The Federal Reserve on Thursday announced a significant change in how it manages interest rates that could cause inflation to more than double. The change means the Fed is likely to keep interest rates near zero for a long time — even after consumers see the prices rising faster than they have in a while.
Fed chairman Jerome Powell announced the proposed change on Thursday during his keynote speech at an annual gathering of global central bankers. The gathering is normally held in picturesque Jackson Hole, Wyoming, amid the towering Grand Teton mountain range, but this year is being conducted virtually because of the coronavirus.
The Fed is hoping that higher inflation will boost wage growth, which has been anemic for over a decade.
"The single most important thing that we can do is support a strong labor market," Powell said on Thursday. "Getting wage gains only in the 8th or 9th year of a recovery is not the best outcome."
Why inflation matters
If the Fed's policy change succeeds in juicing inflation, it could have a significant impact on Americans' lives and their financial well-being. Inflation is closely tied to wages, and years of low inflation in the U.S. appear to have contributed to a. Low wage growth has been a major contributor to the in America. Higher inflation would likely lead to bigger paychecks for most Americans, and a higher standard of living.
The Fed's policy also means that borrowing rates for households and businesses — for everything from auto loans and home mortgages to corporate expansion — will likely remain ultra-low for years to come.
Higher inflation, however, means that prices for goods and services would likely go up for most Americans. But technological advances, and the fact that many U.S. consumer goods are manufactured overseas, would probably keep prices rising more slowly than U.S. wages.
It's a dramatic reversal for U.S. central bank, which became an aggressive inflation fighter in the 1980s. For many Americans, the prospect of "runaway inflation" remains a concern, even though the country hasn't had a sustained period of quickly rising prices for nearly four decades.
"Many find it counterintuitive that the Fed would want to push up inflation," Powell said in his speech. "We are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes. However, inflation that is persistently too low can pose serious risks to the economy."
Stocks rose after Powell's announcement, with the Dow Jones industrial average up nearly 250 points, or 0.9%, at 28,585, and the Nasdaq composite up 0.3%.
"The era of easy money is here," Mike Loewengart, managing director of investment strategy at E-Trade Financial, told the Associated Press.
For the immediate future, the Fed will stay the course. Its short-term interest rate is already set near zero, and the Fed has also dramatically increased its buying of bonds this year to drive down longer-term interest rates, which are typically set by investors and savers.
"The Fed has already said it will keep rates low for the foreseeable future, and no one expects any rate hikes before the end of 2021," Sung Won Sohn, economics and business professor at Loyola Marymount University in Los Angeles, told the AP.
For much of the past decade, the Fed's goal was for prices to rise 2% annually. The new goal, Powell said in his speech, is for inflation to average 2% over time. And he said the Fed would be particularly aggressive in pushing for higher prices in periods after economic downturns.
Powell did not say how the Fed would calculate average inflation. But the inflation measure the Fed normally looks at has averaged 1.6% over the past decade. To reach an average of 2%, that would mean the Fed's new target would be around 2.4%.
That's not much higher than what the target has been, but it's significantly higher than the rate at which prices have been rising recently. The annual inflation rate has sunk to just 1% in the current economic downturn, which has been driven by the spread of the coronavirus and measures to contain it. That means the Fed's new policy goal would be to more than double the current inflation rate.
The Fed, however, has had a mixed record at actually being able to impact prices. Inflation remained stubbornly high in the 1970s, while for the past few decades it has been lower than one would expect. Many have attributed that to a rise in technology and the movement of more of U.S. manufacturing to countries with lower wages and cheaper production costs. More recently, economists have pointed to an increase in the national debt as a reason inflation — and borrowing costs in general — have remained low.
"When deficits grow, debt grows and rates stay low. It doesn't mean inflation follows. When you talk about inflation, it's not what the Fed does, it's what technology does," Rick Rieder, BlackRock global chief investment officer of fixed income, recently told CNBC.
Powell on Thursday acknowledged that it was unlikely that the Fed would be able to boost prices and wages on its own, and that it would take an effort from other parts of the government, including increased stimulus efforts and other spending from Washington.
"I hope he uses this speech to urge lawmakers to act," Mark Zandi, chief economist at Moody's Analytics, told the AP prior to Powell's speech. "[W]e are a long way from normal, and for us to get back to normal Congress needs to step up and provide more support."
The Associated Press contributed to this article.