Powell adopts a dovish stance! Emphasizes employment risks, opens the door for interest rate cuts, expects tariffs to raise prices in one go, but the impact will take time to manifest

Federal Reserve Chairman Jerome Powell delivered a significant speech at the Jackson Hole central bank annual meeting, stating that the current situation indicates an increased downside risk to employment. This shift in the balance of risks may imply the need for interest rate cuts.

At the beginning of his speech, Powell pointed out that this year, the "balance of risks" facing the Federal Reserve's dual mandate of employment and inflation seems to be shifting. He believes that the current economic conditions impact monetary policy as follows:

"The stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, given that policy is in a restrictive range, the baseline outlook and the changing balance of risks may require us to adjust our policy stance."

Regarding the labor market, Powell stated:

"Overall, while the labor market is in balance, it is a 'peculiar balance' resulting from a significant slowdown in both labor supply and demand. This unusual situation suggests that downside risks to employment are increasing."

On the impact of tariffs on inflation, Powell said that a "reasonable baseline assumption" is that tariffs will lead to a "one-time" increase in price levels, but these effects will take time to fully manifest in the economy.

Considering various influencing factors, Powell believes:

"In the short term, inflation risks are tilted to the upside, while employment risks are tilted to the downside—this is a challenging situation."

Regarding adjustments to the monetary policy framework, Powell noted that the new policy framework removed two statements: first, that the Federal Reserve seeks to achieve an average inflation target of 2% over a period of time; and second, that decisions are based on "deviations from full employment levels."

"New Federal Reserve News Agency": Powell Opens the Door for Rate Cuts as Early as September, More Confident in Tariff Impact Assumptions

Some commentators believe that Powell's mention of stable labor market indicators allowing the Federal Reserve to cautiously consider adjusting monetary policy opens the door for a rate cut at the next meeting in September.

Nick Timiraos, known as the "New Federal Reserve News Agency," pointed out in an article that Powell's speech emphasizes concerns about the labor market, paving the way for rate cuts. The article begins by stating:

"Powell indicated that the prospect of further slowing in the labor market may alleviate concerns that tariffs will exacerbate inflation by driving up costs, thereby opening the door for a rate cut at the next meeting as early as September."

Timiraos believes that this speech is Powell's first indication that his confidence in the baseline scenario assumption has increased, which is that the impact of tariff-induced price increases will be relatively short-lived.

He noted that Powell believes the effects of tariffs are now clearly visible and are expected to continue accumulating over the coming months. The issue facing the Federal Reserve is whether these price increases will "significantly increase the risk of persistent inflation problems."

Powell also believes that the one-time price increase due to tariffs may be a reasonable baseline assumption, although this does not mean that the impact on prices will be immediate. Timiraos stated that if the tightness of the labor market is insufficient to support consumers who have lost purchasing power due to tariffs in negotiating stronger wages, then this baseline scenario is more likely to occur The following is the full translation of Powell's speech:

Monetary Policy and the Federal Reserve Framework Review

Federal Reserve Chairman Jerome H. Powell

The speech was delivered at the economic symposium "The Transforming Labor Market: Demographics, Productivity, and Macroeconomic Policy" hosted by the Kansas City Fed in Jackson Hole, Wyoming.

This year, the U.S. economy has shown resilience against the backdrop of significant changes in economic policy. In terms of the Federal Reserve's dual mandate, the labor market remains close to full employment levels, and while inflation is still somewhat elevated, it has significantly decreased from its post-pandemic peak. Meanwhile, the balance of risks seems to be shifting.

In today's speech, I will first discuss the current economic situation and the short-term outlook for monetary policy, and then turn to the results of our second public review of the monetary policy framework, which are reflected in the revised "Statement on Long-Run Goals and Monetary Policy Strategy" we released today.

Current Economic Conditions and Short-Term Outlook

A year ago, when I spoke here, the economy was at a turning point. Our policy interest rate has been maintained in the range of 5.25% to 5.5% for over a year. This restrictive policy stance has helped reduce inflation and has facilitated a sustainable balance between total demand and total supply. Inflation is now significantly closer to our target, and the labor market has cooled from its previously overheated state. The risks of inflation rising have diminished, but the unemployment rate has nearly increased by one percentage point, which historically does not occur without an economic recession. In the subsequent three Federal Open Market Committee (FOMC) meetings, we adjusted our policy stance to lay the groundwork for the labor market to remain close to maximum employment levels over the past year.

