Powell Plans U-Turn on an Economic Strategy That Soured

The Fed unveiled a strategy five years ago for worries that the economy outgrew. Now, it will formally reset.

By Nick Timiraos of The WSJ. Excerpts:

"The 2020 changes involved two main shifts. First, the Fed said it would allow inflation to run modestly above its 2% target for periods to make up for times when it had fallen short. Second, officials said they would focus only on the unemployment rate being too high, rather than also worrying about the rate being too low, removing some urgency to pre-emptively raise rates and prevent the economy from running too hot."

"But when inflation took off in 2021, the Fed’s commitments to maintain low rates to spur a faster labor-market recovery put officials in a bind. Economic conditions could have reasonably called for rate increases later that year, but the central bank didn’t begin raising rates until March 2022.

By that point, inflation had reached levels not seen in four decades. The “raging inferno,” as one Fed official put it that year, was nothing like the modest overshoot of the inflation target the central bank had in mind.

The delay has sparked a debate among economists about what went wrong. In a detailed study last year, economists Christina Romer and David Romer at the University of California, Berkeley, argued that the 2020 framework itself was a reason the Fed acted so slowly. They concluded that officials became too focused on getting unemployment as low as possible.

“Arguably, this asymmetry contributed to a delayed response to the inflation surge of 2021-22,” said Donald Kohn, a former Fed vice chair, at a conference last year." 

Others "fault significant forecast errors made by the Fed and many outside economists in 2021—that inflation would prove so short-lived that the Fed shouldn’t adjust rates in response."

"The Fed misjudged how the U.S. economy’s capacity to produce goods and services had declined, and as a result “it kept in place an exceptionally accommodative monetary policy longer than it would have,” said Richard Clarida, who was Fed vice chair in 2020, in a lecture."