As the Federal Reserve prepares for its annual gathering in Jackson Hole, Wyoming—the meeting will be held virtually again this year—investors, economists, and perhaps a few members of the general public eagerly await Chairman Jerome Powell’s speech on Friday. This year, the focus on Powell’s speech seems unusually heightened as questions about Fed policy abound. However, it is unlikely that Powell will be able to meet the demand for answers.
Why the eagerness?
Here are four reasons for the attention on what the chairman will say this week:
1) The Fed’s importance. The main reason for the focus on the Jackson Hole meeting is the sheer magnitude and importance of the Fed’s support for the economy. For months, the Fed has targeted the interest rate that it directly controls, the federal funds rate, at a rock-bottom range of 0.00–0.25 percent. In addition, since July 2020, the Fed has been buying $80 billion worth of Treasury securities and $40 billion of so-called agency (government-guaranteed) mortgage-backed securities every month. As the U.S. economy has continued to rebound, economists and investors are eager to know when the Fed is going to taper its massive purchasing operation, known as quantitative easing. This program has certainly contributed to low interest rates for government securities, which in turn has led to low rates for private-sector borrowing, such as corporate bonds and mortgages.
With low rates, individuals are more likely to take out a mortgage or a car loan, and firms are more likely to invest in equipment and have the confidence to hire workers. Low rates are also associated with rising stock and housing prices, which increase wealth and drive more spending. It is not an accident that major stock indices such as the S&P 500 are at or near record highs. Investors, traders, and the general public will all be affected by the timing of any change in the bond-buying program and subsequent increase in interest rates. Other countries will, too, as a rise in U.S. interest rates typically induces investors to shift capital to the United States.
2) New inflation framework. The Fed has adopted a new framework in line with its mission of keeping inflation in check. For many years, the Fed used an inflation target of 2 percent and acted preemptively to try to achieve that target. After decades in which inflation fell below the target, the Fed has changed its approach. It will allow inflation to run somewhat above 2 percent to make up for the earlier shortfall. Fed officials also said they will be “patient” before moving to raise interest rates to offset rising inflation. While this approach has given the Fed its desired and appropriate flexibility, it has left many questions unanswered: How much inflation is too much? How long will the Fed allow inflation to run over the target? If the Fed decides to act, how quickly will it raise interest rates? As a result, Fed watchers are awaiting every word from policymakers.
3) Higher inflation. Inflation has been running higher than 2 percent for several months. Earlier this month, the Department of Labor reported that its Consumer Price Index (CPI) rose 5.4 percent over the past year and that its core CPI—which excludes more volatile food and energy prices—rose 4.3 percent. While economists and policymakers recognize that these readings are high, there is an active debate over whether these price increases are a temporary feature of the pandemic recovery or permanent. Which side the Fed takes in this debate will likely guide how quickly it normalizes policy by tapering its quantitative easing and raising interest rates.
4) Internal disagreement. The final reason for the extraordinary interest this year is that Powell’s colleagues on the policy-setting Federal Open Market Committee (FOMC) appear to have differing views on the state of the economy and the appropriate role of monetary policy. Chicago Fed President Charles Evans recently said that more months of labor data are needed before making any changes in policy. This implies a policy change will be delayed until the end of 2021. At the same time, Boston Fed President Eric Rosengren has said that the central bank should announce in September that it will begin reducing its accommodative policy “this fall.” Within the Fed’s Board of Governors, a gap appears to be opening. Governor Christopher Waller seems to be more aligned with those who want a faster return to normal policy, while Governor Lael Brainard has said that she wants to review September data, which will not be available until the following month.
What is Powell likely to say?
Given these circumstances, it is not surprising that the focus on Jackson Hole is intense. Yet, it is unlikely that Powell will be willing or able to answer the open questions to everyone’s satisfaction. Some of these questions are currently unanswerable; economists, including those at the Fed, can only guess how much of the elevated inflation will remain a year from now. And as the pandemic progresses, there are new uncertainties arising every day about its impact on the economy for the rest of 2021 and into 2022. Ultimately, the FOMC will have to debate the question of when and how the Fed intends to taper its quantitative easing, and it should announce its plan with a clear timetable and set of guiding principles, not in a single speech.