This year, the economy faces new challenges. Tariffs among global trading partners have significantly increased, reshaping the global trading system. Stricter immigration policies have led to a sudden slowdown in labor force growth. In the long term, changes in tax, spending, and regulatory policies may also have significant impacts on economic growth and productivity. It is currently difficult to determine where these policies will ultimately land and their lasting effects on the economy.

Changes in trade and immigration policies have affected demand and supply. In such an environment, distinguishing between cyclical changes and trend or structural changes becomes challenging. This distinction is crucial because monetary policy can stabilize cyclical fluctuations but has limited effects on structural changes.

The labor market is a case in point. The July employment report released earlier this month showed that job growth has slowed to an average of only 35,000 per month over the past three months, significantly below the 168,000 per month expected for 2024. This slowdown is much greater than the assessment made a month ago, as the previous May and June data have been significantly revised down. However, the slowdown in job growth does not seem to have led to a significant amount of labor market slack—an outcome we wish to avoid. The unemployment rate in July rose slightly but remains at a historically low level of 4.2%, having been stable over the past year. Other labor market indicators have also shown little change or only a modest decline, including the resignation rate, layoffs, the ratio of job vacancies to unemployment, and nominal wage growth. Labor supply has also slowed, significantly reducing the number of "breakeven" new jobs needed to keep the unemployment rate unchanged In fact, this year, due to a sharp decline in immigration, labor force growth has significantly slowed, and the labor participation rate has also decreased in recent months.

Overall, while the labor market is in balance, this is a "peculiar balance" caused by a significant slowdown in both labor supply and demand. This abnormal situation suggests that the downside risk to employment is increasing. If risks materialize, they may quickly manifest as a surge in layoffs and a rapid rise in the unemployment rate.

At the same time, GDP growth noticeably slowed to 1.2% in the first half of this year, about half of the 2.5% growth expected in 2024. This decline in growth mainly reflects a slowdown in consumer spending. Like the labor market, the slowdown in GDP growth is partly due to a reduction in supply or potential output.

When it comes to inflation, higher tariffs have begun to push up prices for certain goods. According to the latest data, the total PCE price increased by 2.6% for the 12 months ending in July. Excluding the more volatile food and energy prices, core PCE rose by 2.9%, higher than the same period last year. Within the core, goods prices increased by 1.1% over the past 12 months, in stark contrast to the moderate decline expected for the entire year of 2024. In comparison, inflation in housing services continues to trend downward, while inflation in non-housing services is slightly above levels historically consistent with 2% inflation.

The impact of tariffs on consumer prices is now clearly visible. We expect these effects to continue to accumulate in the coming months, with high uncertainty regarding the timing and extent. The core concern of monetary policy is whether these price increases will significantly raise the risk of persistent inflation. A reasonable baseline assumption is that these effects are mostly one-time level jumps. Of course, "one-time" does not mean "instantaneous," as tariff adjustments still require time to fully transmit through the supply chain and distribution network. Additionally, tariff levels are still being adjusted, which may prolong the price adjustment period.

The price pressures caused by tariffs could also potentially trigger more persistent inflation dynamics, which need to be assessed and managed as a risk. One possibility is that workers, facing pressure on real incomes, demand and receive higher wages, leading to a vicious wage-price interaction. However, given that the labor market is not particularly tight and faces more downside risks, this outcome seems unlikely.

Another possibility is that rising inflation expectations drive actual inflation. Inflation has remained above our target for more than four years, which is particularly concerning for households and businesses. However, based on market and survey-based long-term inflation expectations, they currently appear to remain anchored, consistent with our long-term 2% inflation target.

Of course, we cannot be complacent about the stability of inflation expectations. Whatever happens, we will never allow a one-time increase in price levels to evolve into a persistent inflation problem.

In summary, what are the implications for monetary policy? In the short term, inflation risks are tilted to the upside, while employment risks are tilted to the downside—this is a challenging situation. When our goals conflict to some extent, the framework requires us to balance our dual mandate. So far, the policy interest rate has come closer to neutral levels by 100 basis points compared to last year, and the stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, due to the policy being in a restrictive range, the baseline outlook and the constantly changing risk balance may require us to adjust our policy stance.

