Powell's full speech: Restarting interest rate cuts

Author: Powell; Translator: Liam, Carbon Chain Value

Beijing time, at 10:00 PM on August 22, Federal Reserve Chairman Powell delivered a highly anticipated speech at the "Labor Market Transition: Demographics, Productivity, and Macroeconomic Policy" economic seminar hosted by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming.

In his speech, Powell mentioned "comprehensive changes" in tax, trade, and immigration policies. As a result, "the balance of risks appears to be shifting" between the Federal Reserve's two goals of maximum employment and price stability. While he noted that the labor market remains strong and the economy is showing "resilience," he said downside risks are rising. At the same time, he said tariffs are creating the risk of rising inflation again—a stagflationary situation the Fed needs to avoid. Powell said that with the Fed's benchmark interest rate a full percentage point lower than when he delivered his keynote address a year ago and unemployment still low, "we can cautiously consider changing the stance of policy." That was the only time in his speech he came close to endorsing a rate cut, and Wall Street generally believes a rate cut will occur at the next meeting of the Federal Open Market Committee on September 16-17. The following is the full text of Powell's speech at Jackson Hole: So far this year, the U.S. economy has demonstrated resilience amidst a comprehensive overhaul of economic policy. In line with the Federal Reserve's dual mandate, the labor market remains near full employment, and while inflation remains elevated, it has declined significantly from its post-pandemic peak. At the same time, the risk landscape appears to be shifting. Today, I will begin by discussing the current economic situation and the near-term outlook for monetary policy. I will then present the findings of our second public review of the monetary policy framework, which is incorporated into the revised Statement on Longer-Run Goals and Monetary Policy Strategy released today.

Current Economic Conditions and Near-Term Outlook

One ​​year ago, when I stood at this podium, the economy was at a turning point. Our policy interest rate had remained between 5.25% and 5.5% for over a year. This restrictive policy stance was appropriate, helping to lower inflation and promote a sustainable balance between aggregate demand and aggregate supply. Inflation had moved well within our target, and the labor market had cooled from its previous overheating. Upward risks to inflation had diminished somewhat. However, the unemployment rate had risen by nearly a full percentage point, a development historically only seen during a recession. Over the three subsequent Federal Open Market Committee (FOMC) meetings, we adjusted the stance of policy, laying the foundation for a labor market that has remained balanced near full employment over the past year (Figure 1). Figure 1: This year, the economy faces new challenges. Significant tariff increases by major trading partners are reshaping the global trading system. Stricter immigration policies have led to a sudden slowdown in labor force growth. Over the long term, changes in tax, spending, and regulatory policies are also likely to have important implications for economic growth and productivity. Significant uncertainty remains about the ultimate direction of these policies and their long-term impact on the economy. Changes in trade and immigration policies are affecting both demand and supply. In this environment, distinguishing cyclical from trend (or structural) developments becomes difficult. This distinction is crucial, as monetary policy can stabilize cyclical fluctuations but has limited impact on structural changes. The labor market provides a prime example. The July employment report released earlier this month showed that nonfarm payroll growth averaged just 35,000 jobs per month over the past three months, a significant slowdown from the 168,000 monthly average expected in 2024 (Figure 2). This slowdown was much larger than anticipated a month ago, as early data for May and June were significantly revised downward. However, it currently appears that the slowdown in job growth has not created significant slack in the labor market—an outcome we would like to avoid. While the unemployment rate rose slightly in July, it remained at a historically low 4.2% and has remained largely stable over the past year. Other labor market indicators, including quits, layoffs, the ratio of job openings to the unemployed, and nominal wage growth, were also largely flat or weakened only slightly. The simultaneous slowdown in both labor supply and demand has led to a sharp decline in the "break-even" employment growth rate required to maintain a constant unemployment rate. In fact, labor force growth has slowed significantly this year, primarily due to a sharp drop in immigration, while the labor force participation rate has also declined slightly in recent months. Overall, while the labor market appears to be in balance, this equilibrium is an idiosyncratic one, driven by a significant slowdown in both labor supply and demand. This unusual situation suggests rising downside risks to employment. If these risks materialize, they could quickly manifest themselves in the form of a surge in layoffs and a rise in the unemployment rate. Meanwhile, gross domestic