WASHINGTON - The $1.9 trillion fiscal stimulus bill has cleared the Senate, bringing it one step closer to final approval. Widely expected to fuel inflation expectations, the bill has intensified market concerns about the Federal Reserve's ability to manage rising price pressures. As long-term Treasury yields continue to climb, Fed Chair Jerome Powell's repeated insistence on maintaining a "wait-and-see" stance has drawn criticism, with some interpreting it as an implicit admission of the central bank's helplessness against inflation.
However, such interpretations may stem from unfamiliarity with the Fed's revised policy framework. To understand Powell's stance, one must revisit his pivotal August 2020 speech announcing changes to the monetary policy approach, where he fundamentally redefined the Fed's dual mandate of maximum employment and price stability.
Maximum Employment: From "Deviations" to "Shortfalls"
The new framework evaluates labor market conditions by measuring "shortfalls" from maximum employment rather than "deviations" - a subtle but consequential shift.
Under the old framework, "deviations" could indicate either employment above or below the maximum level, triggering corresponding policy responses. The new "shortfalls" terminology exclusively references employment below target, implying:
1. The Fed now believes employment can exceed estimates of maximum levels without necessarily sparking inflation (which would contradict its price stability mandate).
2. Even with strong labor market performance, the Fed may refrain from rate hikes absent clear inflationary pressures.
Inflation Targeting: Tolerance for Overshooting
Facing persistently low inflation and declining neutral interest rates that limit crisis-response capacity, the Fed replaced its fixed 2% inflation target with flexible average inflation targeting (FAIT). While maintaining 2% as the long-run goal, the framework now permits temporary overshooting to compensate for past undershooting.
For example, following a year of 1% inflation, the Fed could tolerate 3% inflation the next year to achieve a two-year average of 2%. This means even inflation above 2% won't automatically trigger tightening, with the tolerance duration depending on the overshoot magnitude.
Essentially, the new framework is inherently more dovish - allowing both employment and inflation to exceed traditional thresholds before responding. Even formerly hawkish policymakers would adopt more accommodative stances under this paradigm. The key variable isn't Powell's personal inclination, but the structural constraints of the new framework.
Current Economic Conditions: Dual Mandate Challenges
Where does the U.S. economy stand relative to these benchmarks?
Employment remains far below pre-pandemic levels, with January 2021's true unemployment rate near 10% (Powell considers the official 6.3% figure understated) versus 3.5% in February 2020. Meanwhile, January's 1.4% inflation rate sits below target, especially given prolonged undershooting since 2012 that briefly approached 0% in 2015.
This context explains Powell's patience: altering policy when neither employment nor inflation meets the framework's adjusted thresholds would undermine its credibility - rendering its entire purpose moot.
The Credibility Imperative
The 2% inflation target regime wasn't divinely ordained, but painstakingly established by former chairs Volcker and Greenspan since the 1980s. Volcker famously raised rates to 20% to cement anti-inflation credibility, despite severe economic pain. Regardless of the new framework's merits, its implementation inevitably creates transitional turbulence.
Recent market volatility largely reflects investors adjusting to this unfamiliar paradigm, requiring reassessment of Fed intentions and personal expectations.
The Inequality Conundrum
Ironically, while inclusive growth represents bipartisan political orthodoxy, massive fiscal stimulus may exacerbate wealth inequality - yet monetary tightening could disproportionately harm vulnerable populations. This Catch-22 lies beyond any central banker's capacity to resolve.
Powell's Paradox: Dovish Framework, Hawkish Commitment
Under the new framework, Powell would only consider tightening under two conditions:
1. An exceptionally tight labor market with unemployment nearing pre-pandemic lows
2. Materialized inflation either significantly exceeding 2% short-term or persistently above target medium-term
Absent these, his dovish stance reflects institutional constraints rather than personal preference. Paradoxically, while policy-wise he's an extreme dove, his rigid adherence to framework credibility exhibits hawkish discipline.
This analysis assumes Powell operates as an idealistic technocrat rather than a political actor. The alternative narrative suggests he recognizes inflation risks but fears triggering a market crash, choosing willful blindness to avoid blame. Should surging yields threaten equities, he might abandon framework credibility to placate markets.
The Fed faces unprecedented challenges balancing inflation control, employment growth and financial stability. Markets will closely monitor whether Powell's team can successfully navigate these crosscurrents.