FOMC Announces Longer-Run Goals: Average Inflation Target

Vito J. Racanelli

This Thursday marked the culmination of a year and half long policy framework review by the Federal Reserve.  And the results can be summed up pretty quickly. In this case, three letters suffice: “AIT” or Average Inflation Targeting. 

Under its newly announced policy framework, the Fed will explicitly aim to achieve average inflation of 2%. And, most importantly, if inflation has persistently undershot 2%, the Fed will “likely aim to achieve inflation moderately above 2 percent for some time”. I guess the Fed doesn’t like to box itself in with its language.

What does this mean from a policy perspective?

A cynic would say this means the Fed got it wrong. Despite PCE inflation barely inching above the 2% mark in the 2010’s, the Fed raised rat es nine times in the 2015-2018 period only to start cutting six months later in July 2019…and then really start cutting in February of this year. But hey, maybe even the Fed should get a pass when it comes to global pandemics. 

An optimist would say that this is a step in the right direction. With the new policy in place, expect the Fed to think twice before raising rates, even in a very tight labor market. I wouldn’t go so far as to say that the Fed has declared the Phillip’s Curve, (or the inherent tradeoff between inflation and unemployment), dead with this policy change. However, the policy is undoubtedly a signal that labor market outcomes may matter a little more to the Fed now than they have in the past.   

The short-term impact of this policy shift was minimal.  By intraday standards, the 30 -year and 10-year interest rates moved a decent amount, but this would be considered trivial in macro terms. And the reaction from the stock market was also muted with the Dow topping the charts of all major indices with a 60bps move.

How long will it be until we get to see the Fed put its money where its mouth is and reveal what moderately above 2% means? A believer in the Phillips Curve would say quite some time.

With the unemployment rate still around 10% and unemployment claims coming in at about 1M last week (about 5x their pre-virus level), the economy is clearly still recovering from the shock of the virus shutdowns. And inflationary pressures, or at least those originating from a tight labor market, should be muted. Or at least that’s what the theory says. 

The yield on the benchmark 10-year U.S. Treasury is 0.72% up from 0.63% last week. Next FOMC meeting is Sept. 15-16.

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Vito J. Racanelli
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