Home Framework EXPLANATOR-As economy moves closer to Fed framework targets, policymakers are responding

EXPLANATOR-As economy moves closer to Fed framework targets, policymakers are responding

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(Updates with publication of the policy statement, projections)

By Howard Schneider

WASHINGTON, Dec.15 (Reuters) – The U.S. unemployment rate is falling, inflation is rising and on Wednesday the Federal Reserve said the combination predisposed it to interest rate hikes next year that would come more quickly and sooner than expected.

The situation amounts to a real-time test of the new approach to monetary policy that the US central bank adopted in August 2020. This framework was intended to prevent the Fed from reacting too quickly to inflation fears and cutting it short. that it had promised to be a “broad and inclusive” job recovery.

Now the question analysts and economists will need to ask is whether the Fed has waited too long to act against inflation, or if its rapid pivot to higher borrowing costs will bring the economy back to its point. pre-pandemic ideal of low unemployment and moderate price increases. .

THE PRELUDE

After the financial crisis and recession of 2007-2009, the US economy entered what would become a historically long period of growth. It has also shown evidence of a fundamental change. The unemployment rate has fallen steadily, but contrary to economic theory, inflation has never really budged. The Fed has slowly raised its interest rates. Some policy makers wonder if this was necessary.

WHAT IS THE NEW APPROACH?

Following a two-year review, the Fed said it would attempt to generate more job gains by targeting average inflation instead of the single numerical goal of 2%, pledging to let low interest rates for a while as inflation rose. He put that strategy into play with his current policy stance, promising that rates would not rise until inflation hit 2%, was on the verge of exceeding it for a while and employment maximum had been reached.

The new strategy was adopted amid the coronavirus pandemic, with high unemployment, low inflation, and an expectation that the economy would behave as before – with low unemployment and low inflation being able to coexist.

Instead, the two moved in opposite directions, as they did in previous decades, when low unemployment rates were coupled with rapid price increases.

WHAT HAPPENS WITH INFLATION AND EMPLOYMENT?

Indeed, inflation rates this year were not only the fastest in decades; the Fed said on Wednesday https://www.reuters.com/markets/us/fed-prepares-stiffen-inflation-response-post-transitory-world-2021-12-15 that its inflation test had been satisfied.

The job market has been a bit more ambiguous. The new framework referred to maximum employment as a “broad and inclusive goal that is not directly measurable,” language meant to signal that the Fed would not only pay attention to the national unemployment rate, but also to things like labor force participation, wages or resuming jobs among different demographic groups.

From this point of view, the Fed’s forward-looking orientations have not been met: there are not only fewer jobs than before the pandemic, fewer people even looking for work, the participation of women in the labor market. remains depressed and the black unemployment rate remains high. On Wednesday, the Fed actually linked any possible rate hikes to a somewhat sharper improvement in the labor market.

But full employment may be near. Salaries and other costs incurred by employers are on the rise.

And at 4.2%, the current US unemployment rate is at a level that in previous years would have already seen the Fed raise rates.

(Reporting by Howard Schneider; Editing by Dan Burns, Andrea Ricci and Paul Simao)


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