Monetary policy is not on a preset trajectory. FOMC members will make decisions based on data and its implications for the economic outlook and risk balance. We will never deviate from this principle.

Evolution of the Monetary Policy Framework

Turning to the second part of the topic, our monetary policy framework is rooted in the unchanging mission granted to us by Congress: to promote maximum employment and price stability for the American people. We continue to steadfastly fulfill our statutory mission, and the framework revisions will support us in accomplishing this task under various economic conditions. Our revised "Statement on Longer-Run Goals and Monetary Policy Strategy," or our "Consensus Statement," describes how we achieve our dual mandate goals, which is crucial for enhancing transparency and accountability and improving policy effectiveness.

The changes reviewed this time are a natural extension based on our deepening understanding of the economy. We continue to advance the initial consensus statement (developed in 2012 under Chairman Bernanke). Today's revised statement is the result of the second public review of the framework, which we conduct every five years. This review includes three aspects: the Fed Listens events held by various Federal Reserve Banks, a flagship academic seminar, and discussions and analyses among policymakers and staff at FOMC meetings.

One of the important goals of this review is to ensure that the framework is applicable under various economic conditions. At the same time, the framework must also adjust with changes in economic structure and our understanding. The challenges faced during different phases, such as the Great Depression, historically high inflation, and moderate expansions, are all distinct.

During the last review, we were in a new normal—interest rates were close to the effective lower bound (ELB), economic growth was low, inflation was low, and the Phillips curve was extremely flat, meaning inflation's response to economic slack was very limited. For example, after the global financial crisis erupted at the end of 2008, policy rates hovered at the ELB level for seven years. Many remember the slow and painful economic recovery during that period. At that time, it seemed that even a slight recession would quickly bring policy rates back to the ELB, where they might remain for a long time. When the economy is weak, inflation and inflation expectations decline, while nominal rates are pinned near zero, leading to rising real rates, exacerbating employment pressures, and continuing to suppress inflation and inflation expectations, creating adverse dynamics.

The economic issues that led policy rates to fall to the ELB and prompted the 2020 framework changes were thought to stem from global, slowly changing factors that could persist for years—if not for the impact of the pandemic, this might have indeed been the case. The 2020 consensus statement emphasized risks related to the ELB, developed over two decades. We highlighted the importance of anchoring long-term inflation expectations for achieving price stability and maximum employment goals. Referring to the extensive literature on strategies to address ELB risks, we adopted a flexible average inflation targeting mechanism, or "compensatory" strategy, to ensure that inflation expectations remain anchored even in the presence of ELB constraints. Specifically, we noted that after a period of inflation consistently below 2%, appropriate monetary policy may aim to push inflation slightly above 2% for a time

In reality, it is not low inflation and ELB, but rather the highest inflation in 40 years that has emerged globally after the pandemic. As most central banks and private analysts expected, until the end of 2021, we believed that inflation would quickly decline without the need for significant tightening of policies. Once the situation clearly changed, we acted swiftly, raising interest rates by 5.25 percentage points within 16 months. Such actions, combined with the elimination of pandemic-related disruptions to supply chains, brought inflation close to target, without the significant rise in unemployment that accompanied past episodes.

Main Content of the Revised Consensus Statement

This review examined the changes in economic conditions over the past five years. During this period, we observed that inflation can change rapidly when subjected to significant shocks, and interest rates are much higher than during the global financial crisis to the pandemic period. The current inflation target is above the benchmark, and the policy rate is restrictive—what I consider moderate. We cannot determine where long-term interest rates will settle, and some neutral rate levels may be higher than in the 2010s, reflecting factors such as productivity, demographic trends, fiscal policy, and others that influence the balance of savings and investment. In the review, we also discussed how the emphasis on ELB in the 2020 statement may have made communication more difficult in responding to high inflation. We believe that an emphasis on overly specific economic conditions may cause confusion, and thus the revised statement made several important adjustments.

First, we removed the content that defined ELB as a characteristic of the economic environment. Instead, we emphasized that "the monetary policy strategy aims to promote full employment and price stability under broad economic conditions." The difficulty of approaching ELB remains a concern, but it is no longer central. The revised statement reiterates that the committee is prepared to use all tools to achieve the goals of full employment and price stability, especially when the federal funds rate is constrained by ELB.

