Monetary Strategies in Practice
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The document discusses the reassessment of monetary policy strategies in light of the challenges posed by consistently low inflation and the potential for hitting the effective lower bound (ELB) in the future. It evaluates three alternative strategies for achieving target inflation—nominal income targeting, price-level targeting, and average-inflation targeting—highlighting the importance of credibility and effective communication. The conclusion suggests that while average-inflation targeting could be a viable option, significant analysis and debate are required before any change is implemented.
Monetary Strategies in Practice
- 1. Monetary Strategies in Practice 2019 Hoover Monetary Policy Conference May 3, 2019 Mary C. Daly President and CEO The views expressed here are mine alone and do not necessarily reflect those of anyone else in the Federal Reserve System.
- 2. 2 • Good practice to reassess our strategies, tools and communications (Bank of Canada does this regularly) • More likely to hit effective lower bound in the future • Frequently will be fighting inflation from below target • Inflation expectations matter Why Review Our Framework?
- 3. More Limited Space for Funds Rate Cuts 3
- 4. 4 Inflation Consistently Short of 2% Target
- 5. 5 Inflation Expectations Matter More Now Note: Specification uses headline CPI inflation. One-year ahead inflation expectations from the Survey of Professional Forecasters. Source: Jordà, Marti, Nechio, and Tallman (FRBSF Economic Letter, 2019). Coefficient on Lagged Inflation and Inflation Expectations
- 6. 6 Three viable alternative strategies at the ELB • Nominal income targeting • Price-level targeting • Average-inflation targeting Achieving Target Inflation in the Future
- 7. All Designed to “Make Up” For Misses 7 Symmetric Inflation Targeting Average Inflation targeting Period 1 1.5 2 2.5 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Inflation% 1 1.5 2 2.5 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 %
- 8. 8Period 1 1.5 2 2.5 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Inflation% 1 1.5 2 2.5 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 % Symmetric Inflation Targeting Average Inflation targeting All Designed to “Make Up” For Misses
- 9. 9 • Good make-up properties • Easier to communicate than NIT or PLT • But important questions remain: • Is the required averaging window of “reasonable” length? • Is AIT effective if expectations are backward looking? • Does AIT work well if some households do not participate in financial markets? • Would AIT be credible? • Should it be a temporary policy at the ELB? Focus on Average Inflation Targeting
- 10. 10 • New Keynesian economy (Amano, Gnocchi, Leduc) • 20% of households with no access to financial markets • 75% of firms with backward-looking expectations • ELB binds 20% of the time • CB minimizes inflation and output gaps using rule: 𝑖 𝑡 = 𝑟𝑡 + 𝜙 1 𝑛 𝑘=0 𝑛 𝜋 𝑡−𝑘 − 𝜋 • With 𝜙=1.5, n=6 quarters A Framework to Assess AIT
- 11. 11 Evaluating Monetary Frameworks Amano, Gnocchi, and Leduc (2019)
- 12. 12 Amano, Gnocchi, and Leduc (2019) Evaluating Monetary Frameworks
- 13. 13 Amano, Gnocchi, and Leduc (2019) Evaluating Monetary Frameworks
- 14. 14 • Credibility is critical • Need to adopt regime before ELB episodes • Implies a willingness to disinflate if necessary Credibility: Make-up Work Both Ways Make-up 1 1.5 2 2.5 3 1 2 3 4 5 Inflation%
- 15. 15 Credibility of IT Regime Achieved Over Time
- 16. 16 • With Fed objectives met, good time to review framework • AIT is an attractive option, but credibility would be key • Still, bar for change is high • A lot of analysis, discussion, and debate is still needed Summary