- Bottom line: At its Wednesday meeting, the Fed suggested that it is likely to hold interest rates near 0% through 2023.
- It was the first meeting since Powell’s Jackson Hole speech when he announced the policy shift to “inflation targeting” which effectively focusses on pushing inflation up to 2% for some extended period.
- For years the Fed has fallen short of its 2% inflation goal. Some inflation is desirable since a lack of inflation could drive interest rates down, leaving the Fed little room to lower rates in a downturn. In addition, low inflation could slip into deflation which could cause a deep recession.
- In particular, the statement read (emphasis ours) “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well-anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”
- Translated, the statement means that the Fed will let inflation run higher than 2% for an extended period, and as a result, will keep rates near 0% for an extended period as well. Previously the Fed would have raised rates if inflation rose persistently above 2%.
- The statement signals that rates will now stay lower for a longer period of time than previously expected.
- In fact, the “dot-plot” accompanying the announcement shows that 16 of 17 Fed members expect rates to stay near 0% through 2022 and that 13 of 17 members still expect rates to stay near 0% through 2023.
- The statement also signaled that the Fed is willing to let the labor market run hotter than it would have before. The previous policy was based on the “Phillips Curve” which suggested that a hot labor market would cause inflation, a relationship that has now broken down. Effectively the Fed has abandoned that long-held assumption.
- The Fed also made another move to a more accommodative monetary policy. It said that its bond-buying program, which originally was meant to promote the smooth functioning of the credit markets, would now also be used to help boost the economy. The new wording read that the bond-buying would “…help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”
- The statement further noted that COVID-19 was the most important risk at the moment. “The COVID-19 pandemic is causing tremendous human and economic hardship… The path of the economy will depend significantly on the course of the virus.”
- That part of the statement effectively says the Fed can’t control the virus, and it can’t do much if the economy shuts down again and it’s up to Congress to act. In the press conference following the announcement, Powell said “My sense is that more fiscal support is likely to be needed. Of course, the details of that are for Congress, not for the Fed. But I would just say there are roughly 11 million people still out of work due to the pandemic and a good part of those people were working in industries that are likely to struggle. Those people may need additional support as they try to find their way through what will be a difficult time for them…”
- Finally, the Fed upgraded its previously overly pessimistic outlook, increasing its forecast of 2020 GDP to -3.7% from -6.5%, and lowering its 2020 unemployment projection to 5.5% from 6.5%. Projections for 2021 were also modestly revised in a stronger direction.
- It was the last meeting before the election.
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