
REUTERS: The U.S. Federal Reserve on Wednesday effectively established a three-part test that must be met before it will raise interest rates: the economy must be at "maximum employment," inflation must have "risen to 2 percent" and it must be "on track to moderately exceed 2 percent for some time."
It may be years before the economy reaches any of those hurdles, let alone all three, fresh forecasts released by the Fed on Wednesday suggest. Most policymakers see inflation only reaching 2per cent by 2023, with unemployment still above pre-crisis levels.
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Even so, questions are already swirling about what the hurdles will mean in practice.
LOW UNEMPLOYMENT, BUT SO MUCH MORE
Fed Chair Jerome Powell said the economy was a "long way" from meeting this test and that he would "love" to get back to the pre-crisis unemployment rate of 3.5per cent or lower, from 8.4per cent now.
Still, he said there is "no magic number" defining maximum employment and then went on to list a number of other benchmarks the Fed would need to see met, including high labor force participation and wage growth.
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The lack of precision for measuring maximum employment, a goal the Fed only last month chose to emphasize in a revamp of its operating framework, "renders the full employment threshold largely meaningless" Barclays economists wrote. It means, in practice, "the Fed will rely on inflationary pressures to indicate when maximum employment has been obtained."
STICKING THE LANDING ON INFLATION
To meet the hurdle on inflation rising to 2per cent, Powell said Wednesday, it wouldn't be enough for inflation to hit 2per cent for just one month and then fall back. "The idea that we would look for the quickest way out is just not who we are," he said.
But how many months of 2per cent inflation are enough? He didn't say. Nor did he say how they would get it there in the first place.
"The direction is a very sensible one," said Randall Kroszner, deputy dean of the University of Chicago's Booth School of Business and a former Fed governor. "But I am concerned that they think this is now going to make a big difference in terms of market expectations and in some sense that this may substitute for other actions" such as more bond buying to push down longer-term borrowing costs.
'ON TRACK TO MODERATELY EXCEED 2per cent… FOR SOME TIME'
Of the three tests, this one came with the most modifiers. Powell gave some clarification, saying the Fed is aiming for inflation "not very high above 2per cent" and "not permanently, not for a sustained period."
Inflation hasn't done more than rise briefly above 2per cent for many years, not just when the U.S. economy was weak but even when unemployment was plumbing decades-low levels in the months before the coronavirus crisis hit. Globalization, trade and advances in technology have been pushing down on prices worldwide; aging populations in the United States and elsewhere have similarly muted inflation by slowing growth and demand. None of that is going away.
Determining whether inflation is "on track" to satisfy both the "moderately" and "for some time" requirements may fall largely to a judgment call.
Still, says Nomura's chief U.S. economist Lewis Alexander, if the Fed manages to meet its first two hurdles – maximum employment and 2per cent inflation, "with short-teRead More – Source