MNI POLICY: Fed Targets Inflation Overshoot, Jobs Gap

The Federal Reserve on Thursday ditched a fixed 2% inflation target in favor of allowing some overshooting around an average rate, and will also now target the shortfall from full employment and take more account of financial stability risks.

The long-awaited shift in its policy framework came sooner than some market expectations for a conclusion at next month's FOMC meeting. The Fed said it was a recognition both of the benefits of running a hot labor market and the difficulties of conducting monetary policy when interest rates are already at zero.

The Fed's shift toward an average inflation target was announced alongside prepared remarks from Fed Chair Jerome Powell to be delivered before a remotely-held Jackson Hole conference, the Kansas City Fed's widely-watched and internationally-attended research symposium.

"Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation," Powell said. His speech largely avoided any issues related to the current outlook for the economy or monetary policy.

On the employment side of its mandate, the Fed shifted its language to say its judgments would be defined by "assessments of the shortfalls of employment from its maximum level," instead of "deviations from our maximum level."

Moderately Above 2%

The Fed shifted toward an average inflation target that largely recognizes the central bank's persistent shortfalls from the 2% target--and a desire to make up for them in the future.

"Following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time," Powell said.

In response to the pandemic and the related economic slump, the Fed cut official borrowing costs rapidly to zero in March, and launched a number of emergency lending facilities aimed at reviving frozen credit markets.

The Fed also said the changes "explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past."

"Sustainably achieving maximum employment and price stability depends on a stable financial system. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals."

The FOMC will now undertake a public review of its monetary policy strategy roughly every 5 years.