Mickey Levy on How to Reboot Fed Policy Ahead of its Upcoming Framework Review

Episode Summary

Executive Summary: Mickey Levy argues that the Fed’s 2019-2020 framework review was overly shaped by fears of low inflation and the zero lower bound, leading to the asymmetric FAIT regime and weaker policy discipline. He and Charlie Plosser recommend rebooting the framework: restore symmetric inflation targeting, use rules as guidance, rethink forward guidance, broaden inflation analysis beyond the Phillips curve, and improve SEPs and balance-sheet transparency.

Main Topics: Why the Fed's 2019-2020 framework review was biased (Priority: 5/5): Levy says the review was preoccupied with low inflation and lower-bound risks, so it ignored other shock environments like the pandemic and high inflation. Evolution from the 2012 strategy to FAIT (Priority: 5/5): The discussion traces the Fed’s move from a simple 2% inflation target plus nonnumeric employment goal to the 2020 flexible average inflation targeting framework. Phillips curve skepticism and inflation forecasting failures (Priority: 5/5): Levy argues the Fed over-relied on a flattened Phillips curve and inflated confidence in its ability to manage inflation expectations. Assessment of the 2021-2022 inflation episode (Priority: 5/5): He says the Fed misread inflation as transitory, kept policy too loose too long, and fell behind the curve despite rising nominal GDP, money growth, and fiscal stimulus. Recommendations for a framework reboot (Priority: 5/5): The paper proposes restoring symmetry, clarifying the mandate, using systematic policy rules, limiting faith in forward guidance, and improving SEPs. Role of fiscal policy and broader monetary indicators (Priority: 4/5): Levy urges the Fed to look beyond labor-market Phillips curves and incorporate nominal GDP, money growth, balance sheet effects, and fiscal impulses.

Key Arguments: The 2019-2020 review was not even-handed; it was dominated by the Fed’s fear that inflation and expectations would fall below target and create a zero-lower-bound problem. The 2012 framework’s 2% inflation goal and nonnumeric employment mandate were clearer and more credible than FAIT’s asymmetric, vague makeup-policy approach. The Fed’s growing belief that the Phillips curve was flat led it to think it could sustain very low unemployment without inflation risk, which proved mistaken. Inflation expectations were already anchored in 2018-2019, so the Fed’s fear of collapse was inconsistent with its own confidence in forward guidance. The 2021-2022 inflation surge showed the Fed had poor judgment: it kept rates at zero, underreacted to rising nominal GDP and M2, and misclassified demand-driven inflation as transitory supply shock. Make-up policy should be used cautiously as a guideline; without clear guardrails it can overshoot, especially after large shocks like the pandemic. The Fed should restore a simple, symmetric 2% inflation objective rather than an asymmetric average-inflation approach that implicitly tolerates prolonged overshoots. Systematic policy rules should be treated as informative benchmarks, not rigid formulas, because they would have warned the Fed earlier that policy was too easy. Forward guidance should not be treated as an independent policy tool because expectations management cannot substitute for actual monetary tightening. The SEPs need reform because the median dot obscures individual views, omits balance-sheet policy, and relies too heavily on unreliable forecasts. The Fed should broaden its analytical framework to include monetary transmission, fiscal policy, nominal GDP, and alternative inflation frameworks beyond the labor-market Phillips curve.

Data Points: Inflation target: 2% - Adopted in the Fed’s 2012 strategic plan as the explicit inflation objective based on the PCE price index. Employment target: No numeric goal - The 2012 framework avoided a numeric employment target, emphasizing maximum employment without a fixed number. Unemployment rate: 3.5% - Described as a 50-year low during the long post-crisis expansion before the pandemic. PCE inflation average: 1.6% - Average inflation from 2016 to 2019, below the Fed’s 2% target. CPI inflation average: 2.0% - Average CPI inflation from 2016 to 2019, cited to show some measures were near target. Headline inflation: near 0% - Fell sharply in 2014-2015 after oil prices declined by more than 50%. Oil price decline: more than 50% - Mid-2014 decline that helped push headline inflation toward zero. M2 money growth: 40% increase - Levy cites unprecedented money growth during the pandemic period as evidence the Fed should have been more cautious. Fiscal response to COVID: over 27% of GDP - Total fiscal support described as much larger than the decline in GDP, especially through transfers. American Rescue Plan: $1.9 trillion - Biden-era fiscal package, described as nearly 10% of GDP, that did not materially alter the Fed’s June 2021 forecasts. Interest rate setting: 0% - The Fed kept rates at zero even as inflation accelerated, leaving the real policy rate increasingly negative. Rate of inflation overshoot: several multiples of the earlier shortfall - Levy argues inflation now exceeds the cumulative undershoot the Fed used to justify FAIT. Unemployment during pandemic shock: nearly 15% - Referenced as the official peak during the COVID collapse before rapid recovery.

Pivotal Quotes: "The Fed's strategic approach to monetary policy needs a reboot." — Mickey Levy / paper title: Core thesis of the paper and the interview. "We need to really step back and use the strategic review period to say, wait a second, let's go back to basic issues of inflation and monetary policy." — Mickey Levy: His central recommendation for the upcoming Fed framework review. "Using forward guidance as an independent monetary policy tool, a little too much hubris there." — Mickey Levy: Critique of the Fed’s reliance on expectations management instead of policy action.

Implications: The Fed may need to abandon FAIT-style asymmetry and rebuild credibility through a simpler, more transparent, and more rules-informed framework that is robust to both low- and high-inflation shocks.