United States: Re-evaluating the Financial Policy Framework and Addressing the Looseness

■ The Federal Reserve (FRB) has significantly revised its Statement on Longer-Run Goals and Financial Policy Strategy following a five-year review of its framework.  

■ The bias toward financial easing has been adjusted, and a reassessment of the neutral interest rate is underway as the economy undergoes structural changes.  

 
    On August 22, the Federal Reserve Board (FRB) announced updates to its Statement on Longer-Run Goals and Financial Policy Strategy, which has been revised annually since 2012. This is the first major update since 2020. In a speech delivered the same day, Fed Chairman Powell also provided additional context and rationale for the framework review. 

 
    The main revisions compared to the previous statement include the addition of the phrase "maximum employment and price stability under a wide range of economic conditions" to the financial policy strategy; and the removal of references to the downside risks to maximum employment and price stability, as well as to a lower neutral interest rate. Specifically, the term "shortfall" previously used in the statement on maximum employment has been entirely eliminated. The relationship between the two major responsibilities of financial policy—maximizing employment and maintaining price stability—has been reorganized and redefined as "the highest level of employment that can be sustained within the context of price stability." With these revisions, the bias toward financial easing was removed; the "Flexible Average Inflation Targeting (FAIT)" introduced in August 2020 after the 2019 and 2020 framework reviews, which had become ineffective, was also officially withdrawn. 

 
    In the latter part of his speech on the 22nd, Chairman Powell^1 highlighted four main reasons for the revision of the "Statement on Longer-Run Goals and Financial Policy Strategy": (1) concerns about constraints on financial policy caused by the effective lower bound (ELB) of nominal interest rates have eased; (2) the need to deliberately allow inflation to overshoot under FAIT has diminished; (3) absent inflationary pressures, there is no need to assess whether to tighten monetary policy based on the real-time estimate of the natural unemployment rate; and (4) it clarifies the response when the objectives of maximizing employment and maintaining price stability are not aligned. When FAIT was adopted in 2012 and introduced following the first "framework review" in 2020, priorities included low growth, low inflation, and responding to the ELB. However, economic conditions have changed significantly over the past five years, prompting the Fed to adjust its approach. While the speech did not specify a particular level, it noted that factors such as productivity, demographic dynamics, and fiscal policy have shifted the balance between savings and investment, and the neutral interest rate may have increased compared to the 2010s. Although this will not directly influence near-term monetary policy, the medium-term target for future rate cuts (the terminal rate) may be reassessed under the new framework. The longer-term outlook expressed by members at upcoming Federal Open Market Committee (FOMC) meetings is also anticipated to become a new focus of policy.