When I complain that the Fed has seemed to abandon average inflation targeting (FAIT), people sometimes respond that the Fed doesn’t seem to interpret the new policy in the same way that I do. After all, the first letter in the acronym “FAIT” stand for flexible.

My problem with this is that I cannot think of any reasonable interpretation of FAIT that is consistent with recent statements by Jerome Powell. Yes, the policy does not require an exact mathematical average for the inflation rate. But if the term “average” is to mean anything, it must mean that there are periods where you’d want to overshoot 2% to make up for past undershoots, and vice verse.  And a recent Dallas Fed paper by Enrique Martínez-García, Jarod Coulter and Valerie Grossman seems to confirm my assumption:

By comparison, average inflation targeting means that policymakers would consider those deviations and can allow inflation to modestly and temporarily run above the target to make up for past shortfalls, or vice versa.  [Emphasis in original]

So “vice versa” it is.  The policy is symmetric.  The term “average” really does mean something. 

Still, I am haunted by nagging doubts that I have missed something.  Maybe FAIT is like one of those ancient mystery cults, where only a few are initiated into the secrets of the temple.  Perhaps the Fed refuses to spell out a clear definition for FAIT because they don’t want the public to know; they’d prefer that only top Fed officials understand how the regime is supposed to work.  In that case, any criticism of Fed policy can be easily deflected by Fed officials who insist that we outsiders just don’t understand the nuances of FAIT.

Chicago Fed President Charles Evans is clearly an insider, one of the top officials at the Federal Reserve.  And he has a radically different view than Martínez-García, Coulter, and Grossman.  Here’s Evans:

With flexible average inflation targeting (FAIT), the FOMC allows for greater discretion as they aim for their average goal of 2%. The window over which the average is taken is not specified yet. Furthermore FAIT is asymmetric: If the FOMC finds themselves undershooting for any extended period of time, they are prepared to overshoot to compensate, but without the same worries for combatting high inflation. Excessively high inflation in the past is not compensated by low inflation in the near future. The reason is that we do not know how to deal with low inflation because of the effective lower bound. There is a second asymmetry depending whether the shock comes from the supply or demand side.

Now there’s no longer a vice versa.  The policy has gone from being symmetric to asymmetric. So what’s going on here?

I suspect that Martínez-García, Coulter and Grossman were never initiated into the secrets of the temple.  Like me, they are looking at things from the outside.  They read the Fed’s new policy directive adopting average inflation targeting, and assumed that average meant average.  But if Evans is correct, then average doesn’t mean average.  (Perhaps the FTC should investigate the Fed for misleading advertising.)  Evans seems to be suggesting that the Fed adopted something closer to temporary price level targeting.

In any case, it’s now pretty clear that whatever the Fed was trying to do, they adopted the wrong form of FAIT.  A serious commitment to undo the effects of inflation overshooting would have largely prevented the sort of excess inflation that we’ve recently experienced. 

To be clear, I am not claiming that they need to commit to undoing 100% of excess inflation.  I agree with the “flexible” part of the mandate.  There’s no need to offset supply shocks.  But surely the Fed should offset at least the portion of the recent inflation overshoot that is due to excessive NGDP growth.  Alas, they don’t even seem to be willing to do that, which is a minimal requirement for “average” inflation targeting to have any coherent meaning at all.

HT:  Jeff