How does the Fed measure inflation

The US Federal Reserve will accept higher inflation rates in the future. With their historic decision, the monetary authorities are creating the necessary leeway to keep key interest rates at the current low level of close to zero percent for the time being. "The decision reflects the lessons learned from the past few years, when the inflation rate did not rise as expected, although the unemployment rate fell sharply," said Fed President Jerome Powell on Thursday in his opening speech at this year's Jackson Hole Fed Symposium, which will be held in takes place virtually on the Internet this year due to the corona pandemic.

The Fed's change of strategy ends a long monetary policy tradition that all major central banks have taken up the cause of. Combating inflation has been the focus since the 1980s. As a result, the monetary authorities set themselves the goal of allowing a maximum of two percent inflation. That was a reasonable mark at a time when annual inflation rates were eight, ten or more percent. As soon as prices approached the two percent mark dangerously, the central banks raised the key interest rate. In this way they achieved price stability for over 20 years. But in the years after the outbreak of the global financial crisis, the world was turned inside out: inflation rates fell well below two percent, although the economy was booming. Since then, the central banks have missed their target, which saps their credibility.

The Fed is therefore giving itself more flexibility for the future. In the future, one would like to achieve an average inflation rate of two percent - the mark therefore no longer represents an upper limit. The following thought game shows what that could mean: If the Fed does not achieve its inflation target of two percent for ten years, then it can also achieve inflation rates of ten years Accept more than two percent without tightening the reins of monetary policy. "We're not tied to any mathematical formula in defining average inflation," Powell said. They want to handle it "flexibly".

Savers could suffer even more in the future than they do today

The Fed's decision suggests that key rates could stay at zero percent for a long time to come, even if inflation rates rise sharply. The central bank is consciously allowing money to lose purchasing power. In this case, savers are likely to suffer even more than they do today. As in previous years, the profiteers would be the shareholders and property owners. After Powell's speech, the stock markets in the United States rose to new record prices.

The Federal Reserve, like the other central banks in the industrialized nations, is faced with a dilemma: They justified their loose monetary policy of the past decade by hitting an inflation rate of two percent, which they failed to do. At the same time, they know that if prices should rise sharply at some point, they should actually turn off the money.

But such a turnaround in monetary policy would have serious consequences: the USA, the EU states and Japan need low key interest rates to finance their budget deficits. Higher interest rates on government debt could bring some countries to their knees. Even companies that have been refinancing themselves at record low cost on the stock exchanges for years would get into a mess, not to mention the upheavals in the financial markets that could be expected after a turnaround in interest rates. The Fed has now reacted to this - the debate on a new strategy has also begun at the ECB.