The Federal Reserve followed through on its update of its long-run monetary framework, stating quite transparently on Wednesday that the policy-setting Federal Open Market Committee “will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer-term inflation expectations remain well anchored at 2%. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.”
We are looking at five years at the least of rates remaining pinned to the zero boundary.
Combined with the forward-looking interest rate forecast included in the Fed’s Summary of Economic Projections, the FOMC’s statement shows that we are looking at five years at least of rates remaining pinned to the zero boundary, if not far longer, given the disinflationary shock caused by the pandemic and Federal Reserve Chairman Jerome Powell’s outlook.
To put that in perspective, the Fed took rates to zero following the Great Financial Crisis and did not budge the policy rate for seven years. If policymakers, investors and firm managers were looking for an additional commitment by the Fed to obtain its policy objectives, there it is in plain English.
Given that measures of inflation expectations remain well anchored below the 2% target, the Federal Reserve has its work cut out for it in pushing those expectations back toward the target. It will be interesting to see just how interested Fed policymakers are in signing up to become verbal stunt pilots as the central bank attempts to reshape long-term expectations, which will be a major policy challenge in the years to come. Ladies and gentlemen, start your engines.
The Fed will need to flesh out what the mechanics of a flexible average inflation target will be — no easy task.
The two dissents, by Dallas Fed President Robert S. Kaplan and Minneapolis Fed President Neel Kashkari, no doubt revolve around internal disagreements around a transparent commitment to fleshing out the flexible average inflation target regime and what that means for forward guidance and the composition of asset purchases.
The Fed will need in the coming months to flesh out what the mechanics of a flexible average inflation target will be and how they will work. Investors should anticipate an ideational offensive by Fed members to fill in policy gaps where necessary to underscore the Fed’s commitment and begin reshaping public expectations. This will not be easy.
The Federal Reserve upgraded its growth forecast for 2020 to minus-3.7%, down from a contraction of 6.5% in June, while reducing its estimate of year-end unemployment to 7.6% compared to 9.3% in June. The 2021 and 2022 growth estimates were improved to 4.1% and 2.9%, respectively.
The central bank’s implied long-run estimate of the unemployment rate is 4.1%. Long-run growth stands at 1.8%, while the dot plot forecast implies a zero policy rate through 2023. The central tendency of the Fed’s policy variable for inflation remains 2%, and the Fed does not anticipate achieving that objective through the 2023 endpoint of the forecast in the Summary of Economic Projections.
The Fed’s long-run estimate of full employment appears to be near 4%, the neutral interest rate 2.5% and the real neutral rate 0.5%, all while expecting growth below 2% over the long run.
In his press conference on Wednesday, Powell said that the Fed’s 13(3) emergency lending power is limited, which we take as an implied signal to the fiscal authority that if Main Street needs further help, Congress and the administration will have to tolerate more risk and provide more direct support.
Powell noted that there is a fundamental mismatch between the economic problem and the Fed’s tools, which are aimed at liquidity crises. The 13(3) loans, including the Main Street Lending Program, must be to solvent borrowers. But businesses today face a solvency, not a liquidity crisis.
Given that the Fed is sitting on roughly $600 billion in dry powder with its Main Street Lending Program, this carries significant meaning for small and medium-size firms that look warily at what will arrive as winter approaches.