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What To Make of Yesterday’s FOMC Meeting Outcome?


Posted: Thursday, September 17th, 2020

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One of the most important FOMC Meetings (Federal Open Market Committee) in recent history concluded yesterday. For the first time since changing its mandate to an Average Inflation Targeting (AIT) one, the Fed delivered its statement and the staff projections for the years ahead.

The market did not know what to expect. Neither did the Fed know how to best communicate that higher inflation leads to good outcomes for society.

Since last August, when the Fed introduced the new AIT framework at the Jackson Hole Symposium, various scenarios circulated on the mainstream financial media. One such scenario considered more easing from the Fed at the end of yesterday’s meeting. Another one indicated to a totally opposite outcome – that the Fed eased already and will do nothing.

In the end, the Fed delivered a little bit of both.

FOMC Meeting

September 2020 FOMC Meeting – No Hikes for the Next Three Years

While the Fed did not ease more at this FOMC meeting, it did strengthen its forward guidance. During the press conference, Fed Powell stressed the importance of forward guidance and what the Fed aims.

The forward guidance showed the path for the federal funds rate for the years ahead. For the rest of the year, and in 2021, the FOMC members expect the federal funds rate to remain at the lower boundary. Only in 2022 and 2023, some members dissented in their views, and the policy normalizes in the longer run.

FOMC

A couple of things deserve mentioning here. First, a dissenter appears already in 2022. Second, in 2023 more members see the scope for raising the federal funds rate.

However, the path forward often differs from projections. Even in the long run, the Fed sees the rates converging towards the 2.5% level, but we do not know how long it will take to get there. One thing is sure – it will not be 2024. Because the majority of members favor keeping the rates close to zero in 2023, they will not raise them in the course of a single year so to reach 2.5%.

How About Inflation?

With the new mandate, the Fed plans to let moderate inflation rising above the 2% target. Moreover, in doing so, inflation needs to remain elevated long enough so that the average inflation comes close to zero.

Looking at other jurisdictions, bringing inflation to target is a long and costly process. A three-year time horizon looks short, especially if we consider average inflation.

On the other hand, the Fed is a central bank like no other. If it wants inflation, it will get inflation.

The only question remains how long it takes to reach its new mandate. And, at what cost.

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