By: Jerome H. Powell, Chairman of the Federal Reserve
Compiled by: Lyric, ChainCatcher
Editor's note: In this speech, Fed Chairman Powell sent out the strongest signal of interest rate cuts so far, and made it clear that he would take action to prevent further weakening of the U.S. labor market. Powell stressed that "we do not seek or welcome further cooling of labor market conditions" and said that now is the time to adjust policies. This remark almost marks the end of the Fed's anti-inflation efforts.
The following is the full text of the speech by Federal Reserve Chairman Powell compiled by ChainCatcher:
Four and a half years after the outbreak of the COVID-19 pandemic, the most severe economic distortions caused by the pandemic are receding. Inflation has fallen sharply. The labor market is no longer overheated, and conditions are now easier than before the pandemic. Supply constraints have normalized. The balance of risks to our two mandates has also shifted. Our goal is to restore price stability while maintaining a strong labor market and avoiding the sharp rise in unemployment that would have occurred in an earlier deflationary period when inflation expectations were less firmly anchored. We have made good progress toward that goal. While the job is not done, we have made great progress toward it.
Today, I will first talk about the current economic situation and the future direction of monetary policy. Then, I will discuss economic events since the outbreak of the epidemic, exploring why inflation has risen to levels not seen in a generation and why inflation has fallen sharply while unemployment has remained low.
Recent Policy Outlook
Let us first understand the current situation and the near-term policy outlook.
For much of the past three years, inflation has been running well above our 2 percent objective, and labor market conditions have been extremely tight. The Federal Open Market Committee’s (FOMC) primary focus has been, and rightly so, on reducing inflation. Most Americans today have not experienced the pain of prolonged high inflation before. Inflation has caused significant hardship, especially for those who can least afford the high costs of necessities such as food, housing, and transportation. The stress and sense of unfairness that high inflation has induced persists today.
Our contractionary monetary policy has helped restore the balance between aggregate supply and aggregate demand, eased inflationary pressures, and ensured that inflation expectations remain anchored. Inflation is now closer to our target, with prices rising by 2.5% over the past 12 months.
After pausing earlier this year, we are back on track toward our 2 percent objective, and I am increasingly confident that inflation will return to 2 percent in a sustainable manner.
Turning to jobs, in the years before the pandemic, we saw significant benefits to society from long-standing strong labor market conditions: low unemployment, high participation rates, historically low racial employment gaps, and low and stable inflation, healthy real wage growth that was increasingly concentrated among low-income people.
Today, the labor market has cooled significantly from its previous overheated state. The unemployment rate began to rise more than a year ago and is currently 4.3%—still low by historical standards, but almost a full percentage point higher than its level at the beginning of 2023.
Most of the increase has occurred in the past six months. So far, the rise in the unemployment rate has not been the result of rising layoffs, which is common in economic downturns. Instead, the increase in the unemployment rate mainly reflects a large increase in the supply of workers and a slowdown in the previously frenetic pace of hiring. Even so, the cooling of labor market conditions is evident. Job gains remain solid but have slowed this year.
The number of job openings has fallen, and the ratio of job openings to unemployment has returned to pre-pandemic levels. Hiring and quit rates are now below their levels in 2018 and 2019. Nominal wage growth has slowed somewhat. All in all, labor market conditions are better now than they were in 2019, before the pandemic, when inflation was below 2%. The labor market seems unlikely to be a source of rising inflationary pressures any time soon. We neither seek nor welcome a further cooling of labor market conditions.
Overall, the economy continues to grow at a solid pace. But inflation and labor market data suggest that the situation is changing. Upside risks to inflation have diminished. Downside risks to employment have increased. As we emphasized in our last FOMC statement, we are mindful of the risks to our dual mandate.
The time for policy adjustment has come. The policy direction has been made clear, and the timing and pace of interest rate cuts will depend on subsequent data, changes in the outlook and the balance of risks.
We will do everything we can to support a strong labor market while further achieving price stability. By reducing policy constraints appropriately, we have every reason to believe that the economy will return to a 2% inflation rate while maintaining a strong labor market. Our current policy rate level provides us with ample room to address any risks we may face, including the risk of a further deterioration in labor market conditions.
The ups and downs of inflation
Now let’s talk about why inflation rose, and why it fell so much while unemployment remained low. There is a growing body of research on these questions, and now is a good time to discuss them. Of course, it is too early to make a definitive assessment. People will still be analyzing and debating this period long after we are gone.
The outbreak of the coronavirus pandemic quickly shut down the global economy. This was a time of uncertainty and significant downside risks. As often happens in times of crisis, Americans adapted and innovated. Governments responded with extraordinary force, most notably the unanimous passage of the CARES Act by Congress. At the Federal Reserve, we used our powers to an unprecedented extent to stabilize the financial system and help avoid a depression.
After the deepest but brief recession in history, the economy began to grow again in mid-2020. As the risk of a deep, prolonged recession recedes and economies reopen, we risk a repeat of the painfully slow recovery that followed the global financial crisis.
Congress provided substantial additional fiscal support in late 2020 and early 2021. Spending recovered strongly in the first half of 2021. The ongoing pandemic has affected the pattern of the recovery. Persistent concerns about the coronavirus pandemic weighed on spending on in-person services. But pent-up demand, stimulus policies, changes in work and leisure habits caused by the pandemic, and additional savings related to limited spending on services have led to a historic surge in consumer spending on goods.
The pandemic has also severely disrupted supply conditions. At the start of the pandemic, 8 million people dropped out of the labor force, and the size of the labor force remains 4 million below its pre-pandemic level in early 2021. The size of the labor force does not return to pre-pandemic levels until mid-2023.
Supply chains are being disrupted by the loss of workers, disruptions to international trade links, and major changes in the structure and level of demand.
