The Jackson 5

Summary

At the 2020 Jackson Hole Economic Policy Symposium, Chair Powell used his address to lay out changes to the FOMC's monetary policy framework. A short five years later, the next monetary policy framework review is nearing a conclusion. We expect Powell to recap how the economy and policy setting evolved over his tenure as Fed Chair, and what the lessons learned mean for the optimal strategy for monetary policy in the years ahead.

• Shaped by the times: The decade leading up to the FOMC’s prior framework review was dominated by persistently low inflation, excess labor market slack and concerns about the zero lower bound. The adjustments made in 2020 at the height of the pandemic reflected these perceived asymmetric risks to the Fed's dual mandate. But, the macroeconomic environment soon proved wildly different. Inflation charged past 2% in March 2021 and has not returned to 2% since. The unemployment rate fell to less than 4% by the end of that same year.
• Coming full circle: Much of the past few years have been marked by U.S. monetary policymakers facing an old but new problem: overheated labor markets and above-target inflation. Today, the risks around the Fed’s 2% inflation target and full employment mandate seem much more symmetric. We suspect changes to the policy framework will be aimed at this newfound symmetry in the dual mandate.
• • Specifically, we look for the FOMC to formally move away from Flexible Average Inflation Targeting (FAIT), which supported inflation running somewhat above 2% to make up for past undershoots, but not vice versa. In its place, we expect the Committee to return to a simple 2% inflation target, where it does not try to make up for past misses. The Committee has said explicitly that the 2% inflation target itself is not under review, so do not expect a new number or a range.
  • Similarly, we look for the FOMC to move away from its emphasis on addressing shortfalls from maximum employment and revert to its focus on deviations. The Fed’s maximum employment goal is not directly observable but reveals itself through the labor market’s impulse on inflation. Thus, the new framework may link its maximum employment objective more directly to its inflation goal.
• All quiet on the balance sheet front: We do not anticipate any changes to the Federal Reserve’s toolkit as part of this year's review. The federal funds rate should remain the main policy tool, and, while we think the FOMC at some point ought to formalize how it uses its balance sheet in support of its longer-run goals, it appears to us that the Committee would prefer to de-emphasize this tool for the time being.
• Formalizing what is already in practice: In our view, the FOMC already has been operating under a more symmetric approach to its inflation and employment objectives in recent years. As such, we expect the new framework to codify what we believe is already the modus operandi. Yet, the shift away from the asymmetric risks around low inflation and maximum employment marks an important departure from the psychology of the 2008-2020 period, and it could result in more preemptive policy tightening when the next inflationary episode occurs.
• More to come: Part II of the FOMC's framework update will focus on the Committee's communication tools, such as the Summary of Economic Projections. Chair Powell has signaled that the second half of the framework review will occur later this year, and we will have more to say about it when the timing is closer.

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