Fed Chair Jerome Powell said interest rates may be higher in the long run due to risks from inflation and supply shocks

Federal Reserve Chairman Jerome Powell on Thursday said that the central bank’s framework for setting monetary policy may need to be adjusted to account for the possibility that supply shocks will become more common given the difficulties they pose for policymakers.

Powell delivered remarks at the Federal Reserve’s Thomas Laubach Research Conference and said that the central bank’s policy rate — the target range for the benchmark federal funds rate — could be higher in the future because of the potential for volatility with inflation and supply shocks occurring more often.

“Many estimates of the longer-run level of the policy rate have risen, including those in the summary of economic projections,” Powell said. “Higher real rates may also reflect the possibility that inflation could be more volatile going forward than during the inter-crisis period of the 2010s.” 

“We may be entering a period of more frequent and potentially more persistent supply shocks — a difficult challenge for the economy and for central banks,” the chairman added.

Powell noted that the Fed’s policy rate is currently well above the “lower bound” of cutting the policy rate to zero — it currently sits at a range of 4.25% to 4.5% — and that the central bank has historically made significant cuts during times of recession.

“While our policy rate is currently well above the lower bound, in recent decades we have cut the rate by about 500 basis points when the economy is in recession. Although getting stuck at the lower bound is no longer the base case, it is only prudent that the framework continue to address that risk,” Powell said.

The Federal Reserve and other central banks face policymaking constraints when the policy rate is near zero, as it negates their ability to cut interest rates to stimulate the economy amid a downturn.

Powell also discussed how keeping longer-run inflation expectations anchored at the Fed’s 2% target will remain a key part of the Fed’s policymaking framework, saying that while some aspects of it “must evolve, some elements of it are timeless.” 

“Since the Great Inflation, the U.S. economy has had three of its four longest expansions on record. Anchored expectations played a key role in facilitating these expansions. More recently, without that anchor, it would not have been possible to achieve a roughly 5 percentage point disinflation without a spike in unemployment,” Powell noted.

Read the full article HERE.