Powell: The Federal Reserve is considering adjusting its monetary policy framework and re-examining the definition of "underemployment" and the path to achieving its inflation target

According to the Zhitong Finance APP, Federal Reserve Chairman Jerome Powell stated that policymakers are considering adjustments to key parts of the framework guiding monetary policy decisions, including their views on U.S. labor market slack and how to achieve inflation targets.

In a speech prepared for a Federal Reserve monetary policy framework research meeting on Thursday, Powell said that officials "have indicated that they believe it is appropriate to revisit the language regarding 'slack.' At last week's meeting, we had a similar view on the average inflation targeting framework."

Powell acknowledged that the current framework was designed during a period of persistently low interest rates and subdued inflation. He stated, "We will ensure that the new consensus statement can adapt to a wide range of economic environments and developments."

Federal Reserve officials initiated a regular review of the long-term strategy (i.e., framework) for implementing monetary policy and its communication tools this year. This framework provides guidance to Federal Open Market Committee (FOMC) officials in setting interest rates, helping them achieve the broad goals of promoting price stability and maximum employment as mandated by Congress. The inflation target set by the Federal Reserve is 2%.

After the last review completed in 2020, the Federal Reserve adopted a new framework aimed at achieving inflation "moderately above 2% for some time" following a prolonged period of inflation below 2%—this approach is known as flexible average inflation targeting.

Since then, critics have argued that the new framework is overly focused on the then-existing low interest rate and low inflation environment, which is no longer applicable after the outbreak of the COVID-19 pandemic.

Powell noted that a major consideration in 2020 was to anchor long-term inflation expectations of Americans close to 2%. He said, "Anchored expectations are critical to everything we do, and we remain fully committed to the 2% target today."

However, he pointed out that the economic environment has changed significantly since 2020, and the current framework review will reflect policymakers' assessments of these changes.

Powell stated that the idea of being constrained by the so-called zero lower bound is "no longer a fundamental assumption." The zero lower bound refers to the situation where interest rates are low, leaving officials with little room to lower borrowing costs to support the economy when needed. But he added, "It is prudent for the framework to continue addressing this risk."

Adjustment of the Definition of "Slack" in Employment

The 2020 framework review also adjusted the Federal Reserve's employment goals, focusing on the so-called "slack"—that is, periods of high unemployment. Previously, the Federal Reserve paid equal attention to both high and low unemployment rates.

This change effectively eased the Federal Reserve's practice of preemptively raising interest rates to cool the labor market and prevent inflation before inflationary pressures emerged.

Powell stated on Thursday that this adjustment does not commit to permanently abandoning preemptive policy measures or ignoring tight labor market conditions (where job vacancies far exceed available labor) He said: "This indicates that merely the apparent tightness in the labor market is insufficient to trigger a policy response, unless the committee believes that allowing it to develop will lead to undesirable inflationary pressures."

Some Federal Reserve observers pointed out that this change is the reason the central bank failed to raise interest rates in a timely manner to respond to post-pandemic inflation, believing that officials were too focused on employment targets. By the time the Federal Reserve began to raise interest rates significantly in early 2022, inflation was already near a 40-year high.

Powell rebutted the claim that the policy framework led to a lag in response. Instead, he noted that at the time, officials judged (a judgment that later proved to be incorrect) that the inflation caused by the pandemic was temporary.

Powell has stated that the Federal Reserve intends to complete the current framework review by the end of this summer