Yesterday (Aug. 27), Federal Reserve Chairman Jerome Powell announced a major policy shift that will squeeze bank margins for the foreseeable future.
In remarks outlining the Fed’s policy blueprint—Statement on Longer-Run Goals and Monetary Policy Strategy, adopted in 2012—Powell revealed that the central bank formally agreed to a policy of “average inflation targeting.” This means the Fed will strategically allow inflation to run “moderately” above the historical goal of 2% for extended periods of time after it had remained below that target objective.
In his remarks, which took place during the annual Economic Policy Symposium (held virtually this year instead of in Jackson Hole, Wyo.), Powell explained this move will provide more robust support for the labor market and the broader economy. However, it also means the Fed will not be raising interest rates anytime soon, even if inflation creeps above 2%. For banks, that means another prolonged period of ultra-low interest rates and razor-thin margins.
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This change in strategy is a marked difference from the Fed of 40 years ago, when Paul Volcker championed changes to make the central bank into a powerful downward force on inflation. Powell’s blueprint, in contrast, is updated for an economy where inflation is weak and low interest rates and slow economic growth are the norm.
In addition to the policy shift regarding inflation, Powell also announced a minor adjustment to the Fed’s approach to employment. The new policy language states the approach to the jobs situation will be informed by the central bank’s “assessments of shortfalls of employment from its maximum level” rather than the previous standard of “deviations” from the maximum [emphasis added].
While it looks like a technical adjustment, Powell emphasized the potential impact of this change in his remarks. “This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities,” he said. “This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.”