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●   Chair Powell’s announced new strategic framework for the Fed introduces significant changes in the conduct of monetary policy that reinforce sustained ease.  In an explicit effort to provide support for strong labor markets for “all American citizens,” the Fed will now flexibly target a 2% average inflation and, importantly, it will no longer tighten policy pre-emptively in anticipation of rising inflation.  Since the Fed established 2% as its inflation target in January 2012, inflation has been nearly persistently sub-2%, so the Fedfs new gmake-up strategyh suggests that it favors inflation above 2% for years to come.  The Fedfs not-so-subtle changes are both a reflection of its recent behavior and represent a significant shift in official strategy.

●   No discussion of the Fed’s monetary policy tools.  Powell did not discuss what tools the Fed would use to achieve its new strategy.  He mentioned the importance of communications, but did not provide any detail. 

●   The Fed’s focus will be providing support to strong labor markets subject to a flexible inflation constraint.  Powell makes it clear the Fed’s aim is to conduct monetary policy that supports maximum and inclusive employment, and that it will aggressively pursue this goal until – and after – inflation and inflationary expectations rise above 2% – that is, until they become a problem.

●   Underlying rationale: the Fed now perceives the Phillips Curve is FLAT until proven otherwise.  In recent years, the Fed has said the trade-off between the unemployment rate and inflation has become flatter.  The Fedfs belief now is that strong employment can be consistent with stable inflation.  Accordingly, maximum employment becomes the dominant mandate for monetary policy as the Fed hopes inflation rises above 2% and makes up for its recent shortfalls.  

●   The critical issue the Fed has not answered is:  why has the Fedfs monetary ease since the financial crisis failed to stimulate economic activity sufficiently to lift inflation to 2%?   Over the years, the Fed’s arguments that the Phillips Curve has become flatter has been an ex post rationale for the persistence of low inflation consistent with low unemployment.  But it reflects the Fedfs lack of understanding of the actual inflation process.  In reality, inflation has remained sub-2% because the Fedfs policies have failed to stimulate a persistent increase in nominal GDP above productive capacity, so that, with little excess demand, there is only modest inflation.  So the issue remains:  will the Fedfs ultra-easy policies actually stimulate accelerating economic activity, or just pump up asset prices and make the stock market happy?

●   The Fedfs new strategic framework supports higher stocks and a weaker U.S. dollar.   

 

 

Dr Mickey D. Levy

Chief Economist US, Americas and Asia

+1 646 445 4842

mickey.levy@berenberg-us.com

 

Roiana Reid

Economist

+1 646 949 9098

roiana.reid@berenberg-us.com

 

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