Powell Signals Monetary Policy Overhaul, Warns of Persistent Inflation Volatility Ahead

On Thursday, Federal Reserve Chair Jerome Powell delivered remarks at the Washington headquarters, previewing potential adjustments to the central bank's monetary policy framework.

The Fed's First Policy Review Since 2020

The Fed is currently conducting its first monetary policy framework review since 2020, aiming to incorporate lessons from the 2021 inflation surge and subsequent aggressive rate hikes. The previous policy framework has been criticized for contributing to the Fed's delayed response that year.

As part of the consultation process, the Federal Reserve Board is hosting the "Thomas Laubach Research Conference" this week, bringing together external experts and policymakers for discussions. The Fed expects to complete the policy assessment by late summer, with a potential announcement at the Jackson Hole symposium in August.

Powell to revise the "Statement on Longer-Run Goals"

Powell noted that in 2012, under then-Chair Ben Bernanke, the FOMC first formalized the Fed's monetary policy framework in a document titled the "Statement on Longer-Run Goals and Monetary Policy Strategy"- also known as the "consensus statement." From 2012 to 2018, the FOMC voted annually in January to reaffirm this statement. In 2019, the Fed decided to conduct a public review every five years.

Powell, who led the last policy review in 2020, pointed out that at that time, policymakers were dealing with nearly a decade of low interest rates, sluggish growth, subdued inflation, and a very flat Phillips curve. Thus, the current framework- still in use- was primarily designed to address persistent inflation undershooting.

During the 2020 review, the Fed also decided that future policy decisions should be based on assessing "shortfalls from maximum employment" rather than "deviations."

In other words, the Fed became more focused on employment being too weak rather than preemptively tightening due to "overheating" concerns. This led to a subtle but crucial shift: keeping interest rates slightly below what most models suggested and allowing inflation to moderately exceed the target.

Under this framework, the Fed believed as late as 2021 that inflation would likely decline rapidly in 2022, requiring only modest rate hikes- but reality proved very different.

Powell: The Economic Landscape Has Changed Dramatically

Powell emphasized that the economic environment has shifted significantly since 2020, and the latest review will reflect these changes. He noted that with rising real interest rates, inflation volatility may be higher than in the 2010s, and the world is entering an era of "more frequent and potentially longer-lasting supply shocks."

So far in the discussions, participants broadly agreed on the need to revisit the language around employment "shortfalls." Additionally, during last week's policy meeting, officials supported revising the "average inflation targeting" approach. Powell reiterated that stable inflation expectations remain the bedrock of policy, and the Fed remains firmly committed to its 2% inflation target.

Beyond updating the consensus statement, the Fed is also considering possible improvements to its formal policy communications, particularly regarding forecasts and uncertainty.