The Federal Reserve has signaled a major shift in its approach to managing inflation as it tries to do more to help the recovery of the US economy.
The central bank will now aim for an “average” inflation of 2%, rather than making 2% a fixed target, which will give it more flexibility, said boss Jerome Powell.
This will allow the bank to keep interest rates lower for longer, thus stimulating growth to combat unemployment.
It comes as millions of people are out of work due to the economic blow from the coronavirus.
“It is difficult to overestimate the benefits of maintaining a strong labor market, a key national goal that will require a range of policies in addition to a supportive monetary policy,” said Powell.
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The Federal Reserve has for years considered 2% to be the optimal level of inflation to maintain a healthy economy.
If he believes inflation could exceed that level, he may raise interest rates – but that makes borrowing more expensive for consumers and businesses.
While the United States is in deep recession due to the pandemic, the Fed has cut rates to almost zero and launched a $ 700 billion stimulus package to help jumpstart growth.
But speaking at Jackson Hole, the Fed’s annual economic symposium, Powell said the bank needs to go further to tackle unemployment, which currently stands above 10%.
“There is a special part of the economy that is bringing people together and feeding them, making them travel across the country, making them sleep in hotels, entertaining them,” Mr. Powell said.
“This part of the economy will have great difficulty in recovering… millions of people will have difficulty finding work. We have to stick with these people… We are probably looking at a long term couple of years at least. ”
Many central banks have kept interest rates very low since the financial crisis more than ten years ago. This made them fear that they would run out of effective tools to fight another recession.
Central banks have innovated, notably with quantitative easing, by buying financial assets with newly created money, and some have experimented with interest rates below zero.
Jerome Powell’s speech does not create new tools. He is proposing to adapt an existing target – the inflation target – to tackle what Mr Powell calls the continuing under pressure of inflation. If inflation were a little higher, interest rates would tend to be too. So there would be a little more scope to cut rates when the economy is in bad shape.
Of course, the United States is now in one of them due to the pandemic. The approach announced by Mr. Powell could not compensate for a slowdown of this magnitude. But it could give the Fed a little more leeway going forward.
Neil Williams, senior economic adviser at Federated Hermes, said that by pursuing an average inflation target, rather than a fixed one, the bank could allow inflation “to travel beyond its preferred destination by 2% before tighten rates ”.
“This should give the recovery more room to breathe. The challenge, however, will be to get the inflation train to go this far. “