MNI EXCLUSIVE: Fed's Inclusiveness Shift to Delay Rate Hikes

The Fed's new framework will make policymakers reluctant to raise rates unless low-income families join the recovery, perhaps going beyond the last cycle where inflation remained weak as unemployment plumbed record lows, current and former Fed officials tell MNI.

Financial markets assume no Fed tightening any time soon, though options trades show some bets on higher rates two-to-three years out. Even once the pandemic cedes and the economy recovers, the Fed may take longer than in the past to begin a hiking cycle, not only because of its commitment to average inflation targeting, but as it increasingly focuses on a broader range of economic and social indicators.

"If you're sitting at a trading desk in New York and thinking in very hard-knuckled terms about what the Fed is up to it might be easy for them to underestimate the Fed's commitment to making sure employment gains are spread throughout the economy," former Atlanta Fed president Dennis Lockhart said in an interview.

"It's a sincere and meaningful change of approach--the inclusion of the word 'inclusive' tells you a lot," he said.

In announcing the shift in its statement of longer-Run Goals in August, Fed Chair Jay Powell said the change "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."

The Fed has no single numeric target for employment, Powell said in September, pointing to a range of factors including low joblessness, labor force participation and wages growth. He has also this year made public statements touching on Black Lives Matter protests and calling Covid-19 a human as well as an economic crisis.

FED UP CAMPAIGN

While the Fed included average inflation-targeting in guidance in September, market participants may need convincing it will stick to its word to be patient if prices start to rise more quickly. The central bank has acted pre-emptively to head off inflationary pressures in the past, and its new framework still aims at ensuring longer-term inflation expectations remain well anchored at 2% as inflation averages 2%.

But the thinking underlying the new approach has deeper roots, suggesting a strong commitment. Under pressure from groups led by Ady Barkan of the "Fed Up Campaign" starting in the Janet Yellen era, the central bank warmed to the notion that early tightening cost the economy millions of jobs. Minneapolis Fed President Neel Kashkari and San Francisco's Mary Daly said much the same this year.

"You've seen FOMC participants say in recent years -- especially those who have been more resistant to the rate increases that were made in 2018 -- if we're not seeing inflation accelerating in a meaningful way, how can we say we're at full employment? So there's room to keep probing," John Weinberg, ex-research director at the Richmond Fed, told MNI.

RUNNING HOT

The change of heart gained momentum as inflation failed to reach the 2% target even as unemployment fell to a half-century low 3.5%. While many officials were reluctant to abandon the dominant view of a Phillips Curve tracing a trade-off between unemployment and price gains, the benefits of running a hot job market were made clear with major payroll gains and broader improvements in minority unemployment and labor force participation until the pandemic struck.

With such evidence running for much longer than the official 18-month policy review, the new regime, including a strong desire to not only meet the 2% inflation target, but also overshoot it for a period, is one that won't be easily overturned, ex-officials say.

"The Fed is going to be guided by its perception of what inflation might be saying about the labor market," Weinberg said. "The change in the framework with regard to average inflation targeting is a move in that direction."