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I’ve had very low expectations for the Fed’s upcoming review of its operating regime. I had thought that the previous review (back in 2020) had hit the nail on the head, until I learned that “average inflation targeting” had nothing to do with stabilizing the average inflation rate. A new paper by Federal Reserve economist Michael T. Kiley suggests they may be about to fix the “asymmetry” problem with FAIT. Here’s the abstract:

I assess monetary policy strategies to foster price stability and labor market strength. The assessment incorporates a range of challenges, including uncertainty regarding the equilibrium real interest rate, mismeasurement of economic potential, and balancing the costs and benefits associated with employment shortfalls and labor market strength. I find that the ELB remains a significant constraint, hindering achievement of the inflation objective and worsening employment shortfalls. Symmetric policy reaction functions mitigate the most adverse effects of employment shortfalls by contributing to economic stability. Make-up strategies address ELB risks. These strategies call for policy to accommodate some period of inflation above its long-run objective following an ELB episode. I also consider an asymmetric shortfalls approach to policy. This approach provides accommodation in response to weak activity while foregoing tightening in response to strong activity. While the approach can, in principle, address ELB risks by raising inflation, it performs poorly. The shortfalls approach exacerbates economic volatility, worsens employment shortfalls, and creates excess inflationary pressures. Mismeasurement is not sufficient to limit the importance of strong responses to measured slack. Overall, monetary policy can promote price stability and labor market strength by focusing on economic stability, with a strategy targeted to address ELB risks.

The Fed’s big mistake in 2020 was adopting an asymmetric policy approach, which involved make-up policies for undershoots but not overheating. Policy must be symmetric.

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