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The Fed May Run Into a Phillips Curve Problem Once Again

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Should Traders Be Paying Attention to the Taper Conversation?

We’re soon coming up on the one-year anniversary of the Federal Reserve’s new Flexible Average Inflation Targeting framework, which was unveiled at the Jackson Hole conference last August.

The broad way to think about the new approach is that it’s designed to avoid certain past policy mistakes, such as prematurely hiking rates long before the labor market had fully healed. The idea now is that instead of heavily relying on models that say things like “If employment falls to X%, then inflation will rise to Y%,” the Fed actually wants to see some of that inflationary rise, and it’s willing to tolerate some overshoot of its target to actually let that play out.

In the wake of the Global Financial Crisis, the first rate hike came in 2015, when the unemployment rate was still 5%. Prior to the pandemic, it got as low as 3.6%, without significant inflationary pressure. And, in theory, it could have gotten lower.