Once again, the chairman of the Federal Reserve, Jerome Powell, has filled up the punch bowl for investors, allowing inflation and employment to run higher as he signals a determination to keep interest rates low for many years.
Speaking at a virtual meeting of the world’s central bankers which is normally held at Jackson Hole, Wyoming, Mr Powell said the Fed would now look for inflation that ran at 2% over time – allowing for higher inflation spikes to appear after periods of sluggish growth.
He also announced that the Fed would change its view of full employment – allowing gains in the labour market to reach workers on lower pay scales before even thinking about tapping the monetary brakes by raising interest rates.
This change gets rid of previous concerns that low unemployment could cause excess inflation as prices rise due to labour market constraints.
Inflation and employment allowed to run higher
Mr Powell said the “robust updating” of the Fed’s strategy on employment and inflation followed a year-long review of the US economy.
In both cases the Fed policy changes are effectively academic for now with US inflation averaging just 1.4% since the inflation target was first set at 2% in 2012 and with the COVID-19 pandemic having caused a steep rise in US unemployment and fall in economic growth that will probably take many years to unwind.
The Fed has been concerned about low inflation because it encourages individuals and companies to defer spending and investment, leading to weaker economic activity and higher unemployment – although it is unclear how the Fed will go about boosting inflation given it is already spending US$80 billion a month buying Treasury bonds.
US economic growth suffered its biggest blow since the Great Depression in the second quarter of this year as the initial COVID-19 pandemic shattered consumer and business spending.
Since then the US economy has been recovering but there are concerns that recovery could stall due to a resurgence in new cases of coronavirus.
Markets higher after Fed policy change
However, the speech immediately had the desired effect with the US share market rising afterwards after firming in the lead up to the speech as investors readied themselves for the stimulus to keep flowing.
Mr Powell said that during the long US economic expansion before the pandemic hit earlier this year, many groups including minorities and women had benefitted by being able to find work.
“Maximum employment is a broad-based and inclusive goal,” Mr Powell said, at a time of notable unrest in the US over racial inequality, with questions being asked about the effect of the Fed’s policies to help the poor.
“This change reflects our appreciation for the benefits of a strong labour market, particularly for many in low- and moderate-income communities,” Mr Powell said.
Low rates here to stay
Market analysts interpreted the changes as reinforcing ultra-low interest rates for years to come as the Fed continues its program of pumping more liquidity into the US economy, keeping rates low by buying Treasury securities, mortgages, exchange-traded funds and even high-yield debt.
However, there are dangers with the Fed’s new approach to persist with negative real interest rates until inflation pumps up beyond 2% and there is strong employment, with the potential for asset price bubbles to inflate even further and the chance of further pressure on the US dollar.
Already debt has been growing strongly throughout the US economy, with junk bond issues hitting a record $US1.34 trillion this year.
The US share market has been posting new records, despite significant economic problems as the pandemic ushers in a period of bankruptcies, high unemployment and sharply lower economic growth.