In its statement on 20 March 2019, the Open Market Committee of the Federal Reserve noted "on a 12 month basis, overall inflation has declined, largely as a result of lower energy prices; inflation for items other than food and energy, remains near 2 percent". This means that the Fed now believes it has hit its inflation target. In the following two paragraphs, the Fed twice made reference to their "symmetric 2 percent objective".
The first time was in the sentence "the committee continues to view sustained expansion of economic activity, strong labour market conditions, and inflation near the committee's symmetric 2 percent objective as the most likely outcomes". This means that the Fed believes it is also achieving its full employment objectives at the same time as hitting its inflation target.
Since the Fed is now hitting both of its targets, the right thing to do should be to do absolutely nothing. This is what they decided to do by leaving the Fed Funds rate unchanged. In the third paragraph of the statement, the Open Market Committee of the Fed said that it would continue to assess "expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective".
Symmetric Inflation Objectives
I was not aware that the Fed had changed its statement of inflation targeting to that of a symmetric inflation target until I attended a presentation by Jay Powell, Chairman of the Federal Reserve, in Atlanta in January 2019. What does the Fed mean by "symmetric"?
In October 2017, former chairman Ben Bernanke published a paper showing that because the Fed had been underachieving its 2 percent inflation target for some years, the increase in the price index for the personal consumption deflator was now around 5% lower than it would be, had the target been achieved. This suggested that the Fed could allow inflation to run above the 2 percent target for a number of years, in order to increase the personal consumption deflator to the level that it would be, if the 2 percent target had been hit each year. Other economists had achieved this same position by suggesting that the price level, rather than just the inflation rate, should be part of the target.
The idea of the symmetric target then came into the Fed statements. It means that over the coming years, the Fed may allow the personal consumption deflator to run higher than its 2 percent annual target, in order to allow the price level to rise towards a long term target.
The Benefit of Symmetrical Inflation Targeting
The Fed believes, and we believe, that the US economy will go into a soft landing or growth recession between the middle of 2020 and the beginning of 2021. As the US economy slows into that growth recession, it is important that the growth remains still positive, even though unemployment goes up. The increase in unemployment that the Fed is seeking to achieve by this slowdown would only raise US unemployment from 3.7% to 4.3%.
The difficult thing in the slowdown is stopping it from being a full blown recession. A smart way to prevent a sharper than desired deceleration of growth in 2020 and 2021 is to be reducing the real Fed Funds rate as we enter 2020. Interestingly, this is exactly what will happen if the Fed keeps the Fed Funds rate exactly where it is and allows the inflation rate to rise for a small period above its inflation target. The decline in the real Fed Funds rate in 2020 and 2021, will provide the support that the US economy will need to prevent further deceleration.
The Fed Outlook
The mid points of the economic projections of the Federal Reserve Board members and Federal Reserve presidents in March 2019, is shown in Figure 1 below:
The median expectation is for US growth to slow to 2.1% in 2019 from the 3.1% growth that was achieved in 2018. They believe that growth will continue to decline to 1.9% in 2020 and 1.8% in 2021.
As this gradual slowdown occurs, they believe that unemployment will rise from 3.7% in 2019 to 3.8% in 2020 and 3.9% in 2021. In the long term, they think that unemployment will stabilise at 4.3%. We point out that if the Fed achieves this low level of unemployment in 2019, 2020 and 2021, they will achieve the lowest level of sustained unemployment the US economy has seen since 1968 and 1969.
The Fed believes the core personal consumption deflator will hit its 2% target in 2019, 2020 and 2021. We believe it will overshoot in 2020 and 2021 and the Fed in response, will do nothing. By doing nothing at that time, they reduce the real Fed Funds rate to put a floor under growth in 2021.
The median expectation, is that the Fed thinks there will be no increases in the Fed Funds rate in 2019, there will be one increase in the Fed Funds rate in 2020, but in the long term, beyond 2021, the Fed Funds rate will settle at a long term equilibrium point around 50 basis points higher than the current level.
The Open Market Committee of the Federal Reserve now believes that they have achieved their objective of a 2% inflation target and full employment. Not wishing to mess up a good thing, they have decided that the best thing to do is nothing.
Interestingly, their inflation target is now stated as "symmetric'. By allowing inflation to run above its objective for a short time, they might be reducing the real Fed Funds rate ahead of an anticipated slowdown in 2020 and 2021. This means that inflation might help the Fed in providing support for a softer US economy in 2021.
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