product (GDP) growth slowed significantly in the first half of this year, to 1.2%, about half the 2.5% growth rate projected for 2024 (Figure 3). The slowdown primarily reflects a slowdown in consumer spending. Similar to the labor market, the slowdown in GDP growth partly reflects slower supply growth, or slower growth in potential output. Figure 3 Speaking of inflation, higher tariffs have begun to push up prices for some goods. According to the latest data estimates, overall personal consumption expenditures (PCE) prices rose 2.6% in the 12 months ending in July. Excluding the more volatile food and energy categories, core PCE prices rose 2.9%, above the same period last year. Within core PCE prices, goods prices rose 1.1% over the past 12 months, a significant reversal from the moderate decline expected throughout 2024. In contrast, housing services inflation remained on a downward trend, while non-housing services inflation remained slightly above the historical 2% inflation target (Figure 4). The impact of tariffs on consumer prices is now clearly visible. We expect these effects to accumulate gradually over the coming months, but the precise timing and magnitude are highly uncertain. For monetary policy, the key question is whether these price increases are likely to significantly increase the risk of persistent inflation. A reasonable baseline scenario assumes that these effects will be relatively short-lived—a one-off shift in the price level. Of course, "one-off" does not mean "all at once." Tariff increases take time to be transmitted through supply chains and distribution networks. Furthermore, tariff rates are still evolving, which could prolong the adjustment process. However, the upward pressure on prices from tariffs could also trigger more persistent inflationary dynamics, a risk that needs to be assessed and managed. One possibility is that, as real incomes fall due to higher prices, workers demand and receive higher wages from their employers, triggering adverse wage-price dynamics. This outcome seems unlikely, given that the labor market is not particularly tight and faces increasing downside risks. Another possibility is that inflation expectations could rise and weigh on actual inflation. Inflation has been above our objective for more than four years and remains a significant concern for households and businesses. However, indicators of longer-term inflation expectations, as reflected in markets and surveys, appear to remain stable and consistent with our 2 percent longer-run inflation objective. Of course, we cannot be complacent about the stability of inflation expectations. Under no circumstances will we allow a one-time increase in the price level to become a persistent inflation problem. Taking all of these factors into account, what are the implications for monetary policy? In the near term, risks to inflation are tilted to the upside, while risks to employment are tilted to the downside—a challenging situation. With our objectives in this tension, our policy framework requires us to balance both sides of our dual mandate. The current policy rate is 100 basis points closer to neutral than it was a year ago, and the stable unemployment rate and other labor market indicators allow us to proceed cautiously as we consider adjusting the stance of policy. However, given that policy is in a restrictive range, shifts in the baseline outlook and the balance of risks may require adjustments to the stance of policy. Monetary policy does not have a preset path. Federal Open Market Committee (FOMC) members will make these decisions solely based on the data and their assessment of its implications for the economic outlook and the balance of risks. We will not deviate from this approach. Evolution of the Monetary Policy Framework Moving to my second topic, our monetary policy framework is based on the unchanging mandate given to us by Congress: to promote maximum employment and price stability for the American people. We remain fully committed to fulfilling our statutory mandate, and the revisions to our framework will support that mandate under a wide range of economic conditions. Our revised Statement on Longer-Run Goals and Monetary Policy Strategy (which we call the Consensus Statement) sets out how we pursue our dual-mandate objectives. It is intended to provide the public with a clear understanding of our views on monetary policy, an understanding that is essential for transparency and accountability, and for enhancing the effectiveness of monetary policy. The adjustments we are making in this review are natural and based on our evolving understanding of the economy. We will continue to build on the initial Consensus Statement adopted in 2012 under Chairman Ben Bernanke. Today's revised statement is the result of the second public review of our framework, which occurs every five years. This year's review consisted of three elements: "Fed Listens" events held at Reserve Banks nationwide, a flagship research conference, and discussion and deliberations among policymakers, supported by staff analysis, at a series of Federal Open Market Committee meetings. In preparing for this year's review, a key goal was to ensure that our framework was applicable across a wide range of economic conditions. At the same time, the framework needed to evolve as the structure of the economy changed and as our understanding of those changes progressed. The