In August 2020, Fed officials announced a new approach to monetary policy called “flexible average inflation targeting.” The idea is to allow some fluctuations in inflation in the short term, but aim for an average inflation rate of 2% in the medium to long term.
What they actually did was something fundamentally different. In 2021, the Fed adopted a highly stimulative 1960s-style monetary policy aimed at printing money and “creating jobs.” As in the 1960s, this policy led to high inflation.
The Fed then claimed it never intended to target average inflation. Rather, the policy was intended to compensate for periods in which inflation was below target, not to compensate for periods in which it was above target. I felt like a dummy because I naively believed that average inflation targeting meant average inflation targeting.
Professor, London School of Economics Ricardo Reis Certainly not a dummy, he had the same views as me.
So where did Reis and I get this crazy idea that average inflation targeting means average inflation targeting? Probably from the Fed itself. In an April 6, 2021 paper, Dallas Fed economists Enrique Martinez García, Jarrod Coulter, and Valerie Grossman also argued that the policy is symmetric.
Notably, the Fed changed its language regarding inflation, replacing its pledge of a 2% inflation target and instead[seek] In the long run, the goal is to achieve an average inflation rate of 2%. ”
This change is a significant departure from the previous flexible inflation targeting regime. Monetary policy under inflation targeting is symmetrical, and the Fed is equally responsive to overshooting and undershooting its target. By refusing to make up for past deviations from its inflation target, the Fed is letting bygones be bygones.
By comparison, average inflation targeting allows policymakers to account for these deviations and allow inflation to rise modestly and temporarily above the target to make up for past shortfalls, or vice versa. means to tolerate.
Note that the phrase “vice versa” is italicized in the original text. They thought it was worth emphasizing this point.
In recent tweets, david beckworth Jerome Powell suggests he is leaning toward abandoning FAIT and returning to a flexible inflation targeting (FIT) system:
David’s Twitter threat is worth reading. He pointed out that the FAIT policy is based on a series of important papers that I have called the “Princeton School” of monetary policy. These papers emphasize the need for some kind of level targeting system, focusing on either the price level or nominal GDP. These proposals were aimed at correcting very specific flaws in the previous inflation targeting regime that led to massive policy failures from 2008 to 2015.
So let’s check what happened here.
1. The Fed adopted FAIT in 2020 based on highly regarded research on the question of what went wrong in 2008.
2. The simple meaning of the term “average” suggests that the policy was symmetric. I thought it was symmetrical. A Dallas Fed publication said the policy is symmetrical.
3. Although this policy did bring about a strong recovery, it also resulted in excessive inflation.
4. The policy failed because it was not symmetrical. The Fed aimed to correct the inflation undershoot, but not the overshoot. The problem is not that the Fed, despite its efforts, has not been able to achieve its flexible average inflation target. They didn’t even try FAIT. They tried a very different, 1960s-style monetary stimulus.
Unfortunately, in our culture, words have an almost magical power, a talismanic power. If an institution announces that it will implement policy . The Fed announced it would do FAIT, did something completely different, and now (if Beckworth’s tweet is correct) appears to be abandoning FAIT and replacing it with something much worse.
On the bright side, a cynic might argue that maybe next time we’ll announce policy Y (FIT), but we’ll actually do policy X (FAIT). Unfortunately, for this type of policy to work, it needs to be well understood and at least somewhat reliable by financial markets.
I understand that the Fed feels it needs to do something different after the debacle of 2021-2022. So why hasn’t the government announced a policy that aims to increase the NGDP level by 4% annually? Given that the long-term growth rate in the United States is around 2%, this kind of policy would raise average inflation to near 2%, and would be vulnerable to supply shocks like the coronavirus or the Ukraine war. In some cases, it will become more “flexible.”
PS.In the 30 years before average inflation targeting was introduced, PCE inflation averaged 1.9%. The average since August 2020 is 4.2%, and if we take the five-year average to avoid distortions caused by the new coronavirus, it is 3.6%.
