Jon Hartley of the Foundation for Research on Equal Opportunity writes about the Fed’s over-reliance on inflation forecasts:
When originally Powell came into the Fed in 2017, he described his approach to monetary policy as “risk management.” While that may sound nice, there’s something deeper to it. It assumes you actually know the risks and their probabilities. Who would have guessed we would be hit with a 100-year pandemic? Who would have guessed that inflation wouldn’t appear until May 2021, quite some time after a year of tame inflation amid significant amounts of fiscal and monetary stimulus? No one can be faulted for not predicting either of these events. What we can do is think about how we want to respond once these things have happened with the acknowledgment that the future will still be difficult to predict.
One insight we do have, however — with lots of empirical evidence — is that inflation does fall conditional on monetary policy tightening. Policy-makers can rely on today’s data and use them in their monetary-policy reaction function to appropriately weigh the risks of inducing unemployment from monetary-policy tightening and the risks of inflation rising further if we don’t tighten. Had it simply been following today’s data as the best forecast of data in the next period, the Fed might not be so behind the curve on inflation right now.
Read the whole thing here.