By Warren Hrung
ABA DataBank
In late 2024, the Federal Reserve announced the next periodic review of its monetary policy strategy, tools, and communications would occur in 2025. These reviews are scheduled to occur roughly every five years. The 2025 review will focus on the Federal Open Market Committee’s Statement on Longer-Run Goals and Monetary Policy Strategy and communications tools, with results expected to be released in the summer or fall of 2025. The Fed was explicit that its 2-percent target for inflation would not be a focus of the review.
The economic environment
Before summarizing the main changes to the Statement stemming from the 2019-2020 review, the economic environment within which this review occurred will help provide context for the changes. Note that the Fed has a dual mandate of price stability and maximum employment.
For price stability, the Fed targets a 2-percent rate for its preferred measure of inflation: the year-over-year percent change in the Personal Consumption Expenditures price index. Figure 1 shows this measure from 2010 through June 2025. Note that in the period leading up to this review through 2018, the inflation rate was typically below 2 percent and occasionally to a substantial degree.
Figure 1. PCE inflation (year-over-year percent change) from 2010-June 2025, monthly
As for maximum employment, there is no explicit definition of what constitutes this goal. Figure 2 illustrates the U.S. unemployment rate from 2010 to June 2025. The figure shows in the period leading up to the review, the unemployment rate was on a sustained downward trend and ended 2024 at 3.9 percent, near historic lows.
Figure 2. U.S. unemployment rate from 2010-June 2025, monthly
The period leading up to the 2019-2020 review can generally be characterized by inflation being below target and a healthy labor market, arguably near or at maximum employment. And as shown in Figure 3, the FOMC began a rate-hiking cycle in late-2015 and its target range for the federal funds rate at the end of 2018 was 2.25-2.50 percent. The economic environment at the end of 2018 is summarized in the first column of Table 1.
Figure 3. The target range for the federal funds rate, 2010-June 2025, daily
Table 1. Economic conditions prior to Fed framework reviews
The 2019-2020 statement revisions
The Fed has provided a useful guide to the additions and deletions in the statement stemming from the 2019-2020 review. For inflation, the main change was that the Fed would seek “to achieve inflation that averages 2 percent over time” (emphasis added). This policy came to be known as Flexible Average Inflation Targeting, or FAIT. For clarity, the statement shares the example of inflation running below 2 percent leading to policy that would “aim to achieve inflation moderately above 2 percent for some time,” in contrast to one that would aim to just reach 2 percent. Given inflation was generally running below target in the years preceding the review (Figure 1), it is not surprising this example was given and not one where the starting point was inflation running above target.
For employment, a notable change was to focus on “shortfalls of employment from its maximum level” (emphasis added) instead of deviations from maximum employment in either direction. There was no discussion of how the Fed would react to perceived overshoots of employment beyond maximum.
Implications of the statement revisions
As shown in Figure 1, the post-pandemic period was characterized by rates of inflation that greatly exceeded those in the prior decade (the prior high for inflation was 10.7 percent in 1980) and the new framework following the 2019-2020 review arguably contained an upside inflation bias. (The degree to which the 2019-2020 framework contributed to the inflation that followed is subject to debate, see here and here.)
From the price stability mandate, after a period of below-target inflation, FAIT allows for inflation to remain above target so inflation averages to target. But in the opposite situation, after a period of above-target inflation, which was not covered in the new statement, it is debatable whether the Fed would purposely restrict monetary policy for an extended period of time for inflation to run below target. In addition, the asymmetry of focus in the employment mandate on shortfalls from maximum employment suggests the Fed would be slower to react to situations where the labor market overshoots its perceived maximum level.
As Figure 1 shows, inflation broke above 2 percent in March 2021 and Figure 3 shows the Fed did not start increasing its interest rate target until March 2022, at which time inflation was running well above 2 percent.
The second column of Table 1 summarizes the economic environment at the end of 2024, leading up to the 2025 review. Similar to 2018, the labor market was healthy as represented by the unemployment rate near historic lows at 4.1 percent. However, the unemployment rate was trending down in 2018, whereas the rate was creeping upwards in 2024. And the inflation rate has been consistently above 2 percent for many years and at the end of 2024, stood at 2.6 percent. The Fed had just initiated a rate-cutting cycle in late 2024 and the federal funds rate target range at the end of 2024 was 200 basis points higher compared to the end of 2018, which was the top for that rate-hiking cycle.
Conclusion
The Fed’s review of its monetary policy framework will be completed this summer and results should be released shortly thereafter. The last review in 2019-2020 occurred during an environment of below-target inflation and resulted in changes to the statement that arguably contained an upward inflation bias. It remains to be seen how the consistent above-target inflation in the post-pandemic period will influence any changes to the Statement from the 2025 review.
For additional research and analysis from the ABA’s Office of the Chief Economist, please see the OCE landing page on the ABA website.
