FED’s New Policy Strategy: Average Inflation Targeting

FED’s New Policy Strategy:
Average Inflation Targeting

The Federal
Reserve (FED) announced a change in its policy strategy during a central bank
speech led by Chairman Jerome Powell in conjunction with the Jackson Hole
symposium on Thursday. The policy decision was made to support the labor market
and economic growth.

According to
Powell, the policy strategy called ‘average inflation targeting’ is considered
a robust update on the Fed’s policy, where inflation is now allowed to stay
above the 2% objective for some time, after years of inflation level below target.
The changes were codified in a policy blueprint created in 2012 called the
‘Statement on Longer-Run Goals and Monetary Policy Strategy’.

Central bank
officials traditionally think that lower unemployment will potentially lead to
dangerously high inflation levels, thus leading to interest rate hike as a tool
to control inflation. However, the new policy strategy implies that the Fed
will not tamper with their interest rate even if unemployment falls and
inflation rises. Many critics argued that the move does not support the Fed’s
intuition; however, Powell emphasized that persistently low inflation poses
serious risks to the economy too.

The policy stance
contrasted the stance from 40 years ago when former Chairman Paul Volcker
carried out a series of rate hikes to push down inflation level. However, over
the years, fundamental changes in the economy such as technology had led to
Fed’s notice on inflation level being too low. Powell said that this could lead
to a fall in longer-term inflation expectations, pulling actual inflation lower
too and eventually resulting in a cycle of ever-lower inflation.

The Fed has been
struggling to hit its 2% inflation target ever since the end of the financial
crisis. Officials now hope that the latest strategy will change the structure,
which allows inflation to float higher under low-level interest rates. Powell
did not specify how much the Fed targets for inflation; however, Dallas Fed
President Robert Kaplan told CNBC that a range of 2.25%-2.50% inflation level would
be satisfactory.