Episode Summary
Executive Summary: This episode examines the Fed’s 2020 Flexible Average Inflation Targeting (FAIT) framework, why it caused confusion, and how it might be “salvaged” rather than scrapped. The guests argue FAIT is asymmetric and discretionary, and propose a symmetric version aligned with nominal GDP level targeting (FAITE-N) as a clearer, more credible medium-run framework.
Main Topics: What FAIT is and why it was adopted (Priority: 5/5): The Fed adopted flexible average inflation targeting in August 2020 to address persistent below-2% inflation, low rates, and repeated effective lower bound constraints that limited conventional policy space. Asymmetry in the FAIT framework (Priority: 5/5): The discussion highlights two asymmetries: making up only for inflation undershoots, not overshoots, and the employment objective focusing on shortfalls from maximum employment rather than deviations on both sides. FAIT vs. temporary price-level targeting (Priority: 4/5): The guests compare FAIT to temporary price-level targeting, noting they are similar make-up strategies, but FAIT preserves inflation-targeting branding and is less clearly defined. Forward-looking vs. backward-looking policy (Priority: 4/5): They debate whether FAIT makes the Fed more outcome-based and less forecast-based, noting Fed statements initially emphasized waiting for realized inflation before easing policy. Why FAIT needs salvaging (Priority: 5/5): FAIT is seen as confusing and overly discretionary, yet valuable because make-up policy and supply-shock tolerance are defensible principles worth preserving. Nominal GDP level targeting as a replacement/salvage path (Priority: 5/5): The paper proposes FAITE-N: a symmetric make-up framework anchored in nominal GDP level targeting, intended to stabilize aggregate spending while supporting medium-run inflation stability. Implementation, rules, and future framework review (Priority: 4/5): The conversation discusses how the Fed could implement a clearer rule-based framework, whether through published Taylor-style rules, gradual updates, or a future framework review in 2024–2025.
Key Arguments: FAIT was designed to offset persistent undershoots of 2% inflation and raise nominal rates enough to create more policy room at the effective lower bound. The framework is asymmetric because it makes up for inflation misses only from below, not from above, and also emphasizes employment shortfalls rather than deviations on both sides. The Fed’s own statements created confusion because its older framework emphasized symmetric inflation deviations, while the new framework’s makeup logic sounded symmetric to many observers even though it was not. A flexible inflation-targeting regime is valuable mainly because it lets policymakers look through temporary supply shocks, especially in advanced economies with anchored expectations. FAIT creates more discretion because the Fed must decide how much makeup is enough and over what horizon, with no strict average window. Nominal GDP level targeting can preserve the useful parts of FAIT—make-up policy and supply-shock flexibility—while being more symmetric and coherent. If medium-run nominal spending is stabilized, inflation can remain consistent with price stability over time, even if the real growth trend shifts. Publishing a clearer operational rule would reduce confusion and improve credibility relative to ad hoc discretion. A positive supply shock can lower inflation and output; under a true make-up framework, the Fed would still need to offset undershoots, which is one reason NGDP targeting is attractive. The next framework review is an opportunity to formalize a more transparent and credible rule without openly abandoning inflation targeting. Changing the target inflation rate higher (e.g., 3% or 4%) is seen as politically riskier and less credible than reforming the framework itself.
Data Points: FAIT adoption date: August 2020 - The Fed introduced flexible average inflation targeting during its framework review. Inflation objective: 2% - The Fed’s target level discussed throughout the episode, both before and after FAIT. Framework review period: 2019–2020 - The Fed reviewed its strategy leading up to adopting FAIT. Updated statement wording: "shortfalls" of employment - The post-2020 statement says the Fed seeks to mitigate shortfalls from maximum employment, implying asymmetry. Conditions for ending make-up policy: September 2020 to November 2021 - FOMC statements said inflation must rise to 2% and moderately exceed 2% for some time before normalization ends. Next framework review: 2024–2025 - The guests refer to the forthcoming review as the next opportunity to revise the framework. Headline inflation concern: above 10% - Eurozone inflation was described as exceeding 10% at the time of recording, used as a supply-shock credibility example. Alternative target proposal: 3%–4% inflation - Discussed as a possible but politically risky alternative to reforming the framework.
Pivotal Quotes: "The committee seeks over time to mitigate shortfalls of employment from the committee's assessment of its maximum level." — Patrick Haran: Used to show the asymmetry in the Fed’s updated employment objective. "We need to see the white of the eyes of inflation." — FOMC (as described by the speakers): Cited as the Fed’s initial post-FAIT stance that it should wait for actual inflation before tightening or normalizing. "A commitment to a nominal GDP level path is completely consistent with a commitment to a medium-term inflation target." — Michael Woodford (quoted by Patrick/David): Used to support the case that nominal GDP level targeting can preserve inflation-targeting goals.
Implications: The episode argues the Fed should move toward a clearer, more symmetric make-up regime—ideally NGDP-level targeting—before the next framework review. Doing so could improve credibility, reduce discretion, and better handle supply shocks.
About Macro Musings
Hosted by David Beckworth of the Mercatus Center, Macro Musings pulls back the curtain on the important macroeconomic issues of the past, present, and future.