The move by the Fed to look more toward inflation averaging was largely expected. This past Monday in our morning notes (8/24) we wrote to clients how we thought the Fed would adopt a “flexible” inflation averaging strategy. We also discussed different ideas that came out of the Fed’s policy review which concluded long before Jackson Hole this week.
From our morning notes this past Monday on conclusions from the Fed listens:
- Powell was clear on providing the “consistent”, across the board feedback from all the “Fed Listens” events. In general, Powell is known to be a consensus builder.
- The importance of a “strong” job market, and in particular, the benefit of reaching low and moderate income communities. This has been a clear message from Powell especially of late through the pandemic. The Fed wants the 2019 job market back and the Chairman has made that clear. The impact of the virus on many of these communities will only emphasis this notion.
- National employment statistics not necessarily reflective of many local communities.
- There was less discussion on inflation than employment.
- Most seeing inflation as stable, questioning the Fed’s concern about inflation shortfalls below 2%. Fed has significant work to do in explaining why they’d let inflation run above 2% with particular attention to communities that were not seeing wages keep pace with inflation.
- A notion of more “plain speak” in communicating, relative to jargon economic terms such as “price stability and maximum employment”. Powell has been good about the “plain speak” informal forward guidance to date: more jobs doesn’t mean more inflation.
Policy implications and discussion:
- Emphasis on strong job market and what that means in a world where the Phillip’s Curve appears to have waned. Powell reverts back to job levels seen at the beginning of 2020.
- Concerns over inflation shortfalls and the implications for declining inflation expectations over time. And the need for the Fed to explain with credibility the impact of anchored inflation expectations going forward and willingness to let inflation run above 2%.
- The notion of different types of inflation averaging and makeup strategies over time. In a research paper presented during one of the Fed’s events, different types of inflation strategies where discussed with one such appearing in line with the Fed’s current thinking: Flexible Averaging Inflation Targeting. Powell was clear about a “flexible” approach this week.
Interestingly, what came of out of this week in the end on inflation was more confusion than clarity. And ironically the exact opposite of what came out of the Fed Listens program: “the need of a clearly defined and well articulated inflation message to be credible”. Yet, no math behind this one: total discretion and very qualitative. And as Powell said on Thursday: “the Fed will not be tied to an explicit formula”. More work to be done here.
The ensuing Fed Speak on Friday did little to clarify the Fed’s new policy goal:
Kaplan: On inflation “a little bit means a little bit, 2.25% (always seems a voice of reason).
Bullard: Referenced the half point “shortfall”, with a likewise makeup for “quite a while.”
Harker: Not about the number but the velocity.
Mester: Not really tied to a formula.
Shift to jobs
Since early 2019, with the unemployment rate near all-time lows, the Fed was easing and moving the Funds rate toward zero even before the pandemic. This was a key theme of ours in 2019. So when Powell indicated during his presser at the July 2020 meeting that the Fed was already carrying out the anticipated inflation changes, it came as little surprise. In the end, the Fed spent considerable time over the past year and a half (including this week) speaking about the flattening Phillip’s curve and declining relationship between inflation and employment.
In our view, the more powerful change this week was on employment: looking at shortfalls rather than deviations. And with a strong notion of leaving no one behind. Listening to the Chairman closely this past year, he has spoken extensively about the recovery since the 2008 crisis and the strong job market that was evolving into 2020. And how that job market was finally beginning to reach lower income communities.
The change in focus on the employment side of the Fed’s mandate is significant in our view. Just as the Fed leaned on shortfalls to inflation throughout 2019, we look for a shift now to the employment side, especially in light of the past six months.