At Jackson Hole, Jay Powell, the Federal Reserve Bank president, spoke of the new Federal Reserve monetary policy. The Fed will target long run inflation at 2%. On the long run, the inflation rate will have to converge to 2%. An inflation rate below the 2% target for an extended period may be followed by an inflation rate above 2% for an extended period.
What will it changed ?
The idea is to target 2% in the long run. This means that an inflation rate higher (or lower)than 2% has not to be necessarily fought by the Fed. The Fed will not have to adopt a tighter monetary policy if if the inflation rate is above 2%. Not ambiguous if it is above 2%. The question is how to avoid the risk of deflation if inflation goes below 1% after a extended period above 2%.
Two consequences
It creates uncertainty on the Fed’s reaction function. The forward guidance will have to be deeply revised.
The other point is that it is a risk for households’ purchasing power if inflation is higher than the wage rate for an extended period of time. This may be the case in coming months/years if the labor market doesn’t perform well. The balance of strength will not be in favor of salarymen.
This change in the Fed’s target may be inflationary biased at the expense of the salaryman.
