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The Fed chairman says the relationship between inflation and unemployment is gone

Key Points
  • "The relationship between the slack in the economy or unemployment and inflation was a strong one 50 years ago ... and has gone away," Powell says.
  • "At the end of the day, there has to be a connection because low employment will drive wages up and ultimately higher wages will drive inflation, but we haven't reached that point. In many cases, that connection between the two is quite small these days," the Fed chief says.
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Powell: The relationship between inflation and unemployment is gone

Federal Reserve Chairman Jerome Powell said the relationship between unemployment and inflation has collapsed.

"The relationship between the slack in the economy or unemployment and inflation was a strong one 50 years ago ... and has gone away," Powell said Thursday during his testimony before the Senate Banking Committee. He added the strong tie between unemployment and inflation was broken at least 20 years ago and the relationship "has become weaker and weaker and weaker."

"In additional to that, we are learning that the neutral interest rate is lower than we had thought and ... the natural rate of unemployment rate is lower than we thought. So monetary policy hasn't been as accommodative as we had thought," Powell said.

Under the Fed's dual mandate of full employment and price stability, the jobless rate has been historically low, inching up to 3.7% in June from 3.6% in May, which was the lowest since 1969. Inflation, however, has been tame in recent years and consistently below the Fed's 2% target.

The so-called Phillips curve, which the Fed relies on in guiding its policy direction, argues that as unemployment declines, inflation should rise, a phenomenon that has not occurred during this economic expansion.

"At the end of the day, there has to be a connection because low employment will drive wages up and ultimately higher wages will drive inflation, but we haven't reached that point. In many cases, that connection between the two is quite small these days," the Fed chief said.

U.S. underlying consumer prices rose by the most in nearly 1½ years in June, but the jump didn't change markets' expectation for a rate cut later this month.

Traders are pricing in a 100% chance of a rate cut in July in part because inflation has remained so low, according to CME FedWatch tool. Powell's testimony also fueled the hope for an easier policy.

Powell said Wednesday that the Fed will "act as appropriate" to sustain expansion as "crosscurrents" are weighing on the economic outlook. He noted business investments across the U.S. have slowed "notably" recently.

The Fed lowered its inflation target for 2019 at its June policy meeting, seeing headline inflation growing at a slower pace of 1.5%, versus the 1.8% predicted in March.