By Syndication The Washington Post, Bloomberg · Christopher Condon
U.S. central bankers dropped some strong hints on the answer to that question this past week.
The minutes of the Federal Open Market Committee's June 9-10 meeting, released July 1, showed "a number" of policy makers favor tying future moves for interest rates and asset purchases to inflation. They even suggested they'll wait until inflation overshoots the Fed's 2% target before making substantial changes.
That surprised some Fed watchers, but perhaps it shouldn't have.
Just before the covid-19 pandemic hit, officials were heading into the home stretch of an extended policy framework review that was already pointing to a major shift in the way the Fed interprets its price-stability mandate.
Chided for long overestimating where they forecast inflation would go -- only to see it fall repeatedly short -- several FOMC members had resolved to push it at least modestly above target.
That the lessons from the framework review -- rooted deeply in fundamental ideas about how the economy has changed over decades -- would merge into the FOMC's month-to-month decision making was probably inevitable. But it was uncertain when and how that might happen.
The recent minutes make clear these two rivers are poised to flow together in coming months as officials lay out guidelines for future policy.
"If you say you're going to adopt this new framework, what do you do to show people that it means something?" said Michael Feroli, chief U.S. economist at JPMorgan Chase. "This is one way of backing it up."
The discussion at the June FOMC meeting -- at which officials forecast they'd keep rates near zero through 2022 -- reflected a shift that had long been underway.
Following the Great Inflation of the 1970s and '80s, the Fed's posture was one of constant vigilance against upward-moving prices. Officials, and economists generally, came to realize only slowly that inflation had grown less and less responsive to shocks and especially to declines in unemployment.
The Fed's favorite measure of price pressures averaged a scant 1.3% in the five years through 2019, even as joblessness dropped to a half-century low.
Gradually, policymakers became more alarmed that inflation was, in fact, running too low -- to the point where it was robbing the Fed of its ability to fight recessions by keeping interest rates too close to zero even in good times.
The framework review was the Fed's attempt to find new ways of lifting long-term inflation back to the 2% target.
In January of this year, the FOMC hadn't quite finalized that review, so no official conclusions had yet been made nor official policy changes put in place. But a number of committee members made clear they wanted to do away with the old approach of always aiming to move inflation precisely to 2%, without regard to past misses.
Having undershot for so long, many now wanted to push inflation a bit above the long-run goal, seeking inflation that averaged 2% over time.
"It was more than tolerating inflation above target, it was actively setting policy to achieve outcomes higher than the target for a period of time," said Michael Gapen, chief U.S. economist at Barclays Capital.
Within that context, it's not surprising that the minutes reveal a preference to build an inflation threshold into the coming forward guidance.
"A number of participants spoke favorably of forward guidance tied to inflation outcomes that could possibly entail a modest temporary overshooting of the committee's longer-run inflation goal," the minutes read.
The record also went on to show that "various participants" stressed the importance of completing the framework review "in the near term" along with revising the Fed's Statement on Longer-Run Goals and Monetary Policy Strategy. Officials have said that document would be altered to reflect the major conclusions of the review.
Stephen Stanley, chief economist at Amherst Pierpont Securities, said the framework review nudged policy makers into favoring forward guidance that incorporates inflation goals instead of unemployment goals, or a combination.
"Putting more emphasis on the inflation number is a function of some of the changes they've come around to that, in turn, were mainly related to how they view how the structure of the economy has changed," he said.
What the minutes do not reveal is whether the Fed is likely to keep fastened to zero until inflation overshoots 2%, or simply keep rates below what they judge to be a neutral setting until that point.
JPMorgan's Feroli expects they'll stay at zero.
"It would be an aggressive step, but probably one that's warranted if you believe the logic behind inflation averaging," he said.