Will The Fed Unveil A New Monetary Policy Today?

The bigger issue is what AIT means for the economy? “The Fed is in a position where they see the recovery is losing momentum at a time when the economy is in a deep hole, and that is worrisome,” says Diane Swonk, chief economist at auditing firm Grant Thornton.

AIT may not be a silver bullet, but it will help, say economists at the Federal Reserve Bank of San Francisco. Average inflation targeting, they write this month, is “a monetary policy framework that is well suited for the current environment.”

Explaining the need to reframe the policy focus, they advise that conventional monetary policy tools “face challenges in a low interest rate environment. While unconventional tools such as forward guidance and asset purchases are available to address these challenges, changes in the fundamental monetary policy framework may help in fulfilling the Federal Reserve’s mandate in prevailing economic conditions.”

Maybe, but skeptics are wondering how high a band will the Fed permit for overshooting its inflation target – and for how long? Ed Yardeni of Yardeni Research recently speculated that the “the Fed publicly would welcome inflation in a range of 2% up to 4% as a long overdue offset to inflation running below 2% for so long in the past.”

The crowd’s assessment, so far, is mostly a yawn. The 10-year Treasury yield, for example, has remained in a tight 0.5%-to-0.7% range since June. The 2-year yield, which is widely monitored as a benchmark for policy expectations, has also been flat-lining for several months, fluctuating between 0.1% and 0.2% recently.

Note, however, that the Treasury market’s implied inflation forecast continues to rise from the pandemic’s low. The yield spread for the nominal less inflation-indexed 5-year maturities rose to 1.63% yesterday (Aug. 26). The current level marks a return to the pre-pandemic levels. The question is whether the bounce over the past several months will continue?

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