Fed Announces Historic Change in Policy

By allowing inflation to creep up at around 2% in order to support higher employment rates, the Fed will likely keep interest rates low for some time.

Author: Steven Lerner   

In a major deviation in policy, Federal Reserve Chairman Jerome Powell vowed to push for more inflation and to keep rates low in an effort to improve the economy and help more Americans gain employment.

The announcement boosted U.S. stocks, which were already in the midst of a record-breaking rally. The Dow Jones Industrial Average is up nearly 1%, with the Nasdaq and S&P 500 ticking up at around.5%.

Bonds moved higher on Thursday, with the U.S. 10-year Treasury note up 0.027% to begin the trading day. Gold prices dropped down as investors reacted to the Fed's inflation position.

Speaking at the virtual Jackson Hole summit, Powell said that the Fed wants inflation to run hotter than normal, with the goal of averaging 2% over a period of time. 

This new plan of flexible average inflation targeting, which will get reviewed every five years, empowers the Fed to make future monetary decisions based on how the economy recovers from the pandemic.

The Fed has aimed for 2% inflation since 2012, but has fallen short almost every year and averaged closer to 1.6% inflation since then.

Powell spoke about the perils of low inflation during the 2010s, which he says is "diminishing our capacity to stabilize the economy through cutting interest rates."

He added: "Inflation that is persistently too low can pose serious risks to the economy."

This reversal in inflation policy stems from the Fed's recognition that a strong labor market reaching its maximum level is critical, particularly for lower-income communities that were devastated by the economic impact of the pandemic.

Powell believes that "a robust job market can be sustained without causing an outbreak of inflation."

By allowing inflation to creep up at around 2% in order to support higher employment rates, the Fed will likely keep its interest rates low for some time.

While Powell said that the Fed is "prepared to use our full range of tools to support the economy," he did not specify how the Fed would achieve its goal of higher inflation.

It's possible that there could be more asset purchases from the Fed and it could be a more active player in the market. However, it isn't clear what else the Fed could do. It has already used some quantitative easing measures to help ease the fallout from the pandemic.

With the next FOMC meeting scheduled in September, investors will expect Powell to provide clarity about how the Fed will reach its inflation goals.

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