The Fed prepares for a more elastic mandate (Aug. 27, 2020)

Updated: Dec 30, 2020

In the keynote speech Jerome Powell, Chair, will give today at the traditional Federal Reserve summer meeting (this year organized in virtual version instead of the usual Jackson Hole headquarters), he could shed light on the revision of the inflation targets of the American central bank. The expectation is for the replacement of the current punctual approach with an approach based on an average inflation value over a certain period.

If this change happened has expected, the immediate implications for financial markets would not be relevant but could be over a longer period of time. For example, in the case of inflation that was below the established average for a certain period, the Fed would be free to decide on bazooka interventions with above-average inflationary effects for an equivalent period of time: the average level would be respected with, de facto, high-impact interventions.

This new approach would not be without contraindications, particularly on the currency front. The severity of the economic crisis originating from Covid-19 could push the Fed to adopt a mixed approach to ensure an even more accommodative monetary policy for a longer period of time without nominally entering the negative rates realm. If this were to be the case, the conditions would be laid in the United States to make new helicopter money available, in the quantities necessary to face any situation. Such a scenario, obviously, is negative for the dollar and potentially positive for all inflation-linked assets.

If we consider it from the perspective of the Fed's dual mandate (maximum sustainable employment and price stability, link), the matter is complex: the perimeter within which the American central bank operates today is the result of years of experience in the most diverse situations (especially after the events of the 1970s, which were marked by simultaneous high inflation and unemployment). Making changes to such a long-tested operational framework cannot be done lightly. After more than a year of studies and meetings between scholars, Powell could thus limit himself to signalling an orientation of the Committee, but a formal announcement does not seem imminent.

We expect the Fed to formally announce variations to its mandate at the Federal Open Market Committee meeting in September along with new medium-term economic forecasts. Since there is no rush to announce the change as the Fed should not, in fact, announce any rate change anytime soon, the announcement could come in January with the annual forecast (that would take into account the new framework), or in 2021. At the moment, however, the markets have no expectations in this sense, as a change in rates is not expected. 

In a scenario of the type described, fiscal policy could have an increasingly important role. With the United States having ample room for manoeuvre, further support for the economy could also come from economic policy choices in fact. Furthermore, a whole discussion could arise on the pro and cons of MMT.

The question that arises spontaneously is whether this use of resources, through these methods, keeps the optimal allocation of resources normally operated by the market alive. Naturally, in fact, the market makes capital available to the most deserving companies, that is, more innovative and better managed, favouring the restart of the economy.

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