The Federal Reserve is making big changes to the way it reacts to and regulates inflation. Those adjustments could drive interest rates up this fall, meaning that many buyers will soon find themselves priced out of homeownership in the current competitive U.S. housing market.
According to comments from Fed chairman Jerome Powell during a video-only annual conference hosted by the Federal Reserve Bank of Kansas City, the Fed will not longer raise benchmark rates to keep unemployment from falling too low. The Fed also will no longer necessarily adhere to previous monetary policy that involved setting hard targets for inflation, but will instead be permitted to use inflation averaging.
Average inflation targeting (AIT) is the practice of adjusting regulations in order to meet benchmarks defined by averages rather than returning inflation to a specific value. This enables the Fed to aim for above-target inflation in some scenarios and run what Peterson Institute for International Economics (PIIE) contributors David Reifschneider and David Wilcox refer to as “undesirably restrictive monetary policy” at times when inflation is already low. However, the analysts continued, pointing out that current Fed policies are not very effective either.
“The Fed’s traditional interest rate tool is no longer adequate to deal with an average recession, let alone a severe one,” they wrote in a policy brief. They suggested employing large-scale asset purchases or removing constraints around the effective lower bound on nominal interest rates.
Powell predicted that in the short-term, overnight lending rates will remain near zero. In fact, he optimistically stated they could remain low “for years” under the new model, along with low rates for home equity lines of credit (HELOCs). Historically, the Fed has raised rates when unemployment was low to avoid overheating the economy, and economists say this new move could create upward wage movement in the short term, possibly ahead of rising interest rates.
Powell reassured listeners at the conference that the Fed would not necessarily enact the new policies immediately. “We will seek to achieve inflation that averages 2 percent over time,” he explained, adding that the policy will “only come into play when the U.S. economy is recovered enough to cause prices to rise.” The Fed does not expect this to happen prior to the COVID-19 pandemic being brought under control.
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