The long period of low inflation before COVID-19 taught the Federal Reserve not to fear low unemployment. But the shock of the pandemic reminded policymakers how painful high inflation could be.
As they
The central bank last reworked its so-called framework in 2020. In that review, officials effectively curbed a decades-long practice of raising interest rates to preempt the build-up of price pressures when unemployment was deemed too low. The move seemed sensible after years when falling unemployment failed to produce any meaningful inflation.
Yet, some inside and outside the institution have since criticized that decision as having made policymakers too slow to react in 2021 and 2022, when government policy to manage the pandemic triggered the worst outburst of inflation in four decades.
In the current review, which began early this year, Fed Chair Jerome Powell and his colleagues are seeking to address those criticisms while avoiding a complete return to the pre-2020 status quo. One way to do that, according to a former policymaker, would be to move toward a leaner framework that can apply to a range of circumstances.
"I think there is room for them to respond in a way that continues to support strong labor markets if the judgment is that inflation is not really a concern," said Charles Evans, president of the Chicago Fed from 2007 to 2023.
From 'deviations' to 'shortfalls'
Fed officials have discussed the framework at each of their last three policy meetings and are set to conclude the review this summer — even as they grapple with Trump administration policies that threaten to boost both unemployment and inflation simultaneously.
They next meet June 17-18 and are expected
A recurring theme in those discussions has been the fate of the word "shortfalls." Officials inserted the word in 2020 to signal their focus on addressing episodes of labor market weakness. Before the change, the central bank's strategy was to respond to "deviations" from its target for employment — either above or below what they estimated to be the maximum sustainable level that wouldn't stoke inflation.
Changing "deviations" to "shortfalls" implied they could maintain low rates even in the face of an unusually strong labor market and not respond with higher rates until inflation actually appeared. In other words, it reined in the practice of preemptive tightening.
At a conference in May, Powell defended the use of the term "shortfalls," while acknowledging it would likely be on the chopping block.
"The change to shortfalls was not a commitment to permanently forswear preemption or to ignore labor market tightness," he said. "Rather, it signaled that apparent labor market tightness would not, in isolation, be enough to trigger a policy response."
Great benefits
Coming after a decade of sluggish growth, the 2020 framework shift was heralded by labor advocacy groups. They pointed to the great benefits already delivered to wide swaths of marginalized workers as the Fed forestalled rate hikes. Unemployment fell to historically low levels without any pickup in inflation.
Under Powell's leadership, the Fed was determined to incorporate those lessons by pledging not to choke off future labor-market expansions — so long as price pressures remained in check — allowing gains to reach those who are typically the last to benefit. That included Black and Hispanic workers, people with disabilities and those in rural areas.
In the 40 years through 2013, the Black unemployment rate in the U.S. exceeded that for Whites by an average of 6.7 percentage points, according to data from the
Mindful of that progress, the Fed also clarified that its employment mandate was a "broad-based and inclusive goal."
But shortly after the revamp, the new framework was rendered almost meaningless by government spending and business closures during the pandemic and the inflation those actions unleashed. After initially believing the episode would quickly dissipate on its own, Fed officials changed course and, in 2022, aggressively raised interest rates to quell demand.
Loretta Mester, president of the Cleveland Fed from 2014 to 2024, said the "shortfalls" language created a perception that the Fed was more concerned about periods when unemployment was too high, and policymakers could rectify that by going back to the "deviations" language. Officials should convey that they will "be reacting to employment to the extent it tells us something about where inflation is going," Mester said.
In April, William Dudley, president of the New York Fed from 2009 to 2018, also recommended scrapping the "shortfalls" approach, as well as the "broad-based and inclusive" language.
The criticism is clearly having an impact at the Fed. In Powell's May speech, he acknowledged that some of his colleagues felt it was appropriate to "reconsider the language around shortfalls."
'Too ruthless'
But records of the Fed committee's discussions this year show they're still grappling with how to best thread the needle between lessons learned before the pandemic and takeaways from the experience thereafter. Minutes of their March gathering showed officials are aware of how difficult it is to "assess maximum employment," noting their twin mandates "are not necessarily in conflict when both unemployment and inflation are low."
That's a strong hint that while policymakers may dump the word "shortfalls," they're not all keen to return to the days of preemptive rate hikes if there's no clear threat of inflation.
Atlanta Fed President Raphael Bostic, speaking to reporters in May, suggested he still wanted to preserve the spirit of the 2020 shift.
"I am uncomfortable about being too ruthless in terms of preempting without signs that there's risk to the other side of the mandate," Bostic said. "I think I will have that view regardless of how the language in the framework changes."
