"New Federal Reserve News Agency": The Federal Reserve will adjust its framework for interest rate setting, acknowledging that the era of long-term low interest rates may be over

On Thursday, Federal Reserve Chairman Jerome Powell stated that in light of significant changes in the inflation and interest rate outlook following the COVID-19 pandemic, the Federal Reserve is working to adjust its overall policy-making framework. "Since 2020, the economic environment has changed significantly, and our review will reflect our assessment of these changes."

Nick Timiraos, a well-known financial journalist referred to as the "new Federal Reserve correspondent," wrote that facing a world where it is no longer certain whether ultra-low interest rates will persist, Powell is guiding a new strategy. The Federal Reserve is about to adjust its interest rate-setting framework, although it is unlikely to affect current policy decisions, it acknowledges that the era of "long-term low interest rates" may be coming to an end.

Timiraos explained that the "framework" Powell referred to is the overall strategy the Federal Reserve uses to set interest rate policy:

The responsibilities assigned to the Federal Reserve by the U.S. Congress are to maintain low and stable inflation while promoting a healthy labor market. How to achieve these goals is primarily determined by the Federal Reserve itself. Since 2012, the Federal Reserve has articulated its approach to achieving these goals through a framework statement.

The current policy framework of the Federal Reserve was adopted five years ago and began a review this year. This review is not expected to affect the Federal Reserve's current interest rate decisions. Powell previously indicated that the review process might be completed in August or September, with results announced.

In his speech on Thursday, Powell hinted that the Federal Reserve would retract some key changes made five years ago.

Powell made the remarks at a research meeting held at the Federal Reserve's headquarters in Washington. Timiraos noted that during the meeting, officials would hear recommendations from leading policy theorists and discuss potential adjustments to the Federal Reserve's policy framework and communication tools.

Timiraos quoted key points from Powell's speech that day:

Powell pointed out that the higher real interest rates (i.e., inflation-adjusted rates) that emerged after the 2020 pandemic may render certain elements of the current framework meaningless.

Higher real interest rates may reflect that future inflation could be more volatile than during the crisis periods of the 2010s. We may be entering a period of more frequent and potentially more persistent supply shocks—this poses a tough challenge for both the economy and the central bank.

At last week's meeting, officials believed that the "average inflation targeting" adopted five years ago should be revised. The idea of intentionally allowing inflation to moderately exceed targets has become irrelevant in policy discussions and remains so to this day.

If the public does not believe inflation will return to pre-pandemic levels, then we cannot achieve the recent decline in inflation without a surge in unemployment.

Timiraos wrote in the article:

The Federal Reserve holds meetings every six to eight weeks to vote on whether to adjust interest rates and releases policy statements explaining the reasons for its decisions. This framework review focuses on another document, which is typically reissued every January, outlining the fundamental way the Federal Reserve sets interest rates.

The Federal Reserve officially set a 2% inflation target in 2012. However, following the 2007–2009 financial crisis, the world has been in a prolonged low-interest-rate environment, leading officials to worry that this target is flawed: with rates often close to zero, the Federal Reserve may lack the means to stimulate growth during economic downturns

Therefore, the Federal Reserve finds it easier to curb an overheating economy through interest rate hikes in many situations, while stimulating the economy during periods of weakness becomes more challenging. Six years ago, the Federal Reserve launched its first "framework review," lasting one year, aimed at addressing this asymmetry.

Under Powell's leadership, the Federal Reserve adopted a new policy framework in 2020, making a seemingly minor but significant change. At that time, inflation was below the 2% target even in an extremely low interest rate environment. As a result, the Federal Reserve adopted a "compensatory" strategy: even if models suggested higher interest rates, they would maintain lower rates, allowing inflation to slightly exceed the 2% target. Officials agreed to revisit this framework every five years.

The post-pandemic economic restart in 2021 rendered the major changes in the 2020 framework inapplicable. In November 2021, U.S. inflation reached 6%. This "exceedance" was driven by strong demand and chaotic supply chains, which were not anticipated when the framework was established.

The Federal Reserve's current review is a reflection on the shortcomings of the 2020 framework—especially its failure to adapt to a wide range of economic scenarios, even if those scenarios initially seemed unlikely to occur.

However, this review is expected to retain the core principles of the Federal Reserve's framework, including the 2% inflation target and the critical mission of ensuring public confidence that the Federal Reserve will maintain low and stable inflation. Officials believe that this inflation expectation has self-fulfilling characteristics and is the main reason for achieving a decline in inflation over the past two years without significantly increasing unemployment