Why the Fed Can't Talk the U.S. Economy Into Inflation

We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome. We want to do what we can to prevent such a dynamic from happening here."

Powell realizes that the coronavirus crisis has brought the Fed to the end of its rope. Interest rates are near zero, and taking them negative is a nonstarter given that such a policy has arguably only made things worse in Europe and Japan.

The central bank can keep buying Treasuries and mortgage-backed securities, and even purchase corporate bonds and backstop the most strapped state and local governments.

Still, all of this largely serves to support financial markets by making it cheap for large companies to borrow and pushing investors into riskier, higher-yielding assets. The Fed can't so easily reach the small businesses and service workers most impacted by this economic slowdown.

Trying to Avoid 'Lower Rates Forever'

Powell wrapped up the Q&A portion by portraying the Fed as fighting tooth and nail to avoid falling into the trap of lower interest rates forever, like the Bank of Japan.

Facing "a reality of a quite difficult macroeconomic context," he said, "we've really got to work to find every scrap of leverage we can get in helping to stabilize the economy, which is our role."

So he and his colleagues naturally pulled one of the few levers they have left in their more traditional toolkit: talking a big game on inflation.

Notably, the Fed also tweaked the way it views full employment, with Powell conveying that the job market can be at or above estimates of its maximum level without any cause for concern from within the central bank.

This is effectively saying that the unemployment rate, on its own, can never be too low. It all points to the Fed holding short-term interest rates near zero for years to come while creating a much higher hurdle for any policy tightening.

It's a tired refrain by now, but fiscal policy looks like the only way out of this Japanification of the U.S. Getting cash into the hands of "those struggling with less jobs and incomes," as Powell put it, will bolster consumer spending, which has long been one of the pillars of the American economy.

That's the kind of policy that will move money around in the real economy.

Here's what won't move the needle: keeping monetary policy so accommodative that cash-rich Apple Inc. can borrow at rock-bottom rates to buy back its own shares, which are already at record highs.

In fact, large companies that keep getting bigger are quite likely contributing to slow wage growth and subdued inflation. But it's about all the Fed can do at this point.

Powell's not sure if this change to the Fed's framework will work: "Time is going to tell," he said, unhelpfully. For one day, at least, his words managed to lift longer-term bond yields.

Whether all this talk will move the needle in the real economy, on the other hand, is out of the central bank's control.

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