At the recent central-bank symposium at Jackson Hole, Federal Reserve Chairman Jerome Powell delivered a widely expected message on interest rates: “The time has come for policy to adjust.” He all but confirmed that the Fed would cut rates by at least a quarter-point when its policymakers next meet in September.
A modest cut makes sense. Inflation remains a little above target but continues to subside — and thanks to a cooler labor market, a lower policy rate would suffice to maintain gentle downward pressure on prices. That said, one of the points Powell made in his address deserves emphasis. Over the coming months, the biggest mistake the central bank could make would be to let investors think its attention is shifting away from inflation.
The Fed has a dual mandate — price stability and maximum employment — and needs to maintain equal weight on both. As Powell said, the upside risk on inflation has diminished and the downside risk on employment has increased. That dictates a policy adjustment, but this shouldn’t be construed as unduly prioritizing employment over inflation. A shift in the balance of risks is not the same as a shift in the importance attached to each goal.
This is no mere semantic distinction. Powell’s speech drew attention to what’s at stake if the Fed is suspected of setting its inflation goal aside.
He asked: How did the Fed succeed in suppressing inflation without tanking the economy? His main answer was that in tightening policy decisively (albeit belatedly) in the spring of 2022, the central bank affirmed its commitment to a 2% inflation target — which, in turn, kept expectations anchored. As a result, the central bank’s preferred measure of underlying inflation stood at 2.6% in June, down from its peak of 5.6% in 2022, with (as yet) no substantial increase in unemployment, much less an outright recession. If the Fed had let expectations rise, a recession might very well have been necessary to get prices under control.
