Baby and Bathwater Questions

2025 06 15

Baby and Bathwater Questions

David Beckworth has an informative update “Is the Fate of FAIT Sealed?” concerning the Fed’s development of a new framework for monetary policy a development in which he has been involved:

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“As many of you know, I have been deeply engaged in the ongoing Fed framework review. I have written papers, participated in multiple conferences, commissioned policy briefs, recorded podcasts, written newsletters, and contacted Fed officials about the framework review. Through these efforts I’ve had two main objectives: (1) to urge the FOMC to adopt NGDP [Nominal GDP] as a cross-check on their traditional economic indicators, and (2) to help ensure they don’t throw out the makeup policy baby with the FAIT [Flexible Average Inflation Target] bathwater.”

Of course, it coud be contained in some of those papers, conferences, briefs, podcasts, and newsletters, but this post leaves open the questions:

1) Why NGDP[1] instead of FAIT[2]

2) Exactly what is the baby?

3) Why throw out the bathwater?

Beckworth quotes a 2025 Fed statement:

Participants discussed the advantages and disadvantages of flexible average inflation targeting, under which monetary policy seeks to make up for persistently below-objective inflation to achieve average inflation of 2 percent, and flexible inflation targeting, under which policy seeks to return inflation to 2 percent without making up for previous deviations from target… Participants noted, however, that the strategy of flexible average inflation targeting has diminished benefits in an environment with a substantial risk of large inflationary shocks or when ELB risks are less prominent. Participants indicated that they thought it would be appropriate to reconsider the average inflation—targeting language in the Statement on Longer-Run Goals and Monetary Policy Strategy

That seems totally off base. "Flexible" ought to mean flexible to inflate enough restore full employment and then return to a forward looking 2% path whether this is more or less than enough to restore the Price Level (PL) trajectory.

Instead, Beckworth raises the specter that the statement presages a bare bones AIT, shooting for 2% from any position. “So is this the end of makeup policy at the Fed? It might be tempting to say yes, but at the end of that same paragraph there was a big reveal that suggests otherwise.”

Participants… viewed flexible inflation targeting as a more robust policy strategy capable of correcting persistent deviations of inflation from either side of the Committee's 2 percent longer-run objective.

This alleviates Beckworth’s concern that the new policy woud not allow even “catchup” inflation to restore the former PL trajectory, but deviations "from either side" would still imply that the Fed would sometimes reduce inflation to less than targeted 2% Personal Consumption Expenditure (PCE) index.

How could this be optimal if 2% had been correctly chosen as the minimum inflation needed to allow relative prices to continuously adjust to "Brownian Movement" micro shocks? Why would below-target become desirable in one period just because in some previous period inflation had been greater than 2%? What is the Fed trying to optimize with its inflation management[3]]

Beckworth summarizes, "The inflation target, in short, isn’t purely forward-looking, it retains a shadow of its recent history. That is remarkable!"

Remarkable, but in what kind of model would a “shadow” that called for under-target infation maximize real income growth or anything else?

Beckworth goes on to ask and answer, "So how can the Fed implement a [Flexible Inflation Target] that (1) responds to persistent, demand-driven deviations of inflation from target while ignoring supply shocks and (2) keeps long-term inflation expectations firmly anchored? A straightforward way to achieve this vision is to anchor the FIT regime to a stable growth path of total dollar spending."

Of course. The Fed could adopt a target of a stable a stable growth path of NGDP, but

1) How could such a policy "respond to persistent, demand-driven deviations of inflation from target?” Does that not imply downward deviations in real GDP growth during those periods of “persistent demand driven deviations?”

2) Inflation expectations remained anchored during FAIT with forward looking targeting (TIPS falling substantially below target only briefly). Where is the advantage of NGDP targeting?

The conclusion, “Anchoring FIT to a stable path of total dollar spending offers a coherent way to formalize that spirit without the baggage of overshoot promises," only gathers together the unanswered questions.

What does it even mean to “anchor” a Flexible Inflation Target to an NGDP path? Which is the target?

And what “baggage of overshoot promises?" FAIT certainly _allows_ a period of over-target inflation that moves the PL trajectory above a previous trajectory if that is what is required to restore full employment after a shock. That is what the “F” means and perhaps that is what Beckworth means by "overshoot," but where is the "promise?"

Bonus points question: How does the new framework position the Fed to deal with Trump pressure for lower interest rates NOW and preserve Fed independence?

Will we find out only at Jackson Hole?

Image Prompt: Explorers in pith helmets staring quizzically at a jungle with predators’ eyes staring back at them.

[Standard bleg: Although my style is know-it-all-ism, I am aware that I could be mistaken or overstate my points. I know there is an amazing range of talents and experience among readers. Bring that to bear by commenting on these posts.]

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[1] There is always a Flexible NGDPLT that is isomorphic with FAIT. Is it just that the Fed cannot bring itself to say publicly that sometimes more than just "catch up" inflation is needed to allow full adjustment to economic shocks?

[2] The "A" of "FAIT" can be problematic if interpreted as a backward looking average.

[3] As before, there is always a translation of any inflation targeting statement into an NGDP targeting statement.