For the first time since 2012, the Federal Reserve has updated its \”Statement on Longer-Run Goals and Monetary Policy Strategy,\” and has produced a useful \”Track Changes\” version of the alterations. A set of 12 notes and background papers for these changes is available, too. Perhaps the main substantive change is that the specifies that if inflation has run below its 2% annual target rate for a time, it will then expect inflation to run above that 2% rate for a time. Thus, the Fed\’s 2% annual rate of inflation should not be viewed as an upper bound on the inflation it will allow, but rather as a long-run average. I have nothing against this change, but I strongly suspect that it is not a fix for ails the US economy.
[T]he general level of interest rates has fallen both here in the United States and around the world. Estimates of the neutral federal funds rate, which is the rate consistent with the economy operating at full strength and with stable inflation, have fallen substantially … This rate is not affected by monetary policy but instead is driven by fundamental factors in the economy, including demographics and productivity growth—the same factors that drive potential economic growth. The median estimate from FOMC participants of the neutral federal funds rate has fallen by nearly half since early 2012, from 4.25 percent to 2.5 percent.
As Powell points out, the lower interest rate means that the Fed has less power to stimulate the economy by reducing interest rates–because the interest rate is already closer to zero percent. Powell writes: \”This decline in assessments of the neutral federal funds rate has profound implications for monetary policy. With interest rates generally running closer to their effective lower bound even in good times, the Fed has less scope to support the economy during an economic downturn by simply cutting the federal funds rate.\”
In my own view, these changes in beliefs about the long-run direction of the US economy have at least two main implications. One is that a serious economic agenda for the future needs to focus on how to improve productivity and long-run economic growth. Another is that when (not if) the economy goes bad the next time, the Federal Reserve will be in a weakened position to provide assistance, so thinking in advance about what policies could kick in very quickly seems worth consideration.