Monetary policy U. S.

Fed’s new framework of monetary policy

Last week the FOMC announced the results from monetary policies review. The revised approach will have significant impact on economy growth, value of money, social equality, environmental and to some degree politics in the future.

Review and adjust of monetary policies is a normal course and central banks do it regularly.

“The economy is always evolving, and the FOMC’s strategy for achieving its goals must adapt to meet the new challenges that arise.” The review this time “reflects … appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation.”

The Fed has congressional mandates to maintain price stability and pursue maximum employment. The monetary review does not (in fact can not) change those goals but the focus can be operationally rebalanced according to economic, monetary environment, and other factors. These two changes seem significant:

  • On maximum employment, the FOMC emphasized that maximum employment is a broad-based and inclusive goal.
  • On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2 percent by noting that it “seeks to achieve inflation that averages 2 percent over time.”

The new approach will focus more on maximizing employment than maintaining price stability. With one control variable – interest rate, the Fed in the past has found it difficult and sometime conflicting to achieve the two goals at the same time. Inflation control becomes less meaningful and less demand in the current environment of low interest rates and sustained low inflation.

The Fed will target inflation for a longer period than a year. Hence allow inflation below or above 2% for some time without monetary policy adjustment so that the policy can focus on supporting economic growth.

The new approach overall is welcome by many experts and economists but it also comes with some potential challenges. In my view the most side effect is the risk of Fed independence from politics, and of its credibility to maintain price stability. After all the Fed is not the primary institute for the purpose of economic growth, social equality or environmental protection.