Written by: Li Dan, Wall Street Watch.
Federal Reserve Chairman Powell delivered a significant speech at the Jackson Hole Central Bank Annual Meeting, stating that the current situation implies rising downside risks to employment. This shift in risk balance may mean that a rate cut is needed.
Powell pointed out at the beginning of his speech that this year, the 'risk balance' facing the Federal Reserve in achieving its dual mandate of employment and inflation seems to be shifting. He believes that the current economic situation impacts monetary policy as follows:
"The stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, since the policy is in a restrictive range, the baseline outlook and evolving risk balance may require us to adjust our policy stance."
Regarding the labor market, Powell stated:
"Overall, while the labor market is in balance, it is a 'peculiar balance' resulting from both supply and demand for labor slowing significantly. This unusual situation suggests that the downside risk to employment is increasing."
Regarding the impact of tariffs on inflation, Powell stated that a 'reasonable baseline assumption' is that tariffs will lead to a 'one-time' increase in price levels, but these effects take time to fully manifest in the economy.
Considering various influencing factors, Powell believes:
"In the short term, the inflation risk is tilted upwards, while the employment risk is tilted downwards - this is a challenging situation."
Regarding adjustments to the monetary policy framework, Powell pointed out that the new policy framework removed two statements: one is that the Federal Reserve seeks to achieve an average inflation target of 2% over a period of time; the other is using 'deviation from full employment levels' as a basis for decision-making.
"New Federal Reserve Communications Agency": Powell opens the door to a rate cut as early as September, more confident about the impact of tariffs.
Commentary has suggested that Powell's mention of stable labor market indicators such as the unemployment rate allows the Federal Reserve to cautiously consider adjusting its monetary policy stance, cautiously opening the door for a rate cut at the next meeting in September.
Nick Timiraos, known as the 'New Federal Reserve Communications Agency,' pointed out in an article that Powell's speech emphasizes concerns about the job market, paving the way for a rate cut. The article begins by noting:
"Powell stated that the prospect of further slowing in the job market may alleviate concerns that rising costs due to tariffs will exacerbate inflation, opening the door for a possible rate cut at the next meeting as early as September."
Timiraos believes that Powell's speech is the first indication that his confidence in the baseline assumption has strengthened, which is that the price increases caused by tariffs will have a relatively short-term impact.
He noted that Powell believes the impact of tariffs is now clear and expects it to continue to accumulate in the coming months. The question facing the Federal Reserve is whether these price increases will 'significantly increase the risk of persistent inflation issues.'
Powell also believes that the one-time price increase caused by tariffs could be a reasonable baseline assumption, although this does not imply that the impact on prices is immediate. Timiraos noted that if the tightness in the labor market is insufficient to support consumers who have lost purchasing power due to tariffs in stronger wage negotiations, then this hypothetical situation is more likely to occur.
The following is the full translation of Powell's speech:
Monetary policy and the Federal Reserve framework review.
Federal Reserve Chairman Jerome H. Powell.
The speech was delivered at the economic symposium 'Transforming Labor Markets: Demographics, Productivity, and Macroeconomic Policy' hosted by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming.
This year, the U.S. economy has shown resilience amidst dramatic changes in economic policy. In terms of the Federal Reserve's dual mandate objectives, the labor market remains close to full employment levels, and while inflation is still somewhat elevated, it has significantly declined from its post-pandemic peak. Meanwhile, the risk balance seems to be shifting.
In today's speech, I will first discuss the current economic situation and the short-term outlook for monetary policy, and then turn to the results of our second public review of the monetary policy framework, which are reflected in the revised (long-term goals and monetary policy strategy statement) we are releasing today.
Current economic conditions and short-term outlook.
A year ago when I spoke here, the economy was at an inflection point. Our policy rate has been maintained in the range of 5.25% to 5.5% for over a year. This restrictive policy stance has helped lower inflation and has prompted a sustainable balance between total demand and total supply. Inflation has significantly approached our target, and the labor market has cooled from its previous overheating state. The upward risk of inflation has decreased, but the unemployment rate has nearly risen by one percentage point, which historically does not occur outside of an economic recession. In the subsequent three Federal Open Market Committee (FOMC) meetings, we adjusted our policy stance, laying the groundwork for the labor market to remain close to maximum employment levels over the past year.
