Framing up the next move in monetary policy: Powell at Jackson Hole

The main event of the week in economic policy may sound bland: “Economic Outlook and Framework Review.” However, Fed Chair Powell’s speech on Friday at Jackson Hole will be anything but bland. We should not expect clarity on when or how much the Fed will cut rates. Instead, Powell will reinforce the principles the Committee will apply to its upcoming decisions and lessons learned from its framework review.

With sharply slower job growth and still-elevated inflation, the Fed faces a challenge in which its dual mandate of maximum employment and price stability will likely come into tension. Powell’s speech will begin to bring the framework and interpretation of the most recent data together, a process that the Committee as a whole will oversee to completion.

Of interest will be how Powell characterizes the labor market. It’s his first time speaking after the employment report for July, including its large downward revisions to payrolls in May and June. Expect Powell to discuss the role of supply-side factors, such as reduced immigration and an aging workforce, while acknowledging the risks of weakening demand for labor. With inflation, Powell’s description of the underlying pace of inflation (excluding tariffs) will be as important as his comments on tariffs. Non-housing services inflation picked up pace in July. A worrisome sign, given that it remains elevated and cannot be easily explained by tariffs.

The outlook and changes to the framework from Powell may be perceived as hawkish, with the Fed more concerned about inflation than employment, especially at a time when financial markets expect imminent rate cuts. More accurately, this is what the Fed looks like when navigating risks to both sides of its mandate.

Now is the right time to update the framework.

Powell’s last speech at Jackson Hole as Fed Chair might seem like an odd time to update the monetary policy framework (aka the “Statement on Longer-Run Goals and Monetary Policy Strategy”). In less than a year, a new Fed Chair will be in place. The timing serves as a good reminder that the framework is an agreement of the Committee; it’s not the Chair’s framework. It is a set of strategies and principles.

The Fed Chair may influence how these strategies and principles are applied more than the typical Fed official, but the Chair does not determine them alone. That’s a good reminder to the hopefuls looking to fill Powell’s shoes. The framework is also about accountability, and the regular reviews aim to apply the ‘lessons learned’ over the past five years. Powell was Chair during that period, oversaw the first review in 2020, and is well-suited to share the changes to the framework now.

The framework is part of the Fed’s commitment to transparency. The Fed does not have a crystal ball on the economy, nor should it pretend to. What it can do is be clear about its thinking and its process. The opening of the framework (unchanged since the first version in 2012) emphasizes that commitment:

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.

The framework review included public events at the Reserve Banks (Fed Listens), a research conference, and a series of internal discussions (summarized in this year’s FOMC meeting minutes). Transparency and accountability also help maintain the Fed’s independence.

Finally, now is the right time for the framework review, because the Fed committed to it. In a time of heightened policy uncertainty, it’s reassuring that the Fed is doing what it said it would do five years ago. They are following a predictable process.

It’s the assumptions, not the new strategies, that didn’t work out as planned.

While the Fed’s process has been predictable with the framework reviews, the world has not. The changes to the framework in 2020 rested on the assumption that the low-inflation, low-interest-rate environment that followed the Global Financial Crisis in 2008 would persist. The framework in 2020 identified dominant risks to the downside for inflation and employment:

Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Monetary policy plays an important role in stabilizing the economy in response to these disturbances. The Committee’s primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate. The Committee judges that the level of the federal funds rate consistent with maximum employment and price stability over the longer run has declined relative to its historical average. Therefore, the federal funds rate is likely to be constrained by its effective lower bound more frequently than in the past. Owing in part to the proximity of interest rates to the effective lower bound, the Committee judges that downward risks to employment and inflation have increased. The Committee is prepared to use its full range of tools to achieve its maximum employment and price stability goals. [Emphasis added.]

As a result, the Fed introduced strategies in 2020 to increase inflation to its 2% target, such as allowing a period of modestly above-target inflation or unusually low unemployment without raising rates. The pandemic upended those economic assumptions, and the Fed’s primary problem since has been high inflation.

