Author: Li Dan, Wall Street Journal

Federal Reserve Chairman Jerome Powell delivered a significant speech at the Jackson Hole central bank annual meeting, stating that the current situation indicates an increased downside risk to employment. This shift in risk balance may imply the need for interest rate cuts.

At the beginning of his speech, Powell pointed out that this year, the "risk balance seems to be shifting" regarding the Fed's dual mandate of employment and inflation. He believes that the current economic conditions impact monetary policy as follows:

"The stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, given that policy is in a restrictive range, the baseline outlook and the evolving risk balance may require us to adjust our policy stance."

Regarding the labor market, Powell stated:

"Overall, while the labor market is in balance, it is a 'peculiar balance' resulting from a significant slowdown in both labor supply and demand. This unusual situation suggests that the downside risk to employment is increasing."

On the impact of tariffs on inflation, Powell mentioned that a "reasonable baseline assumption" is that tariffs will lead to a "one-time" increase in price levels, but these effects will take time to fully manifest in the economy.

Considering various influencing factors, Powell believes:

"In the short term, inflation risks are tilted to the upside, while employment risks are tilted to the downside—this is a challenging situation."

Regarding adjustments to the monetary policy framework, Powell noted that the new policy framework removed two statements: one is that the Fed seeks to achieve an average inflation target of 2% over a period; the other is using "deviation from full employment levels" as a decision-making basis.

"New Federal Reserve News Agency": Powell Opens the Door for Rate Cuts as Early as September, More Confident in Tariff Impact Assumptions

Some commentators believe that Powell's mention of stable labor market indicators like the unemployment rate allows the Fed to cautiously consider adjusting its monetary policy stance, which opens the door for a rate cut at the next meeting in September.

Nick Timiraos, known as the "New Federal Reserve News Agency," pointed out in his article that Powell's speech emphasizes concerns about the job market, paving the way for rate cuts. The article begins with:

"Powell stated that the prospect of further slowing in the job market may alleviate concerns that tariffs will exacerbate inflation by raising costs, thus opening the door for a rate cut at the next meeting as early as September."

Timiraos believes that this speech is Powell's first indication that he has increased confidence in the baseline assumption that the impact of tariffs leading to higher prices for goods will be relatively short-lived.

He noted that Powell believes the effects of tariffs are now clearly visible and are expected to continue accumulating over the next few months. The Fed faces the question of whether these price increases will "significantly increase the risk of persistent inflation issues."

Powell also believes that the one-time price increase caused by tariffs may be a reasonable baseline assumption, although this does not mean that the impact on prices will be immediate. Timiraos stated that if the tightness of the labor market is insufficient to support consumers who have lost purchasing power due to tariffs in negotiating stronger wages, then this baseline assumption is more likely to occur.

Here is the full translation of Powell's speech:

Monetary Policy and the Review of the Federal Reserve Framework

Federal Reserve Chairman Jerome H. Powell

The speech was delivered at the economic symposium "The Labor Market in Transition: Demographics, Productivity, and Macroeconomic Policy" hosted by the Kansas City Fed in Jackson Hole, Wyoming.

This year, the U.S. economy has shown resilience against the backdrop of significant changes in economic policy. In terms of the Fed's dual mandate, the labor market remains close to full employment levels, and while inflation is still somewhat elevated, it has significantly decreased from its post-pandemic peak. Meanwhile, the risk balance seems to be shifting.

In today's speech, I will first discuss the current economic situation and the short-term outlook for monetary policy, and then turn to the results of our second public review of the monetary policy framework, which is reflected in the revised "Statement on Long-Run Goals and Monetary Policy Strategy" we released today.

Current Economic Conditions and Short-Term Outlook

A year ago, when I spoke here, the economy was at a turning point. Our policy interest rate has been maintained in the range of 5.25% to 5.5% for over a year. This restrictive policy stance has helped reduce inflation and promote a sustainable balance between total demand and total supply. Inflation has come significantly closer to our target, and the labor market has cooled from its previous overheating state. The upside risk of inflation has decreased, but the unemployment rate has risen by nearly one percentage point, which historically does not occur without an economic recession. In the subsequent three Federal Open Market Committee (FOMC) meetings, we adjusted our policy stance to lay the groundwork for the labor market to remain close to maximum employment levels over the past year.

