Another neoliberal shibboleth has fallen, in one of the biggest developments in monetary policy in decades. Hard targeting of inflation — long the obsession of the rugged individualists of the neoliberal right — has been officially abandoned by the US Federal Reserve, in favour of an approach very similar to Australia’s inflation targeting model.
Following an extended review, Federal Reserve chairman Jerome Powell has announced the Fed will no longer base monetary policy on a 2% inflation target, but seek inflation that averages 2% over time. It also adjusted its view of full employment to allow labour-market gains to reach more workers without triggering a tightening of monetary policy via a rise in interest rates.
The Fed has had a formal hard target since 2012 (after having an informal one since the 1990s) along with the Reserve Bank of NZ (1990), the Bank of England (1992) and the Bank of Canada (1991). In contrast, the Reserve Bank of Australia (RBA) starting referring to its (more relaxed) target in the early 1990s under then-treasurer Paul Keating. It was later formalised in an agreement with former Treasurer Peter Costello in 1996: the RBA aims for consumer price inflation between 2–3%, on average, over time.
The RBA’s inflation target is flexible and allows for temporary fluctuations in inflation above or below the target. A hard target significantly reduces flexibility, driving interest rate rises the moment the target is reached. The RBA is allowed to base policy on a longer view of the trajectory of inflation, and not worry too much about slightly higher inflation if it believes the economy is not in danger of overheating (something we can only dream about now).
The neoliberal right has always preferred hard targets, reflecting the monetarist origins of their economic thinking, a 1930s-bred conviction that inflation is far more damaging than high unemployment and that the moment unemployment falls below a certain point inflation will skyrocket.
Perhaps above all they’re driven by a deeply ingrained desire to punish what they perceive as indulgent economies relying on easy money. For neoliberal economists, inflation targeting isn’t just an economic issue, but a moral one as well, with communities needing to feel the lash of tighter interest rates rather than luxuriating in the feel-good result of low unemployment.
So pernicious is this thinking that when inflation in Australia persistently fell below the RBA’s 2-3% band, some economists, and The Australian Financial Review, demanded not that interest rates be lowered, but that the 2-3% band be reduced to 1-2% so the RBA could increase rates.
Instead, the Federal Reserve has embraced the Australian approach, in a vindication for monetary policymakers at the RBA and in Treasury since the 1990s. The Fed hasn’t embraced a target band, but 2% will be an “average” target — and it explicitly says that after an extended period of undershooting 2%, the Fed will allow inflation moderately above 2%.
The Fed also says its decisions would be informed by its assessment of “shortfalls of employment from its maximum level.” Its previous version referred to “deviations from its maximum level” — that is, it is now downplaying concerns about the risk of low unemployment causing inflation.
For the Fed, “maximum employment is a broad-based and inclusive goal,” suggesting it will want to see evidence of employment growth benefiting all sectors of US society beyond the headline numbers.
This is all academic at the moment. After inflation staggered back into positive territory in the US in July, the annual inflation rate is currently 1%. But whenever the US economy resumes growth, Powell and the Fed have signalled they won’t be lifting interest rates the moment inflation crawls back to 2%.
The shift will be welcomed by investors — yay for lower interest rates for longer — but neoliberals and inflation hawks in the US and here will likely begin lamenting the indulgence and laziness of the Fed under Powell. They’ve been impervious to economic reality for years, and that’s unlikely to change now.