Reflections on Jackson Hole 2025

The Monetary Framework Puts a Premium on Discretion as Fed Chairman Hints at Easing Policy

Last week, the Federal Reserve Bank of Kansas City's Jackson Hole Economic Policy Symposium brought guests from around the world to discuss changing demographics and their effects on nations’ economic landscapes. Among the speakers were Andrew Bailey, Governor of the Bank of England; Christine Lagarde, President of the European Central Bank; and Kazuo Ueda, Governor of the Bank of Japan.

Federal Reserve Chairman Jay Powell opened the symposium with remarks focused on two topics: potential interest rate cuts and the Federal Open Market Committee’s (FOMC’s) new policy framework.

Interest Rate Cut

First, Powell laid out the possibility of a rate cut this September. The critical sentence in his remarks was, “Nevertheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.” This is being interpreted as a statement that rates will be cut, which predictably has led to debates among economists and others over its appropriateness. Wall Street is celebrating, with stocks rising last Friday. Others are questioning the wisdom of cutting interest rates, given that inflation remains above the Fed’s 2% target and is rising, while unemployment remains low at 4.2% and the real rate fed funds rate is low at 1.5% (nominal fed funds of 4.3% minus inflation of 3%).

To ease policy when inflation remains well above the announced 2% target is a mistake, and it’s particularly unfortunate in this instance since inflation appears to be rising, while unemployment remains near historic lows. Powell’s remarks also failed to acknowledge the significant future stimulus effects of Congress’s recently passed budget. The budget will add to the nation’s debt and worsen the inflationary pressures confronting the U.S. economy.

Finally, Chairman Powell continues to insist that current monetary policy is restrictive. In saying this, he must be assuming that the real equilibrium policy interest rate, r*, is below the current real fed funds rate of 1.5%. But given the current strength of the U.S. economy and demand for capital to fund both private investment and the growing national debt, r* is likely to be closer to 1.5% than 1%. Thus, the Fed’s more prudent action would be to focus on the risk of higher inflation and avoid easing rates when the economy is strong and the policy rate may already be at equilibrium.

New Policy Framework

Second, the chairman outlined the FOMC’s new “Policy Framework,” which pretty much reestablishes its original 2012 framework. He suggested that the FOMC will again emphasize the dual mandate of maximum employment and stable prices, and it will deemphasize the Effective Lower Bound (ELB) issue, when interest rates were exceptionally low and inflation was below the FOMC’s 2% target. Powell also emphasized that the revised framework is meant to support the FOMC’s goal of keeping long-run inflation expectations anchored.

The framework reflects modest changes and a return to its earlier version. It does nothing to bind the FOMC’s actions. It provides no policy boundaries or rule to follow. Monetary policy remains fully discretionary, allowing the FOMC to conduct policy as it deems appropriate. The framework would better serve both the FOMC and the public if it provided more specific guidelines or rules to govern its actions. While the Fed should be independent from short-run political pressure, it should have rules, or at least more specific guidelines, governing its actions in the tradeoffs between inflation, maximum employment and financial stability.

Demographic Challenges

Following Powell’s comments, the conference attendees turned to the main theme of the symposium. Highly regarded economists and leaders of central banks from around the world attended to discuss demographic changes, their effects on the labor force and their implications for economic growth and monetary policy.

The challenges arising from these trends have become more apparent in the post-pandemic period and have influenced economists’ research, including the effects of demographics on monetary and fiscal policies as nations expand social support and healthcare programs. Early trends show an unsurprising decline in the growth of the labor force and a decrease in the participation rate of working-age populations. These trends will place increasing pressure on nations’ resources and budgets, raising already high debt-to-GDP levels. Such trends make productivity gains all the more important if nations are to grow economically. Ruth Porat, President and CIO of Alphabet and Google, spoke of the rapid advancements in AI as one part of the solution.

How these trends move, and what policies are implemented, will influence how nations’ wealth and debt trends evolve. Should these trends be ignored, nations will face considerable risks to their future economic growth and prosperity.