In recent years, inflation soared beyond expectations, shocking both the Federal Reserve and the market forecasts. However, simply blaming external factors is not a valid excuse. Let’s delve into a comparison of inflation targeting and price level targeting to understand the implications of these discrepancies.
- The Ideal Scenario:
- Assuming a 2% inflation target, the Fed aims for a 0.5% quarterly price level increase.
- Hypothetically, the price level would ideally rise as follows over two years:
100, 100.5, 101, 101.5, 102, 102.5, 103, 103.5, 104
- Inflation Targeting Flaws:
- If the Fed consistently underestimated inflation by 1% per quarter, the price level would deviate significantly from the target.
- The resulting price level path under inflation targeting would look like this:
100, 101.5, 103, 104.5, 106, 107.5, 109, 110.5, 112 - This approach leads to a drastic 6% annual inflation rate, far exceeding the desired 2%.
- Price Level Targeting Benefits:
- Under price level targeting, despite the same 1% underestimation per quarter, the price level path remains closer to the ideal scenario.
- The price level would progress like this, emphasizing stability:
100, 101.5, 102, 102.5, 103, 103.5, 104, 104.5, 105 - This strategy averages a modest 2.5% annual inflation rate, significantly lower than the inflation targeting approach.
The reality painted a different picture. Despite promises of average inflation targeting, the Fed failed to align its actions with its public declarations. Neither supply chain disruptions nor geopolitical crises can justify the excessive inflation experienced. Neglecting the missed market forecasts, a more disciplined policy approach could have limited the overshooting effects.
In conclusion, the Fed’s policy stance failed to uphold its professed regime, leading to a significant inflation overshoot. Moving forward, it is crucial to reevaluate the effectiveness of monetary policies and ensure alignment with stated objectives. Only with a balanced and strategic approach can stability and economic growth be sustained in the long term.