Second, we returned to a flexible inflation target framework and eliminated the "compensatory" strategy. It has proven that a deliberate and moderate inflation overshoot as a strategy is no longer applicable. As I publicly acknowledged in 2021, several months after we announced the modification of the 2020 consensus statement, inflation emerged that was neither deliberate nor moderate.

Anchored inflation expectations have contributed to our success in curbing inflation without raising unemployment. Anchoring inflation expectations helps drive inflation back to target when facing adverse shocks while reducing the risk of deflation during economic weakness. Furthermore, anchored inflation expectations allow monetary policy to support maximum employment during economic downturns without jeopardizing price stability. Our revised statement emphasizes that we are committed to taking strong actions to ensure long-term inflation expectations are anchored, which benefits both aspects of our dual mandate, and points out that "price stability is essential for a healthy, stable economy and the well-being of all Americans." This view was particularly prominent in the feedback from the Fed Listens event. The experiences of the past five years remind us that the suffering brought about by high inflation particularly affects those who are least able to cope with rising basic living costs.

Third, the 2020 statement proposed that we would mitigate the "shortage" of full employment, rather than "deviation." The use of the term "shortage" reflects our insights into the natural rate of unemployment and the high uncertainty in real-time assessments of "full employment." After the global financial crisis, actual employment has long exceeded the sustainable level estimated by mainstream assessments, while inflation has remained below 2%. In the absence of inflationary pressures, there is no need to tighten policies solely based on uncertain real-time estimates of the natural unemployment rate.

We still hold this view, but the term "shortage" may not always be correctly interpreted, leading to communication barriers. In particular, "shortage" does not imply a commitment to never act preemptively, nor does it disregard the tightness of the labor market. Therefore, we have removed the term "shortage" and more accurately express it as “the (FOMC) committee acknowledges that employment may sometimes exceed the real-time estimate of full employment levels, but this does not necessarily pose a risk to price stability.” Of course, if the labor market is excessively tight or other factors affect price stability, preemptive action may be necessary.

The revised statement also notes that maximum employment is “the highest level of employment that can be sustained in an environment of price stability.” It emphasizes that a strong labor market brings broad employment opportunities and welfare for all, a principle that has been fully corroborated by feedback from the Fed Listens initiative, showcasing the value of a strong job market for American families, employers, and communities.

Fourth, in line with the removal of "shortage," we clarified our response when employment and inflation targets are incompatible. In such cases, we will pursue a balanced approach to advance both objectives. The revised statement returns more to the original wording from 2012— we will consider the degree of deviation from the targets and the different time spans that may be involved in bringing both back to a level consistent with our dual mandate. These principles are guiding our current policy decisions and have previously led us in addressing deviations from the 2% inflation target between 2022 and 2024.

Aside from the changes mentioned above, there is also a high degree of continuity with past statements. The document continues to clarify how we interpret the mission granted to us by Congress and describes the policy framework we believe is most suitable for achieving maximum employment and price stability. We still advocate that monetary policy must be forward-looking and consider its lagged effects. Therefore, our policy actions depend on the economic outlook and our assessment of the balance of risks to that outlook. We still believe that setting specific employment targets is inadvisable, as the maximum employment level cannot be directly measured and may change due to factors unrelated to monetary policy.

We also maintain that a long-term inflation rate of 2% best aligns with our dual mandate objectives. We believe our commitment to this target helps anchor long-term inflation expectations. Experience shows that 2% inflation allows households and businesses to make decisions without worrying about inflation, while also providing central banks with some policy flexibility during economic downturns.

Finally, the revised consensus statement still commits to conducting a public review approximately every five years. There is nothing particularly special about five years; this frequency helps policymakers reassess structural economic issues and facilitates communication with the public, industry, and academia regarding the performance of the framework, while also aligning with practices of some global peers.

Conclusion

Finally, I would like to thank Chair Schmid of the Kansas City Fed and all the staff for their tireless efforts in hosting this outstanding event every year. Even counting virtual speeches during the pandemic, this is my eighth time having the honor to speak here. Each year, this seminar provides Federal Reserve leaders with the opportunity to engage with top economists and focus on challenges More than forty years ago, the Kansas City Federal Reserve successfully invited Chairman Volcker to this national park, and I am honored to be a part of this tradition