This year, the economy faces new challenges. Tariffs among global trading partners have significantly increased, reshaping the global trading system. Stricter immigration policies have led to a sudden slowdown in labor growth. In the long term, changes in tax, spending, and regulatory policies may also have significant impacts on economic growth and productivity. It is currently difficult to determine where these policies will ultimately land and their lasting effects on the economy.

Changes in trade and immigration policies have affected demand and supply. In such an environment, it becomes challenging to distinguish between cyclical changes and trend or structural changes. This distinction is crucial because monetary policy can stabilize cyclical fluctuations but has limited effects on structural changes.

The labor market is a case in point. The July employment report released earlier this month showed that job growth has slowed to an average of only 35,000 per month over the past three months, significantly below the 168,000 per month expected for 2024. This slowdown is much greater than the assessment made a month ago, as the previous data for May and June has been significantly revised down. However, the slowdown in job growth does not seem to have led to a significant amount of slack in the labor market—an outcome we wish to avoid. The unemployment rate rose slightly in July but remains at a historically low level of 4.2%, having remained stable over the past year. Other labor market indicators have also changed little or only slightly declined, including the quit rate, layoffs, the ratio of job openings to unemployment, and nominal wage growth. Labor supply has also slowed, significantly reducing the number of "breakeven" new jobs needed to keep the unemployment rate stable. In fact, this year, due to a sharp decline in immigration, labor growth has noticeably slowed, and the labor force participation rate has also declined in recent months.

Overall, while the labor market is in balance, it is a "peculiar balance" resulting from a significant slowdown in both labor supply and demand. This unusual situation suggests that the downside risk to employment is increasing. If risks materialize, they may quickly manifest as a surge in layoffs and a rapid increase in the unemployment rate.

At the same time, GDP growth in the first half of this year has noticeably slowed to 1.2%, about half of the expected 2.5% growth for 2024. This slowdown in growth primarily reflects a deceleration in consumer spending. Like the labor market, the slowdown in GDP growth is partly due to a slowdown in supply or potential output.

Regarding inflation, higher tariffs have begun to push up prices for certain goods. According to the latest data, the total PCE price increased by 2.6% for the 12 months ending in July. Excluding the more volatile food and energy prices, core PCE rose by 2.9%, higher than the same period last year. Within the core, prices for goods increased by 1.1% over the past 12 months, in stark contrast to the moderate decline expected for the entire year of 2024. In comparison, inflation in housing services continues to trend downward, while inflation in non-housing services is slightly above levels historically consistent with 2% inflation.

The impact of tariffs on consumer prices is now clearly visible. We expect these effects to continue accumulating over the next few months, with high uncertainty regarding the specific timing and extent. The core question for monetary policy is whether these price increases will significantly increase the risk of persistent inflation issues. A reasonable baseline assumption is that these effects are mostly one-time level jumps. Of course, "one-time" does not mean "instantaneous," as tariff adjustments will still take time to fully transmit through the supply chain and distribution network. Additionally, tariff levels are continuously being adjusted, which may extend the time for price adjustments.

The price pressures caused by tariffs could also potentially trigger more persistent inflation dynamics, which is a risk that needs to be assessed and managed. One possibility is that workers, facing pressure on real incomes, demand and receive higher wages, leading to a vicious wage-price interaction. However, given that the labor market is not particularly tight and faces more downside risks, this outcome seems less likely.

Another possibility is that rising inflation expectations drive actual inflation. Inflation has remained above our target for over four years, and households and businesses are particularly concerned about this. However, based on market and survey-based long-term inflation expectations, they remain clearly anchored, consistent with our long-term 2% inflation target.

Of course, we cannot be complacent about the stability of inflation expectations. Whatever happens, we will never allow a one-time increase in price levels to evolve into a persistent inflation problem.

In summary, what are the implications for monetary policy? In the short term, inflation risks are tilted to the upside, while employment risks are tilted to the downside—this is a challenging situation. When our goals conflict to some extent, the framework requires us to balance our dual mandate. So far, the policy interest rate has come closer to neutral levels by 100 basis points compared to last year, and the stability of the unemployment rate and other labor market indicators allows us to cautiously consider adjustments to our policy stance. However, since policy is in a restrictive range, the baseline outlook and the evolving risk balance may require us to adjust our policy stance.

