Analysts suggest that future monetary policy frameworks may improve the measurement methods for full employment objectives by monitoring real-time employment and unemployment data to assess cyclical pressures in the labor market. Adjustments to asymmetric average inflation targeting and enhanced policy communication are also likely.
The second Thomas Laubach Research Conference, held on May 15-16, 2025, is a high-level academic and economic policy symposium hosted by the Federal Reserve. It aims to explore critical issues such as monetary policy, macroeconomics, and financial stability. This year’s conference focused on potential revisions to the Federal Reserve’s policy framework, with numerous scholars and former Fed officials proposing improvements to the 2020 monetary policy framework. These discussions provide insights into possible directions for future revisions. In his opening remarks, Federal Reserve Chair Jerome Powell stated that the Fed is adjusting its overall policy framework to address structural changes in inflation and interest rate prospects following the 2020 pandemic. “The U.S. may be entering a period of more frequent and prolonged supply shocks, posing significant challenges for both the economy and central banks,” Powell noted. He added that the policy review is expected to be completed and results published by August or September, with no immediate changes to the current interest rate decision-making process. This article reviews the background and key changes of the 2020 Federal Reserve policy framework revision and summarizes the lessons learned and improvement suggestions proposed by experts at the second Thomas Laubach Research Conference. **Revisions to the 2020 Monetary Policy Framework** 1. **Policy Challenges in a ‘Low Interest Rate, Low Inflation’ Environment** From early 2019 to August 2020, the Federal Reserve conducted its first public review of the 2012 monetary policy framework document, *Statement on Longer-Run Goals and Monetary Policy Strategy* [1], announcing that such reviews would occur every five years thereafter. The review covered the Fed’s policy strategy, tools, and communication practices. The motivation for reassessing the monetary policy framework stemmed from profound economic changes and policy challenges in the decade following the financial crisis. During this period, the Fed and other major central banks faced a new normal of low interest rates, low growth, low inflation, and an extremely flat Phillips curve. The most notable features were policy rates persistently near the lower bound and inflation consistently below the 2% target [2]. In this context, monetary authorities confronted three main challenges: – Constraints on policy space due to the zero lower bound on interest rates; – Prolonged below-target inflation, undermining the credibility and effectiveness of inflation targeting; – A flattened Phillips curve complicating the dual mandate of managing inflation and employment. A flatter Phillips curve means inflation alone is insufficient to gauge economic overheating [3], and the transmission mechanism for stabilizing inflation through employment weakens. Inflation becomes more influenced by expectations than demand or supply shocks, making anchored inflation expectations increasingly critical.Based on the aforementioned challenges and past lessons, on August 27, 2020, the FOMC released a revised monetary policy statement [4], making significant strategic adjustments to the policy framework adopted in 2012. The focus was on addressing downside risks related to the effective lower bound (ELB, the lowest interest rate level a central bank can set) of nominal interest rates.
Table 1: Changes in the Federal Reserve’s Monetary Policy Framework After the 2020 Revision According to the document and interpretations by Federal Reserve officials and economists, the main changes in the framework include: (1) Inflation Target: While maintaining the long-term inflation target of 2%, the operational target shifted from a flexible, symmetric inflation targeting regime to a flexible, asymmetric average inflation targeting regime. This means that after periods of inflation below 2%, inflation is allowed to moderately exceed 2% for some time. Theoretically, if the new mechanism is credible, the asymmetric preference for inflation would make the central bank more focused on addressing low inflation, thereby increasing the average inflation rate. (2) Employment Target: First, the new statement defines the full employment goal as a “broad and inclusive objective” and acknowledges that there is no widely accepted measure for this target. Second, policy decisions in the new statement will be based on “shortfalls” rather than “deviations” in employment relative to the estimated full employment level. This implies that policies will more frequently consider situations where the unemployment rate is above the estimated normal level but not necessarily when it is below. In other words, in the absence of inflationary pressures or financial stability risks, the Federal Reserve will avoid preemptive tightening, allowing the economy to remain overheated for longer. Third, the order of policy objectives was adjusted, with employment goals discussed before price stability. Some economists note that this signals a shift in the prioritization of the two mandates, with the Federal Reserve placing greater emphasis on employment over inflation [5]. Deficiencies in the 2020 Monetary Policy Framework and Lessons from Practice 1. Deficiencies in the 2020 Monetary Policy Framework Carl Walsh, an economics professor at the University of California, Santa Cruz, argues that one of the primary objectives of the 2020 monetary policy framework was to eliminate the downward inflation bias (a trend where actual inflation is systematically below the central bank’s target inflation rate) caused by the effective lower bound of nominal interest rates. To address this, the framework introduced an asymmetric average inflation targeting regime and an employment shortfall approach to increase positive inflation bias. However, inherent issues with these mechanisms undermine the framework’s effectiveness: (1) Ambiguity in the inflation target.Walsh argues that if monetary policy under asymmetric inflation targeting is well understood and credible, inflation expectations would act as an automatic stabilizer. However, the current asymmetric average inflation targeting framework is not only difficult to comprehend but also lacks a clearly defined averaging window, undermining its credibility and hindering the anchoring of inflation expectations.
