The Federal Reserve Needs a Hard Look in the Mirror

The Fed’s Statement on Longer-Run Goals and Monetary Policy Strategy, published in 2012, established a balanced approach to its dual mandate of price stability and maximum employment. It set a target of 2% inflation but made clear that a numeric employment target is inappropriate because labor-market conditions are determined by factors beyond the scope of monetary policy. Each January, until 2020, the Fed reaffirmed this strategy.

The Fed’s 2020 strategic plan was misguided. It was heavily influenced by fears that the effective lower-bound interest rate was dragging down inflation expectations and that rates could fall to zero, creating challenges for monetary policy. Few within the Fed questioned the presumption that low inflation was harming economic performance and would persist.

This led the Fed to adopt an overly complex and unworkable new scheme of flexible average inflation targeting that favored higher inflation and prioritized an enhanced mandate of maximizing “inclusive” employment. The approach eschewed pre-emptive monetary tightening when higher inflation appeared imminent, which seems at odds with the Fed’s goal of managing inflationary expectations.

The new 2020 framework was a sharp departure from the 2012 statement and the practices with which the Fed had succeeded in the past. Lost was

Paul Volcker

and

Alan Greenspan’s

fundamental theme that price stability is the most important contribution monetary policy can make for sustained economic growth and job creation. The benefits of the Fed’s balanced approach were cast aside for asymmetries and greater reliance on the Fed’s discretion and judgment.

Things began to unravel even quicker than we had anticipated following our early published critique of the plan. As inflation soared, the Fed kept interest…