In a speech Thursday, Federal Reserve Chair Jerome Powell hinted that the central bank’s five-year framework review will focus on the particulars of its maximum employment and stable price goals, as well as efforts to communicate clearly with the public. In both cases, the Fed should be guided by humility in the face of uncertainty.
The potential fracturing of the globalized trading system and a return to 1930s-style tariffs are developments that are expected to boost consumer prices and hurt growth in the US, but the propositions haven’t been tested in nearly a century. It’s impossible to know for sure whether price or growth effects will dominate — or whether some unforeseen third outcome will materialize.
After the last framework review in 2020, the Fed’s rate-setting committee famously implemented a policy based on the bold assumption that the future would look a lot like the past. Influenced by the so-so labor market and low inflation of the post-financial crisis period, the rate-setting committee agreed to target inflation that averaged 2% over time and to permit inflation moderately above that level following periods of persistently low price increases, based on the concept of flexible average inflation targeting. It also committed to reacting to perceived shortfalls in its maximum employment goal, but not necessarily to overshoots, despite the risks to inflation. When inflation took off in 2021 and 2022, critics said these principles had slowed the Fed down, and there appears to be a measure of truth to the criticism, despite Chair Powell’s denials.
That wasn’t the only error and maybe not even the primary one. Powell argued on Thursday — as he has in the past — that the mistakes of 2021 were largely the result of widespread forecast errors, both inside the Fed and beyond, rather than a conscious decision to allow consumer prices and the labor market to run hot. By and large, policymakers and forecasters initially viewed the 2021 inflation as an idiosyncratic supply shock — impacting just used cars and a few other items — and decided to look through the data that was staring them in the face. It was overconfidence in this narrow interpretation and the audacity to ignore the evolving data that ultimately led the Fed astray. The Fed’s goals should return to a simple 2% inflation target and maximum employment, but policymakers shouldn’t pretend that will solve all their problems.
There’s also more to be done involving forecasts and how they’re communicated. The Fed’s Summary of Economic Projections, first published in 2007, is one of the great innovations of US central bank communication. It provides markets and the public with transparency about how the rate-setting committee sees the economy developing. But the now-quarterly reports allow policymakers to hide behind anonymous projections and tacitly encourage market participants to focus on the median outlook for where rates are heading — a summary statistic that conveys a false sense of certainty about the destination.
A more candid and helpful SEP might reveal the Federal Reserve Board members and Federal Reserve Bank presidents behind the anonymous projections and, equally as important, demand that they submit scenario analyses to show how their outlook would change under different assumptions. The latter would be similar to a suggestion that former Fed Chair Ben Bernanke made in an independent review of practices for the Bank of England. Beyond improving communications, a heightened focus on scenarios — rather than a “base case” — will also help prevent policymakers from falling into the overconfidence trap, as they did in 2020. Alternatively, my Bloomberg Opinion colleague Bill Dudley, former president of the Federal Reserve Bank of New York, has suggested that the Fed should publish staff forecasts after each policy-making meeting.
All in all, the Fed’s framework review isn’t a moment to throw the baby out with the bathwater. In his latest remarks, Powell said “we remain fully committed to the 2% target today.” There is no reason to revisit that target, despite some claims that it’s become too dated for a world of more frequent supply shocks. Some people believe that we’ve moved permanently to a higher inflation regime, but it would be an error to assume that with any high degree of confidence — just as it was an error to think that the low-inflation world of 2008-2020 would last forever. The best framework for the world’s most powerful central bank, therefore, is one which assumes maximum uncertainty and consistently conveys its anchors to the market and the public.
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