The Fed drives a stake into its new flexible average inflation target

The twist of fate. Rest in peace flexible average inflation target. The Federal Reserve raised interest rates 0.75 percentage point on Wednesday, the biggest hike since 1994, due to rising prices. This may not end inflation, but it will end the efforts of President Jay Powell, who has been emphasizing inclusive employment for two years.

In the end, rising prices forced Powell’s hand. In May, the Fed chief had said he favored a steady 0.5 percentage point rate hike to contain inflation. But then data from the Labor Department showed an 8.6% year-over-year rise in consumer prices, the biggest increase since 1981. And the median expectation of Americans for inflation in May 2023 has risen, according to a survey of the New York Federal Reserve released Monday.

That has made the Fed’s new framework, whose acronym is FAIT (Flexible Average Inflation Targeting), unsustainable. Already in 2020, Powell said that, after years of inflation below the 2% target set by the central bank, it would move to a new flexible approach. Rates would be allowed to stay near zero, even if inflation ran above 2% for a while, to make sure the economy was creating enough jobs for groups like black workers, who are often the last to benefit from economic expansions and which were not considered separately in the old ways of setting rates.

Raising rates aggressively risks leaving those workers in the lurch. The unemployment rate for black Americans in May was 6.2%, compared to the general level of 3.6% and 3.2% for white workers. And now the Fed projects that the rate of unemployment will increase in the coming years. Delinquency expectations, meanwhile, rose from April to May for those with a high school education or less, according to the New York Fed survey. It will be up to politicians, not central bankers, to decide how best to help the laggards.

There may still be room for Powell to innovate, for example by revising the 2% inflation target. The Fed fell short of it for years, but the pandemic, trade wars and Russia’s invasion of Ukraine may have permanently altered supply chains and spending patterns. The central bank’s June median projection for inflation this year is higher than in March, at 5.2%. Even so, it will be better to leave new ideas for when prices have found their level.