The Fed will be very cautious about policy tightening

Significance

The Fed targets an average annual inflation rate of 2% but, under its 2020 monetary policy framework, will tolerate a moderate overshoot to make up for past low inflation. The Fed has been willing to let the economy 'run hot' to sustain the post-pandemic recovery.

Impacts

• Inflation pressures and expectations will be only one guide to Fed policy; the path of the public health crisis will weigh more.
• As policy is now anchored on inflation expectations, miscommunicating its next move would hurt the Fed more than the 2013 'taper tantrum'.
• Structural economic transformation is making CPI less sensitive to resource slack, complicating the assessment of inflationary pressures.
• If high inflation takes hold, the necessary high interest rates will strain the government's ability to service its record deficits.