Federal Reserve policymakers have been able to stave off sharply higher inflation even with low unemployment by managing expectations, central bank Chairman Jerome Powell said Tuesday.
Should those attitudes change, Powell said in a speech, the Fed won’t hesitate to respond.
“From the standpoint of contingency planning, our course is clear: Resolutely conduct policy consistent with the [Federal Open Market Committee’s] symmetric 2 percent inflation objective, and stand ready to act with authority if expectations drift materially up or down,” he told the National Association for Business Economics in Boston.
The past several years have seen an economic anomaly: sharply lower unemployment without an associated rise in labor costs. That defies an economic model called the Phillips Curve, which generally shows that when joblessness falls inflation will rise.
Central bankers still believe in the Phillips Curve even though the relationship seems to have broken down during a recovery that is less than a year away from being the longest on record.
Powell said the model isn’t dead, but instead is part of a change in circumstances that has taken place during an unprecedented time for the Fed.
“What is more likely, in my view, is that many factors, including better conduct of monetary policy over the past few decades, have greatly reduced, but not eliminated, the effects that tight labor markets have on inflation,” he said.
The central bank kept its benchmark interest rate anchored near zero for seven years while engaging in a bond purchasing program that ballooned its balance sheet to more than $4.5 trillion. Along with that, the Fed used guidance to help manage inflation expectations, letting the market know that while the FOMC would be content to let inflation hold somewhat above or below its 2 percent target for a period of time, it would remain vigilant at making sure it didn’t move too far in either direction.
“When monetary policy tends to offset shocks to inflation, rather than amplifying and extending them, and when people come to expect this policy response, a surprise rise or fall in labor market tightness will naturally have smaller and less persistent effects on inflation,” Powell said.
The unemployment rate currently stands at 3.9 percent, near a 50-year low, and core inflation is right around 2 percent. Powell said the two numbers are part of a “very good” economy that boasts “a remarkably positive outlook” from forecasters.
He indicated the Fed will continue to raise rates but in the gradual manner that has accompanied the current cycle that began in December 2015. The central bank approved a quarter-point hike in the funds rate last week that brought the target range to 2 percent to 2.25 percent. FOMC members indicated another hike before the end of the year, three more in 2019 and likely one more in 2020 before pausing.
Powell said the policy is mindful of controlling growth while making sure the recovery continues.
“Removing accommodation too quickly could needlessly foreshorten the expansion,” he said. “Moving too slowly could risk rising inflation and inflation expectations. Our path of gradually removing accommodation, while closely monitoring the economy, is designed to balance these risks.”