After Federal Reserve officials send a clear message about their desire for higher inflation, it's difficult to convince the world that they can do it.
Over the past decade, the Fed has struggled to bring inflation to the 2% target that it believes is compatible with a growing economy and that allows policy makers sufficient policy leeway during times of economic stress.
In a historic shift on Thursday, Chairman Jerome Powell announced that policymakers will allow inflation to rise slightly for certain periods of time, rather than the previous practice of using preventive rate hikes to control price pressures. The new practice is known as the "average inflation target".
As markets rebounded on sentiment that the approach would anchor short-term rates near zero going forward, there was also much skepticism that the Fed might achieve its goal.
"It is leading us down a dangerous path because it is clear that deflation is the prevailing trend and they cannot change that," said Christopher Whalen, investment banker and head of Whalen Investment Advisory. "They mistakenly believe that the tools they have can enable them to manipulate inflation expectations and I think they are wrong."
Inflation has been below a little below most of the period for most of the period since the Great Recession, falling closer to 1% during the Covid-19 downturn.
Long before this year's recession even hit, Fed officials had grappled with low inflation expectations, which they found problematic because they tend to be self-sufficient and create political problems. Powell's statement Thursday not only represented the chairman's sentiments, it was unanimously endorsed by the Federal Open Market Committee of Politics.
Codifying the targets took the campaign to another level and established a firm policy that will make setting interest rates part of the work of the FOMC until inflation rises and unemployment falls well below its current 10.2%.
Further action required
"To put something down in writing after a unanimous vote means something," said Peter Ireland, an economics professor at Boston College and a member of the Shadow Open Market Committee, a Fed watchdog group of economists and academics. "It means the committee agrees. Not only do you agree, it's on paper on the Fed's website. There can be no question of how to interpret this."
While the Fed's intentions may be clear, its ability to break inflation above 2% requires additional action.
The investing public will follow the upcoming FOMC meetings for more detailed action in support of inflation exposure. Among them: more specific predictions about which parameters would have to be met before the Fed would change interest rates.
According to Powell's statement, the committee will at least not set a specific unemployment target. Robert Kaplan, president of the Dallas Fed, told CNBC's Steve Liesman in an interview Thursday that he would look for inflation in the 2.25% to 2.5% range before acting, but it's unclear where that is other officials.
"If we get to next spring and it looks like we've pushed all of this into the past, at that point the Fed would likely come up with a more detailed plan for planning ahead of when asset purchases will begin and when to relax can begin, "said Ireland. "The problem right now is that there is so much uncertainty that it is very difficult to enumerate all the scenarios and how the Fed would react to each possible outcome."
However, the markets may be looking for something more immediate and the asset purchase program could play a key role.
The Fed accelerated bond buying during the pandemic, adding $ 2.4 trillion to its holdings of government bonds and mortgage-backed securities in the past five months. However, officials have stressed that the purchases are aimed more at the functioning of the market than the traditional quantitative easing used during the financial crisis to lower long-term interest rates, revitalize the property market, and create a prosperity effect through the economy.
At the July meeting, FOMC officials suggested changing the communication strategy to highlight more traditional QE goals.
Krishna Guha, head of central bank strategy for Evercore ISI, expects the Fed to commit to keeping interest rates low until inflation is at least 2% as early as September, and by the time the committee believes it is on that Significant progress has been made towards these goals. "
"We cannot over-emphasize the importance of the FOMC holding the talks and taking additional policy measures that specifically express the strategic principles set out in the new framework," Guha said in a note.
Fed officials have been criticized for exceeding their Congressional mandate by taking measures that include several credit and liquidity programs deployed by Congress under the central bank's emergency powers.
However, they have defended their measures in line with the times, with the new inflation mandate being part of ongoing efforts to bring the economy back to the strength it saw before the pandemic.
"The Fed has to do what it does," said Jack Janasiewicz, portfolio strategist at Natixis Investment Managers. "The idea of pushing its boundaries is great from a conceptual standpoint. If the Fed hadn't done what it did, we could be looking at what is not a recession but a depression."
Correction: In an earlier version, Peter Ireland's affiliation was incorrectly stated. He is on the faculty of Boston College.