The 3 must-know elements of the FOMC’s “Framework Statement”

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The three main elements of the “Framework Statement”

Narayana Kocherlakota, the Minneapolis Fed president, explains the three main elements of the FOMC’s “Framework Statement.”

3 elements

1. Set the long-run inflation goal at 2%

The statement explicitly translates the words “price stability” into a longer-run goal of a 2% annual inflation rate. Here, the term “inflation rate” refers specifically to the personal consumption expenditures (or PCE) inflation rate. This measures the rate of increase in the prices of all goods and services, including those related to food and energy.

2. Challenges in fixing an employment goal

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Kocherlakota points out that the framework rightly emphasizes that monetary policy isn’t a prime determinant of maximum employment, even in the long run. Instead the policy’s stance is based on an ever-evolving assessment of the maximum level of employment that’s consistent with 2% inflation. For Kocherlakota, this level is currently 5%.

3. How the two goals weigh against each other

The framework statement describes how the FOMC weighs the two mandates—promoting maximum employment and promoting price stability—against one another. Importantly, it stresses that the two mandates are typically complementary, as monetary policy pushes employment and inflation in the same direction.

The statement does explain that, in cases when the mandates aren’t complementary, the FOMC will use a balanced approach to the two mandates when formulating monetary policy. This implies that the FOMC is willing to allow inflation to run above 2% for some time to facilitate a faster decline in the unemployment rate.

A declining unemployment rate with controlled inflation levels helps boost household income, in turn boosting spending. Popular exchange-traded funds such as the SPDR Consumer Discretionary Select Sector ETF (XLY) and the SPDR S&P Retail ETF (XRT) track companies such as Amazon (AMZN), Home Depot (HD), and JC Penney (JCP) in the consumer discretionary sector. They gain when consumer spending increases.

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