Fed relaxes inflation target in major policy shift

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The Federal Reserve has signalled a major shift in its approach to managing inflation, as it tries to do more to aid the US economy’s recovery.

The central bank will now target an “average” of 2% inflation, rather than making 2% a fixed goal, giving it more flexibility, boss Jerome Powell said.

It will allow the bank to keep interest rates lower for longer, stimulating growth to help tackle unemployment.

Millions of Americans are out of work due to the economic hit of coronavirus.

“It is hard to overstate the benefits of sustaining a strong labour market, a key national goal that will require a range of policies in addition to supportive monetary policy,” Mr Powell said.

The Federal Reserve has for years seen 2% as an optimal level of inflation to maintain a healthy economy.

If it feels inflation could go above that level, it can raise interest rates – however this makes borrowing money more expensive for consumers and businesses.

With the US in a sharp recession due to the pandemic, the Fed has cut rates to almost zero and launched a $700bn stimulus programme to help revive growth.

But speaking at Jackson Hole, the Fed’s annual economic symposium, Mr Powell said the bank needed to go further in order to tackle unemployment, which is currently above 10%.

“There is a particular part of the economy which involves getting people together and feeding them, flying them around the country, having them sleep in hotels, entertaining them,” Mr Powell said.

“That part of the economy will find it very difficult to recover… That is millions of people who are going to struggle to find work. We need to stay with those people… We are looking at long tail of probably a couple of years at least.”

Neil Williams, senior economic adviser at Federated Hermes, said that by pursuing an average, rather than fixed, inflation target, the bank could allow inflation “to travel beyond its preferred 2% destination before tightening rates”.

“This should give the recovery extra room to breathe. The challenge, though, will be getting the inflation train to get that far.”