For instance, research by Yuriy Gorodnichenko, a professor of economics at UC Berkeley, reveals that during the pre-surge, surge, and post-surge phases of inflation since 2020, long-term inflation expectations among households and businesses remained significantly above 2%, contrary to the stable expectations of financial markets and professionals. This indicates a lack of understanding of average inflation targeting among these sectors [6]. Experimental evidence also suggests that long-term average inflation targeting may lead to extrapolation of inflation expectations in the opposite direction. The Federal Reserve has not explicitly specified a time window for achieving average inflation targets, defining it merely as an average “over time,” which complicates public understanding of the central bank’s intentions. Walsh notes that before 2020, the FOMC typically targeted a 4-quarter year-on-year inflation average, with a very short averaging window. Under the new framework, the specific range of the averaging window has become ambiguous, granting the Fed greater discretion but also removing a key anchor for expectations. Walsh views this as a regression in policy. (2) Ambiguity in the employment mandate. Walsh points out that the description of the full employment mandate has shifted from “may not be directly measurable” in 2012 to “cannot be directly measured,” further obscuring its definition. Between 2012 and 2020, the employment mandate was often linked to the FOMC’s long-term unemployment rate projections, providing a benchmark for evaluating the Fed’s performance and enhancing accountability. However, under the 2020 framework, the Fed’s performance regarding the full employment mandate is difficult to assess, effectively weakening constraints on its discretion. Additionally, there may be a fundamental conflict between inflation and employment objectives. In the 2020 framework, the inflation target is directly quantifiable and primarily determined by monetary policy, whereas full employment cannot be measured and is largely influenced by non-monetary factors. Walsh highlights that if the Fed’s definition of full employment falls below the natural rate of unemployment, the actual employment gap will remain positive, creating a conflict with the 2% inflation target. This implies that when the Fed attempts to close an employment gap that may be unachievable, it risks pushing inflation above the 2% target.Harvard University economics professor Kenneth Rogoff pointed out that the revision of the monetary policy framework in 2020 was originally designed to address the persistent low-interest-rate, low-inflation, and weak labor market environment, with high inflation not being a primary concern for major central banks at the time [7]. However, the 2020 policy framework review was delayed by several months due to the outbreak of the pandemic, and the economic environment faced by the Federal Reserve after the framework’s adoption underwent profound changes.
Under the impact of the pandemic, supply chain disruptions, and the Russia-Ukraine conflict, the Federal Reserve’s challenge shifted to addressing high inflation and a robust labor market environment. Meanwhile, unemployment rates surged during the COVID-19 pandemic but subsequently recovered rapidly, with the employment gap calculated by the Congressional Budget Office (CBO) and the Federal Reserve’s Summary of Economic Projections (SEP) turning negative in early 2022. Reflecting on the past five years, experts at academic conferences summarized several practical lessons from the 2020 monetary policy framework in addressing unexpected new environments and challenges. First, scholars such as Walsh and Rogoff argued that the 2020 policy framework limited the Federal Reserve’s ability to respond promptly to soaring inflation. The framework prioritized employment objectives, diverting the Federal Reserve’s attention from its responsibility to control inflation. The Federal Reserve began raising policy rates at the end of the first quarter of 2022, by which time the employment gap based on the FOMC’s long-term unemployment rate forecast had dropped to zero, while PCE inflation had already approached 7%. According to various model expectations, under standard scenarios, the Federal Reserve should have reacted more swiftly to the inflation surge, but in practice, it emphasized achieving employment goals in the four quarters preceding the rate hike. Additionally, the time window for the average inflation targeting regime may have been excessively long, reducing the policy’s responsiveness to new inflationary developments and potentially delaying the Federal Reserve’s reaction to significant shocks. The consequence of this delayed response was a short-term economic boom, as fixed interest rates amid rising inflation led to lower real rates, stimulating aggregate demand, driving economic expansion, and reducing unemployment. However, the delayed response also exacerbated the inflation surge. After holding rates steady for four quarters, the Federal Reserve sharply increased interest rates as inflation far exceeded expectations, causing unemployment to peak before declining. Walsh suggested that the FOMC’s failure to address the 2021-2022 inflation shock earlier was due to its bet that long-term and even medium-term inflation expectations would remain stable. In hindsight, this was a dangerous gamble: the lack of timely action allowed short- and medium-term inflation expectations to rise alongside actual inflation, potentially making inflation more persistent and even risking the de-anchoring of long-term expectations.Figure 1: 2021-2025Q1 Employment Gap, Core Inflation, and Fed Inflation Expectations Under Different Time Windows. Source: Carl Walsh[8]
