Roberto Perli on Average Inflation Targeting and Improving the Fed's Framework

Episode Summary

Executive Summary: Roberto Perli argues the Fed’s new average inflation targeting framework is a meaningful shift toward makeup policy and a more labor-market-friendly stance, but its ambiguity is intentional and useful for coalition-building. He sees the policy as a soft form of temporary price-level targeting aimed at lifting inflation expectations, raising nominal neutral rates, and reducing premature tightening, while warning that low rates still reflect deeper structural forces and may pose financial-stability and communication challenges.

Main Topics: Fed’s New Average Inflation Targeting Framework (Priority: 5/5): Discussion of how the Fed’s 2020 framework differs from prior policy: it now seeks inflation moderately above 2% for some time after persistent misses, while prioritizing maximum employment and accepting overshoots. Makeup Policy and the Zero Lower Bound (Priority: 5/5): Perli explains the framework as a response to long-running inflation undershoots that keep inflation expectations and nominal neutral rates too low, increasing the risk of hitting the zero lower bound. Ambiguity, Committee Management, and Communication (Priority: 4/5): The vague terms—'moderately above 2%,' 'for some time,' and the averaging window—are presented as a feature for flexibility and consensus, though they create confusion for markets and the public. Temporary Price-Level Targeting Analogy (Priority: 4/5): Perli argues the framework is effectively a watered-down, politically easier version of temporary price-level targeting, allowing the Fed to promise makeup policy without explicitly adopting price-level targeting. Policy Tools and Fed Independence (Priority: 4/5): The conversation covers forward guidance, asset purchases, yield curve control, emergency facilities, and the limits of the Fed’s legal authority, alongside concerns about greater cooperation with fiscal authorities and independence. Market Misperceptions and Rate Expectations (Priority: 4/5): Perli says many investors still expect hikes earlier than the Fed projects, and he stresses that while policy may be less effective on the real economy, it still strongly moves markets. Long-Run Rates, Fundamentals, and Financial Stability (Priority: 5/5): He argues long-term real rates are set by savings-investment fundamentals, not central-bank fiat, and that low-rate policies can contribute to asset-price distortions and financial-stability risks via a perceived Fed put.

Key Arguments: The Fed’s new framework is primarily a makeup-policy response to years of inflation running below 2%, meant to lift inflation expectations and move the nominal neutral rate away from zero. A second major change is the shift from focusing on deviations from the natural rate of unemployment to shortfalls from maximum employment, which should reduce preemptive tightening and allow labor markets to run hotter. The framework’s vagueness is partly intentional: it helps the Fed preserve flexibility and secure committee agreement, even if it reduces clarity for markets. Average inflation targeting functions like a temporary price-level target in practice, even if the Fed frames it as continuing inflation targeting for political and communication reasons. Perli expects the Fed to rely on forward guidance, asset purchases, and possibly yield curve control rather than rate cuts, because policy rates are already low and transmission is weaker than in the past. The Fed cannot sustainably set long-term rates against market fundamentals; neutral rates are driven by savings-investment balance, demographics, productivity, and inflation expectations. Low rates themselves are not the main financial-stability concern; the bigger risk is the market interpretation that the Fed will backstop risky assets, encouraging excess risk-taking. If the Fed fails to raise inflation despite the new framework, or if it later has to justify 4% inflation to the public, credibility problems could intensify.

Data Points: Core PCE inflation undershoot: below 2% almost constantly since 2008 - Used to illustrate the persistent inflation shortfall motivating the new framework. FOMC dissents: 2 dissents - Perli cites dissents as evidence that even vague language required significant committee compromise. Client survey expecting hikes: 47% had rate hikes in 2023 or earlier - Perli cites Cornerstone Macro survey results showing market participants still expect earlier tightening than the Fed signals. Fed’s forecast horizon: no overshooting through 2023 - He interprets the SEP as implying no inflation overshoot for several years, delaying hikes. Potential overshooting window: at least 1 year - Perli says a serious makeup period would likely need at least a year above 2% to matter. Earliest hike under his interpretation: 2025 - Based on no overshoot until 2023 and then at least a year above target. Fed review duration: almost 2 years - He notes the framework was deliberated from October 2018 to Jackson Hole 2020. Temporary emergency lending facilities: 13(3) facilities - Perli references the Fed’s crisis-only legal authority for emergency lending outside normal operations. March 23 market turning point: March 23rd - He says the S&P 500 bottomed and corporate spreads peaked when the Fed signaled broad support. World War II yield peg example: 3/8% on T-bills and about 2% on the 10-year - Historical example used to show how pegging rates can force massive balance-sheet expansion.

Pivotal Quotes: "We want to achieve moderately above 2% for some time so that average inflation 2% over time and longer term inflation expectations remain well anchored at 2%." — David Beckworth reading the FOMC statement: The statement’s key but undefined parameters are used to frame the ambiguity of average inflation targeting. "The job of the central bank is to manage the deck of cards that they have been handled." — Roberto Perli: He explains that long-term rates and macro constraints are driven by underlying fundamentals, not central-bank preference. "It is not the Fed keeping them there. It’s the economy." — Roberto Perli: His answer to concerns that low rates themselves are a discretionary Fed choice rather than a reflection of structural forces.

Implications: The Fed’s new regime may keep rates low for longer, boost the odds of a hotter labor market, and raise market sensitivity to Fed communication. But its success depends on credibility, clearer implementation, and avoiding new financial-stability distortions.