworks. I’m not sure the benefit of the commitment is worth the cost of the choices you face down the road when something happens that you didn’t anticipate.”
“The Fed is going from a traditional doctrine of pre-empting inflation to a proposed doctrine of responding to inflation to a yet further doctrine of not responding to inflation until it’s conclusively proven to be permanent. That is somewhat problematic.”
“When your policy operates with a lag, you should be trying to reduce the lags not increase the lag. When you condition the policy on past events rather than on projected future events you’re in effect lengthening the lags of your policy instrument.”
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