This year, the economy faces new challenges. Tariffs between global trading partners have risen significantly, reshaping the global trading system. More stringent immigration policies have led to a sharp slowdown in labor force growth. In the long term, changes in tax, spending, and regulatory policies may also have significant impacts on economic growth and productivity. It is currently difficult to determine where these policies will ultimately settle and their lasting effects on the economy.
Changes in trade and immigration policies have affected demand and supply. In such an environment, distinguishing between cyclical changes and trend or structural changes becomes difficult. This distinction is crucial, as monetary policy can stabilize cyclical fluctuations but has limited influence on structural changes.
The labor market is exactly the example. The July employment report released earlier this month showed that job growth has slowed to an average of only 35,000 per month over the past three months, significantly below the 168,000 per month expected for 2024. This slowdown is far beyond the previous month’s assessment, as the data for May and June had been significantly revised downward. However, the slowdown in job growth does not seem to have resulted in significant labor market slack - a result we aim to avoid. The unemployment rate rose slightly in July but remains at a historically low 4.2%, stable over the past year. Other labor market indicators have also shown little change or only a mild decline, including the quit rate, layoffs, job vacancies to unemployment ratio, and nominal wage growth. The labor supply has slowed simultaneously, significantly reducing the number of 'breakeven' new jobs needed to keep the unemployment rate constant. In fact, this year, due to a sharp decline in immigration, labor force growth has slowed significantly, and the labor force participation rate has also declined in recent months.
Overall, while the labor market is in balance, it is a 'peculiar balance' resulting from both supply and demand for labor slowing significantly. This unusual situation suggests that the downside risk to employment is increasing. If risks materialize, they may soon manifest as a surge in layoffs and a rapid increase in the unemployment rate.
At the same time, GDP growth slowed significantly to 1.2% in the first half of this year, about half of the 2.5% growth expected for 2024. This slowdown in growth mainly reflects a deceleration in consumer spending. Like the labor market, the slowdown in GDP growth is partly due to a reduction in supply or potential output.
Speaking of inflation, higher tariffs have begun to push up the prices of some goods. According to the latest data, total PCE prices rose 2.6% over the 12 months ending in July. Excluding the more volatile food and energy prices, core PCE rose by 2.9%, higher than the same period last year. Within the core category, goods prices rose by 1.1% over the past 12 months, contrasting sharply with a mild decline expected for the entire year of 2024. In contrast, inflation in housing services continues to trend down, while inflation levels in non-housing services are slightly above historical levels consistent with 2% inflation.
The impact of tariffs on consumer prices is now clear. We expect these effects to continue to accumulate in the coming months, with a high degree of uncertainty regarding the timing and extent. The core issue of concern for monetary policy is whether these price increases will significantly increase the risk of persistent inflation. A reasonable baseline assumption is that these impacts are largely one-time level jumps. Of course, 'one-time' does not mean 'instantaneous,' and tariff adjustments still require time to fully pass through supply chains and distribution networks. Additionally, tariff levels are continuously adjusting, which may extend the time for price adjustments.
Price pressures caused by tariffs may also trigger more persistent inflation dynamics, which need to be assessed and managed as a risk. One possibility is that workers, pressured by real income, demand and receive higher wages, thereby triggering a vicious wage-price interaction. However, given that the labor market is not overly tight and faces more downside risks, this outcome seems unlikely.
Another possibility is that inflation expectations rise, pushing actual inflation higher. Inflation has consistently been above our target for over four years, a particular concern for households and businesses. However, based on market and survey-based long-term inflation expectations, they remain clearly anchored at present, consistent with our long-term 2% inflation target.
Of course, we cannot be complacent regarding the stability of inflation expectations. Whatever happens, we will never allow a one-time increase in price levels to evolve into a persistent inflation issue.
In summary, what are the implications of monetary policy? In the short term, the inflation risk is tilted upwards, while the employment risk is tilted downwards - this is a challenging situation. When our goals conflict to some extent, the framework requires us to balance our dual mandate. So far, the policy rate has moved closer to neutral levels by 100 basis points compared to last year, and the stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, since the policy is in a restrictive range, the baseline outlook and the evolving balance of risks may require us to adjust our policy stance.
