The Fed’s Open Secret

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At the annual Jackson Hole Symposium in August, Fed Chair Jerome Powell announced the outcome of the Fed’s multi-year monetary policy framework review. The Fed intends to adopt a “flexible form of average inflation targeting” (or FAIT) that (1) considers only “shortfalls” of employment rather than “deviations” to the upside and downside, and (2) seeks to achieve inflation that averages 2% over time, specifically by tolerating moderate above-target inflation to compensate for periods of undershoot. Powell’s announcement heralded an apparently significant shift from the Fed’s prior “balanced approach” framework, where its reaction function responded symmetrically with respect to the labor market and its inflation target was fixed at 2%, irrespective of the recent past, as described by then-Fed Chair Ben Bernanke in 2012.

Markets reacted with a sharp rise in long-term interest rates, higher market-implied long-term inflation rates, and a steeper yield curve. These moves subsequently reversed, for the large part, in the weeks following the announcement, reflecting a fundamental truth about the Fed’s framework review: as we explain below, we believe the much ballyhooed framework shift simply acknowledges what has been the Fed’s actual policy since at least 2006.

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