Monetary policy is not on a preset path. FOMC members will make decisions based on data and their significance for the economic outlook and risk balance. We will never deviate from this principle.

Evolution of the Monetary Policy Framework

Turning to the second part of the topic, our monetary policy framework is rooted in the unchanging mission given to us by Congress: to promote maximum employment and price stability for the American people. We continue to steadfastly fulfill our statutory mission, and the framework revisions will support us in accomplishing this task under various economic conditions. Our revised "Statement on Long-Run Goals and Monetary Policy Strategy," our "consensus statement," describes how we achieve our dual mandate goals and is crucial for enhancing transparency and accountability, as well as improving policy effectiveness.

The changes in this review are a natural extension based on our deepening understanding of the economy. We continue to advance the initial consensus statement (developed in 2012 under Chairman Bernanke). Today's revised statement is the result of the second public review of the framework, which we conduct every five years. This review included three aspects: Fed Listens events held by various Federal Reserve Banks, a flagship academic symposium, and discussions and analyses among policymakers and staff at FOMC meetings.

One of the key goals of this review is to ensure that the framework is applicable under various economic conditions. At the same time, the framework must also adjust as the economic structure and our understanding evolve. The challenges faced during different phases, such as the Great Depression, historically high inflation, and moderate expansions, are all different.

During the last review, we were in a new normal—interest rates were close to the effective lower bound (ELB), with low economic growth and low inflation, and the Phillips curve was extremely flat, meaning inflation's response to economic slack was very limited. For example, after the global financial crisis erupted at the end of 2008, the policy interest rate hovered at the ELB level for seven years. Many remember the slow and painful recovery during that period. At that time, it seemed that even a slight recession would quickly bring the policy interest rate back to the ELB, where it could remain for a long time. When the economy is weak, inflation and inflation expectations decline, while nominal rates are pinned near zero, leading to rising real rates, increasing employment pressures, and continuing to suppress inflation and inflation expectations, creating adverse dynamics.

The economic issues that led to the policy interest rate falling to the effective lower bound (ELB) and drove the framework changes in 2020 were once thought to stem from global, slowly changing factors that could persist for years—had it not been for the impact of the pandemic, this might have indeed been the case. The 2020 consensus statement emphasized the risks associated with the ELB, which had developed over two decades. We highlighted the importance of anchoring long-term inflation expectations for achieving price stability and maximum employment goals. Drawing on a wide range of literature regarding strategies to address ELB risks, we adopted a flexible average inflation targeting mechanism, or "compensatory" strategy, to ensure that inflation expectations remain anchored even in the presence of ELB constraints. Specifically, we noted that after a period of inflation consistently below 2%, appropriate monetary policy might aim to push inflation slightly above 2% for a time.

In reality, it was not low inflation and the ELB, but rather the pandemic that led to the highest inflation in 40 years globally. As most central banks and private analysts expected, we thought that inflation would quickly decline without the need for significant tightening of policy until the end of 2021. Once the situation became clear that this was no longer the case, we acted swiftly, raising rates by 5.25 percentage points within 16 months. Such actions, combined with the elimination of pandemic-related supply chain disruptions, brought inflation close to target without the significant rise in unemployment that had accompanied past adjustments.

Main Content of the Revised Consensus Statement

This review examined the changes in economic conditions over the past five years. During this period, we observed that inflation can change rapidly when subjected to significant shocks, and interest rates have been much higher than during the period from the global financial crisis to the pandemic. The current inflation target is above the benchmark, and the policy interest rate is restrictive—what I consider moderate. We cannot determine where long-term interest rates will settle, and some neutral rate levels may be higher than in the 2010s, reflecting factors such as productivity, demographics, fiscal policy, and other influences on the balance of savings and investment. In the review, we also discussed how the emphasis on the ELB in the 2020 statement may have made communication more difficult when addressing high inflation. We believe that an emphasis on overly specific economic conditions may cause confusion, and thus the revised statement made several important adjustments.

First, we removed the content that defined the ELB as a characteristic of the economic environment. Instead, we emphasized that "the monetary policy strategy aims to promote maximum employment and price stability under broad economic conditions." The challenges of being close to the ELB remain worthy of attention, but they are no longer central. The revised statement reiterates that the committee is prepared to use all tools to achieve the goals of maximum employment and price stability, especially when the federal funds rate is constrained by the ELB.