Clearly, this is nothing like the slow recovery following the global financial crisis.
Inflation is starting to show up. After running below target throughout 2020, inflation surged in March and April 2021. The initial burst of inflation was concentrated rather than broad-based, with sharp price increases for scarce goods such as automobiles. My colleagues and I judged from the outset that these pandemic-related factors would not persist and that, therefore, the sudden rise in inflation was likely to pass quickly without requiring a monetary policy response—in short, that it would be temporary. Standard thinking has long been that central banks can ignore temporary rises in inflation as long as inflation expectations remain well anchored.
The good ship "ransitory" is packed, with most mainstream analysts and central bankers from advanced economies on board. There is a broad expectation that supply conditions will improve fairly quickly, allowing for a rapid recovery in demand, with demand shifting from goods to services, lowering inflation.
For a while, the data were consistent with the transitory assumption. Monthly readings of core inflation declined every month from April to September 2021, albeit at a slower pace than expected.
As reflected in our letter, this began to abate around mid-year. Starting in October, data ran counter to the transitory assumption. Inflation rose and broadened from goods to services. It became clear that high inflation was not transitory and that a strong policy response was needed if inflation expectations were to remain anchored. We recognized this and began to shift policy in November. Financial conditions began to tighten. We began raising interest rates in March 2022 after phasing out our asset purchase program.
By early 2022, headline inflation was above 6% and core inflation was above 5%. A new supply shock emerged. Russia’s invasion of Ukraine led to a sharp rise in energy and commodity prices. The improvement in supply conditions and the shift in demand from goods to services took much longer than expected, in part because of a further escalation of the coronavirus pandemic in the United States. The coronavirus pandemic continued to disrupt global production, including new and extended lockdowns in China.
High inflation is a global phenomenon that reflects a common experience: rapid growth in demand for goods, tight supply chains, tight labor markets, and sharply higher commodity prices. The nature of global inflation this time is different from any period since the 1970s, when high inflation was entrenched, an outcome we did everything we could to avoid.
By mid-2022, the labor market was extremely tight, with more than 6.5 million more people employed than by mid-2021. As health concerns began to recede, workers rejoined the labor force, partially meeting the increase in labor demand. But labor supply remained constrained, and in the summer of 2022, the labor force participation rate remained well below pre-pandemic levels. From March 2022 to the end of the year, the number of job openings was almost twice the number of unemployed people, indicating a severe labor shortage.
Inflation peaked at 7.1% in June 2022.
Two years ago, I argued from this podium that addressing inflation would likely involve some pain in the form of higher unemployment and slower economic growth. Some argued that controlling inflation would require a recession and prolonged periods of high unemployment. I expressed our unconditional commitment to restore full price stability and to maintain it until the job was done.
The FOMC has performed its duties without fear, and our actions have powerfully demonstrated our determination to restore price stability. In 2022, we raised our policy rate by 425 basis points and by an additional 100 basis points in 2023. We have held our policy rate at its current restrained level since July 2023.
The summer of 2022 proved to be the peak of inflation. Inflation has fallen 4.5 percentage points from its peak two years earlier, and this decline has occurred against a backdrop of low unemployment—a welcome and historically unusual outcome.
How did inflation fall without unemployment rising sharply above the estimated natural rate of unemployment?
The supply and demand distortions caused by the pandemic and the severe shocks to energy and commodity markets were important drivers of high inflation, and the reversal of these factors was a key part of the decline in inflation. These factors took much longer to dissipate than expected but ultimately played an important role in the subsequent deflation. Our tight monetary policy has contributed to the moderation in aggregate demand, which, together with the improvement in aggregate supply, has reduced inflationary pressures while allowing economic growth to continue at a healthy pace. As labor demand has also moderated, the historically high ratio of job openings to unemployment has normalized, primarily through the decline in the job vacancies rate, without the large and disruptive layoffs that have made the labor market a less of a source of inflationary pressure.
A word about the importance of inflation expectations. Standard economic models have long reflected the view that as long as inflation expectations are anchored around our target, inflation will return to target when product and labor markets are in equilibrium, without the need for economic easing. That’s what the models say, but the stability of long-term inflation expectations has not been tested by persistently high inflation since the 2000s. It is far from clear that the inflation anchor will hold. Concerns about unanchoring have contributed to the view that deflation requires economic easing, especially labor market easing. An important conclusion from recent experience is that anchored inflation expectations can promote deflation without economic easing, driven by strong central bank action.
This narrative attributes much of the rise in inflation to an unusual collision between overheated and temporarily distorted demand and constrained supply. Although researchers differ in their methods and, to some extent, in their conclusions, a consensus seems to be emerging that I think attributes much of the rise in inflation to this collision.
All in all, the distortions caused by the pandemic have healed, our efforts to moderate aggregate demand, and our efforts to anchor expectations should work together to put inflation on a sustainable path to achieve our 2% objective.
Achieving deflation while maintaining a strong labor market is only possible if inflation expectations are anchored, reflecting the public's confidence that the Bank will achieve its 2 percent inflation objective over time. This confidence has been built over decades and reinforced by our actions.
This is my assessment of events. Your opinion may differ.
in conclusion
I want to emphasize that the pandemic economy has proven unlike any other, and we still have much to learn from this extraordinary period. Our Statement on Longer-Run Goals and Monetary Policy Strategy emphasizes our commitment to reviewing our principles every five years through a comprehensive public review and making appropriate adjustments. When we begin that process later this year, we will be open to criticism and new ideas while preserving the strength of our framework. The limits of our knowledge—made apparent during the pandemic—require us to remain humble and skeptical, focused on learning lessons from the past and nimbly applying them to our current challenges.
