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Why Yes, The FOMC Would Like Some Inflation Overshoot Now

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by: David Beckworth

The Fed claims it has a symmetric inflation target. From its 2017 and 2018 Statements on Longer Run Goals and Monetary Policy, the FOMC states:

The Committee reaffirms its judgment that inflation at the rate of 2 percent... is most consistent over the longer run with the Federal Reserve's statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored...

Numerous Fed officials have repeated this point as well. They too see the inflation target as a symmetric one, an understanding that allows for an occasional inflation overshoot. Despite these claims, however, the Fed has persistently undershot its inflation target. If one acknowledges the Fed implicitly targeted 2 percent long before the explicit target was adopted in 2012, then the undershooting has lasted for almost a decade. This is not a pretty picture.

Many observers, including myself, have taken this as evidence that the Fed's 2 percent target is more of a ceiling and not symmetric. This understanding has been borne out by the FOMC's own Summary of Economic Projections (SEP) forecasts for core PCE. Recall the definition of the SEP:

Each participant's projections are based on his or her assessment of appropriate monetary policy.

So the SEP reveals FOMC members' forecasts conditional on the Fed doing monetary policy right. And for the longest time, doing monetary policy right was not overshooting 2 percent inflation in the next year, as seen in the figure below. It is hard to square these revealed preferences from the SEP with a symmetric inflation target. This is a point Narayana Kocherlakota has made many times and has been a source of frustration for many Fed watchers. Ryan Avent of The Economist, for example, has been asking the Fed for years to "try overshooting for once."

Well, ask no more. FOMC members in the March FOMC meeting decided it was time to give inflation overshooting a try. They did not say so explicitly, but did so implicitly via the SEP. For the first time since 2009, the SEP's central tendency forecast for core PCE inflation in the next year breached 2 percent. Specifically, this central tendency forecast for 2019 ranged from 2.0 to 2.2 percent. Yes, this is not far above 2 percent, but it is progress and it is an inflation overshoot.

The FOMC minutes for the March meeting also hinted at this new tolerance for an inflation overshoot:

A few participants suggested that a modest inflation overshoot might help push up longer-term inflation expectations and anchor them at a level consistent with the Committee's 2 percent inflation objective.

Maybe all complaining about the lack of an inflation overshoot has finally come to fruition. If so, the irony is that this overshoot, just like Trump's expansionary fiscal policy, is probably coming several years too late. The inflation overshoot would have been much better in the 2009-2011 period. But as seen in the above figure, the FOMC in its infinite wisdom thought inflation should be closer to 1 percent during that time. FOMC officials, accordingly, seem to be calling for procyclical inflation according to the SEPs. This is not the way to do monetary policy.

If only there were a monetary policy framework that avoided these timing problems by making inflation more countercyclical. Yes, it is so unfortunate that no one has come up with a monetary policy approach that would cause inflation to rise during recessions and fall during booms. Oh wait, there is such a policy.