Fed Sets Stage for Longer Periods of Lower Interest Rates

Jerome H. Powell, the chair of the Federal Reserve, announced a major shift in how the central bank approaches its economic policies, signaling it will no longer raise interest rates to keep the unemployment rate from falling too far and will allow inflation to run slightly higher in good times.

In emphasizing the importance of a strong labor market and less concern about runaway inflation, Mr. Powell and his colleagues laid the groundwork for extended periods of low interest rates. That could translate into long periods of cheap mortgages and business loans that foster strong demand and robust job markets.

“Our revised statement emphasizes that maximum employment is a broad-based and inclusive goal,” Mr. Powell said in the remarks, and “this change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities.”

The Fed chief is speaking at the Kansas City Fed’s annual Jackson Hole symposium, which is usually held in Wyoming at the base of the towering Teton mountains. This year, it is being held virtually and is being webcast, making it accessible to the public for the first time. He used that forum to explain the results of the central bank’s year and a half long review of its monetary policy strategy — its first ever. The Fed released an outline of its long-run policy goals in conjunction with his remarks.

Mr. Powell’s announcement signals a meaningful shift. The Fed once raised rates as joblessness fell to avoid economic overheating that ended in breakaway inflation. But in recent years, price gains have been tepid, and the changes are an explicit recognition that the problem is now too low inflation, rather than too high.

The Fed’s statement now says that its policies will be informed by “shortfalls” of employment from its maximum level, rather than by “deviations” — meaning, essentially, that the central bank is not gearing up to raise rates to cool off the labor market when unemployment dips to low levels.

“This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation,” Mr. Powell said.

The central bank is also shifting its inflation approach, aiming to average 2 percent inflation over time, rather than as an absolute goal. In doing so, the Fed is trying to convince the public and investors that it will allow prices to rise a little bit faster. If public inflation expectations slip, it can lock in slow price gains. Those feed directly into the level of interest rates, and leave the central bank with even less room to cut them during times of crisis.

“If inflation expectations fall below our 2 percent objective, interest rates would decline in tandem,” Mr. Powell said. “In turn, we would have less scope to cut interest rates to boost employment during an economic downturn.”

While higher inflation may seem like a weird goal to anyone who buys milk or pays rent, excessively weak price gains can actually have economically damaging effects. A circle of stagnation in which lower prices leave less room to cut rates has played out in other countries, including Japan.

“We are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes,” Mr. Powell said. “However, inflation that is persistently too low can pose serious risks to the economy.”

In a question-and-answer session after speech, Mr. Powell said the Fed is “talking about inflation moving moderately. The overshoots will be moderate.”

If the Fed can achieve slightly higher inflation, it will translate into more room for future rate cuts — and buying that extra headroom is a crucial goal in 2020. Long-running economic changes, such as population aging and weaker productivity gains, have weighed on the interest rate setting that neither stokes nor slows the economy. That has left the central bank with less recession-fighting wiggle room.

Still, Mr. Powell pointed out that he and his colleagues “are not tying ourselves to a particular mathematical formula that defines the average.”

The long-run document promises that the Fed will continue doing reviews, roughly every five years, and that the “thorough public” events will again look at strategy and communication practices. That will help it to deal with the challenges of very-low interest rates as the economy moves forward.

“With interest rates generally running closer to their effective lower bound even in good times, the Fed has less scope to support the economy during an economic downturn by simply cutting the federal funds rate,” Mr. Powell said.

“The result can be worse economic outcomes in terms of both employment and price stability, with the costs of such outcomes likely falling hardest on those least able to bear them.”

The Fed also explicitly noted that financial stability will be a concern moving forward. In recent decades, expansions have ended when asset price bubbles got out of control, rather than at the hands of too-high inflation.

“Sustainably achieving maximum employment and price stability depends on a stable financial system,” the Fed said in its statement. “Therefore, the committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the committee’s goals.”

Mr. Powell’s remarks, and the central bank’s shift, are set against an unhappy backdrop. The coronavirus pandemic tipped the United States into a deep recession, one that has left millions out of work, hitting vulnerable populations the hardest.

Fed officials have taken action to support the economy — cutting interest rates to zero, buying government-backed bonds in vast sums, and rolling out emergency lending programs. Still, more than one million people filed initial state jobless claims last week, data released Thursday morning showed.

The Fed has repeatedly emphasized that a strong job market and economy is an imperative goal, but that Congress will need to help achieve it. “It is hard to overstate the benefits of sustaining a strong labor market, a key national goal that will require a range of policies in addition to supportive monetary policy,” Mr. Powell said.