The Fed Just Reviewed Its Strategy. What History Says Happens Next.

Federal Reserve Chair Jerome Powell unveiled the results of the Fed’s second formal strategy review on Friday. (Andrew Harnik/Getty Images)

It often feels like the Federal Reserve is always fighting the last war. But history suggests it’s also more than capable of learning from past mistakes.

Buried in Chair Jerome Powell’s speech in Jackson Hole, Wyoming on Friday were the results of the U.S. central bank’s second formal review of its monetary policy strategy, something it’s committed to doing every five years. The long shadow hanging over this report is what happened after the 2020 one.

Back then, Powell declared that, after a decade of undershooting its inflation target, the Fed would be willing to let inflation run hotter than target for a while until the long-run inflation rate returned to the desired 2% level.

We all remember what happened next. Surging demand, supply-chain bottlenecks, and spiking energy prices as the economy emerged from the Covid-19 pandemic led to a massive wave of price increases. Powell and others assured Americans the inflation was transitory and waited to start raising interest rates. Inflation rates kept climbing, peaking in June 2022 at 9%, the highest since 1981.

The 2020 strategy policy review is largely seen as having contributed to the Fed’s complacency. And the gist of this year’s review is that trying to make up for too-low inflation in the past won’t be a part of the Fed’s strategy in the future. In other words, forget most of what we said five years ago, the world is different now.

At the same time, it’s worth remembering that previous, less formal shifts in strategy in the Fed’s 112-year history haven’t always backfired so spectacularly.

To start at the beginning, the Fed was created by Congress in 1913 with a mandate to promote maximum employment, stable prices, and moderate long-term interest rates. The institution’s overarching goals haven’t changed since, but the means of achieving them—which is largely left up to the Fed to decide on, rather than Congress—has changed a lot.

The Fed shifted to inflation targeting when it became the vogue in the mid-1990s, though it didn’t make it official until January 2012. That was the first time it explicitly said that it would try to keep the annual rate of consumer prices at 2%. Even though that had been the unofficial policy since Alan Greenspan was chair of the central bank, it still took more than a decade to agree on how to communicate that aim to the public.

That was because targeting a specific inflation rate wasn’t uncontroversial. Officials could have given themselves a range to allow more wiggle room. And the focus on inflation rates of consumer prices may have been partly to blame for the 2008-09 financial crisis, because it allowed the Fed to play down the bubble in asset prices that ultimately led to the housing crash that sparked the crisis.

But on perhaps the most important measure, inflation targeting has been a huge success. Expectations of future inflation have been remarkably consistent around that 2% goal, both in market measures such as the 5-year forward inflation expectation rate and in surveys of consumers. Even when inflation was surging after the pandemic, most people agreed the Fed would eventually get it under control.

Before the financial crisis, the Fed’s biggest failures were around the great inflation and economic stagnation of the 1970s. Chair Paul Volker experimented with money-supply targeting, which ultimately didn’t work. But he did succeed in bringing inflation back down to around 3% in 1983 from more than 14% in 1980.

Powell’s latest policy review is just another example of the Fed trying to learn the lessons of past mistakes. Even if the 2020 review led to trouble—and even if President Donald Trump’s administration is putting the most political pressure on the Fed in living memory—the market still expects the U.S. central bank to get the job done.

Write to Brian Swint at brian.swint@barrons.com