Will the Fed's Inflation Target Change?

Currently, the Federal Reserve changing its 2% inflation target seems unlikely. However, with changes in the composition of the Fed's Board of Governors and the expiration of Fed Chairman Powell's term next May, will discussions about "alternatives to the 2% fixed inflation target" gradually heat up? The market expects Friday's data to show that US inflation has exceeded the Fed's 2% target for the 54th consecutive month. Even taking into account all recent shocks and the flexibility built into the Fed's post-pandemic era inflation framework, it is still rare for a central bank to fail to achieve its target for such a long time.

US Inflation Indicators

Moreover, inflation is unlikely to return to 2% in the coming months (or even years). The median forecasts of Fed officials show that overall Personal Consumption Expenditures (PCE) inflation and core PCE inflation are not expected to return to 2% until 2028. Even this timeline may be difficult to achieve. The Fed has a dual mandate of "full employment and price stability," and rising risks on the employment front have prompted it to restart its rate-cutting cycle. However, current financial conditions are the most accommodative in many years, and economic growth is still maintaining a solid pace. Therefore, current rate cuts may further exacerbate price pressures. The Fed's failure to achieve its inflation target is not new, but the longer inflation stays above the target, the more likely the public's trust in "the inflation target itself" and "the Fed's overall policymaking" is to be damaged. This may prompt the Fed to completely re-examine the inflation target.

The Possibility of Adopting an "Inflation Range"

For a target that has "not been achieved monthly for more than four consecutive years," choosing to change it (which is essentially a "temporary rule adjustment") is certainly not a glorious thing. That being said, "policy probing" is best done as early as possible. One potential alternative to the current inflation target is an "inflation range," which some Fed officials have recently expressed approval of, most notably Atlanta Fed President Bostic. This week, Bostic stated in an interview with David Beckworth, a senior research fellow at George Mason University, on the "Macro Musings" podcast that he is open to adopting an "inflation range" in the future. "Sometimes there is a kind of 'illusion of precision,' as if we can control inflation to three decimal places, but I don't think that's realistic," Bostic said. "In the current environment, with inflation in the range of 2.4%, 2.6%, and 2.8%, people ask 'is this considered achieving the 2% target?' For me, the answer is no. I imagine the range would be narrower, but this type of discussion is valuable." He added that a range of 1.75% to 2.25% would be a good starting point. A significant advantage of an "inflation range" is that it provides policymakers with greater flexibility compared to a specific numerical target. This means that even if inflation is above 2%, as long as it is within the range, the Fed is technically not violating its publicly stated target. The wider the range, the greater the policy freedom; but on the other hand, if inflation momentum gets out of control, pressure may quickly accumulate, forcing the Fed to take overly forceful and uncomfortable policy measures.

The Process of Achieving the Inflation Target is "More Vague and More Prolonged"

Although an "inflation range" is more common in emerging markets with high economic volatility, monetary authorities in developed economies such as Canada, Australia, and New Zealand are also using this model. However, central banks still seem to prefer a "more precise inflation target" rather than a "range." At least, the Bank for International Settlements (BIS) reached this conclusion in a recent study - which covered 26 central banks that have implemented some form of "inflation targeting" since 1990. But the BIS also found that over time, the "allowed time range" for central banks to achieve "these more rigid targets" has become "more vague and more prolonged." The second half of this conclusion clearly applies to the Fed - which has taken four and a half years so far, and is still being extended. If Fed officials believe it will take another three years for inflation to return to the target, consumer expectations are even more pessimistic. The latest consumer survey from the University of Michigan shows that respondents expect one-year inflation to be 4.8% and five-year inflation to be 3.9%. Given the obvious vulnerabilities in the labor market, these expectations may be excessive, but the Fed will not be satisfied with such high values, because "unanchored inflation expectations" may trigger a "wage-price spiral." In the economic field, at least, the market prefers "gradual change." Therefore, compared to suddenly raising the inflation target in the future, adopting an "inflation range" (which the Fed has already done to some extent) may attract more officials to join Bostic's ranks and push this discussion together. The above content comes from Jamie McGeever, a well-known analyst at Reuters, who mainly focuses on global economic and financial market dynamics, especially in the field of US economic policy, monetary policy, and financial market volatility where he has published many analytical reports.