challenges of the Great Depression were different from those of the Great Inflation and the Great Moderation, which in turn were different from the challenges we face today. At the time of our last review, we were in a new normal characterized by interest rates near the effective lower bound (ELB), coupled with low growth, low inflation, and a very flat Phillips curve—meaning that inflation was less responsive to economic slack. A statistic that epitomizes that era for me is that, starting in late 2008 at the onset of the global financial crisis, our policy rate remained stuck at the ELB for seven years. Many of you will remember that era's weak growth and painfully slow recovery. At the time, it appeared quite likely that our policy rate would quickly return to the effective lower bound, potentially for an extended period, if the economy experienced even a modest downturn. In a weak economic environment, inflation and inflation expectations would likely decline, pushing up real interest rates, given that nominal interest rates were anchored near zero. Higher real interest rates would further depress employment growth and exacerbate downward pressure on inflation and inflation expectations, setting off an adverse dynamic. The economic conditions that pushed the policy rate to the ELB and prompted the 2020 framework changes were believed to be rooted in slow-moving global factors that would persist for an extended period—and would likely have persisted had it not been for the pandemic. The 2020 Consensus Statement included several elements designed to address the risks associated with the ELB that had become increasingly prominent over the past two decades. We emphasized the importance of anchoring longer-term inflation expectations to support our price stability and maximum employment goals. Building on the extensive literature on strategies to mitigate risks associated with the ELB, we adopted a flexible average inflation targeting approach—a "compensatory" strategy—to ensure that inflation expectations remained well-anchored even under the ELB constraint. Specifically, we argued that, following periods of sustained inflation below 2%, appropriate monetary policy might target inflation moderately above 2% for a period. Consequently, rather than delivering low inflation and an effective lower bound on interest rates, the post-pandemic reopening delivered the highest inflation in 40 years across global economies. Like most other central bankers and private sector analysts, we assumed that inflation would recede fairly quickly by the end of 2021, without requiring a significant tightening of the policy stance (Figure 5). When it became clear that this was not the case, we responded forcefully, raising the policy rate by 5.25 percentage points over 16 months. This action, combined with the gradual easing of pandemic-induced supply disruptions, brought inflation closer to our target, whereas previous efforts to address high inflation had resulted in a painful rise in unemployment. Figure 5: Elements of the Revised Consensus Statement. This year's review considers the evolution of economic conditions over the past five years. During this period, we have seen that inflation can evolve rapidly in the face of large shocks. Moreover, interest rates are currently much higher than during the period between the global financial crisis and the pandemic. With inflation above target, our policy rate is restrictive—and, in my view, modest. We cannot be certain where interest rates will stabilize in the long run, but the neutral level is likely higher now than in the 2010s, reflecting changes in productivity, demographics, fiscal policy, and other factors affecting the balance between saving and investment (Figure 6). During our review, we discussed how the 2020 statement's focus on the effective lower bound complicated our communication about our response to high inflation. We concluded that the emphasis on overly specific economic conditions may have led to some confusion, and we have therefore made several important revisions to the consensus statement to reflect this insight. Figure 6 First, we have removed the language that indicated that the effective lower bound was a defining feature of the economic landscape. Instead, we noted that "our monetary policy strategy is designed to foster maximum employment and price stability across a range of economic conditions." The difficulty of operating near the effective lower bound remains a potential concern, but it is not our primary concern. The revised statement reaffirms the Committee's readiness to use its full range of tools to achieve maximum employment and price stability, particularly if the federal funds rate is constrained at the effective lower bound. Second, we returned to a flexible inflation targeting framework and eliminated the "make-up" strategy. The idea of ​​intentional, moderate inflation overshoot has proven unrealistic. As I publicly acknowledged in 2021, the inflation that emerged a few months after we announced the revisions to the 2020 Consensus Statement was neither intentional nor moderate. Anchored inflation expectations are essential to our success in reducing inflation without significantly increasing unemployment. Well-anchored inflation expectations can help return inflation to target when adverse shocks push it higher, and they can limit deflationary risks during periods of economic