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Opinion Perryman: Federal Reserve policy shift is a big deal

Perryman: Federal Reserve policy shift is a big deal

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Even if inflation trends upward and rises above 2%, the new Fed policy permits it to not immediately tighten interest rates to slow expansion. For the millions who lost their jobs due to COVID-19, this is good news indeed.

A shift in Federal Reserve (Fed) policy was recently announced. This newsflash could easily be missed in the midst of a pandemic, significant economic dislocations, and social unrest.
I wrote my dissertation on Fed policy in the mid-1970s (as well as numerous academic articles and my first book). As part of that ordeal, I read the meeting minutes dating back to the 1950s. Thus, I am likely the only person who has perused the notes from every meeting for the past 70 years (comments regarding my social life are discouraged).

Ray Perryman

All of that to say, believe me, this one is a big deal. 
The modification to the Federal Open Market Committee’s (FOMC) Statement on Longer-Run Goals and Monetary Policy Strategy revises 2012 language. The statement is the foundation for policy actions, such as adjusting target interest rates, and the update accommodates economic patterns over the past decade.

The Fed’s objectives, which have at times been in conflict, are to maximize employment while keeping inflation low. The change is in the way inflation targets operate.
Specifically, the inflation goal has shifted from a maximum level to an average over time. In other words, if during expansionary periods inflation exceeds the goal (currently 2%), there wouldn’t be an immediate slowing of the economy. 
If, as under the old rule, inflation is below 2% in downturns but never moves above 2% even when the economy is strong, then inflation will necessarily average less than 2%.
This rigidity makes it harder for the Fed to stimulate the economy. After periods when inflation has been running below 2% (such as currently, with the pandemic causing economic contraction), the Fed can now allow inflation moderately above 2% as growth ensues.

The economy has evolved notably since 2012. During the recent expansion, unemployment fell to levels previously thought to be unsustainable. Nevertheless, inflation never escalated.
Instead, the labor market adapted, more people were enticed into the workforce, and companies found ways to enhance productivity. Unemployment across all groups fell to historic lows, offering opportunities across ages, races/ethnicities, and education levels. 
In addition to changing the management of interest rate targets, maximum employment will also be seen as more inclusive and able to change over time. The economy has proven an ability to increase jobs beyond prior performance without triggering excessive inflation, and the new policy perspective takes a broader view.

We are likely to see these new approaches surface as the economy emerges from the pandemic.
Even if inflation trends upward and rises above 2%, the new Fed policy permits it to not immediately tighten interest rates to slow expansion. For the millions who lost their jobs due to COVID-19, this is good news indeed.
M. Ray Perryman, Ph.D., is president and chief executive officer of The Perryman Group, which has served the needs of more than 2,500 clients over the past four decades.

Home | The Perryman GroupThe Perryman Group provides the economic insights you need for the board room, the courtroom, the hearing room, or any other room where decisions are made.www.perrymangroup.com
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