The Fed’s New Strategy: Tiny Steps Forward

Many experts seem to have mixed feelings about AIT. While some experts are sure that AIT will be disastrous, pro-free market economists tend to view the situation as a rejection of Keynesian Phillips Curve models.

The paragraph that caught my attention in Powell’s speech was this:

“Our revised statement says that our policy decision will be informed by our “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level” as in our previous statement. This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.

In earlier decades when the Phillips curve was steeper, inflation tended to rise noticeably in response to a strengthening labor market. It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation. The change to “shortfalls” clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals.”

I thought the Fed will abandon the Keynesian Phillips Curve models. And the phrase “signs of unwanted increases in inflation” made me think that the Fed would seek an increase in its market forecast. But unfortunately, I cannot say that I have received AIT enthusiasm. Even though I am more inclined to view AIT positively, like Beckworth, there are some problems that I cannot overlook. In addition to thinking that a huge potential has been missed, the new strategy certainly contains a loophole that can create a lot of trouble. Moreover, as George Selgin emphasized, AIT also has a very serious drawback:

Faced with stiff-enough opposition, the Fed might fail to carry out some or all of a needed correction, undermining the credibility of its policy commitment. Because the Fed’s efforts to make up for excessively low inflation are less likely to meet with similar opposition, the result could be an “asymmetrical” average inflation targeting strategy that allows the price level path to drift upwards. In that case, even if the Fed starts out with a clearly-specified AIT rule, its reluctance to stick with it will cause the long-run inflation rate to exceed the Fed’s target, while making the future course of the price level just as unpredictable as it is under strict inflation targeting.

Perhaps increasing the intended average speed will get you to it, but you will undoubtedly have to hit the throttle more at some point. If your goal is just that, there are many other ways to do this(QE, negative rates, etc). But if you are going to change your strategy substantially, perhaps there are strategies that can be more efficient.

To be honest, I don’t see AIT as a strategy that can work for a long time. It seems obvious to me that, after making up for the period that the Fed was below target, AIT will expire for the above reason. That is why the Fed missed out on a much better option(NGDPLT).

Regardless, I interpret this change as the Fed’s tacit admission that the market monetarists were right about the Great Recession. Although the AIT does not contain many of the changes I was hoping for, I believe this tacit admission will be a further step towards making up for this missed chance. The Fed is certainly not in what I would call ideal, but there is a glimmer of hope: they are taking very, very tiny steps in the right direction.

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Dawson

Why do you think AIT is implying that the Fed accepts the market monetarists’ arguments?

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