The first framework review in 2020 assumed that the challenges in orange would persist: inflation struggling to reach 2%, even with the federal funds rate at a very low level. The challenges of the past five years in green could not have been more different. The lesson is that the Fed needs strategies that can deal with both the upside and downside of inflation and employment.

Average inflation targeting and reacting to shortfalls (but not excesses) in employment will likely be removed from the framework on Friday, not because they failed, but because they are specific to the downside risks that did not persist. The framework will reset the assumptions with symmetric risks, and consequently, the strategies will also be reset. It’s not about re-shuffling the importance of the inflation or employment mandates.¹

The landscape of risks can change rapidly, and the Fed should be ready to adapt.

The framework’s next challenge.

The changes to the framework will primarily reflect lessons learned from the past five years. The Fed’s strategy over the coming months will draw heavily on three parts of the framework that are already in place.

First, the framework will maintain the Fed’s commitment to the 2% PCE inflation target.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

It’s the only topic that Powell explicitly removed from the discussion in this review. Inflation, although currently only somewhat elevated, has remained above target for more than four years. That’s important context for the Fed.

Second, the current framework does not offer a specific target for maximum employment and explains that some changes in employment are beyond the scope of the Fed’s mandate:

The maximum level of employment … changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. Consequently, it would not be appropriate to specify a fixed goal for employment…The Committee considers a wide range of indicators in making these assessments.

The theme of the Jackson Hole Symposium this year, “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy," is on exactly this topic. Reduced immigration and population aging are the kind of “nonmonetary factors” that could reduce maximum employment (the level sustainable without causing inflation) and temper the Fed’s response to the slowdown in job growth. It will be a matter of interpretation among the Committee.

Third, and most importantly, the framework lays out the strategy when the mandate is in conflict: assess the expected magnitude and duration of deviations:

The Committee’s employment and inflation objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it takes into account the employment shortfalls [will likely revise to “deviations”] and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.

That’s the situation we are likely headed toward. The labor market is reasonably close to maximum employment and has been for some time, but the risk of a deterioration is rising. Inflation is elevated and drifting upward. The framework establishes the decision-making principle that the Fed has agreed to use at rare times like these.

It’s not about how much weight a Fed official puts on employment versus inflation (dovish or hawkish); it’s about their assessment of which one is a larger, more enduring problem relative to the Fed’s goals. The framework clarifies the process, but the outcome in terms of the federal funds rate remains uncertain.

In closing.

The goal for Powell this week is to bring some clarity to an environment that’s anything but clear-cut. That’s been a recurring theme in his tenure as Fed Chair. Powell’s ability to communicate the Fed’s thinking and its actions is one of his strengths as Chair. Navigating the dual mandate in conflict is one more test.

Bonus Links:

• Here is a video clip of my interview on Bloomberg TV, discussing many of the issues addressed in this post.

• I was a guest on the National Association of Business Economics’ monthly inflation podcast. Laura Rosner-Warburton, the regular host (alongside Greg Daco), is one of my go-to experts on the inflation data.

• My LinkedIn post last week raised concerns about the inflation outlook. My current assessment is that inflation remains the larger and enduring problem than employment.

1. I expect the Fed to remove the word “inclusive” from the framework, which currently states that “maximum employment is a broad-based and inclusive goal.” The framework is a communication device, and the term has become political and misinterpreted. The Fed never meant to suggest that it was targeting the unemployment rate of a disadvantaged group. Its mandate is for the labor market as a whole. The reality is that maximum employment is an inclusive goal. Given the longstanding differences in the US labor market, the last person to get a job before we reach maximum employment (the level sustainable without causing inflation) does not look like the first person. Keeping the economy as close to maximum employment as possible benefits people on the margins the most. Perhaps the Fed's wordsmiths will come up with a new term for inclusive, but I wouldn't read too much into what happens with that word.