Walsh highlights several key lessons from the delayed response to high inflation in this cycle. First, central banks cannot independently set employment targets; long-term employment goals must align with operational inflation targets. Second, inflation depends not only on what central banks do but also on what they refrain from doing. Third, when policy lags behind the curve, a more aggressive response is required. Fourth, forward guidance is a conditional commitment, and central banks should not be constrained by their own guidance—adjustments are necessary when circumstances change. Fifth, policy frameworks must withstand shifts in economic conditions, and scenario analysis and stress testing should be used to evaluate proposed frameworks. Sixth, central bank objectives are often not complementary, and rigid preferences or deviations from core mandates should be avoided. Seventh, in the face of highly uncertain shocks, overestimating their persistence is more likely to yield robust policy responses. Finally, the Fed’s battle against inflation is far from over. Comparing this inflationary cycle to the 1970s reveals striking similarities. While inflation has stabilized at lower levels, another shock within the next 12 months could reignite inflation, echoing the 1970s scenario. Figure 2: Comparison of 1970s High Inflation Period and 2021-2022 Inflation Shock. Source: Carl Walsh[9] Second, Gorodnichenko notes[10] that the recent decline in inflation after its surge was largely due to luck rather than the Fed anchoring inflation expectations. His research finds that over the past five years, short- and long-term inflation expectations among most economic participants were not as anchored as policymakers believed, and current expectations remain significantly higher than the FOMC’s projections. Figure 3: Actual Inflation vs. Long-Term Inflation Expectations (FOMC, Financial Professionals, Households, Firms). Source: Yuriy Gorodnichenko[11] The study points out that the inflation surge and subsequent decline over the past five years were primarily driven by unstable inflation expectations (attributable to volatile gasoline and commodity prices) and other supply-side shocks (global supply chain pressures, post-Ukraine conflict natural gas price spikes, etc.). Policymakers’ “illusion” of anchored expectations stems from their overreliance on financial market and professional forecasts while underestimating the “seemingly irrational” expectations of households and firms—the primary economic actors.In reality, as economic and financial practitioners are the most knowledgeable about economic operations, their inflation expectations often align with those of FOMC members, which can easily lead to cognitive biases among policymakers. Gorodnichenko’s research found that short-term inflation expectations, rather than long-term ones, determine price-setting behavior, and it is the inflation expectations of firms—not financial markets or professional forecasters—that drive this transmission mechanism.
Therefore, monetary authorities should take the inflation expectations of firms, consumers, and financial markets more seriously. Given that household sector inflation expectations remain elevated, when inflation expectations are unanchored, the Federal Reserve should focus on reducing inflation to lower levels rather than prioritizing the trade-off between inflation and unemployment. Additionally, the Fed should proactively address potential one-off shocks in the future to avoid triggering high and persistent inflation again. Regarding potential adjustments to the Federal Reserve’s monetary policy framework and communication strategies, the official Fed announcement notes that the current review focuses on two specific areas: the FOMC’s monetary policy approach and its communication tools, with the 2% long-term inflation target not being a focus of this review [12]. At the Thomas Laubach Research Conference, Powell further stated [13] that the FOMC internally believes it is necessary to reconsider the phrasing of the employment gap and average inflation targeting to ensure the new framework can withstand various economic environments and developments. Moreover, the Committee will explore ways to improve policy communication to better convey its uncertainty about the economy and its outlook during periods of more frequent, larger, and more unusual shocks. Based on discussions at the research conference and expert recommendations, the 2020 monetary policy framework and communication strategy may be adjusted in the following ways. (1) Improving the Measurement of Full Employment Goals To address the challenge of directly measuring employment targets, Ayşegül Şahin, Professor of Economics and Public Affairs at Princeton University, suggested [14] that a flow-based approach could be used to assess the employment mandate. This involves monitoring real-time data on employment and unemployment to gauge cyclical pressures in the labor market, rather than relying solely on static indicators like unemployment and participation rates, thereby better fulfilling the Fed’s full employment mandate. Şahin pointed out that current static measures of labor market slack fail to accurately capture the flows between employment, unemployment, and labor force non-participation, as well as their underlying drivers. For example, monetary policymakers often interpret low labor force participation as evidence of economic weakness, but participation cycles tend to lag behind unemployment cycles (typically by nine months), making participation rates potentially misleading for assessing labor market slack.Additionally, the job vacancy-to-unemployment ratio is increasingly used to assess labor market tightness, but this approach overlooks the dynamic changes in labor turnover and fill rates, potentially exaggerating labor demand. Sahin’s research highlights that the employment-to-population ratio is a critical measure of full employment, as it is influenced by both the unemployment rate and labor force participation rate, which are more affected by changes in unemployment and employment flows.
