WASHINGTON — For more than a year, the Federal Reserve has wrestled with how to achieve its twin goals — maximum employment and stable inflation — in an era of tepid price increases and very low interest rates.
While not a major kitchen table topic, the Fed’s approach to monetary policy affects every household in America. When it lifts or lowers interest rates to slow or speed growth, it changes the cost of mortgages and car loans. Because its policies help to determine economic strength, they inform how many jobs are available and how long expansions last.
On Thursday, Chair Jerome H. Powell will have a chance to update America on the central bank’s soon-to-conclude framework review, in which it has revisited its policy tools for good and bad times, in a speech at the Kansas City Fed’s annual conference. The storied gathering of elite economists has been held behind closed doors in Jackson Hole, Wyo., since 1982. Because of the coronavirus pandemic, the event will be held remotely and streamed on the Kansas City Fed’s YouTube page this year, allowing the public to tune in for the first time ever.
Mr. Powell, who is scheduled to speak at 9:10 a.m., is expected to summarize what the Fed has discovered as it has spent 21 months discussing its future policy approach. He may stop short of offering up the full set of final results — the central bank has hinted that will happen when it updates its long-run policy statement, an outline of overarching principles that officials usually release in January but which many economists expect them to revamp at their Sept. 15-16 meeting.
Fed watchers expect the central bank to shift from targeting 2 percent inflation exactly to a more flexible approach, such as aiming for 2 percent on average over time. The exact details remain unclear, but the adjustment could lay the groundwork for long periods of near-zero interest rates and very low unemployment.
Officials have promised the coming tweaks will be more “evolution” than “revolution.” Yet they will represent the culmination of not just the review, but also a yearslong process in which economists have been forced to fundamentally rethink the relationship between unemployment and prices, and the role of central bankers in a modern economy that has undergone tectonic shifts as the population has aged and productivity growth has slowed.
“What we’ve seen over the past six to seven years is a gradual shift which, cumulatively, is powerful,” Stephanie Aaronson, a former Fed research official now at the Brookings Institution. Whatever adjustment is adopted “has to be seen in the context of all of the changes since the Great Recession.”
For decades, economists believed that as unemployment fell, worker scarcity would force employers to raise wages in order to hire. Businesses would raise prices to cover those labor costs, and inflation would result.
The Fed saw its role as choking off that upward price spiral before it got going. Because rate changes take time to work, that meant lifting the federal funds rate well before inflation actually materialized, in a bid to cool off demand and slow the economy.
But real life diverged sharply from the textbook scenario. Since the 2008 financial crisis, inflation has remained stubbornly below the Fed’s 2 percent target — a goal it is sees as just enough to grease the wheels of the economy without causing harmful side effects.
People once criticized Janet L. Yellen, a former Fed chair, and her colleagues for waiting so long to raise interest rates after the 2007 to 2009 recession, warning that they were setting the stage for runaway prices. Now, critics more often say that the Fed’s first post-recession rate increase — in December 2015 — came too early.
Lackluster inflation is not the only problem confronting the Fed. Interest rates have been falling across advanced economies, seemingly driven by gradual economic shifts such as population aging and weaker productivity growth. That leaves central banks with less room to bolster economic growth when times are tough by making money cheaper.
Because policy interest rates include inflation, weak price gains only serve to worsen the dilemma. Inadequate room to lower rates also leads to tepid recoveries and longer periods of slow inflation, feeding an unhappy cycle of stagnation.
In light of the changes, the Fed has become more patient when it sets policy in recent years, allowing unemployment to drift lower in hopes of coaxing inflation higher.
By formally updating its framework, the Fed is trying to avoid a fate similar to the one that has befallen Japan. There, both interest rates and inflation trended downward for years, and the central bank has been forced to go to extreme lengths to try to stimulate the economy. Despite innovative and experimental policies — stock buying and negative interest rates among them — price increases have remained weak, trapped by public expectations. Europe is battling a similar phenomenon.
In part because the public’s understanding of future inflation seems to drive real-world economic results, the Fed is intent on clearly communicating what it is doing, and why. Officials have also increasingly taken the view that the Fed should try to be accountable to the people it serves.
The Fed went to great lengths to get the broader public involved in the policy overhaul, holding “Fed Listens” community events around the country alongside more typical academic conferences. On Thursday, Mr. Powell’s speech will be simultaneously available to academics and government officials — the usual Jackson Hole conference invitees — and armchair enthusiasts who have been following along from home.
While the Jackson Hole conference’s new democratization is driven by necessity, it is a fitting early conclusion for a review that focused on openness.
Wall Street analysts expect officials to set out a more concrete plan for the near future of interest rates once they have made the formal tweaks to their long-run statement. Fed officials signaled in their July meeting minutes that the updated document “would be very helpful in providing an overarching framework that would help guide the committee’s future policy actions and communications.”
To some degree, the anticipated adjustments will just commit to what is already happening in practice. Fed officials have given no indication that they are eager to raise rates, now at nearly zero, even if unemployment should fall quickly. Mr. Powell said at his late-July news conference that the framework changes “are really codifying the way we’re already acting with our policies.”
Still, “it’s a big change for them to codify and formalize it,” said Julia Coronado, founder of MacroPolicy Perspectives and a former Fed economist, in part because it means that Federal Open Market Committee, which sets interest rates, will now be tied into the approach. “It commits future committees.”
But it is unclear whether the adjustments Mr. Powell and his colleagues make will be enough to deal with the changes that have quietly transformed the modern economy.
The theoretical interest rate that would neither speed up nor slow down growth has dropped by more than 2 percent since the early 2000s, based on one popular model. Wringing out a few extra fractions of a percent by pumping up inflation will not fully restore that decline. And when it comes to crisis tools, longer-term interest rates have also dropped, rendering large-scale bond-buying programs meant to push them down less powerful.
“It’s not going to be enough,” Ms. Coronado said. After this crisis is over, she said, Congress should look at what tools the Fed has at its disposal to counter future crises. “We should be thinking big, and structurally.”
For now, Fed officials have turned to talking about government taxing and spending policy — the other lever that can stoke the economy, but one that is out of their hands. Central bankers have made clear that they believe Congress should pass another pandemic response package.
“The bottom line is that monetary policy is approaching its limits,” Paul Ashworth at Capital Economics wrote in an Aug. 25 note. “While Fed officials would never admit that publicly, that explains why they have become so outspoken in encouraging Congress to put more fiscal stimulus in place.”