The Fed must abandon the average inflation target
The author is a visiting professor at Columbia University
The most serious mistake made by a leading central bank in its pursuit of price stability August 2020.
2% per year inflation The personal consumption expenditure price index target launched in 2012 is applicable to the inflation rate in any given period and the expected inflation rate in all future periods. AIT-even the flexible variety favored by most members of the Federal Open Market Committee-also calls for deliberate overshoot when inflation is below the target to ensure that the average inflation rate is closer to the target.
A 2020 statement The Federal Open Market Committee promised to achieve “over time, an average inflation rate of 2%“. But committee members have different views on what this means in practice.
President of the Federal Reserve Bank of Atlanta Rafael Bostic Consider four to eight-year moving averages for various inflation indicators. His counterpart at the Cleveland Fed, Loretta Meister, Referring to the five-, six-, or seven-year moving average of PCE inflation, or even a fixed starting point instead of a moving average.Chairman of the Federal Reserve Bank of St. Louis James Brad Think that the five-year window period is realistic, and Charles Evans The Chicago Fed’s report mentions an asymmetric five-year average, which does not require corrections for past inflation targets.
All these versions of AIT may mean years of deliberate and completely unnecessary inflation above the target.
The AIT argument usually starts with the correct observation that due to the extremely low level of neutral real interest rates, the effective lower limit of the Fed’s policy interest rate has become a binding constraint. Therefore, from the beginning of the financial crisis to the first quarter of 2021, inflation in the United States has been below the target. Japaneseization The US economy-the combination of deflation and weak growth-has been driving the Fed’s decision until the recent overshoot of the inflation target put monetary policy tightening back on the agenda.
It is bound to happen that when the economic system has been operating in the ELB for a long time, even the most effective pursuit of the traditional inflation target will produce an average inflation rate below the target. Following the AIT method of deliberately exceeding the inflation target (during the period when the ELB does not restrict monetary policy) may indeed result in the average inflation rate being closer to the target.But the price of doing this is a higher average absolute Deviation from the target rate (and higher mean square deviation). Below the target when you can’t reach the goal and below the goal when you can reach the goal, instead of being below the goal when you can’t reach the goal and above the goal when you can reach the goal!
AIT is a form of price level positioning. However, basic economics tells us that the price level is irrelevant. Actual and expected future inflation rates are important. Inflation is a tax on nominal assets and distorts relative price signals. Expected future inflation will affect the expected return of a range of assets.
Proponents of AIT are concerned about past inflation. If there is a causal relationship between it and monetary policy objectives, this may be indirectly related to monetary policy makers. Contracts with lagging index clauses are such a channel. Past inflation will affect expectations of future inflation, which in turn will promote current and future actual inflation.When the adoption of AIT was announced last year, Federal Reserve Chairman Jay Powell Emphasize the inflation expectations channel.
However, there are other drivers of expected future inflation: past, present, and expected future currency growth, forward-looking guidance, expected and unexpected changes in monetary and fiscal policy systems, supply-side development, and so on. When ELB becomes a binding constraint on Fed policy, even well-informed economic agents will learn to recognize events.
Except in the unlikely special circumstances, the role of past inflation in driving current and future inflation expectations, and through their actual current and future inflation, will not require anything similar to AIT rules.
The choice of the average inflation target is economically illiterate. Why should the unintentional and almost inevitable failure of the inflation target in the past be a reason for deliberate failure in the future? And the cost of adopting AIT may be high: there will be unnecessary and deliberately higher inflation in the future. Now is the time to get rid of this potentially costly nonsense.