David Beckworth directed me to this tweet:
If the Fed had a single mandate to target inflation, then there would be an argument for switching from a point target like 2% to a band such as 1.5% to 2.5%. But the Fed has a dual mandate, under which an inflation band would be completely pointless. The Fed already allows inflation to fluctuate above and below 2% as required to achieve the high employment side of their mandate.
Calling something “pointless” might be viewed as mild criticism, but I have other concerns. I fear that something like this might be the sole outcome of the next Fed review of its operating procedure, which is scheduled for 2025. In that case, an inflation band would shift from pointless to deplorable.
The past two years have clearly demonstrated that the Fed is off track, and it’s not hard to see where the problem lies. Fed policy since 2021 has been far too expansionary. The biggest problem seems to have been the Fed’s “flexible average inflation target,” which, despite its name, does not call for flexible average inflation targeting. The best outcome for the Fed upcoming policy review would be to actually adopt flexible average inflation targeting. Under this regime, the Fed would make up for inflation overshoots with lower than 2% inflation going forward, and inflation undershoots with above 2% inflation going forward. Over longer periods, the Fed would keep the average inflation rate close to 2%. Obviously, the Fed isn’t doing that today. The policy must be symmetrical.
As for the “flexible” part of the policy, the Fed would allow transitory deviations from 2% inflation due to supply shocks. The best way of implementing flexible average inflation targeting would be to set a target path for the level of NGDP at a rate of 2% plus the Fed’s estimate of long run RGDP growth. Those trend growth estimates might be updated every 5 or 10 years.
I’d actually prefer a simple NGDP level target, but as long as Congress gives the Fed a mandate for stable prices, they cannot entirely ignore inflation. Fortunately, the two options are pretty similar in practice, as long run growth trends change very slowly over time.
READER COMMENTS
Rajat
Jun 7 2023 at 11:40am
Without researching, I’m guessing an important driver for the lack (or dropping) of symmetry in FAIT has been a belief that the (until-recently) asymmetric supply shocks that hit the US and most other economies in the wake of Covid and the Russian invasion of Ukraine would be permanent. If negative supply shocks are/were permanent, would you accept the case for an asymmetric AIT? A symmetric AIT (set at a fairly low level) in the face of a large permanent negative supply shock could prevent the necessary adjustment in real wages if nominal wages were sticky downward. As it happens, the negative supply shocks have now largely reversed, such that FAIT could appropriately be applied symmetrically. But often central banks won’t know that in advance.
MarkLouis
Jun 7 2023 at 12:43pm
I see no evidence that supply shocks are asymmetric. Just one example of a temporary positive supply shock: post-WTO China integrated many millions of low wage workers into the global manufacturing economy. This was an enormous, one-time, positive supply shock. It’s entirely possible shale drilling ends up being another temporary positive supply shock.
The Fed only likes to see things as asymmetric when it allows them to run looser. Until we diagnose and address this underlying bias, no framework will work properly.
Scott Sumner
Jun 7 2023 at 7:48pm
Rajat, Good question. I don’t actually favor AIT, I favor flexible AIT. As long as it’s FAIT, then it should be symmetric. The “flexible” part of FAIT deals with supply shocks.
In my view, the best way to implement FAIT is with NGDP level targeting, which is a symmetric policy. I favor that policy even if supply shocks are asymmetric.
I would oppose a AIT policy that didn’t have any flexibility.
BTW, in my view a symmetric FAIT policy (such as NGDPLT) would have prevented the big inflation overshoot in 2022.
vince
Jun 7 2023 at 3:55pm
Stable prices = flexible average inflation target ??
What exactly is meant by mandate anyway? If there’s a mandate in the Federal Reserve Act, it’s that the Fed maintain a level of monetary and credit aggregates commensurate with long run potential production. The goals of employment and stable prices are added to the Act as a dependent clause.
Scott Sumner
Jun 7 2023 at 7:50pm
Like the Bible and the Constitution, the mandate must be interpreted. In my view, something like FAIT or NGDP level targeting is the most sensible interpretation of what Congress was recommending. But it’s a judgment call.
vince
Jun 8 2023 at 1:31pm
If maximum employment and stable prices are emphasized, the case for NGDP targeting is harder to make. If maintaining aggregates commensurate with long run production is emphasized, the case for NGDP targeting is stronger. The way I read it, long run production should be given more emphasis.
Scott Sumner
Jun 8 2023 at 8:19pm
I think the case is strong either way.
Michael Rulle
Jun 8 2023 at 9:29am
Is Powell really in charge? I assume so. He has become a constant “changer”——and then half the time he does not follow up on his new rules. He is random
David S
Jun 8 2023 at 3:36pm
Powell still operates like a trader, which makes him more malleable than other Fed members. In many respects I think he has a better sense of sunk costs—or policy positions that act like sunk costs–than many economists and acts more quickly.
He seems to have a better appreciation of what happened between 2006 and 2010. The Fed during that period certainly wasn’t random in its policy—it was consistently and persistently bad.
Scott Sumner
Jun 8 2023 at 8:20pm
“He seems to have a better appreciation of what happened between 2006 and 2010. The Fed during that period certainly wasn’t random in its policy—it was consistently and persistently bad. ”
I used to think that—but he’s making consistent mistakes in the other direction.
spencer
Jun 8 2023 at 3:35pm
Utter nonsense. There’s no reason to overshoot or undershoot because of past errors.
vince
Jun 8 2023 at 7:20pm
Someone on a fixed income would certainly disagree. At least when inflation is too high.
spencer
Jun 9 2023 at 9:38am
Banks don’t lend deposits. Ergo, bank-held savings are impounded. You get higher real rates of interest for saver-holders by driving the banks out of the savings business, by activating monetary savings (and simultaneously tightening bank credit). This doesn’t reduce the size of the payment’s system and it makes the banking system more profitable.
The economy is being run in reverse. The payment of interest on interbank demand deposits suppresses interest rates. It stokes asset prices, housing, stocks, etc. It causes income inequality, lower standard of livings, and a rentier economy. It’s Marxism.
spencer
Jun 9 2023 at 10:40am
As Dr. Milton Friedman posited; From Carol A. Ledenham’s Hoover Institution archives: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.
Link: https://files.stlouisfed.org/files/htdocs/publications/review/2023/06/02/fiscal-dominance-and-the-return-of-zero-interest-bank-reserve-requirements.pdf
“imposing high reserve requirements for zero-interest paying reserves may seem quite attractive to a policymaker interested in reducing the inflationary consequences of fiscal dominance.”
The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves.
The first rule of reserves and reserve ratios should be to require that all money creating institutions have the same legal reserve requirements, both as to types of assets eligible for reserves, as well as the level of reserve ratios.
Monetary policy should limit all reserves to balances in the Federal Reserve banks (IBDDs), and have uniform reserve ratios, for all deposits, in all banks, irrespective of size.
spencer
Jun 9 2023 at 11:15am
Link: Daniel L. Thornton, May 12, 2022:“However, on March 26, 2020, the Board of Governors reduced the reserve requirement on checkable deposits to zero. This action ended the Fed’s ability to control M1.”
So, Shadowstats reports the ratio of “basic M1” (currency + demand deposits) to M2. Basic M1 is increasing as a percentage of M2. I.e., income, Vi, and transaction’s, Vt, velocity is increasing as an offset to the deceleration in M.
George Garvey would agree.
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