The Fed’s New Inflation Policy Will Shape The Future

Commentary

Of two potentially momentous addresses Thursday, President Donald Trump's acceptance speech to the Republican National Convention was bound to get more attention. But the calm, analytical lecture on central bank policy by Federal Reserve Chair Jerome Powell should not be neglected.

Powell outlined a significant departure in monetary policy that will guide the Fed at least through the end of his term in 2022 - that is, regardless of who wins the November election - which will affect the future of everything from jobs to car loans.

For the first time ever, Powell committed the Fed to achieving inflation that averages out to 2 percent "over time." Translation: In contrast to the past decade of Fed policy - which aimed for inflation to hit, but not exceed, 2 percent - the central bank will tolerate extended periods of 2-plus- percent inflation. Additionally, the Fed - newly emphasizing the need to bolster low- and moderate-income Americans' prospects - will define "maximal" employment in ways that would allow it to pursue faster job growth for longer.

Like any economic policy, this new, dovish Fed posture carries risks and benefits. Powell emphasized the latter, and there are indeed several. The essential benefit is that the Fed may now operate more consistently with economic reality.

The Fed, and its peer central banks in the developed world, have been unable to achieve their inflation targets for years, creating the potential for inflation expectations to spiral downward and trigger deflation, which would leave the Fed near-helpless to respond to changes in the economy because interest rates have already declined on a seemingly permanent basis.

Recent experience also suggests the risk of uncontrolled inflation from full employment is lower than it used to be, diminishing the chances that inflation will dangerously overshoot the Fed's new average target.

But that chance is greater than zero - which is the first risk. Additionally, since monetary policy stimulates growth and job creation - in part, by boosting prices for stocks and other assets, tangible and financial - the Fed must be vigilant about creating bubbles. Of course, asset appreciation benefits people who own a lot of assets, i.e., the wealthy.

The share of the American public owning stocks seems to have declined, and not just temporarily, since the 2008 crash, from 62 percent to 55 percent. And high-income households own the most stock. Given the existing levels of wealth inequality, Congress and financial regulators - including the Fed - must counteract it through other means.

The new Fed policy was in the works before the pandemic, though the global economic collapse has made inflation even less of a near-term concern. Yet beyond the hard data supporting it, there is an undeniable linkage between the Fed's new stance and a more general shift in public priorities.

It has been roughly four decades since Powell's predecessor Paul Volcker administered an epic dose of tight money to kill the double-digit inflation of the 1970s.

Memories of that wage-price-spiral trauma are long gone, replaced by fresher ones of mass unemployment in 2008-2009 - and now. The Fed is changing with the times.

- The Washington Post