Therefore, Sahin suggests focusing more on real-time data such as the job-finding rate and job-loss rate. She also notes that linking labor flow dynamics to inflation through the Phillips curve model can help estimate the natural unemployment rate, aiding the Federal Reserve in balancing its dual mandate of price stability and full employment. (2) Adjusting Asymmetric Average Inflation Targeting: A shift toward a more symmetric response to inflation deviations from the target may be a direction for framework adjustment. Although this academic conference did not specifically address inflation targeting, several experts sharply criticized asymmetric average inflation targeting. Walsh pointed out that asymmetric average inflation targeting creates an upward inflation bias, with experimental evidence suggesting that long-term average inflation targeting may lead to unstable and counterintuitive inflation expectations due to its inherent complexity. Gorodnichenko’s research found that inflation targeting is not well understood by the public and is ineffective in anchoring inflation expectations. Survey evidence indicates that households prefer prices returning to normal levels, implying that a price-level targeting framework, rather than average inflation targeting, may better anchor expectations. The study concludes that adjusting the policy framework alone is insufficient to stabilize inflation expectations. When inflation is low, households and businesses often ignore it, but during high inflation, attention shifts sharply, leading to unanchored expectations. The research suggests that central banks should enhance policy communication during periods of low and stable inflation, while focusing on concrete actions to bring inflation down during high-inflation periods. (3) Strengthening Policy Communication: Former Federal Reserve Chair Ben Bernanke noted that while the Fed has developed a substantial toolkit for policy communication—including post-FOMC press conferences, statements, meeting minutes, the Summary of Economic Projections, and semi-annual reports to Congress—its communication strategy still has two major shortcomings. First, beyond the Chair’s press conference remarks and responses to reporters, the Fed provides relatively little economic context or explanation for its monetary policy decisions.In contrast, other central banks typically provide detailed background information on policy decisions, including a review of recent economic and financial market dynamics, discussions on monetary strategies, in-depth analysis of issues influencing policy decisions, and assessments of risks to the economic outlook. Ben Bernanke argues that such information helps the public better understand the rationale behind policy decisions and the factors influencing future policy actions.
Secondly, the Federal Reserve does not release baseline economic projections alongside policy decisions, unlike other major central banks. The FOMC attempted this in 2012 but failed to establish a process for summarizing collective forecasts. The current approach involves separately listing the predictions of 19 FOMC participants for key economic variables in the Summary of Economic Projections. A flaw in this design is that public attention tends to focus on individual participants’ forecasts of economic and policy directions, making it difficult to reduce the interference of forecast uncertainty in policy formulation. Bernanke suggests that the Fed could publish a concise quarterly economic commentary, featuring a dynamic summary of economic and financial conditions, in-depth analysis, and thematic reports. The core content should include the Committee’s multi-scenario composite forecasts for key economic and policy variables across different time horizons. On one hand, composite forecasts would be more definitive than individual participants’ predictions. On the other hand, disclosing other plausible economic scenarios and policy responses would demonstrate the uncertainty of forecasts to the public. This approach would allow the FOMC to provide clearer and more dynamic policy guidance, particularly during periods of heightened uncertainty, thereby improving the Fed’s policy communication. Author: CF40 Research Institute, Source: China Finance 40 Forum, Original Title: “The Federal Reserve Plans to Adjust Its Monetary Policy Framework: Possible Directions” Risk Disclosure and Disclaimer: Markets involve risks, and investments should be made with caution. This article does not constitute personal investment advice, nor does it consider the specific investment objectives, financial situations, or needs of individual users. Users should evaluate whether any opinions, views, or conclusions in this article align with their particular circumstances. Investments made based on this article are at the investor’s own risk.
