Suddenly! Federal Reserve, significant changes! Has Powell given up his 2% inflation target? ——What does Powell's speech mean? (in-depth interpretation) I just made a speech at the second Thomas Laubach seminar, which sparked widespread market discussion. Many people believe that we should abandon the 2% inflation target? We will answer four questions about this statement from the perspective of inflation. 1. Can you summarize the meaning of this speech in one sentence? Answer: The Federal Reserve may return to the monetary policy framework before 2019 in dealing with inflation issues, shifting from "focusing on whether the average inflation target (AIT) in the past period has reached 2%" to "only focusing on whether the current inflation target (IT) has reached 2%". 2. Can you explain the cause and effect in detail? During the more than 10 years between the 2008 Global Financial Crisis (GFC) and the 2020 pandemic, the world fell into the "three lows" era of low growth, low inflation, and low interest rates. Policy interest rates in developed economies were generally around 0%, which is known as the zero lower bound (ZLB). ZLB has brought great troubles to the central bank, because once the economy declines again in the future, the central bank has no way to lower it, resulting in an economic recession - a decrease in inflation expectations - but the nominal policy interest rate cannot be lowered due to ZLB - the real interest rate (nominal interest rate minus inflation expectations) instead rises - the economic recession deepens. This is called a 'deflation spiral'. The most important thing to break this cycle is how to avoid a "decline in inflation expectations" for resident enterprises in the ZLB environment. The traditional central bank's inflation target (IT) only focuses on current and future inflation, and does not care about past inflation. In the ZLB environment, the result of IT is that monetary policy is powerless in cases where inflation is below 2%, but once inflation exceeds 2%, it will quickly raise interest rates, making the downside risk of inflation higher than the upside risk. As a result, inflation expectations are systematically below 2%, exacerbating the possibility of a deflationary spiral. How to solve this problem? Central bank scholars have proposed a new framework: the Average Inflation Targeting (AIT) or the Flexible Average Inflation Targeting (FAIT, a variant of AIT) implemented by the Federal Reserve. Its meaning is that when inflation remains below the 2% target for a period of time, even if inflation rises above 2%, the central bank should not immediately raise interest rates, but should allow inflation to moderately overshoot for a certain period of time. In other words, the central bank has shifted from "only focusing on current inflation vs. target" to "focusing on average inflation vs. target over the past period of time". The advantage of doing so is that in the ZLB environment, when inflation is below 2%, as businesses and residents expect the central bank to tolerate inflation above 2% for a longer period of time in the future, inflation expectations may not necessarily decrease. The new framework adopted in 2019 was originally designed to address the issue of low inflation during the "three lows" era. Unexpectedly, fate played tricks on people. After the epidemic, the massive rescue policy led the United States and Europe back to the era of high interest rates, high growth, and high inflation. The problem suddenly turned into high inflation. In such an environment, AIT has become very outdated and even caused many misunderstandings. The first misunderstanding is whether the Fed's late rate hike in 2022 was intentional, and whether it came from AIT's "allowing moderate inflation overshoot" policy? Powell has repeatedly expressed his denial of the answer, and emphasized in this meeting that the inflation in 2021 was "neither intentional nor moderate", but completely exceeded expectations. The second misunderstanding is that if we continue to operate according to the AIT framework, since inflation has been consistently above 2% since 2021, the Federal Reserve should keep inflation below 2% for the next 3-4 years to ensure that "average inflation=2%". This means stronger tightening expectations. But Powell also stated in this meeting that the post pandemic Federal Reserve has already returned to the traditional IT framework in a factual sense, and AIT has become irrelevant in our policy discussions. In summary, Powell's main implication this time is to abandon the average inflation system and return to the traditional and more flexible inflation target system in the new round of monetary policy framework revisions to be announced in mid-2025. 3. Why does the short-term US bond interest rate drop rapidly after speaking? Because if the average inflation target system is abandoned, inflation above 2% in the past few years will not necessarily mean that the Federal Reserve needs to push inflation below 2% in the future, which marginally implies a relatively looser monetary policy. 4. Has the Federal Reserve abandoned its 2% inflation target? Answer: No. In his speech just now, Powell made it clear that 'we still fully committed to the 2 percent target today.'. However, after the revision is completed, the calculation method for 2% will change, no longer focusing on historical averages, but only on the present. At the end of the sentence: Even the Federal Reserve reminds everyone not to look back, to look forward, to focus on the present, especially for trading! What reason do we have to live a bad life!