New Federal Reserve News Agency: Powell will reassess the current policy framework on Friday

Federal Reserve Chairman Jerome Powell may announce a significant policy framework adjustment at the Jackson Hole central bank annual meeting on Friday, abandoning the policy innovations introduced five years ago.

Recently, renowned financial journalist Nick Timiraos, known as the "New Federal Reserve Correspondent," wrote that Federal Reserve officials are preparing to formally abandon their landmark policy framework established five years ago, which was designed to address the risks of low inflation and near-zero interest rates, but is no longer applicable in the current high inflation environment.

Timiraos revealed that this adjustment is the result of months of evaluation by the Federal Reserve, concluding that the key innovations introduced in 2020 should be abandoned. Powell will take this opportunity to explain why this strategic shift is being made and to refute external accusations that these adjustments have led to the worst inflation in forty years.

Powell's annual speech this Friday is the most anticipated event in the global central banking community and will be his last address as Federal Reserve Chairman at this meeting.

The article suggests that although the upcoming framework changes will not affect recent policy decisions, they signify an important strategic reset in how the Federal Reserve interprets its dual mandate from Congress to maintain low inflation and promote a healthy labor market.

UBS also stated that an increasing number of people believe Powell may deliver a retrospective "exit" speech rather than the interest rate cut guidance the market expects.

Farewell to the 2020 Policy Framework

The article indicates that the Federal Reserve's policy adjustments in 2020 involved two major shifts.

First, the Federal Reserve stated it would allow inflation to moderately exceed the 2% target for a certain period to compensate for previous periods of below-target inflation. Second, officials indicated they would focus only on the issue of excessively high unemployment rates, no longer worrying about excessively low unemployment rates, thereby reducing the urgency of preemptive interest rate hikes and preventing the economy from overheating.

Timiraos pointed out that this framework was seen as a significant policy innovation five years ago, against a backdrop of growing concerns among economists about the ability of central banks to respond to future recessions due to historically low interest rates.

The article cites a stern warning from Harvard economist Lawrence Summers at a 2018 conference, stating that under the existing framework, the economy is "exceptionally fragile."

Now, officials are preparing to abandon these strategies, which are seen as no longer timely. They hinted that they may abandon more ambitious employment targets, bringing the policy framework closer to versions prior to 2020.

Inflation Surge Exposes Framework Flaws

When inflation surged in 2021, the Federal Reserve's commitment to maintaining low interest rates to stimulate labor market recovery put it in a difficult position.

The article notes that although economic conditions might have supported interest rate hikes later that year, the Fed did not take action until March 2022—by which time inflation had reached levels not seen in forty years, significantly different from the central bank's expected moderate overshoot of the inflation target Economists Christina Romer and David Romer from the University of California, Berkeley pointed out in a study last year that the framework of 2020 itself was one of the reasons for the Federal Reserve's slow response, as they believed officials were overly focused on reducing unemployment as much as possible.

Former Federal Reserve Vice Chairman Donald Kohn also believed that this asymmetric employment goal "could be said to have led to a delayed response to the inflation surge in 2021-22."

However, some Federal Reserve officials disagree with this view. They argue that the framework itself is not the main issue, but rather the significant forecasting errors made by the Federal Reserve and many external economists in 2021. At that time, it was widely predicted that inflation would be transitory, and therefore interest rates should not be adjusted.

Richard Clarida, who was the Federal Reserve Vice Chairman in 2020, stated that the Federal Reserve misjudged the extent to which the U.S. economy's capacity to produce goods and services had declined, and thus "maintained an excessively accommodative monetary policy for too long."

Former Ben Shalom Bernanke also stated last year that even under the old framework, policymakers would wait for a period before raising interest rates to observe whether the pandemic-related disruptions would dissipate on their own.

Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, added that the errors did not stem from the new framework itself, but from the subsequent execution of it, including the specific commitments made by officials to delay rate hikes to demonstrate resolve, and the hesitation to exit the stimulus plan due to fears of a repeat of the "taper tantrum" in 2013.

The "stability" of the framework is more important than its content

Timiraos emphasized that the events of 2021 highlight a risk, namely that decision-makers often tend to assume that the next decade will be similar to the past decade.

Kenneth Rogoff from Harvard University pointed out at a Federal Reserve conference held in May this year that the European Central Bank got "into big trouble" after the 2008 financial crisis for raising interest rates to guard against inflation, while it turned out that the bigger concern at that time was weak growth. He stated that the lesson from the past decade seems to be "we do not need to be overly harsh on inflation."

Similarly, concerns about ultra-low interest rates that seemed reasonable in 2020 now appear outdated.

Therefore, Timiraos believes that the greater challenge that Federal Reserve officials are concerned about is how to respond to shocks that simultaneously raise inflation and suppress employment, and such issues cannot be found in any framework with a concise answer. As Matthew Luzzetti said:

"One thing we have learned is that you need a robust framework—a framework that hopefully won't be completely overturned by macroeconomic results in one, two, or three years."