Big questions remain about Fed policy
“Economic Stability Remains the Fed’s Core Objective”
By Marc DuPont, courtesy of the Mercatus Center
As America collectively holds its breath waiting for the final results of the US presidential election, Federal Reserve (Fed) Chair Jerome Powell spoke on November 5 on the state of the economy and how the Fed will continue to respond to the COVID-19 pandemic and its macroeconomic implications. As many may have expected, however, there was little change in the current outlook of the Federal Open Market Committee (FOMC) or plans for policy action as the economy continues to show signs of recovery across various sectors.
As Powell noted during the FOMC’s press conference, despite positive signs of third-quarter GDP growth, economic activity still remains solidly below the levels that were seen before the pandemic spread across the globe. Although the economy has rapidly improved since reopening from lockdowns, the travel and hospitality industries—as well as others within the services sector—continue to struggle amid the COVID-19 pandemic. This is a trend that may continue until the public feels confident the virus is under control. Because of these factors, and with the addition of declines in oil prices, inflation has also remained below the Fed’s 2% target level.
Consistent with its newly adopted average inflation targeting framework, the FOMC has signaled that the Fed will continue to respond to this undershooting through aiming to boost inflation “moderately above two percent for some time” so that inflation levels will average 2% “over time” and “longer-term expectations remain well anchored at two percent.” Despite this commitment, however, Chairman Powell was reluctant to provide more detail on how this temporary overshooting will be achieved in order to remain consistent with the Fed’s new regime. Instead, Powell offered vague reassurance that the FOMC would continue to keep monetary policy “accommodative” as the central bank continues to provide credit to households and businesses in the midst of the pandemic—policies that include sustained purchases of Treasury and mortgage-backed securities at its current pace.
Additionally, Powell announced that the Fed will keep its interest rate target between 0% and 0.25% and that it will maintain this range until “labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to two percent and is on track to moderately exceed two percent for some time.” However, if the Fed’s quarterly Summary of Economic Projections (SEP) is a reliable guide for when this inflation overshooting can be expected, we may not see any changes in interest rates anytime soon, as long-term inflation is not even projected to hit the 2% target range until at least 2023.
Lastly, Powell revealed some new additions to the SEP, including an earlier release schedule and two new graphs displaying how FOMC participants’ risk and uncertainty assessments have changed over time. As Powell detailed, these new graphs should “provide a timely perspective on the risks or uncertainties that surround the modal or baseline projections, thereby highlighting some of the risk management considerations that are relevant for monetary policy.” In simpler terms, this will allow a more in-depth look into how the Fed prepares for potential risks that fall outside the expected path of the economy. Coupled with an earlier release of the SEP, these changes will allow for a more transparent and real-time glimpse into the Fed’s policymaking.
Overall, the FOMC seems content with keeping the economy on a steady course through these turbulent times, but it has reiterated that if conditions were to change unexpectedly, the Fed’s stance on monetary policy would be adjusted to respond to these changes. In response, many have continued to question whether the Fed should be doing more beyond ensuring macroeconomic and financial stability, as millions of Americans look for fiscal relief in wake of the COVID-19 crisis. Addressing these concerns during his press conference, Powell reiterated that the Fed would not be pursuing any form of money-financed fiscal policy, such as “helicopter money,” adding that any additional fiscal stimulus must be administered through the proper legislative channels. Despite this, however, Powell still believes not only that the fiscal actions taken thus far have been critical for economic recovery, but that continued stimulus may be essential if the economy is to return to its pre-pandemic levels.
Unfortunately, major question marks still loom about the Fed’s response to the crisis and its commitment to its new average inflation targeting regime. The FOMC has provided little clarification on the question of when it will begin overshooting its 2% target, as well as how aggressive and quick this makeup policy will be. As highlighted in the September SEP, current longer-term levels of inflation are expected to remain stifled below target, which runs contrary to the Fed’s commitment to any form of makeup policy. The central bank would do well to address these concerns sooner rather than later, since congressional pushes for additional stimulus appear to be stalled and COVID-19 cases continue to surge across the nation. As a result, if the FOMC wants to remain credible in its aims to bolster inflation while achieving its dual-mandate objectives, it should provide additional guidance on its plans to accomplish these goals, as the country continues to wade through this unprecedented period of economic pain and uncertainty.
Marc DuPont covers monetary policy for Mercatus and is co-producer of the Macro Musings Podcast.