The Fed is making a big move next year! It’s about the next five years.

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The Federal Reserve will conduct its five-yearly “routine” next year on monetary policy, inflation, communication and more ……

Fed policymakers will need to consider more than just how to adjust interest rates to inflation and employment in 2025. The central bank will also conduct a review of its monetary policy strategy and tools, something it routinely does every five years.

The last time the Fed’s framework was updated was in 2020, during the New Crown epidemic, when U.S. inflation had been in the doldrums for more than a decade and interest rates were only slightly above zero. Today, the U.S. economy is coming out of the worst period of inflation since the 1970s and interest rates are well above the so-called zero lower bound.

A key question for the Fed’s 2025 framework review is whether officials should return to a more traditional inflation-targeting regime of always aiming for 2%, rather than the more flexible target they adopted for 2020.

Also up for review is the effectiveness and implementation strategy of the Fed’s monetary policy tools, which include setting benchmark interest rates, buying and selling Treasuries and other securities, and providing forward guidance. Communication will also be part of the review. The results of the study will likely be announced at the Kansas City Fed’s Economic Policy Symposium in Jackson Hole, Wyoming, in August.

The Fed will host a research conference in Washington, D.C., next May to get outside input on monetary policy and the economy. Officials will also travel around the country to participate in “Fed Listening” events with the public.

In a November statement, Fed Chairman Jerome Powell said, “We are open to new ideas and critical feedback, and will learn from the lessons of the past five years and adjust our approach where appropriate to better serve the American people to whom we are accountable.”

As mandated by Congress, the Fed’s goal is to pursue maximum employment and price stability, which it has defined since 2012 as an annual inflation rate of 2 percent as measured by the personal consumption expenditures (PCE) price index. This specific goal will not be part of the five-year review, according to the statement.

The Fed completed its most recent framework review in the summer of 2020, with Powell announcing the conclusions at the Jackson Hole conference in August of that year. Officials revised their longer-term inflation target to an annual average of 2 percent over time, rather than always hitting that level precisely. This so-called flexible average inflation-targeting system means that higher inflation can be allowed to occur to make up for price increases that were previously below target.

Powell said at a Nov. 14 event at the Dallas Fed, “[We chose] to develop a strategy to make up for it so that if inflation is too low, we can commit to making it slightly higher. The idea is that if people believe you’re going to do that …… then inflation won’t be too low.”

The 2020 update to the Fed’s Statement on Long-Term Objectives and Monetary Policy Strategy also emphasized efforts to mitigate “shortfalls” in the maximum unemployment rate, rather than “biases” in both directions. This subtle change suggests that policymakers will not start raising interest rates if the labor market is merely tight and inflation is not too high.

The Fed has since been criticized for its flexible approach to inflation management, which has been blamed for causing it to fall behind the curve in dealing with the 2021 inflation spike. At the beginning of that year, U.S. price inflation began to accelerate, but the Fed kept its target rate slightly above zero until March 2022, when the PCE price index was 7% higher than a year earlier.

Since then, inflation has slowed and the labor market has loosened, and the Fed began to cut the rate, which sits at a 20-year high, in September.

The half-century since the Fed’s last framework review has been an eventful one for monetary policy, and the conclusions reached in 2025 will determine how the Fed responds to the challenges of the next five years.