Has the Fed abandoned its average inflation target?

Inflation has exceeded the Federal Reserve’s 2 percent target. The Personal Expenditure Price Index (PCEPI), the Federal Reserve’s preferred measure of inflation, grew at a steady compound annual rate of 6.1 percent from February 2021 to February 2022, up from 5.9 percent in the previous month.

Prices have risen by an average of 3.7 percent since January 2020, just before the epidemic. As Figure 1 shows, the price level in February 2022 was 3.9 percentage points higher if it had only increased by two percent during this period.

Fed officials are clearly committed to the goal of average inflation. Under such a rule, a period of inflation below the target will be offset by a period of above-target inflation so that inflation is equal to the target on average. The Federal Open Market Committee (FOMC) reaffirmed its statement in January 2022 on long-run goals and monetary policy, which outlines the rules. But the policy course assumed by FOMC members suggests that it is not really committed to delivering 2 percent inflation. Average.

In March, FOMC members were asked to project an inflation under the assumption that the Fed manages monetary policy appropriately, as it sees fit. The range of central, central trends, and FOMC member inflation estimates is presented in the summary of economic forecasts and reproduced in Table 1 below.

Two things come out of Table 1. First, most FOMC members believe that inflation should be above the target by 2024. The lower limit of the central trend, which excludes the three highest and three lowest estimates, is 4.1 percent in 2022, 2.3 percent in 2023, and 2.1 percent in 2024. Second, no FOMC member thinks that inflation should fall below the target during the projection window. The lower limit of the forecast range is 3.7 percent in 2022, 2.2 percent in 2023 and 2.0 percent in 2024. In other words, Fed officials do not want to offset the over-target inflation realized last year over a period of time. Low-target inflation so that inflation during the projection window averages equal to the Fed’s target.

Bond markets are similarly predicting that inflation will remain above the target in the next few years and that the Fed will not offset above-target inflation with inflation below the target. As of March 30, 2022, bond markets had set prices at about 3.21 percent PCEPI inflation for the next five years and 2.66 percent PCEPI per annum for the next ten years.

Undoubtedly, some will try to excuse the Fed for failing to achieve an average of 2 percent inflation, pointing to supply disruptions. The Kovid-19 epidemic and, more recently, Russia’s invasion of Ukraine have certainly raised prices. And an average inflation-targeting central bank Should Let the price rise in response to the negative real shock. Even still, letting that fade off the hook is not enough.

Although prices rise due to temporary supply disruptions, they do so temporarily. As restrictions on activity and the risk of COVID-19 decrease, supply increases again and prices fall. The same can be said about the conflict in Ukraine, which will eventually end. There is no reason to expect prices to rise because of this supply disruption Within the next three years. Indeed, many of the supply constraints associated with the COVID-19 epidemic should have already been reversed had policymakers decided to relax restrictions on the widespread use of the vaccine, a less dangerous form of circulation, and to stop its spread.

There is no reason to believe that prices have risen so far due to supply disruptions. If supply disruptions are only blamed, the nominal cost trend will continue. In fact, nominal spending has grown much faster. From 2010 to 2020, nominal expenditure grew at a steady compound annual rate of 3.93 percent. During that time, it grew at a rate of 5.06 percent. Last year’s high inflation is not the only supply-side problem. Inflation is high because the Fed has failed to control nominal spending.

Despite confirmation of the opposite, the Fed seems to have abandoned its average inflation target. Excessive nominal spending has pushed prices above a level consistent with the Fed’s average inflation target. Instead of offsetting the above-target inflation with the lower-target price period as required by an average inflation-targeting central bank, the Fed has only promised to bring inflation down to 2 percent. In that case, inflation will exceed 2 percent on average.