In a speech that wasn't entirely surprising given his recent public comments, Federal Open Market Committee Chairman Jerome Powell said the Federal Reserve needed to rethink its framework, specifically when it came to inflation and raising rates. The major implication is that the Fed isn't going to raise rates anytime soon.

Phillips Curve

Previously, the Fed had targeted 2% inflation and even started tightening in anticipation of reaching the 2% inflation target. For example, it began tightening monetary policy in 2013 and 2015 as unemployment declined. Historically, there's been a strong link between falling unemployment and rising inflation as it would lead to wage inflation which would result in inflation moving higher. However, over the last decade, inflation hasn't materialized despite the tight labor market.

This is evident when looking at all the FOMC forecasts over the past decade. They basically were too pessimistic on employment improving and their inflation forecasts were too high. Most Fed governors lived through inflation in the 70s and that experience was embedded in their heads. Taming this inflation was one of the keys to the strong economic recovery in the 80s. It's likely that future policymakers will be shaped by living through our current economic experience of exploding inequality, weak wage growth, and low inflation.

New Framework

The new Fed policy will be to target an "average inflation level". It basically means that if inflation underperformed for a certain amount of time then it would be allowed to run higher to balance this out. Risk assets have been rallying for weeks in anticipation of this policy. It also inspired Powell's recent dovish comments when he said that they wouldn't hike rates until 2022 and that he wasn't even thinking about thinking about raising rates.

This new policy was unanimously approved by the other members of the FOMC. Low unemployment is no longer a sufficient reason for the Fed to hike or even remove accommodation. If this policy was in effect over the past few years, it's likely that there never would have been tightening of money between 2013 and 2018 via the gradual removal of QE, signaling of higher rates, and then rate hikes.

It's also interesting to think about how the world would be different if this policy had been in place. Maybe there would be more inflation now with more wage growth and less unemployment. That could have impacted the 2016 Presidential Election given how close it was. It's also likely that oil never would have crashed from $100 to $25 like in 2014-15. The dollar would have also been stronger which would have positive effects on emerging markets.