Understanding the Fed’s New Inflation Goals
Understanding the Fed’s New Inflation Goals
By: Stacey Nickens
In August, the Federal Reserve announced that they may allow inflation to rise slightly above its 2% target to compensate for years with depressed inflation rates. This move is a shift from the Fed’s inflation targeting practices, where the Fed would reduce stimulus or increase interest rates in order to depress inflation rates.
The Fed’s shift in inflation targeting may signal that they believe the relationship between unemployment and inflation has changed. Traditionally, a concept called the Phillips curve said inflation would rise as unemployment fell. However, after the 2008 financial crisis, inflation did not rise significantly. In fact, inflation did not rise significantly even after government stimulus and lower unemployment rates.
Federal Reserve Chairman Jerome Powell seemed to confirm that the Fed believed that the United States’s economic picture had changed. He said they’re making this inflation rate goal change to account for the “reality of a quite difficult macroeconomic context of low interest rates, low inflation, relatively low productivity, slow growth and those kinds of things… We’ve really got to work to find every scrap of leverage in helping stabilize the economy.”
In other words, the Fed is attempting to counteract a concerning possibility whereby central banks experience both low interest and low inflation rates and thus have few tools to manage economic downturns. Allowing inflation rates to rise would assist the Fed in being able to respond to unexpected financial crisis.
This possible shift in inflation targeting comes alongside the Fed’s year-long policy review. We will likely hear more news about this policy review after the Fed’s September 15-16 meeting. Overall, the Fed has already stated that they want to build a strong labor market and said raising interest rates would be informed by attempts to avoid employment shortfalls. Moving forward, the Fed will likely provide more clarity around what circumstances would prompt them to raise interest rates.
All of this said, what could this new inflation goal mean for individual investors?
For those still working and earning a paycheck, you probably don’t have significant reason to be concerned. Most paychecks experience cost-of-living increases, and as a long as earners are not withdrawing from their portfolio, a moderate increase in inflation would likely not significantly impact your financial situation. Similarly, I wouldn’t be too concerned about the outlook for investors 10 or more years from retirement with a majority of their portfolio in stocks. I say this because stocks have historically outearned inflation.
If you’re retired, you have some other factors to consider. Those who receive Social Security benefits do typically receive slightly more income to adjust for inflation. This means that a portion of your income stream is adjusted for inflation. However, your portfolio withdrawals are not automatically adjusted for inflation. Knowing this, I would consider ensuring you’ve included a bit of insulation against inflation in your portfolio. This may mean increasing your exposure to equities, which might allow your portfolio growth to outpace inflation. Those who prefer fixed income positions might look at Treasury Inflation-Protected Securities. As you watch the Fed’s moves around interest rates, keep in mind that when interest rates rise, the value of existing bonds often fall.
However, as the Fed has signaled, some traditional economic trends have shifted. Beyond that, each individual has a unique financial situation and portfolio. With this in mind, I encourage you to contact ELM3 to discuss your specific portfolio and financial needs.