weakness. Furthermore, these measures enable monetary policy to support maximum employment during downturns without compromising price stability. Our revised statement emphasizes our commitment to taking forceful action to ensure that longer-term inflation expectations remain well-anchored, thereby fulfilling our dual mandate. The statement also notes that "price stability is essential to a healthy and stable economy and supports the well-being of all Americans." This theme was clearly reflected in our "Fed Listens" events. The past five years have been a painful reminder of the difficulties that high inflation can cause, particularly for those least able to afford the high costs of necessities. Third, our 2020 statement stated that we would mitigate "gap" rather than "deviation" from full employment. The use of the term "gap" reflects the recognition that our real-time assessment of the natural rate of unemployment (and, by extension, "full employment") is highly uncertain. In the late stages of the recovery from the global financial crisis, employment remained persistently above mainstream estimates of its sustainable level, while inflation remained persistently below our 2% objective. In the absence of inflationary pressures, tightening policy based solely on uncertain real-time estimates of the natural rate of unemployment may not be warranted. We continue to hold this view, but our use of the term "gap" has not always been understood as intended, which has created communication challenges. In particular, the use of the term "gap" was not intended to be a commitment to permanently abandon priority actions or to ignore tightness in the labor market. Therefore, we have removed the term "gap" from our statement. The revised document now more accurately states: "The Committee recognizes that the level of employment may at times exceed real-time assessments of full employment, but this does not necessarily pose risks to price stability." Of course, if labor market tightness or other factors pose risks to price stability, priority actions may be warranted. The revised statement also states that full employment is "the highest level of employment that can be achieved sustainably with stable prices." This focus on promoting a strong labor market underscores the principle that durable full employment fosters broad economic opportunity and well-being for all Americans. The feedback we received during our Fed Listens program reinforced the value of a strong labor market for American families, employers, and communities. Fourth, consistent with the removal of the "gap" provision, we have made some changes to clarify our approach during periods when our employment and inflation goals are not mutually reinforcing. In such situations, we will adopt a balanced approach to promote these goals. The revised statement is now more consistent with the original 2012 language. We have taken into account the extent of deviations from our goals and the potentially different timeframes over which we anticipate each goal will return to levels consistent with our dual mandate. These principles guide our policy decisions today, as they will during the 2022-24 period, when deviations from our 2% inflation objective are of primary concern. Aside from these changes, the document maintains much of its consistency with past statements. It continues to explain how we interpret the mandate given to us by Congress and describes the policy framework we believe will best promote maximum employment and price stability. We continue to believe that monetary policy must be forward-looking and account for the lagged effects of its impact on the economy. Therefore, our policy actions depend on the balance of the economic outlook and its risks. We continue to believe that it is unwise to set a numerical target for employment because its maximum level cannot be directly measured and varies over time for reasons unrelated to monetary policy. We continue to believe that a 2% longer-run inflation rate is most consistent with our dual-mandate objective. We believe that our commitment to this objective is a key factor in helping to keep longer-term inflation expectations anchored. Experience has shown that a 2% inflation rate is low enough to ensure that inflation does not become a concern for households and businesses, while also providing central banks with some policy flexibility to provide accommodative policy during economic downturns. Finally, the revised consensus statement retains our commitment to a public review approximately every five years. This five-year review cadence is not a magical one. This frequency allows policymakers to reassess the structural characteristics of the economy and communicate with the public, practitioners, and academics on the performance of our framework. It also aligns with some of our global peers. Conclusion Finally, I would like to thank President Schmid and his entire staff for their hard work in putting on this excellent event each year. Including several online appearances during the pandemic, this is my eighth time having the honor of speaking here. Every year, this symposium provides Federal Reserve leaders with an opportunity to hear from leading economic thinkers and focus on the challenges we face. More than 40 years ago, the Kansas City Fed made a wise move by inviting Chairman Volcker to this national park, and I am honored to be part of this tradition.