Monetary policy is not on a predetermined path. FOMC members will make decisions based on data and their interpretation of the significance of the economic outlook and risk balance. We will never deviate from this principle.
Evolution of the monetary policy framework.
Turning to the second part of the topic, our monetary policy framework is rooted in the unchanging mandate given to us by Congress: to promote maximum employment and price stability for the American people. We continue to firmly fulfill our statutory mandate, and the framework revisions will support us in achieving this task under various economic conditions. Our revised (long-term goals and monetary policy strategy statement), our 'consensus statement,' describes how we achieve our dual mandate objectives, which is essential for enhancing transparency and accountability and improving policy effectiveness.
The changes reviewed are a natural extension based on our deepening understanding of the economy. We continue to advance the initial consensus statement (2012, chaired by Chairman Bernanke). Today's revised statement is the result of the second public review of the framework, which we conduct every five years. This review includes three aspects: Fed Listens events held by various Federal Reserve Banks, a flagship academic symposium, and discussions and analyses among policymakers and staff at FOMC meetings.
One of the important objectives of this review is to ensure that the framework is applicable under various economic conditions. At the same time, the framework must adjust with changes in economic structure and our understanding. The challenges faced during different phases such as the Great Depression, historically high inflation, and moderate expansions are all different.
At the time of the last review, we were in a new normal - with interest rates close to the effective lower bound (ELB), low economic growth, low inflation, and an extremely flat Phillips curve, meaning inflation's response to economic slack was very limited. For example, after the global financial crisis erupted at the end of 2008, the policy rate hovered at the ELB level for seven years. Many remember the slow and painful economic recovery during that time. It seemed that even a slight recession would quickly bring the policy rate back to the ELB, where it might remain for an extended period. During economic weakness, inflation and inflation expectations would decline, while nominal rates remained pinned near zero, causing real rates to rise, exacerbating employment pressures and continuing to suppress inflation and inflation expectations, creating adverse dynamics.
The economic issues that led the policy rate to dip to the ELB and prompted the changes in the 2020 framework were initially thought to stem from global, slowly changing factors that could persist for years—had it not been for the pandemic's impact, this may well have been the case. The 2020 consensus statement emphasized the risks related to the ELB, and its content has developed over two decades. We emphasized the importance of anchoring long-term inflation expectations to achieve the goals of price stability and maximum employment. Drawing on a broad literature on strategies for addressing ELB risks, we adopted a flexible average inflation targeting mechanism, i.e., a 'compensatory' strategy to ensure that even under ELB constraints, inflation expectations remain anchored. Specifically, we noted that after a sustained period of inflation below 2%, appropriate monetary policy may allow inflation to run slightly above 2% for a time.
In fact, what emerged was not low inflation and ELB, but the highest inflation in 40 years post-pandemic. As most central banks and private analysts expected, until the end of 2021, we believed that inflation would quickly decline without significantly tightening policy. When the situation became clear that this was no longer the case, we acted swiftly, raising rates by 5.25 percentage points over 16 months. Such actions, combined with the elimination of pandemic-induced supply chain disruptions, brought inflation close to the target without a significant rise in unemployment as seen in the past.
Main contents of the revised consensus statement.
This review examined changes in economic conditions over the past five years. During this period, we observed that inflation dynamics change rapidly when subjected to significant shocks, with interest rates well above those during the global financial crisis to the pandemic period. Currently, the inflation target is above baseline, and the policy rate is restrictive - in my view, this is moderate. We cannot determine where long-term interest rates will settle, with some neutral rates potentially higher than those in the 2010s, reflecting factors that influence savings and investment balances such as productivity, demographics, and fiscal policies. In the review, we also discussed that the emphasis on the ELB in the 2020 statement may have made communication about addressing high inflation more difficult. We believe that overly specific emphasis on economic conditions may lead to confusion, so the revised statement includes several important adjustments.
First, we removed the content defining ELB as a characteristic of the economic environment. Instead, we emphasized that 'the monetary policy strategy aims to promote full employment and price stability under broad economic conditions.' The challenges of being close to the ELB still deserve attention, but they are no longer central. The revised statement again emphasizes that the committee is prepared to use all tools to achieve the goals of full employment and price stability, especially when the federal funds rate is constrained by the ELB.