Second, we **returned to a flexible inflation targeting framework and eliminated the *"compensatory" strategy*. It has proven that a deliberate and moderate inflation overshoot as a strategy is no longer applicable. As I publicly acknowledged in 2021, a few months after we announced the modification of the 2020 consensus statement, inflation emerged that was neither deliberate nor moderate.

Anchored inflation expectations have enabled us to successfully curb inflation without raising unemployment. Anchoring inflation expectations helps drive inflation back to target when facing adverse shocks while reducing the risk of deflation during economic weakness. Furthermore, anchored inflation expectations allow monetary policy to support maximum employment during economic downturns without jeopardizing price stability. Our revised statement emphasizes that we are committed to taking strong actions to ensure long-term inflation expectations remain anchored, which benefits both aspects of our dual mandate, and notes that "price stability is essential for a healthy, stable economy and the well-being of all Americans." This view was particularly highlighted in feedback from the Fed Listens events. The experiences of the past five years remind us that the suffering caused by high inflation particularly affects those who are least able to cope with rising basic living costs.

Third, the 2020 statement proposed that we would mitigate the "shortage" of maximum employment, rather than "deviation." The use of the term "shortage" reflects our insights into the natural rate of unemployment and the high uncertainty of real-time assessments of "maximum employment." In the post-global financial crisis period, actual employment long exceeded the sustainable levels estimated by mainstream estimates, while inflation remained persistently below 2%. In the absence of inflationary pressures, there is no need to tighten policy based solely on uncertain real-time estimates of the natural rate of unemployment.

We still hold this view, but the term "shortage" may not always be correctly interpreted, leading to communication barriers. In particular, "shortage" does not commit us to never act preemptively, nor does it disregard the tightness of the labor market. In light of this, we removed the term "shortage" and more accurately stated that "(FOMC) committee recognizes that employment may sometimes exceed real-time estimates of maximum employment levels, but this does not necessarily pose a risk to price stability." Of course, if the labor market is excessively tight or other factors affect price stability, preemptive action may be necessary.

The revised statement also notes that maximum employment is "the highest level of employment that can be sustained in a price-stable environment." It emphasizes that a strong labor market brings broad employment opportunities and benefits for all, a principle that was fully corroborated by feedback from the Fed Listens events, demonstrating the value of a strong job market for American families, employers, and communities.

Fourth, consistent with the removal of "shortage," we clarified our response when employment and inflation targets are incompatible. In such cases, we will pursue a balanced approach to advance both objectives. The revised statement has returned more to the original wording from 2012— we will consider the degree of deviation from the targets and the different time spans that may be involved in bringing both back to levels consistent with our dual mandate. These principles are guiding our current policy decisions and have previously led us to address deviations from the 2% inflation target between 2022 and 2024.

Aside from the changes mentioned above, there is also a high degree of continuity with past statements. The document continues to clarify how we interpret the mission given to us by Congress and describes the policy framework we believe is most suitable for achieving maximum employment and price stability. We still advocate that monetary policy must be forward-looking and consider its lagged effects. Therefore, our policy actions depend on the economic outlook and our assessment of the balance of risks to that outlook. We still believe that setting specific employment targets is inadvisable because maximum employment levels cannot be directly measured and can change due to factors unrelated to monetary policy.

We also maintain that a long-term inflation rate of 2% best aligns with our dual mandate goals. We believe that our commitment to this target helps anchor long-term inflation expectations. Experience shows that 2% inflation allows households and businesses to make decisions without worrying about inflation while providing central banks with some policy flexibility during economic downturns.

Finally, the revised consensus statement still commits to conducting a public review approximately every five years. Five years is not particularly special; this frequency helps policymakers reassess structural economic issues and facilitates communication with the public, industry, and academia regarding the framework's performance, aligning with practices of some global peers.

Conclusion

Finally, I would like to thank (Kansas City Fed) President Schmid and all the staff for their tireless efforts in hosting this outstanding event every year. Even counting the virtual speeches during the pandemic, this is my eighth time speaking here. Each year, this symposium provides Federal Reserve leaders with the opportunity to engage with top economists and focus on challenges. Over forty years ago, the Kansas City Fed successfully invited Chairman Volcker to this national park, and I am honored to be part of this tradition.

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