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Fed Announces Plan to Preserve Low Interest Rates Even When Inflation Picks Up

  • On Thursday, the Federal Reserve announced a new approach to inflation, allowing inflation to run above the 2 percent target before increasing interest rates
  • The move signals that interest rates on home and business loans will likely remain extremely low for several years
  • Fed also shifts stance on employment in response to higher jobless levels due to the COVID-19 pandemic

The Federal Reserve has significantly altered its approach to inflation, indicating that it will keep interest rates extremely low even if inflation exceeds the Fed’s annual target of 2 percent on average. The move indicates that borrowers will likely continue to enjoy low rates on loans for several years.

The new approach indicates that the Fed is willing to accept “moderately” higher rates of inflation “for some time” in order to preserve low rates. While home sales and the stock market have shown a strong rebound in the months following the start of the COVID-19 pandemic, unemployment has persisted and consumer confidence has dropped as many businesses watch their revenues decrease substantially.

Balancing inflation can be a tricky proposition. Economists regard moderate increases to prices and wages to be healthy, since rapid inflation carries significant risks and persistently low inflation forces the Fed to maintain baseline interest rates near zero and limits its ability to stimulate the economy during a downturn. The Fed has not hit its 2 percent target since it was implemented at the end of the Great Recession.

The Fed is also adjusting its approach to the labor market, as Fed Chairman Jerome Powell noted that low unemployment levels before the pandemic did not result in more inflationary risks. Instead, the Fed will assess deviations from the maximum employment level and consider the benefits of a strong labor market, particularly in low- or moderate-income areas.

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