Tuesday, February 23, 2021

Fed reiterates plan for make-up inflation

Fed Chairman Powell testified at a hearing today. It was the equivalent of a 6-month check-up on American currency.

Background: The Federal Reserve has twin monetary policy objectives from Congress: full employment, and two percent annual inflation.

While these objectives remain intact, the Fed completed a review of its “monetary policy strategy, tools, and communication practices” last year as “the U.S. economy has changed in ways that matter for monetary policy.” The goal: “maximum employment and price stability.”

After reviewing its strategy and tools, the Federal Open Market Committee made “some key changes.”

Originally announced last year, instead of aiming for an annual inflation rate of 2 percent, the Fed is now seeking to achieve “inflation that averages 2 percent over time.”

Yes, boys and girls, that means if “inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

In other words, once the Fed think the economy is doing better (which it's no longer just characterizing according to jobs reports), then its planning some make-up time on inflation. 

Quick math tip #1: The average of 0 & 4 is 2.

Quick math tip #2: Average speed traveled is not calculated by averaging out speeds, but by averaging out total distance over total time.

It's not directly as if inflation holding at 1 percent for a while would need 3 percent inflation to make up for the lag, or 0 percent to 4 percent. However, it could be close to that since the percentages are relatively small. 

The biggest problem with this is the lack of time scope. For how long would the Fed look back at years with inflation below 2 percent? Japan had decades of stagnation. Could the Fed go that far back in terms of calculating how much additional inflation was needed? For how long into the future would the Fed expect to make up for extended periods of stagnation with accelerated inflation rates in order to achieve “2 percent over time”?

Percentages increases can be more exponential than linear in nature. In other words, once the effect is started, inflation could take on a life of its own that's harder to control.

There's undoubtedly a lot of tinkering to be done with the formulas and economic indicators, but make no mistake about it, the bottom line here is the Fed is giving itself ample room to aim for inflation well above its 2 percent goal for as much as it thinks it should have been able to achieve 2 percent previously.

“We will continue to clearly communicate our assessment of progress toward our goals well in advance of any change in the pace of purchases” on its balance sheet, Powell said.

Full Monetary Policy Report, February 19, 2021

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