How Fed Is Planning To Achieve 2% Inflation Target? 2023

The Federal Reserve is committed to maintaining price stability & returning inflation to its long-term goal of 2%. To achieve this goal, the Fed is tightening monetary policy to reduce inflation. This article will analyze the most recent FOMC’s statement & Explore how Fed is planning to achieve 2% inflation target

How Fed is Planning to Achieve 2% Inflation Target?

Effective from 1^st February, 2023, the Federal Reserve raised the interest rate paid on reserve balances to 4.65 per cent. It has to be noted that the US has inflation targeting of 2 per cent. 

Federal Open Market Committee (FOMC) on 1^st February, 2023, in their statement that “In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4 3/4 per cent.” 

The Fed Chair Powell Stated that “We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time”

Effective from 2^nd February, 2023, the Board of Governors of the Federal Reserve System unanimously voted for a ¼ % increase in the primary credit to 4.75%. 

It is important to know that on 31^st January, 2023, the FOMC reaffirmed in the “Statement on Longer-Run Goals and Monetary Policy Strategy” that inflation at the rate of 2 percent is most consistent over the long run with the Federal Reserve’s statutory mandate. 

Now, it is clearer that the FOMC is always committed to return inflation to its objective of 2 percent.

Summary from Federal Chair Powell’s Press Conference

The Federal Reserve Chair Powell in his press conference speech stated that “Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone” 

He stated that the continuing raise in interest rate is to attain the stance of monetary policy – that is to return inflation to 2% over time. Significantly reducing the size of Fed’s balance sheet is also an additional priority for Fed at the moment. Maintaining restrictive stance is required in order to restore price stability. 

Economy

The Real GDP is rising at a below-trend pace of 1% as the U.S. economy has slowed dramatically last year. There is a modest growth of spending and production this quarter, according to recent indicators. Due to tighter financial conditions over the past year, consumer spending seems to be growing at a subdued pace. The prevalent higher mortgage rates weakens the activity in the housing sector. The Business fixed investment also is affected due to slower output growth and higher interest rates. 

Job Market

The Labor maker remains tremendously tight due to slowdown in growth. U.S. is witnessing an unemployment rate of 50-year low; where job vacancies are still high and wage growth raised. Job gains are stronger with employment rising by an average of 247,000 jobs per month for the past 3 months. The labour market continues to be out of balance, despite the speed of job gains has slowed during the past year and nominal wage growth has shown some sign of easing. The supply of available workers was substantially low to the labour demand. In other words, the labour demand is considerably higher than labour supply. The Labor force participation rate is marginally changed compared to last year. 

Inflation

Inflation are still higher than the Fed’s long-run goal of 2%. The Total PCE prices over the past 12 months (ending in December), has increased 5%; whereas the core PCE (excluding food and energy prices) has increased 4.4%. Though, recent data shows a decline in the monthly pace of increases FOMC requires substantial evidence that inflation is on a continued descending path. Though inflation has moderated recently, it is still too high. If the present high inflation continues longer then the expectation of higher inflation expectation may become engrained.

Our Perspective

The Fed’s hike of interest rate is highest in 15 years (highest level since late 2007). The Fed is rapidly raising the interest rates since March 2022, to tame inflation. When there are high interest rates then it will slow the economy – making borrowing costlier for both businesses as well as consumers/individuals. There are many policymakers who are worrying that too high interest rates may lead the economy into recession. 

Many investors as well as individuals may question when the interest rate hike will stop? Many analysts say the Fed may stop the hike at a range of 5%, which means one more hike this year and then the Fed will cut interest rates this year when the economy enters a mild recession.  For those who are having this expectation – Fed Chair Powell had already poured the water on their expectations. 

In this press conference he stated that though the process of disinflation has started, Inflation is still 40 years high and the job is not fully done. This means until inflation comes to the Fed’s target of 2%, it’s going to tighten its (or) follow restrictive policies. Fed Chair Powell expects subdued GDP growth this year and very much particular about inflation coming down to the Fed’s target (of 2%). 

The Fed has already signalled (a couple of times at least) that it is not going to ease the pace of monetary tightening till the inflation falls to the inflation target of 2%.  

It is still too early to state how this policy change will impact the economy and will the U.S. enter recession. But, from Fed Chair Powell’s press conference it is clear that he wanted to bring inflation down to 2% target despite subdued growth rate. 

Conclusion

The Fed is continuing to raise interest rates and reduce the size of its balance sheet in order to bring inflation down to its target of 2%. However, the U.S. economy is currently experiencing a slowdown & the labor market is still tight, which may pose a challenge for the Fed in achieving this goal. Nevertheless, the Fed is dedicated to maintaining price stability and returning inflation to its long-term target of 2%.

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