(Bloomberg Opinion) -- Federal Reserve Chair Jerome Powell, in remarks delivered on Thursday for the annual symposium traditionally held in Jackson Hole, Wyoming, outlined the revision to the central bank’s policy framework. But he did more than consolidate and extend a shift in monetary policy approach that has been gaining momentum in the past few years. He also set a new formal milestone in global central banking that is certain to fuel much debate that will not be resolved for some time.
Before the COVID-19 shock to the economy, the work on the new policy framework, led by Vice Chair Richard Clarida, benefited from a decidedly more open consultation process, including “a series of Fed Listens events around the country,” according to Powell. These were centered on the need to adapt monetary policy to “the new challenges that arise.” Specifically, the two-year review took into account the multiyear experience of lower potential growth, more depressed global interest rates, “the best [pre-Covid] labor market we had seen in some time” and muted inflation. The result — a self-described evolution (as opposed to revolution) to the dual objectives of the Fed — includes a more “broad-based and inclusive goal” for maximum employment and the flexible use of “average inflation targeting,” which enables monetary policy to “aim to achieve inflation moderately above 2 percent for some time” following periods when inflation has been below that level.
Here are my five key takeaways:
- As noted by Powell, the changes seek to enhance the central bank’s effectiveness in a “new normal” environment that, in the eyes of Fed officials, has become clearer since the concept was first floated in the aftermath of the global financial crisis. They formalize what has been increasing activism by the central bank to counter the risk of collapsing inflationary expectations and promote employment as a means to making economic recoveries more inclusive while also noting the importance of maintaining financial stability.
- Many advocates of Modern Monetary Theory are likely to welcome the new framework as a big step in embracing a policy approach that allows the economy to run hotter for longer, finances large fiscal deficits at low costs and pushes out inflation speed limits on stimulative monetary policy.
- This is also why concern is likely to be expressed by those worried about excessive mission creep at the Fed, as well as an erosion in the central bank’s independence and effectiveness. There is also reputational risk in pursuing an operationally more aggressive target after having repeatedly failed to deliver a less-ambitious variant and in formalizing an approach that risks an even wider disconnect between Wall Street and Main Street.
- Many in the marketplace will see the new framework as hard-wiring what until now was seen as data-dependent dovishness. This will reinforce the faith investors have in ample and predictable liquidity support, further decoupling asset prices from economic and corporate fundamentals.
- Even if deemed necessary to produce superior economic outcomes — in particular, that of sustainably high and inclusive growth without disruptive financial bubbles — the changes are unlikely to prove sufficient on their own. The Fed will remain highly dependent on the ability of successive Congresses and administrations to maintain more pro-growth policies, particularly the pursuit of measures at the intersection of fiscal policy and structural reforms that promote higher productivity growth and lower household economic insecurity.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."