Secondly, we returned to a flexible inflation target framework, removing the 'compensatory' strategy. It has proven that a deliberate and moderate inflation overshoot as a strategy is no longer applicable. As I publicly acknowledged in 2021, a few months after we announced the modifications to the 2020 consensus statement, inflation emerged that was neither deliberate nor moderate.
Anchored inflation expectations have enabled us to successfully curb inflation without raising unemployment. Anchored inflation expectations help push inflation back to target when faced with adverse shocks while reducing the risk of deflation during economic weakness. Furthermore, anchored inflation expectations allow monetary policy to support maximum employment during economic downturns without jeopardizing price stability. Our revised statement emphasizes our commitment to taking strong actions to ensure long-term inflation expectations remain anchored, benefiting both aspects of our dual mandate, and notes that 'price stability is essential for a healthy, stable economy and the well-being of all Americans.' This view is particularly prominent in the feedback from the Fed Listens event. The experiences of the past five years remind us that the suffering caused by high inflation particularly affects those who are least able to cope with rising basic living costs.
Thirdly, the 2020 statement proposed that we would mitigate the 'shortage' of full employment rather than 'deviation.' The use of the term 'shortage' reflects our insight into the high uncertainty regarding the natural rate of unemployment and real-time assessments of 'full employment.' In the post-global financial crisis period, actual employment long exceeded the sustainable levels estimated by mainstream estimates, yet inflation remained persistently below 2%. In the absence of inflationary pressures, there is no need to tighten policy based solely on uncertain real-time estimates of the natural rate of unemployment.
We still hold this view, but the term 'shortage' may not always be correctly interpreted, leading to communication barriers. In particular, 'shortage' does not imply a permanent commitment to preemptive action, nor does it disregard tight labor market conditions. Therefore, we have removed the term 'shortage' and more accurately expressed it as '(FOMC) committee acknowledges that employment can sometimes exceed real-time estimates of full employment levels, but this does not necessarily pose a risk to price stability.' Of course, if the labor market is excessively tight or other factors affect price stability, preemptive action may be necessary.
The revised statement also notes that full employment is 'the highest level of employment that can be sustainably achieved in a price-stable environment.' It emphasizes that a strong labor market brings widespread employment opportunities and benefits for all, a principle that has been fully corroborated by feedback from the Fed Listens events, showcasing the value of a strong job market for American families, employers, and communities.
Fourthly, in line with the removal of 'shortage,' we clarified our response when employment and inflation targets are incompatible. In such circumstances, we would take a balanced approach to pursue both objectives. The revised statement returns more closely to the original wording from 2012 - we will consider the degree of deviation from the targets, as well as the different time spans that may involve both returning to the consistent levels of our dual mandate. These principles are guiding our current policy decisions and have previously led us to respond to deviations from the 2% inflation target between 2022 and 2024.
Aside from the changes mentioned above, there is also a high level of continuity with past statements. The document continues to clarify how we interpret the mandate given to us by Congress, and describes the policy framework we believe is best suited to achieving maximum employment and price stability. We still advocate that monetary policy must be forward-looking and consider its lagged effects. Therefore, our policy actions depend on the economic outlook and our judgment of the risk balance regarding that outlook. We still believe that setting specific employment targets is impractical, as maximum employment levels cannot be measured directly and may vary due to factors unrelated to monetary policy.
We also maintain that a long-term inflation rate of 2% best aligns with our dual mandate objectives. We believe that our commitment to this target helps anchor long-term inflation expectations. Experience shows that a 2% inflation rate allows families and businesses to make decisions without worrying about inflation and provides central banks with some policy flexibility during economic downturns.
Finally, the revised consensus statement still commits to conducting a public review approximately every five years. There is nothing special about five years; this frequency helps policymakers reassess economic structural issues and facilitates communication with the public, industry, and academia regarding framework performance, aligning with practices of some global peers.
Conclusion.
Lastly, I want to thank (Kansas City Fed) President Schmied and all the staff for their tireless efforts over the years to host this outstanding event annually. Even accounting for virtual speeches during the pandemic, this is my eighth time speaking here. Each year, this seminar provides Federal Reserve leaders with the opportunity to engage with top economists and focus on challenges. More than forty years ago, the Kansas City Fed successfully invited Chairman Volcker to this national park, and I am honored to have become part of this tradition.
