Scott Sumner  

Don't change the forecast; change the policy

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Today the Fed abandoned its previous forecast, which called for 2% inflation in 2018. Now they forecast that inflation will run below 2% in 2018, as it has for most of the past decade.

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I agree that it is likely that inflation will run below 2% in 2018. Nonetheless, I believe the Fed made a mistake by forecasting sub-2% inflation in 2018. Instead, the Fed should have changed its policy, so that it could continue to forecast inflation at 2% in 2018. This is what Lars Svensson means by "targeting the forecast."

The Fed is like a ship captain that intends the ship to arrive in New York, forecasts the ship will arrive in Boston, and then refuses to turn the steering wheel enough to equate the geographic goal with the geographic forecast.


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COMMENTS (10 to date)
Thaomas writes:

Of course if this happened to an actual ship captain over and over again, we might come to believe that he never intended to reach New Your at all. Or he sort of intended to but had an aversion to ever turning the wheel toward more than 2 degrees South of East.

Where are the political scientists to explain FED behavior?

bill writes:

but, but, but... we have to normalize! [sarcasm]
It's like they work for a private consulting firm and forget that they control the levers.

Kevin Erdmann writes:

Inflation has been trending down, and if my calculations on my phone just now are right, core pci inflation would need to average 3% for the last 5 months of 2017 to hit the new lower forecast they just released for the full year. I'd say it's better than 50/50 odds that 2017 pci inflation misses their forecast and they still raise rates in December.

Kevin Erdmann writes:

Oops. That's what I get for trying to do math on my phone. It would take 3% annualized inflation over the last 5 months of the year in order for 2017 inflation to be 2%. It would only take 1.7% to hit their 1.5% target.

Rajat writes:

I would like to register a 'like' for all three previous comments!

Michael Byrnes writes:

Have you read this fascinating argument from George Selgin?

https://www.alt-m.org/2017/09/19/the-two-per-cent-solution/

BC writes:

I think Yellen says that the Fed has a 2% inflation target "over the medium term". Is "medium term" 2018 or 2019 and beyond? Maybe, the Fed thinks that if they adjust policy to expect 2% instead of 1.9% in 2018, then their expectation in 2019 and beyond would exceed 2%. There is a graph on the page after the table that shows projected PCE inflation. The projected range in 2019 does seem symmetrically centered around 2.0.

I also heard Yellen say yesterday that monetary policy works with lags. Maybe, the Fed thinks it's too late to appreciably change 2018 inflation. The Fed also often mentions "transitory factors" that affect inflation in the short term.

I think the Fed views itself as having originally set a course for Boston and being knocked off course towards New York by transitory currents. Now, it is trying to reset a course towards Boston, but it takes time (until 2019) for the ship to turn. The Fed may also not want to oversteer because it doesn't know what transitory currents are affecting the ship's turning right now.

BC writes:

One criticism I do have is that the Fed keeps saying they don't want to "fall behind the curve" on inflation because that would cause them to raise rates sharply, which in turn might cause a recession. They seem to be admitting an asymmetric approach to their inflation targeting: once they overshoot on inflation ("fall behind the curve"), they will look to correct that very aggressively by raising rates sharply, so aggressively that they might cause a recession. They don't assume that they will try to gradually steer back to 2% from above in the way they try to gradually steer back to 2% from below.

If the market expects the Fed to counter future inflationary forces aggressively but deflationary forces cautiously, then I would think that would lower the natural rate of interest. On balance, the market would perceive greater deflation risk than inflation risk.

Brian Donohue writes:

Good post, good comments. Selgin describes a framework that Scott has hinted at- the relationship between IOER and the Fed balance sheet. This is where the monetary policy conversation needs to move.

Instead, the Fed keeps going through the same motions of saying they're targeting 2% and falling short.

Question: cui bono? Who are the big winners from sustained sub 2% inflation?

Scott Sumner writes:

BC, That might be a plausible defense if the Fed hadn't repeatedly missed the target.

Michael, Thanks, I agree with George on IOER.

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