I have expressed a great deal of frustration with the Fed’s “Flexible Average Inflation Target”, which does not target the average inflation rate. Commenter Jeff recently made the point much more effectively than I could have done. I thought it was worth bringing his comment to the attention of readers that do not bother with the comment section:
Let’s not forget that the meaning of “FAIT” was extremely unclear to you, your readers, and even some of the Fed’s own researchers through the better part of 2021. Both the plain English and technical meanings of the word “average” imply that both undershoots and overshoots will be compensated for. Anything else is not properly described as an “average”. Monetary policymakers do not have license to redefine mathematics any more than energy policymakers get to redefine the fundamental constants of the physical universe. No doubt many professional Fed-watchers saw through the murky verbiage and were able to personally benefit as a result, but I’m not exactly a fan of societies where only courtiers and palace whisperers know what is really going on because the royals speak a different language from everyone else.
Jeff nailed it.
Next year, the Fed plans to review its targeting strategy. Let’s hope they come up with a less confusing approach.
PS. I notice that 2023:Q3 NGDP growth came in at 8.5%—still way too fast. I see very little evidence for the “tight money policy” that everyone keeps talking about. What is the evidence that money is tight?
READER COMMENTS
roundtree
Oct 27 2023 at 3:54pm
Seems like many analysts quote Bloomberg’s index for financial conditions, though searching broadly doesn’t turn up any direct quote of this value, nor does it provide a symbol to reference. :/
The Fed’s own measure (https://fred.stlouisfed.org/series/NFCI) absolutely matches your expectations: financial conditions are now as loose as March 2022 and have loosened considerably since the Fed instituted BTFP in March 2023. Reverse repos are dramatically lowered, but that’s clearly not enough given the marginally lower value of the Fed’s balance sheet and the M2 money supply. All that missing cash, I suspect, is parked in money market funds and, recently, T-bonds/bills.
David Henderson
Oct 27 2023 at 4:30pm
Jeff DID nail it.
I should read the comments on your posts more often. I will definitely look for Jeff’s comments.
vince
Oct 27 2023 at 5:30pm
Real GDP increased at an annual rate of 5 percent? Makes you wonder how valid these statistics are. Does anyone notice a productivity increase?
Matthias
Oct 28 2023 at 8:38pm
Real GDP can also increase with population increase, more people entering the labour force, or more capital being used. Or people switching jobs to higher value added sectors. Or via cheaper imports.
That’s all without anyone experiencing a productivity increase per labour input at their old job.
vince
Oct 29 2023 at 12:07pm
Productivity is real gdp divided by hours worked. I assume hours worked doesn’t change much from one quarter to the next quarter.
Trina Halppe
Oct 28 2023 at 3:59am
In the other thread you said… “In addition, it makes sense to look through supply shocks, and focus on maintaining stable growth in aggregate demand. (That’s the flexible part of FAIT.)”
How do you know that is the type of flexibility the Fed is allowing itself or limiting itself to?
marcus nunes
Oct 28 2023 at 9:35am
Trina, it was a hopeless targeting scheme from the get go!
Is the new Monetary Policy Framework (AIT) an improvement? | Historinhas (wordpress.com)
Thomas L Hutcheson
Oct 29 2023 at 10:40pm
I do not think the Fed “looks through” (extraordinary) supply shocks so much as actively taking them into account, knowing that above target inflation is needed temporarily to facilitate the (extraordinary) relative price changes.
spencer
Oct 28 2023 at 9:21am
The “demand for money” is fickle. It fluctuates more than the money stock. But the FED discontinued the G.6 Bank Debits and Deposit Turnover Release in Sept. 1996 for spurious reasons.
marcus nunes
Oct 28 2023 at 9:30am
It started off as “AIT”. When did the “F” come in? To allow more time to get to the Average?
Thomas L Hutcheson
Oct 29 2023 at 10:34pm
“Flexible” is to allow for above-target inflation (which is chosen to facilitate relative price changes in response to shocks of expected size and frequency) to accommodate extraordinary shocks.
Thomas L Hutcheson
Oct 28 2023 at 6:56pm
“Average” seems pretty clear to me. The Fed thinks a rate of 2% , given average/normal/regular/expected size and frequency of shocks maximizes real income growth, but of course from month month the rate might be higher or lower but 2% on average. Why would the Fed ever intentionally shoot for less than its target in order to achieve a backward-looking arithmetic “average? Both positive shocks and negative shocks whether demand or supply require changes in relative prices and the target rate of inflation has, ex hypothesi, been chosen to maximally facilitate relative price changes/real income.
“Flexible” means that sometimes thee will be out of the ordinary shocks and to facilitate adjustment to that kind of shock, the Fed would engineer/allow greater than target inflation. This looks like what the Fed did with the COVID/supply chain shocks and to lesser extent with the spike in oil/grain prices internationally. Unfortunately it miscalculated (perhaps because it was not paying salient attention to TIPS) and delayed increasing interest rates from Sept 20121 to March 2022.
I also wonder if an element in the error was not having unwisely speculated about its future policy instrument settings by saying that it would first cut back on QE purchases before raising ST rates. Speculation seems like a bad thing to do because it means the Fed may feel constrained from doing what it thinks best at the time of the decision, based on the latest data, and what it has said it would or would not do. And that may explain the delay until March ’22.But as a statement of policy FAIT seems both clear and reasonable. [Yes I can see that a FANGDPT target might be better, given that some people still do not real “get” the idea that the Fed may sometimes want to increase inflation.]
A
Oct 29 2023 at 9:46am
Is there a benefit to using seasonally adjusted NGDP growth? YOY NGDP, before annualizing or seasonally adjusting, is only 5.8%.
Michael Sandifer
Oct 30 2023 at 4:47pm
Can anyone point to actual forward-looking evidence that NGDP growth is too high? NGDP being above trend is evidence for running hot, but in and of itself is not conclusive. The same is true for ECI/NGDP. And, these are backward-looking indicators.
The bond market, stock market, and commodities markets are telling us that lower NGDP growth is expected to begin soon. The yield curve predicts this will begin within 6 months. If market monetarism is to mean anything at all, it must rely on forward indicators.
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